-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V7K7I02qml93JGgS9z8Yy34IAFnrdSuWlMhUifDjiBVY+HhmhPQg2agfs6y+XUMA lo19pyaJim54PW5oh/f40Q== 0001047469-98-009074.txt : 19980310 0001047469-98-009074.hdr.sgml : 19980310 ACCESSION NUMBER: 0001047469-98-009074 CONFORMED SUBMISSION TYPE: S-4/A PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 19980309 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TELEPHONE & DATA SYSTEMS INC /DE/ CENTRAL INDEX KEY: 0001051512 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4/A SEC ACT: SEC FILE NUMBER: 333-42535 FILM NUMBER: 98560248 BUSINESS ADDRESS: STREET 1: 30 NORTH LASALLE STREET STREET 2: 8401 GREENWAY BLVD CITY: CHICAGO STATE: IL ZIP: 60602 BUSINESS PHONE: 3126301900 MAIL ADDRESS: STREET 1: 30 NORTH LASALLE STREET STREET 2: 8401 GREENWAY BLVD CITY: CHICAGO STATE: IL ZIP: 60602 S-4/A 1 S-4/A #2 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 9, 1998 REGISTRATION NO. 333-42535 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------------------- AMENDMENT NO. 2 TO FORM S-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ---------------------------------- TELEPHONE AND DATA SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 6749 APPLIED FOR (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of Classification Code Number) Identification incorporation or organization) Number)
30 NORTH LASALLE STREET CHICAGO, ILLINOIS 60602 (312) 630-1900 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ---------------------------------- LEROY T. CARLSON, CHAIRMAN WITH A COPY TO: TELEPHONE AND DATA SYSTEMS, INC. WILBUR C. DELP, JR., SIDLEY & AUSTIN 30 NORTH LASALLE STREET ONE FIRST NATIONAL PLAZA CHICAGO, ILLINOIS 60602 CHICAGO, ILLINOIS 60603 (312) 630-1900 (312) 853-7000 (Names, addresses, including zip codes, and telephone numbers, including area code, of agents for service) ---------------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER APPROVAL BY SHAREHOLDERS. ---------------------------------- If the securities being registered on this form are to be offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. / / ---------------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT(2) OFFERING PRICE(2) Preferred Shares................................... 326,664 shares (1) N.A. (2) N.A. (2) Series A Common Shares............................. 6,933,233 shares (1) N.A. (2) N.A. (2) Common Shares...................................... 53,878,129 shares (1) N.A. (2) N.A. (2) TDS Telecommunications Group Common Shares......... 40,540,908 shares (3) N.A. (2) N.A. (2) United States Cellular Group Common Shares......... 60,811,362 shares (3) N.A. (2) N.A. (2) Aerial Communications Group Common Shares.......... 40,540,908 shares (3) N.A. (2) N.A. (2) TITLE OF EACH CLASS OF AMOUNT OF SECURITIES TO BE REGISTERED REGISTRATION FEE Preferred Shares................................... $0 (2) Series A Common Shares............................. $0 (2) Common Shares...................................... $0 (2) TDS Telecommunications Group Common Shares......... $0 (2) United States Cellular Group Common Shares......... $0 (2) Aerial Communications Group Common Shares.......... $0 (2)
(1) If the Tracking Stock Proposal described herein is approved by the shareholders and the reincorporation merger of Telephone and Data Systems, Inc., an Iowa corporation ("TDS Iowa"), with and into Telephone and Data Systems, Inc., a Delaware corporation ("TDS Delaware"), becomes effective: (i) each Preferred Share, no par value ("Existing Preferred Stock"), of TDS Iowa outstanding at the effective time of the merger will be converted into one Preferred Share, par value $0.01 per share of TDS Delaware ("New Preferred Stock"); (ii) each Common Share, par value $1.00 per share ("Existing Common Stock"), of TDS Iowa outstanding at the effective time of the merger will be converted into one Common Share, par value $0.01 per share, of TDS Delaware ("New Common Stock"); and (iii) each Series A Common Share, par value $1.00 per share ("Existing Series A Common Stock"), of TDS Iowa outstanding at the effective time of the merger will be converted into one Series A Common Share, par value $0.01 per share, of TDS Delaware ("New Series A Common Stock"). The amount of New Preferred Stock being registered is based on 326,664 shares of Existing Preferred Stock issued and issuable at November 30, 1997. The amount of New Series A Common Stock being registered is based on 6,933,233 shares of Existing Series A Common Stock issued and outstanding at November 30, 1997. The amount of New Common Stock being registered is based on 53,878,129 shares of Existing Common Stock issued and outstanding at November 30, 1997. In addition, there is being registered hereby such additional shares of New Preferred Stock, New Series A Common Stock and New Common Stock as may be required due to changes in the number of shares of Existing Preferred Stock, Existing Series A Stock and Existing Common Stock between November 30, 1997 and the effectiveness of the Tracking Stock Proposal. (2) The shares will be issued to shareholders without consideration. Accordingly, pursuant to Section 6(b) of the Securities Act of 1933, as amended, there is no registration fee. (3) If the Tracking Stock Proposal described herein is approved by the shareholders of TDS Iowa, TDS Delaware expects to distribute two-thirds of one TDS Telecommunications Group Common Share of the Company, par value $0.01 per share ("Telecom Group Shares"), one United States Cellular Group Common Share of the Company, par value $0.01 per share ("Cellular Group Shares") and two-thirds of one Aerial Communications Group Common Share, par value $0.01 per share ("Aerial Group Shares"), per share of New Series A Common Stock and per share of New Common Stock (the "Distribution"). The amount of Telecom Group Shares, Cellular Group Shares and Aerial Group Shares being registered is based on 60,811,362 shares of Existing Series A Common Stock and Existing Common Stock issued and outstanding at November 30, 1997 which, pursuant to the Merger Agreement, will be converted into an equivalent number of shares New Series A Common Stock and New Common Stock. In addition, there is being registered hereby such additional number of Telecom Group Shares, Cellular Group Shares and Aerial Group Shares as may be required due to changes in the number of shares of Existing Series A Stock and Existing Common Stock between November 30, 1997 and the record date for determination of holders of New Series A Common Stock and New Common Stock entitled to receive the Distribution. ---------------------------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PRELIMINARY COPY TELEPHONE AND DATA SYSTEMS, INC. 30 North LaSalle Street, 40th Floor Chicago, Illinois 60602 312/630-1900 [LOGO] , 1998 Dear Fellow Shareholders: You are cordially invited to attend a Special Meeting of Shareholders of the Company to be held on , 1998, at 10:00 a.m. Chicago time, at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium (the "Special Meeting"). The formal notice of the meeting and a proxy statement/prospectus are enclosed. At the Special Meeting, you are being asked to vote on a proposal that would, among other things, create three new classes of common stock intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications service businesses ("Tracking Stocks"), and change the state of incorporation of the Company from Iowa to Delaware (the "Tracking Stock Proposal"). The Tracking Stock Proposal and the related transactions discussed below are important to the Company's long-term performance and to all shareholders of the Company. Some of the principal reasons for the Tracking Stock Proposal are: - to give greater market recognition to the value (individually and collectively) of the Company and of the Company's three principal business groups ("Tracking Groups"), thereby enhancing shareholder value over the long term, while at the same time enabling the Company's businesses to preserve the benefits of being part of a consolidated enterprise; - to provide the Company with greater flexibility in raising capital and making acquisitions, using equity securities specifically related to the Tracking Groups; - to enable the Company to more effectively tailor employee benefit plans to provide incentives to employees of the Tracking Groups; and - to provide shareholders with the opportunity to invest in separate securities that specifically reflect the underlying businesses, depending upon their investment objectives, as well as permit shareholders to continue to invest in all of the TDS businesses through the Common Shares and Series A Common Shares. Credit Suisse First Boston ("C.S. First Boston") and Salomon Brothers Inc and Smith Barney Inc. (collectively doing business as "Salomon Smith Barney") have acted as financial advisors to the Company in connection with the Tracking Stock Proposal. The Company has received opinions from each of those firms with respect to certain aspects of the Tracking Stock Proposal. As indicated in the letters from such firms attached as Exhibits C-1 and C-2 to the accompanying proxy statement/prospectus, such firms state that they are not expressing any opinions as to other aspects of the Tracking Stock Proposal, including any opinions as the value of the Tracking Stocks or the prices at which such Tracking Stocks may trade. See the section entitled "Proposal 1--Tracking Stock Proposal-- Opinions of Financial Advisors" in the accompanying proxy statement/prospectus. The Board of Directors has studied the Tracking Stock Proposal, has consulted with its financial and legal advisors, and has carefully weighed potential advantages against potential disadvantages, and has concluded that the positive aspects of the Tracking Stock Proposal outweigh potential adverse aspects. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE TRACKING STOCK PROPOSAL, BELIEVES THAT THE ADOPTION OF THE TRACKING STOCK PROPOSAL IS IN THE BEST INTERESTS OF THE COMPANY AND ITS SHAREHOLDERS AND UNANIMOUSLY RECOMMENDS THAT YOU VOTE "FOR" THE TRACKING STOCK PROPOSAL. Under the Tracking Stock Proposal, you are being asked to approve an Agreement and Plan of Merger (the "Merger Agreement") between the Company and Telephone and Data Systems, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("TDS Delaware"), pursuant to which the Company would be merged (the "Merger") with and into TDS Delaware, with TDS Delaware continuing as the surviving corporation. Immediately prior to the effective time of the Merger, the Certificate of Incorporation of TDS Delaware would be amended and restated to, among other things, authorize Preferred Shares, Series A Common Shares and Common Shares and to establish the rights, limitations and preferences of such shares. In the Merger, except to the extent that the holder of any shares dissents from the Merger and seeks appraisal rights for such shares, each issued Preferred Share of the Company would be converted into one Preferred Share of TDS Delaware having substantially similar rights, limitations and preferences, except as described herein, and each issued Common Share and Series A Common Share of the Company would be converted into one Common Share and one Series A Common Share, respectively, of TDS Delaware, having the rights, limitations and preferences described herein. YOU SHOULD RETAIN ALL CERTIFICATES WHICH REPRESENT SHARES OF THE COMPANY SINCE SUCH CERTIFICATES WILL CONTINUE TO REPRESENT SHARES OF THE SAME CLASS OR SERIES OF TDS DELAWARE FOLLOWING THE MERGER. The Restated Certificate of Incorporation of TDS Delaware would also, among other things, authorize three new classes of common stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Shares") and Aerial Communications Group Common Shares (the "Aerial Group Shares"). - The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of the Company's interest in United States Cellular Corporation, currently an 81%-owned subsidiary of the Company operating and investing in cellular telephone companies and properties ("U.S. Cellular"). - The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which consists of the Company's interest in TDS Telecommunications Corporation, a wholly-owned subsidiary of the Company operating landline telephone companies ("TDS Telecom"), and includes the allocation of certain corporate debt. - The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of the Company's interest in Aerial Communications, Inc., currently an 83%-owned subsidiary of the Company providing broadband personal communications services ("Aerial"). Subject to the approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, the Company intends to: - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group; - offer and issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by the Company, subject to approval by a special committee of the board of directors, the full board of directors and the shareholders of U.S. Cellular, pursuant to a merger between a subsidiary of the Company and U.S. Cellular (the "U.S. Cellular Merger"); - offer and issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by the Company, subject to approval by a special committee of the board of directors, the full board of directors and the shareholders of Aerial, pursuant to a merger between a subsidiary of the Company and Aerial (the "Aerial Merger"); and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of the Company (the "Distribution"). It is currently expected that the Distribution would take place in July 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. As soon as practicable after the Distribution, the Transfer Agent for TDS Delaware will mail certificates representing whole shares of Tracking Stock (and cash in lieu of fractional shares) to all shareholders. The Merger and the Distribution are intended to be tax-free to non-dissenting shareholders (except with respect to any cash received in lieu of fractional shares). Upon the completion of the Telecom Public Offering, the U.S. Cellular Merger, the Aerial Merger, and the Distribution, the outstanding shares of each Tracking Stock would represent in the aggregate an approximately 80% interest in the related Tracking Group. Approximately 20% of the common equity value of TDS attributable to each Tracking Group would initially be retained (the "Retained Interest") in a residual group (the "TDS Group"), along with all other interests held by the Company. The value of the common equity of TDS in the TDS Group would be represented by the outstanding Series A Common Shares and the Common Shares of TDS Delaware. -ii- The Company is filing an application to list each of the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares on the American Stock Exchange ("AMEX"). The Common Shares of TDS Delaware would be substituted for the existing Common Shares of the Company and would continue to be listed on the AMEX under the symbol "TDS." If the Tracking Stock Proposal is implemented, holders of Preferred Shares issued before October 31, 1981 and Common Shares would have the power to elect one more director in addition to the directors which they currently elect. Immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is equal to the aggregate dividend which such shareholder currently receives from the Company, assuming the shareholder retains the Telecom Group Shares received in the Distribution. Approximately 25% of the current dividend would be paid with respect to the Common Shares and Series A Common Shares, and approximately 75% of the current dividend would be paid with respect to the Telecom Group Shares. The Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. An example which illustrates the effects of the Tracking Stock Proposal with respect to a hypothetical holder of 100 Common Shares is attached to this letter. At the Special Meeting, shareholders are also being asked to vote on related proposals to amend or adjust certain existing employee stock plans and agreements in connection therewith as a result of the Tracking Stock Proposal and to approve a new plan which would permit stock awards to be made with respect to shares of Tracking Stock. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE "FOR" THE TRACKING STOCK PROPOSAL AND THE RELATED PROPOSALS. YOUR PROXY IS VERY IMPORTANT. THE TRACKING STOCK PROPOSAL WILL NOT BE APPROVED UNLESS IT RECEIVES THE AFFIRMATIVE VOTE OF THE HOLDERS OF A MAJORITY OF THE OUTSTANDING VOTING POWER OF EACH OF THE FOLLOWING VOTING GROUPS, EACH VOTING SEPARATELY AS A CLASS: (I) COMMON SHARES, SERIES A COMMON SHARES AND PREFERRED SHARES; (II) SERIES A COMMON SHARES; (III) COMMON SHARES; (IV) PREFERRED SHARES ISSUED BEFORE OCTOBER 31, 1981; AND (V) PREFERRED SHARES ISSUED AFTER OCTOBER 31, 1981. If you have any questions prior to the Special Meeting, please call the Company's Information Agent, McKenzie Partners, Inc., at 1-800-322-2885. We look forward with pleasure to visiting with you at the Special Meeting. Very truly yours, LeRoy T. Carlson LeRoy T. Carlson, Jr. Chairman President and Chief Executive Officer -iii- ILLUSTRATION OF EFFECTS OF TRACKING STOCK PROPOSAL The following illustration assumes that you own 100 Common Shares of Telephone and Data Systems, Inc., an Iowa corporation ("TDS Iowa"). - If the Tracking Stock Proposal is approved, TDS Iowa will be merged with its wholly-owned subsidiary, Telephone and Data Systems, Inc., a Delaware corporation ("TDS Delaware"). - Your 100 Common Shares of TDS Iowa would be automatically converted into 100 Common Shares of TDS Delaware without any action on your part. The certificates which you hold for 100 Common Shares of TDS Iowa will, after such merger, represent 100 Common Shares of TDS Delaware and there will be no need for you to exchange stock certificates. - In addition, based on the expected distribution ratios, you would receive 100 United States Cellular Group Common Shares ("Cellular Group Shares"), 66 TDS Telecommunications Group Common Shares ("Telecom Group Shares"), plus cash in lieu of 2/3 of a share, and 66 Aerial Communications Group Common Shares ("Aerial Group Shares"), plus cash in lieu of 2/3 of a share. - The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of the Company's interest in United States Cellular Corporation, currently an 81%-owned subsidiary of the Company operating and investing in cellular telephone companies and properties ("U.S. Cellular"). - The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which consists of the Company's interest in TDS Telecommunications Corporation, a wholly-owned subsidiary of the Company operating landline telephone companies ("TDS Telecom"), and includes the allocation of certain corporate debt. - The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of the Company's interest in Aerial Communications, Inc., currently an 83%-owned subsidiary of the Company providing broadband personal communications services ("Aerial"). - Your Common Shares would represent an equity interest in TDS Delaware attributable to a residual group (the "TDS Group"), which would have approximately a 20% Retained Interest in each of the Cellular Group, the Telecom Group and the Aerial Group upon the completion of all of the transactions contemplated by the Tracking Stock Proposal. The TDS Group would also include all of the Company's interest in businesses that are not attributed to a Tracking Group. - The Cellular Group Shares, the Telecom Group Shares, the Aerial Group Shares and the Common Shares of TDS Delaware would be traded on the AMEX. - The 100 Common Shares of TDS Delaware would have 100 votes in the election of 25% of the directors plus one additional director, and 100 votes on all other matters (other than the directors elected by holders of Series A Common Shares and Preferred Shares issued after October 31, 1981). - The 100 Cellular Group Shares, the 66 Telecom Group Shares and the 66 Aerial Group Shares would initially have one vote per share. Thereafter, the voting power of such shares would be adjusted prior to the record date before each annual meeting of shareholders, based on relative market values at such time. Such shares would vote in the election of 25% of the directors plus one additional director together with the Common Shares. Such shares would generally not vote on other matters, except that each of the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares would have a class vote in the event of an amendment to the TDS Delaware charter which was adverse to that class. - If you continue to retain the Common Shares and the Telecom Group Shares, you would receive an annual dividend of $0.10 per share with respect to each of the 100 Common Shares and $0.48 per share with respect to each of the 66 Telecom Group Shares, or an aggregate annual dividend of approximately $42, which is the amount of the annual dividend a holder of 100 Common Shares currently receives. -iv- TELEPHONE AND DATA SYSTEMS, INC. NOTICE OF SPECIAL MEETING OF SHAREHOLDERS TO BE HELD , 1998 TO THE SHAREHOLDERS OF TELEPHONE AND DATA SYSTEMS, INC A Special Meeting of Shareholders of Telephone and Data Systems, Inc., an Iowa corporation (the "Company" or "TDS"), will be held at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium, on , , 1998, at 10:00 a.m. Chicago time (the "Special Meeting"), for the following purposes: 1. To consider and approve an Agreement and Plan of Merger between the Company and Telephone and Data Systems, Inc., a Delaware corporation and wholly-owned subsidiary of the Company, which would alter the capital structure of the Company and change the state of incorporation of the Company from Iowa to Delaware, as more fully described in the accompanying Proxy Statement/Prospectus. 2. To consider and approve certain amendments or adjustments to employee benefit plans as a result of Proposal 1, as more fully described in the accompanying Proxy Statement/Prospectus. 3. To consider and approve the Company's 1998 Long-Term Incentive Plan, as more fully described in the accompanying Proxy Statement/Prospectus. 4. To transact such other business as may properly come before the Special Meeting or any and all adjournments thereof. If Proposal 1 is not approved, Proposal 2 and Proposal 3 will not be implemented even if they are approved. If Proposal 1 is approved, it will be implemented even if Proposal 2 and Proposal 3 are not approved. This Notice of Special Meeting and Proxy Statement/Prospectus is first being mailed to shareholders on or about , 1998 to holders of record on , 1998. The Board of Directors would like to have all shareholders represented at the Special Meeting. If you do not expect to be present, please sign and mail your proxy in the enclosed self-addressed envelope to Harris Trust and Savings Bank, 311 West Monroe Street, Chicago, Illinois 60606. If you hold more than one class of the Company's shares, you will receive a separate proxy for each holding. To assure that all of your shares are represented, you must return a proxy printed in black ink for Common Shares, including Common Shares owned through the TDS dividend reinvestment plan and through the TDS Tax-Deferred Savings Plan; a proxy printed in green ink for Series A Common Shares, including Series A Common Shares owned through the dividend reinvestment plan; a proxy printed in red ink for Preferred Shares issued before October 31, 1981; and a proxy printed in blue ink for Preferred Shares issued after October 31, 1981. Proxies given pursuant to this solicitation may be revoked at any time prior to the closing of polls at the Special Meeting (by written notice to the Secretary of the Company or attendance at the Special Meeting and notice to the Secretary of such revocation). Once the polls are closed, however, proxies may not be retroactively revoked. By order of the Board of Directors, Michael G. Hron Secretary PLEASE HELP US AVOID THE EXPENSE OF FOLLOW-UP PROXY MAILINGS TO SHAREHOLDERS BY SIGNING AND RETURNING THE ENCLOSED PROXY CARD PROMPTLY TABLE OF CONTENTS
PAGE ---- PROXY STATEMENT/PROSPECTUS................................................ 1 WHERE YOU CAN FIND MORE INFORMATION....................................... 2 QUESTIONS AND ANSWERS..................................................... 4 ILLUSTRATION OF CURRENT AND PROPOSED COMMON STOCK CAPITAL STRUCTURE....... 8 PROXY STATEMENT/PROSPECTUS SUMMARY........................................ 9 The Special Meeting..................................................... 9 The Merger.............................................................. 10 The Transactions........................................................ 10 Certain Federal Income Tax Consequences................................. 10 Reasons for Tracking Stock Proposal..................................... 11 Risk Factors............................................................ 12 Summary Comparison of the Current Capital Structure with the Proposed Tracking Stock Proposal............................................... 13 Significant Differences Between Iowa and Delaware Law................... 27 Dissenters' Rights...................................................... 30 Summary Selected Consolidated and Group Financial Information........... 30 RISK FACTORS.............................................................. 32 GENERAL................................................................... 41 DIVIDENDS AND PRICE RANGES OF COMMON SHARES............................... 43 DIVIDEND POLICY........................................................... 44 SELECTED FINANCIAL INFORMATION............................................ 44 PROPOSAL 1--TRACKING STOCK PROPOSAL....................................... 50 General................................................................. 50 The Transactions........................................................ 51 Background and Reasons for the Tracking Stock Proposal and Related Transactions; Recommendation of the Board............................. 54 Opinions of Financial Advisors.......................................... 58 Interests of Certain Persons............................................ 61 Changes to Board of Directors........................................... 62 The Company............................................................. 62 The Cellular Group...................................................... 63 The Telecom Group....................................................... 65 The Aerial Group........................................................ 68 PAGE ---- The TDS Group........................................................... 70 Effect of Pre-Distribution Convertible Securities and Committed Acquisition Shares.................................................... 72 Description of Articles of Incorporation of TDS Iowa.................... 73 Description of Restated Certificate of Incorporation of TDS Delaware.... 74 Description of Terms of Tracking Stock.................................. 84 The Retained Interests.................................................. 99 Inter-Group Interests................................................... 102 Management and Allocation Policies...................................... 104 Comparison of Shareholder's Rights Under Iowa and Delaware.............. 107 Dissenting Shareholders' Rights......................................... 114 Certain Federal Income Tax Considerations............................... 115 Securities Law Consequences of the Merger............................... 118 Listing on the AMEX..................................................... 118 Stock Transfer Agent and Registrar...................................... 118 Accounting Treatment.................................................... 118 Regulatory Approvals and Consents....................................... 118 Dividend Reinvestment Plans............................................. 119 Employee Benefit Plans.................................................. 119 Certain Definitions..................................................... 119 PROPOSAL 2--AMENDMENT AND ADJUSTMENT OF EMPLOYEE STOCK PLANS.............. 127 PROPOSAL 3--APPROVAL OF 1998 LONG-TERM INCENTIVE PLAN..................... 128 BENEFICIAL OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......... 132 SHAREHOLDER PROPOSALS..................................................... 135 SOLICITATION OF PROXIES................................................... 135 EXPENSES.................................................................. 135 EXPERTS................................................................... 135 LEGAL MATTERS............................................................. 135 OTHER BUSINESS............................................................ 135 INDEX TO EXHIBITS......................................................... 136 INDEX TO ANNEXES.......................................................... 136
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED MARCH 9, 1998 TELEPHONE AND DATA SYSTEMS, INC., TELEPHONE AND DATA SYSTEMS, INC., An Iowa Corporation A Delaware Corporation PROXY STATEMENT PROSPECTUS
-------------------------- This Proxy Statement and Prospectus (the "Proxy Statement/Prospectus") is being furnished to the shareholders of Telephone and Data Systems, Inc., an Iowa corporation (the "Company" or "TDS"), in connection with the solicitation of proxies by the Board of Directors of TDS (the "Board"), for use at a Special Meeting of Shareholders of TDS to be held at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium, on , 1998, at 10:00 a.m. Chicago time and at any and all adjournments or postponements thereof (the "Special Meeting"). This Proxy Statement/Prospectus is first being mailed to shareholders of the Company on or about , 1998. For definitions of certain defined terms used in this Proxy Statement/Prospectus, see "Proposal 1--Tracking Stock Proposal-- Certain Definitions." An index of certain defined terms is attached as Exhibit G. This Proxy Statement/Prospectus also constitutes the Prospectus of Telephone and Data Systems, Inc., a Delaware corporation and wholly-owned subsidiary of the Company ("TDS Delaware"), filed as part of a Registration Statement on Form S-4 (the "Registration Statement") with the Securities and Exchange Commission (the "SEC") under the Securities Act of 1933, as amended (the "Securities Act"), relating to the shares of TDS Delaware preferred and common stock described herein. This Proxy Statement/Prospectus relates to the approval by shareholders of the Company of a proposal that would, among other things, create three new classes of common stock which are intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications services businesses, and change the state of incorporation of the Company from Iowa to Delaware (the "Tracking Stock Proposal"). Under the Tracking Stock Proposal, shareholders of the Company are being asked to approve an Agreement and Plan of Merger dated as of , 1997 (the "Merger Agreement"), among TDS and TDS Delaware, which provides for the merger (the "Merger") of TDS with and into TDS Delaware, with TDS Delaware surviving the Merger. A conformed copy of the Merger Agreement is attached hereto as EXHIBIT A. Immediately prior to the effective time of the Merger, the Certificate of Incorporation of TDS Delaware would be amended and restated to, among other things, authorize 475,000,000 shares of capital stock and to establish the rights, limitations and preferences of such shares (the "Restated Certificate"). A copy of the Restated Certificate is attached hereto as EXHIBIT B. Subject to the terms and conditions of the Merger Agreement, each share of TDS capital stock outstanding immediately prior to the effective time of the Merger will be converted into shares of TDS Delaware stock of the same class and series. The Preferred Shares will be converted into an equivalent number of TDS Delaware Preferred Shares of the same series and each Common Share and Series A Common Share will be converted into one Common Share and one Series A Common Share, respectively, of TDS Delaware. The consummation of the Merger is subject, among other things, to: (i) the approval and adoption of the Merger Agreement by the shareholders of the Company entitled to vote thereon; and (ii) the receipt of certain regulatory approvals. See EXHIBIT A. After the Merger, the Voting Trust which controls TDS (the "TDS Voting Trust") will continue to control the election of a majority of the Board of Directors and a majority of the voting power of TDS Delaware. However, if the Tracking Stock Proposal is approved, the number of directors that the TDS Voting Trust will elect will decrease by one director, and the number of directors that will be elected by the voting group which includes the holders of Preferred Shares issued before October 31, 1981 and Common Shares of the Company will increase by one director. There has been no prior market for the Cellular Group Shares, the Telecom Group Shares or the Aerial Group Shares. The Company is filing an application to list each of the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares on the American Stock Exchange ("AMEX"). The Common Shares of TDS Delaware would be substituted for the existing Common Shares of the Company and would continue to be listed on the AMEX under the symbol "TDS." -------------------------- SEE "RISK FACTORS" BEGINNING ON PAGE 33 FOR CERTAIN INFORMATION THAT SHOULD BE CONSIDERED IN CONNECTION WITH THE TRANSACTIONS DESCRIBED HEREIN. --------------------- THE APPROVAL OF THE TRACKING STOCK PROPOSAL REQUIRES THE AFFIRMATIVE VOTE OF THE HOLDERS OF A MAJORITY OF THE OUTSTANDING VOTING POWER OF EACH OF THE FOLLOWING VOTING GROUPS, EACH VOTING SEPARATELY AS A CLASS: (I) COMMON SHARES, SERIES A COMMON SHARES AND PREFERRED SHARES; (II) SERIES A COMMON SHARES; (III) COMMON SHARES; (IV) PREFERRED SHARES ISSUED BEFORE OCTOBER 31, 1981; AND (V) PREFERRED SHARES ISSUED AFTER OCTOBER 31, 1981. ALTHOUGH THE TDS VOTING TRUST HAS THE VOTING POWER TO CAUSE THE AFFIRMATIVE VOTE OF EACH OF (I) AND (II) ABOVE TO BE ASSURED, THE TDS VOTING TRUST HOLDS NO COMMON SHARES OR PREFERRED SHARES. ACCORDINGLY, SUCH PROPOSAL WILL NOT BE APPROVED UNLESS IT IS ALSO APPROVED BY THE AFFIRMATIVE VOTE OF THE HOLDERS OF A MAJORITY OF EACH OF THE VOTING GROUPS IDENTIFIED IN (III), (IV) AND (V) ABOVE. ALTHOUGH THE TDS VOTING TRUST HAS THE VOTING POWER TO APPROVE THE TWO ADDITIONAL PROPOSALS RELATED TO THE TRACKING STOCK PROPOSAL, SUCH PROPOSALS WILL NOT BE IMPLEMENTED IF THE TRACKING STOCK PROPOSAL IS NOT APPROVED. IT IS IMPORTANT TO NOTE THAT HOLDERS OF CELLULAR GROUP SHARES, TELECOM GROUP SHARES AND AERIAL GROUP SHARES WHEN ISSUED WILL, TOGETHER WITH THE HOLDERS OF COMMON SHARES AND SERIES A COMMON SHARES, BE COMMON SHAREHOLDERS OF THE COMPANY AND WILL BE SUBJECT TO RISKS ASSOCIATED WITH AN INVESTMENT IN THE COMPANY AND ALL OF ITS BUSINESSES, ASSETS AND LIABILITIES. THE COMPANY CAN PROVIDE NO ASSURANCE AS TO THE DEGREE TO WHICH THE MARKET PRICE OF ANY CLASS OF STOCK WILL REFLECT THE SEPARATE PERFORMANCE OF THE RELATED GROUP OR AS TO THE IMPACT OF THE TRACKING STOCK PROPOSAL ON THE MARKET PRICE OF THE COMMON SHARES. IN ADDITION, IMPLEMENTATION OF THE TRACKING STOCK PROPOSAL WILL MAKE THE CAPITAL STRUCTURE OF THE COMPANY MORE COMPLEX AND MAY GIVE RISE TO OCCASIONS WHEN THE INTERESTS OF THE HOLDERS OF THE SEPARATE CLASSES OF COMMON STOCK MAY DIVERGE OR APPEAR TO DIVERGE. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. -------------------------- THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS , 1998 WHERE YOU CAN FIND MORE INFORMATION The Company files reports, proxy statements and other information with the SEC. You may inspect and copy such reports, proxy statements and other information at the public reference facilities maintained by the SEC at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the following Regional Offices of the SEC: Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 7 World Trade Center, Suite 1300, New York, New York 10048. Copies may be obtained by mail at prescribed rates from the Public Reference Section of the SEC at its principal office at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information. Such materials also may be accessed electronically by means of the SEC's web site at http://www.sec.gov. Copies of such materials may also be inspected at the offices of the American Stock Exchange, 86 Trinity Place, New York, New York 10006. TDS Delaware filed a Registration Statement on Form S-4 related to the transactions described in this Proxy Statement/Prospectus. This Proxy Statement/Prospectus is a part of that Registration Statement and constitutes a prospectus of TDS Delaware in addition to being a proxy statement of the Company for the Special Meeting. As allowed by SEC rules, this Proxy Statement/Prospectus does not contain all of the information which you can find in the Registration Statement. You are referred to the Registration Statement and the Exhibits thereto for further information. This document is qualified in its entirely by such other information. The SEC allows the Company to "incorporate by reference" information into this Proxy Statement/Prospectus, which means that the Company can disclose important information to you by referring you to another document filed separately with the SEC. The information incorporated by reference is deemed to be part of this Proxy Statement/Prospectus, except for any information superseded by information in this Proxy Statement/Prospectus. This Proxy Statement/Prospectus incorporates by reference the documents set forth below that have been previously filed with the SEC. These documents contain important information about the Company's businesses and finances. 1. TDS's Annual Report on Form 10-K for the year ended December 31, 1996; 2. TDS's Quarterly Reports on Form 10-Q for the quarters ended March 31, June 30 and September 30, 1997; and 3. TDS's Current Reports on Form 8-K reporting events on November 18, December 1, December 18 and December 23, 1997 and on January 28 and February 10, 1998. This Proxy Statement/Prospectus also incorporates by reference additional documents that may be filed by the Company with the SEC between the date of this Proxy Statement/Prospectus and the date of the Special Meeting. YOU MAY OBTAIN COPIES OF SUCH DOCUMENTS WHICH ARE INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT/ PROSPECTUS (OTHER THAN EXHIBITS THERETO WHICH ARE NOT SPECIFICALLY INCORPORATED BY REFERENCE HEREIN), WITHOUT CHARGE, UPON WRITTEN OR ORAL REQUEST TO INVESTOR RELATIONS, TELEPHONE AND DATA SYSTEMS, INC., 30 N. LASALLE STREET, CHICAGO, IL 60603, (312) 630-1900. IN ORDER TO ENSURE DELIVERY OF DOCUMENTS PRIOR TO THE SPECIAL MEETING, ANY REQUEST THEREFOR SHOULD BE MADE NOT LATER THAN , 1998. YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROXY STATEMENT/ PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM WHAT IS CONTAINED IN THIS PROXY STATEMENT/PROSPECTUS. YOU SHOULD NOT ASSUME THAT THE INFORMATION CONTAINED IN THIS PROXY STATEMENT/PROSPECTUS IS ACCURATE AS OF ANY DATE OTHER THAT THE DATE OF SUCH PROXY STATEMENT/PROSPECTUS, AND NEITHER THE MAILING OF THIS PROXY STATEMENT/PROSPECTUS TO SHAREHOLDERS NOR THE ISSUANCE OF ANY SECURITIES HEREUNDER SHALL CREATE ANY IMPLICATION TO THE CONTRARY. -2- PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS PROXY STATEMENT/PROSPECTUS 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. THE COMPANY 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 THE COMPANY 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. SEE "RISK FACTORS." READERS SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS. QUESTIONS Questions concerning the Tracking Stock Proposal to be acted upon at the Special Meeting should be directed to the Company's Information Agent, MacKenzie Partners, Inc., at the telephone number and address indicated below. Additional copies of this Proxy Statement/Prospectus or the Proxy Card may be obtained from the Information Agent or the Company's Investor Relations Department at its principal office. [LOGO] 156 FIFTH AVENUE NEW YORK, NEW YORK 10010 (212) 929-5500 (CALL COLLECT) OR CALL TOLL-FREE (800) 322-2885 FAX: (212) 929-0308 -3- QUESTIONS AND ANSWERS RELATING TO TRACKING STOCK PROPOSAL AND RELATED TRANSACTIONS Q: WHY AM I RECEIVING THIS PROXY STATEMENT/PROSPECTUS? A: The Board of Directors of Telephone and Data Systems, Inc., an Iowa corporation (the "Company" or "TDS") is distributing this Proxy Statement/Prospectus to shareholders of the Company in connection with a proposal that would, among other things, create three new classes of common stock intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications service businesses ("Tracking Stocks"), and change the state of incorporation of the Company from Iowa to Delaware (the "Tracking Stock Proposal"). The Board of Directors is seeking your proxy to vote in favor of the Tracking Stock Proposal at a special meeting of shareholders. At the special meeting, you are also being asked to vote on two related proposals to amend or adjust certain existing employee stock plans and agreements in connection therewith as a result of the Tracking Stock Proposal and to approve a new plan which would permit stock awards to be made with respect to shares of Tracking Stock. Q: WHEN AND WHERE WILL THE SPECIAL MEETING BE HELD? A: The special meeting will be held on , 1998, at 10:00 a.m. Chicago time, at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium. Q: WHAT DO I NEED TO DO NOW? A: Just mail in your signed proxy card in the enclosed return envelope as soon as possible, so that your shares may be represented at the special meeting. Q: WHAT DOES THE BOARD OF DIRECTORS RECOMMEND? A: The Board of Directors has unanimously approved each proposal, believes that the adoption of each proposal is in the best interests of the Company and its shareholders and unanimously recommends that you vote "FOR" the Tracking Stock Proposal and the related proposals. Q: WHAT VOTE IS REQUIRED TO APPROVE THE TRACKING STOCK PROPOSAL AND THE RELATED PROPOSALS? A: The approval of the Tracking Stock Proposal requires the affirmative vote of the holders of a majority of the outstanding voting power of each of the following voting groups, each voting separately as a class: (i) Common Shares, Series A Common Shares and Preferred Shares; (ii) Series A Common Shares; (iii) Common Shares; (iv) Preferred Shares issued before October 31, 1981; and (v) Preferred Shares issued after October 31, 1981. Although the Voting Trust which controls TDS has the voting power to cause the affirmative vote of each of (i) and (ii) above to be assured, the TDS Voting Trust holds no Common Shares or Preferred Shares. Accordingly, the Tracking Stock Proposal will not be approved unless it is also approved by the affirmative vote of the holders of a majority of each of the voting groups identified in (iii), (iv) and (v) above. Although the TDS Voting Trust has the voting power to approve the two related proposals, such proposals will not be implemented if the Tracking Stock Proposal is not approved. -4- Q: WILL THE TRACKING STOCK PROPOSAL RESULT IN A CHANGE IN CONTROL OF TDS? A: There will be no change in control of TDS if the Tracking Stock Proposal is approved. The TDS Voting Trust currently controls, and after the proposed transactions will continue to control, the election of a majority of the directors of TDS and all other matters submitted to a vote of shareholders of TDS, except for matters that require a class vote. Q: WHAT WILL HAPPEN IF THE TRACKING STOCK PROPOSAL IS APPROVED? A: If the Tracking Stock Proposal is approved, TDS will be reincorporated as a Delaware corporation through a merger (the "Merger") of the Company into a wholly-owned Delaware subsidiary ("TDS Delaware"). The Merger is being effected simply for the purpose of changing the state of incorporation of TDS from Iowa to Delaware and will not result in any change in the name, management, businesses, operations, strategies, assets or liabilities of TDS. Q: WHAT IS THE PURPOSE OF REINCORPORATING INTO DELAWARE? A: It will allow the Company to benefit from Delaware's well-developed corporate laws, which are periodically updated and revised to meet changing business needs. Delaware courts have developed considerable expertise in dealing with corporate issues and a substantial body of case law has been established construing Delaware law and establishing public policies with respect to Delaware corporations. As a consequence, a greater measure of predictability is possible in Delaware with respect to corporate legal affairs than is available in other states. In addition, the Company believes that Delaware law will offer clearer guidance with respect to legal issues that may arise as a result of the existence of separate classes of Tracking Stock. Q: SHOULD I SEND IN MY STOCK CERTIFICATES? A: No. It will not be necessary for shareholders to exchange their existing stock certificates representing shares of TDS Iowa for stock certificates representing shares of TDS Delaware. Shareholders should retain all certificates which represent shares of the Company since such certificates will continue to represent shares of the same class or series of TDS Delaware following the Merger. Q: WHAT IS A TRACKING STOCK? A: Tracking stock represents shares of common stock of a parent corporation, in this case TDS, which are intended to "track" the performance of a group of assets or a subsidiary. The Restated Certificate of Incorporation of TDS Delaware would, among other things, authorize three new classes of tracking stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Shares") and Aerial Communications Group Common Shares (the "Aerial Group Shares"). - The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of the Company's interest in United States Cellular Corporation, currently an 81%-owned subsidiary of the Company operating and investing in cellular telephone companies and properties ("U.S. Cellular"). - The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which consists of the Company's interest in TDS Telecommunications Corporation, a wholly-owned subsidiary of the Company operating landline telephone companies ("TDS Telecom"), and includes the allocation of certain corporate debt. - The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of the Company's interest in Aerial Communications, Inc., currently an 83%-owned subsidiary of the Company providing broadband personal communications services ("Aerial"). Q: WHAT ARE THE COMPANY'S PLANS AFTER THE MERGER? A: If the Tracking Stock Proposal is approved and the Merger takes place, the Company intends to: -5- - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group; - offer and issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by the Company, subject to approval by a special committee of the board of directors, the full board of directors and the shareholders of U.S. Cellular, pursuant to a merger between a subsidiary of the Company and U.S. Cellular (the "U.S. Cellular Merger"); - offer and issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by the Company, subject to approval by a special committee of the board of directors, the full board of directors and the shareholders of Aerial, pursuant to a merger between a subsidiary of the Company and Aerial (the "Aerial Merger"); and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of the Company (the "Distribution"). Q: WHEN WILL ALL OF THIS TAKE PLACE? A: If the Tracking Stock Proposal is approved, the Merger to reincorporate TDS into Iowa is expected to take place shortly after the special meeting. The Telecom Public Offering is expected to occur shortly after that, subject to favorable market conditions. The Company hopes that the U.S. Cellular Merger and the Aerial Merger can be completed by June 1998, but the timing of these transactions depends on negotiations with independent special committees of U.S. Cellular and Aerial. If all of these events occur as planned, the Distribution would take place in July or as soon as practicable thereafter, following the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. However, the Board of Directors could choose to make the Distribution or any part thereof at any time, or not to make the Distribution, depending on the circumstances at the time. Q: WHAT DO I NEED TO DO TO RECEIVE MY CERTIFICATES FOR THE TRACKING STOCKS? A: You do not need to do anything to receive your certificates for the Tracking Stocks. If all of the transactions take place as planned, certificates representing whole shares of Tracking Stock (and cash in lieu of fractional shares) will be mailed to all shareholders in July 1998 or later. Q: WHAT ARE THE TAX CONSEQUENCES TO ME? A: The Merger and the Distribution are intended to be tax-free to non-dissenting shareholders (except with respect to any cash received in lieu of fractional shares). Q: WHAT WILL MY SHARES REPRESENT AFTER THESE TRANSACTIONS? A: Upon the completion of the Telecom Public Offering, the U.S. Cellular Merger, the Aerial Merger, and the Distribution, the outstanding shares of Tracking Stock would represent in the aggregate an approximately 80% interest in the related Tracking Group. Approximately 20% of the common equity value of TDS attributable to each Tracking Group would initially be retained (the "Retained Interest") in a residual group (the "TDS Group"), along with all other interests held by the Company. The value of the common equity of TDS in the TDS Group would be represented by the outstanding Series A Common Shares and Common Shares of TDS Delaware. Q: WHAT WILL MY COMMON SHARES REPRESENT IF EVERYTHING TAKES PLACE AS PLANNED? A: The Common Shares and the Series A Common Shares would represent an equity interest in the TDS Group. Upon the completion of all the transactions as planned, the TDS Group would have an approximately 20% Retained Interest in each of the Tracking Groups. The TDS Group would also include all of the Company's interest in businesses that are not attributed to a Tracking Group. The TDS Group would provide management, accounting, financial, cash management and other services to the Tracking Groups. The TDS Group would also be credited with the benefit of any tax losses which any Tracking Group cannot utilize on a stand-alone basis, but which can be utilized to reduce the consolidated tax liability of TDS. -6- Q: WILL THE COMMON SHARES AND THE TRACKING STOCK BE LISTED ON THE AMERICAN STOCK EXCHANGE? A: The Common Shares of TDS Delaware will be substituted for the existing Common Shares of the Company and will continue to be listed on the American Stock Exchange under the symbol "TDS." The Company is filing an application to list each of the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares on the American Stock Exchange. Q: WHAT VOTING RIGHTS WILL I HAVE? A: Immediately after the Distribution, the holders of Preferred Shares issued before October 31, 1981 and Common Shares would have the same voting power which they currently have and would also become entitled to elect one more director in addition to the directors which they currently elect. In the election of directors, the holders of the Tracking Stocks would vote together with the holders of Preferred Shares issued before October 31, 1981 and Common Shares (the "Public Holders") in the election of 25% of the directors (rounded up) plus one additional director (or four directors based on a Board of twelve directors). The Preferred Shares issued before October 31, 1981 and Common Shares would have one vote per share in the election of such directors and with respect to all other matters, other than the election of directors elected by the Series A Holders discussed below. The Tracking Stocks would have no votes except in the election of such directors and as otherwise required by law. In the election of such directors, each class of Tracking Stock would initially have one vote per share. Thereafter, the number of votes of each class of Tracking Stock would vary based on the aggregate market value of such class held by Public Holders as compared to the aggregate market value of all shares of stock held by the Public Holders, calculated over a twenty-trading day period ending ten days prior to the record date for each annual meeting of shareholders. It is anticipated that the Cellular Group Shares would have more than one vote per share and that the Telecom Group Shares and Aerial Group Shares would have approximately one vote per share based on anticipated market values, although this may change over time. Under the Tracking Stock Proposal, holders of Preferred Shares issued after October 31, 1981 and Series A Common Shares (the "Series A Holders") would vote in the election of one less director than at present. Based on twelve directors, the Series A Holders would vote in the election of eight directors, as compared to nine directors currently. The Preferred Shares issued after October 31, 1981 would continue to have one vote and Series A Common Shares would continue to have ten votes per share in the election of such directors, as well as with respect to all other matters (other than the election of the directors elected by the Public Holders described in the preceding paragraph). Q: WHAT HAPPENS TO MY FUTURE DIVIDENDS? A: Immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is equal to the aggregate dividend which such shareholder currently receives from the Company, assuming the shareholder retains the Telecom Group Shares received in the Distribution. Following the Distribution, the Board currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share and an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, the dividend rate on the Telecom Group Shares would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share. The total of this rate and the rate of $0.10 per Common and Series A Common Share is equal to $0.42 per share per annum, which is the same as the current annual dividend rate on the existing Common Shares and Series A Common Shares. The Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. Future dividends on all shares of common stock will be payable only if declared by the Board out of the lesser of (i) all funds of the Company legally available therefor and (ii) the available dividend amount with respect to the relevant Group, as described in the proxy statement/prospectus. Q: WHAT DO I DO IF I HAVE ADDITIONAL QUESTIONS? A: If you have any questions prior to the special meeting, please call the Company's Information Agent, McKenzie Partners, Inc., at 1-800-322-2885. -7- CURRENT COMMON STOCK CAPITAL STRUCTURE OF THE COMPANY [GRAPHIC] PROPOSED COMMON STOCK CAPITAL STRUCTURE OF THE COMPANY [GRAPHIC] -8- PROXY STATEMENT/PROSPECTUS SUMMARY THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION FROM THIS DOCUMENT AND DOES NOT CONTAIN ALL OF THE INFORMATION THAT IS IMPORTANT TO YOU. TO UNDERSTAND THE TRACKING STOCK PROPOSAL FULLY AND FOR A MORE COMPLETE DESCRIPTION OF THE LEGAL TERMS OF THE TRACKING STOCK PROPOSAL, YOU SHOULD READ CAREFULLY THIS ENTIRE DOCUMENT AND THE DOCUMENTS WHICH ARE INCORPORATED BY REFERENCE IN THIS DOCUMENT. SEE "WHERE YOU CAN FIND MORE INFORMATION." FOR DEFINITIONS OF CERTAIN DEFINED TERMS USED IN THIS SUMMARY, SEE "PROPOSAL 1--TRACKING STOCK PROPOSAL--CERTAIN DEFINITIONS" AND EXHIBIT G--INDEX OF CERTAIN DEFINED TERMS. THE SPECIAL MEETING Date, Time and Place of Meeting.................... A Special Meeting of Shareholders will be held on , , 1998 at 10:00 a.m., Chicago time, at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium. Proposals to be Considered at the Special The following proposals will be considered at Meeting.......................................... the Special Meeting:
PROPOSAL 1--A proposal to create three new classes of common stock which are intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications businesses, and to change the state of incorporation of the Company from Iowa to Delaware (the "Tracking Stock Proposal"). PROPOSAL 2--A proposal to approve certain amendments and adjustments to certain employee stock plans to reflect the effects of Proposal 1. PROPOSAL 3--A proposal to approve the Company's 1998 Long-Term Incentive Plan to permit the award of options and stock awards with respect to shares of Tracking Stock as well as Common Shares. Vote Required...................................... The following votes are required with respect to each of the Proposals:
PROPOSAL 1--The approval of the Tracking Stock Proposal requires the affirmative vote of the holders of a majority of the outstanding voting power of each of the following voting groups, each voting separately as a class: (i) Common Shares, Series A Common Shares and Preferred Shares; (ii) Series A Common Shares; (iii) Common Shares; (iv) Preferred Shares issued before October 31, 1981; and (v) Preferred Shares issued after October 31, 1981. Although the TDS Voting Trust has the voting power to cause the affirmative vote of each of (i) and (ii) above to be assured, the TDS Voting Trust holds no Common Shares or Preferred Shares. Accordingly, such proposal will not be approved unless it is also approved by the affirmative vote of the holders of a majority of each of the voting groups identified in (iii), (iv) and (v) above. PROPOSAL 2--This proposal requires the affirmative vote of the holders of a majority of the voting power of the Company. Since the TDS Voting Trust holds a majority of the voting power of the Company, the approval of this proposal is assured. However, this proposal will not be implemented if the Tracking Stock Proposal is not approved. PROPOSAL 3--This proposal requires the affirmative vote of the holders of a majority of the voting power of the Company. Since the TDS Voting Trust holds a majority of the voting power of the Company, the approval of this proposal is assured. However, this proposal will not be implemented if the Tracking Stock Proposal is not approved. THE BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED EACH PROPOSAL, BELIEVES THAT THE ADOPTION OF EACH PROPOSAL IS IN THE BEST INTERESTS OF THE COMPANY AND ITS SHAREHOLDERS AND UNANIMOUSLY RECOMMENDS THAT ALL SHAREHOLDERS VOTE "FOR" THE TRACKING STOCK PROPOSAL AND THE RELATED PROPOSALS. -9- THE MERGER If the Tracking Stock Proposal is approved, the Company will be merged with and into TDS Delaware, with TDS Delaware as the surviving company. In the Merger, the Preferred Shares will be converted into an equivalent number of TDS Delaware Preferred Shares of the same series, and each Common Share and Series A Common Share will be converted into one Common Share and one Series A Common Share, respectively, of TDS Delaware. It will not be necessary for you to exchange your stock certificates since such certificates will continue to represent TDS Delaware shares of the same class or series. THE TRANSACTIONS Subject to the approval of the Tracking Stock Proposal and the effectiveness of the Merger, the Board intends to take the following action: Telecom Public Offering........... Offer and sell between 10,000,000 and 17,000,000 Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions, and to allocate the net proceeds thereof to the Telecom Group. U.S. Cellular Merger.............. Offer and issue 1.14613 Cellular Group Shares in exchange for each Common Share of U.S. Cellular which is not owned by the Company (based on shares outstanding as of November 30, 1997), pursuant to a merger between a subsidiary of the Company and U.S. Cellular. This transaction is further subject to negotiation of the other terms of a merger agreement, approval by a special committee of the board of directors, the full board of directors and the shareholders of U.S. Cellular and certain other conditions. Aerial Merger..................... Offer and issue .91485 Aerial Group Shares in exchange for each Common Share of Aerial which is not owned by the Company (based on shares outstanding as of November 30, 1997), pursuant to a merger between a subsidiary of the Company and Aerial. This transaction is subject to negotiation of the other terms of a merger agreement, approval by a special committee of the board of directors, the full board of directors and the shareholders of Aerial and certain other conditions. Distribution...................... Distribute Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in the form of a stock dividend on a pro rata basis to holders of Series A Common Shares and Common Shares. It is currently contemplated that the Distribution would take place after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. However, the Board reserves the right not to effect all or any part of the Distribution, or to effect all or any part of the Distribution, regardless of whether or not the Telecom Public Offering, the U.S. Cellular Merger or the Aerial Merger have been completed. The intended distribution ratio is one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share for each of the outstanding Common Shares and Series A Common Shares.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES The Company has been advised by counsel that no gain or loss will be recognized by the non-dissenting shareholders of the Company in connection with the Merger or the Distribution (except with respect to any cash received in lieu of fractional shares in the Distribution); however, there are no court decisions bearing directly on the Tracking Stock Proposal and the Internal Revenue Service has announced that it will not issue advance rulings on the federal income tax consequences of transactions similar to the Tracking Stock Proposal. See "Proposal 1-- Tracking Stock Proposal--Certain Federal Income Tax Considerations." -10- REASONS FOR TRACKING STOCK PROPOSAL The Board believes that the division of the Company's interests in its principal businesses into the Tracking Groups would enable the Company to benefit in a variety of ways, some of which are described below. GREATER MARKET RECOGNITION. The Tracking Stock Proposal is intended to result in greater market recognition of the value (individually and collectively) of the Company and the Company's three principal business groups, thereby enhancing shareholder value over the long term. Additionally, a public market for each of TDS's three principal business groups should make it easier for the capital markets to understand and value the Company's businesses and assets. INCREASED LIQUIDITY FOR U.S. CELLULAR AND AERIAL. The Board believes that the Distribution would serve to increase the liquidity of the publicly-traded equity related to U.S. Cellular and Aerial. The Financial Advisors have advised the Company that this increased liquidity may increase the valuation of the Cellular Group Shares and Aerial Group Shares as compared to the recent public market values of the Common Shares of U.S. Cellular and Aerial. FINANCING FLEXIBILITY. The Tracking Stock Proposal should provide the Company with greater flexibility in raising capital and making acquisitions, with equity securities specifically related to the Tracking Groups. The Tracking Stocks may also be used, rather than Common Shares, for TDS's employee stock purchase plans, stock option plans and other employee benefit plans. SHAREHOLDER FLEXIBILITY. The issuance and sale of the Tracking Stocks would also provide shareholders with the opportunity to continue to invest in all of the TDS businesses through the TDS Group or any one or more of the Tracking Groups individually, depending upon their investment objectives. CONSOLIDATED ENTERPRISE. The Tracking Stock Proposal will retain for the Company the advantages of doing business as a single company, including synergies that may result from the eventual convergence of the telecommunications and wireless industries and strategic, financial, operational benefits, economies of scale and debt capacity that would not be available if the Groups were separate legal entities. It would also permit the Company to retain the advantages of tax consolidation. TAX FACTORS. Implementation of the Tracking Stock Proposal should not be taxable to the Company or non-dissenting shareholders (except for cash in lieu of fractional shares). FUTURE ALTERNATIVES. The Tracking Stock Proposal will not preclude other alternatives to increase shareholder value. EMPLOYEE COMPENSATION. The ability to issue shares of one or more of the Tracking Stocks would increase TDS's flexibility to tailor stock incentives to employees by creating stocks that are tied directly to the stock price performance of the Group in which they are employed. ACCEPTANCE OF TRACKING STOCK CAPITAL STRUCTURES. The use of tracking stocks by other companies, including several large, well-known companies, has increased in the last several years and tracking stocks are now generally well-followed by financial analysts and accepted by investors. BENEFITS OF DELAWARE REINCORPORATION. Delaware is generally recognized as having a modern, flexible and nationally recognized corporate statute and a well-developed body of case law that provides predictability and certainty in business planning. Cases involving corporate law issues are decided in a separate Court of Chancery in Delaware, where judges have substantial experience and precedent in making their decisions. Due to the importance of corporate law in Delaware, the Delaware legislature puts a high priority on corporate law matters and is at the forefront of keeping the Delaware corporate statute current in the face of changing business practices and legal developments. Due to such factors, reincorporating in Delaware may reduce the impediments and increase the opportunities for structuring securities and financial transactions, which would facilitate acquisitions, raising capital and other financing transactions. In addition, the Company believes that Delaware will offer clearer guidance with respect to legal issues that may arise as a result of the existence of separate classes of Tracking Stock. For additional Reasons for the Tracking Stock Proposal, see "Proposal 1--Tracking Stock Proposal-- Reasons." -11- RISK FACTORS When evaluating the Tracking Stock Proposal, shareholders should be aware of certain risk factors relating thereto. Such risk factors include the following: LIMITATIONS AND QUALIFICATIONS IN FINANCIAL ADVISOR OPINIONS. The Company has received opinions from the Financial Advisors with respect to certain aspects of the transactions described in the Proxy Statement/ Prospectus. Such opinions do not address all aspects of such transactions and are subject to material qualifications, limitations, assumptions and other factors. Shareholders should carefully consider and evaluate the opinions of the Financial Advisors in view of these assumptions, limitations, qualifications and other factors. See "Proposal 1-- Tracking Stock Proposal--Opinions of Financial Advisors." See also Exhibits C-1 and C-2 for copies of the full text of such opinions. ABILITY OF BOARD TO UNILATERALLY CONVERT TRACKING STOCK. The Company could, at any time, in the sole discretion of its Board, without further shareholder approval, determine to convert each outstanding share of a class of Tracking Stock for shares of another class of Tracking Stock or Special Common Shares at a predetermined premium to relative market values. The determination by the Board to redeem shares of a class of Tracking Stock for shares of another class of Tracking Stock or Special Common Shares could be made at a time when any class of the Company's stock may be considered to be overvalued or undervalued, or at a time when there is no public market for any class of stock. In addition, any such redemption would preclude holders of the redeemed Tracking Stock from retaining their investment in a security that is intended to reflect separately the performance of the related Tracking Group. See "Proposal 1--Tracking Stock Proposal-- Description of Terms of Tracking Stock--Conversion at Option of Company." CONTROL BY TDS VOTING TRUST. The Tracking Stock Proposal will not alter the TDS Voting Trust's present control of TDS. As of November 30, 1997, the TDS Voting Trust held 6,334,473 Series A Common Shares, representing over 50% of the voting power of TDS with respect to matters other than the election of directors. Based on such shares, the TDS Voting Trust would receive 6,334,473 Cellular Group Shares, 4,222,982 Telecom Group Shares and 4,222,982 Aerial Group Shares in connection with the Distribution. Under the current terms of the TDS Voting Trust, such shares of Tracking Stock will be distributed by the trustees to the beneficiaries. Following the Distribution, and after the distribution of such shares by the TDS Voting Trust to the beneficiaries thereof, the TDS Voting Trust will continue to hold such 6,334,473 Series A Common Shares, representing over 50% of the aggregate voting power of the Company with respect to all matters other than the election of directors, and will continue to be able to elect a majority of the directors. ANTITAKEOVER CONSIDERATIONS. The control by the TDS Voting Trust is likely to deter any potential unsolicited or hostile takeover attempts or other efforts to obtain control of TDS and may make it more difficult for shareholders to sell shares of TDS at higher than market prices. Implementation of the Tracking Stock Proposal will allow TDS to issue Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as Special Common Shares, which would not vote except in the election of certain directors and as required by law. This may preserve the ability of the TDS Voting Trust to continue to exercise control over a majority of TDS's voting power and is likely to limit or deter a merger proposal or tender offer that is not acceptable to the TDS Voting Trust. The Restated Certificate and the Company's Bylaws also contain provisions which may serve to discourage or make more difficult a change in control of the Company without the support of the Board or without meeting various other conditions. In addition to the foregoing, other risk factors include: (i) the risks associated with an investment in a single company and all of the Company's businesses, assets and liabilities; (ii) the potential diverging interests of the classes of common stock; (iii) the lack of legal precedent with respect to the fiduciary duties of the board of directors of a company with a capital structure which includes tracking stocks, (iv) limited separate shareholder rights with respect to the classes of common stock; (v) the ability of the Board to change certain management and accounting policies without shareholder approval; (vi) the ability of the Board to transfer funds between the Groups; (vii) the Company's ability to issue authorized but unissued shares of stock without shareholder approval; and (viii) the potential effects of a possible Disposition of assets attributed to a Group; and (x) the lack of assurances as to the market price of the classes of stock following the Merger. See "Risk Factors." -12- SUMMARY COMPARISON OF THE CURRENT CAPITAL STRUCTURE WITH THE PROPOSED TRACKING STOCK PROPOSAL THE FOLLOWING SUMMARIZES THE TRACKING STOCK PROPOSAL AS COMPARED TO THE CURRENT CAPITAL STRUCTURE OF THE COMPANY. COMMON EQUITY INTERESTS IN BUSINESSES:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Common Shares and Series A Currently, the Common Shares and the Series A The Common Shares and Series A Common Shares, Common Shares (and Special Common Shares represent 100% of the common together with any issued Special Common Common Shares, if authorized equity of the Company Shares, would represent interests in the and issued) Company's common equity in the TDS Group. The TDS Group would consist of all businesses and assets of the Company other than the Cellular Group, the Telecom Group and the Aerial Group. In addition, upon completion of all of the Transactions as contemplated, the TDS Group would have approximately a 20% Retained Interest in each of the Cellular Group, the Telecom Group and the Aerial Group. Cellular Group Shares N/A The Cellular Group Shares, when issued, are intended to reflect the separate performance of the Cellular Group, which consists of the Company's interest in U.S. Cellular, currently an 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties. Upon the completion of the U.S. Cellular Merger, U.S. Cellular would become a wholly-owned subsidiary of the Company. Telecom Group Shares N/A The Telecom Group Shares, when issued, are intended to reflect the separate performance of the Telecom Group, which consists of the Company's interest in TDS Telecom, a wholly-owned subsidiary of the Company which operates landline telephone companies. The Telecom Group also includes the allocation of certain TDS debt. Aerial Group Shares N/A The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Group, which consists of the Company's interest in Aerial Communications, Inc., currently an 83%-owned subsidiary of the Company which is developing broadband personal communications services. Upon the completion of the Aerial Merger, Aerial would become a wholly-owned subsidiary of the Company.
-13- AUTHORIZED SHARES:
CURRENT CAPITAL TRACKING STOCK STRUCTURE PROPOSAL ----------------------- ---------------------- Preferred Shares 5,000,000 326,664(1) Undesignated Shares -- 4,673,336(1) ------------ ------------ SUBTOTAL 5,000,000 5,000,000 ------------ ------------ Common Shares 100,000,000 100,000,000 Series A Common Shares 25,000,000 25,000,000 Special Common Shares -- 20,000,000 Cellular Group Shares -- 140,000,000 Telecom Group Shares -- 90,000,000 Aerial Group Shares -- 95,000,000 ------------ ------------ SUBTOTAL 125,000,000 470,000,000 ------------ ------------ TOTAL AUTHORIZED SHARES 130,000,000 475,000,000 ------------ ------------ ------------ ------------
- ------------ (1) Based on shares issued and issuable at November 30, 1997; the actual numbers will be based on the number of outstanding Preferred Shares prior to the Merger. In the Merger, the issued Preferred Shares of TDS Iowa will be converted into Preferred Shares of TDS Delaware with substantially the same rights, limitations and preferences, except as described herein. The authorized but unissued Preferred Shares of TDS Iowa will be reclassified as Undesignated Shares of TDS Delaware. As so reclassified, the Undesignated Shares will authorize the Board to designate one or more series of common as well as preferred stock. Such reclassification will permit the Board to designate and issue new series of Tracking Stock, as well as preferred stock. See "Proposal 1-- Tracking Stock Proposal--Description of Restated Certificate of Incorporation of TDS Delaware." PRO FORMA SHARES (based on shares outstanding as of November 30, 1997, assuming shareholder approval of the Tracking Stock Proposal and assuming the Merger, the Distribution and the other Transactions):
CURRENT CAPITAL TRACKING STOCK STRUCTURE PROPOSAL PERCENT ----------------------- ---------------------- ----------- Preferred Shares Issued 296,664 296,664 Issuable 30,000 30,000 ----------- ----------- Total 326,664 326,664 ----------- ----------- ----------- ----------- Common Shares 53,878,129(2) 53,878,129 Series A Common Shares 6,933,233 6,933,233 ----------- ----------- Total Common and Series A Common Shares 60,811,362 60,811,362 ----------- ----------- ----------- ----------- Cellular Group Shares(3) Outstanding (75%) -- 60,811,362 60.8% Retained Interest (25%) -- 20,270,454 20.3% ----------- ----- Subtotal -- 81,081,816 81.1% U.S. Cellular Merger(4) -- 18,897,187 18.9% ----------- ----- Total -- 99,979,003 100.0% ----------- ----- ----------- ----- Telecom Group Shares(5) Outstanding (75%) -- 40,540,908 60.0% Retained Interest (25%) -- 13,513,636 20.0% ----------- ----- Subtotal -- 54,054,544 80.0% Telecom Public Offering (6) -- 13,500,000 20.0% ----------- ----- Total -- 67,554,544 100.0% ----------- ----- ----------- ----- Aerial Group Shares (7) Outstanding (75%) -- 40,540,908 61.9% Retained Interest (25%) -- 13,513,636 20.6% ----------- ----- Subtotal -- 54,054,544 82.5% Aerial Merger (8) -- 11,453,996 17.5% ----------- ----- Total -- 65,508,540 100.0% ----------- ----- ----------- -----
- ------------ (2) Includes 484,012 Common Shares held by a subsidiary of TDS. (3) The distribution ratio for the Cellular Group Shares is expected to be one Cellular Group Share for each outstanding Common Share and Series A Common Share. -14- (4) This amount is the product of the number of U.S. Cellular Common Shares outstanding on November 30, 1997 which are not held by TDS (16,487,822) and the exchange ratio offered by TDS (1.14613). The exchange ratio is equal to the quotient obtained by dividing the total number of Cellular Group Shares which would be deemed to be outstanding or held by the TDS Group pursuant to the Retained Interest immediately after the completion of the Merger and the Transactions as contemplated (99,979,003) by the total number of outstanding shares of U.S. Cellular as of November 30, 1997 (87,231,658). (5) The distribution ratio for the Telecom Shares is expected to be two-thirds of a Telecom Group Share for each outstanding Common Share and Series A Common Share. (6) The Company intends to offer between 10,000,000 and 17,000,000 Telecom Group Shares. For purposes of this Proxy Statement/ Prospectus, the midpoint of this amount is assumed for all purposes. (7) The distribution ratio for the Aerial Group Shares is proposed to be two-thirds of an Aerial Group Share for each outstanding Common Share and Series A Common Share. (8) This amount is the product of the number of Aerial Common Shares outstanding on November 30, 1997 which are not held by TDS (12,520,081) and the exchange ratio offered by TDS (.91485). The exchange ratio is equal to the quotient obtained by dividing the total number of Aerial Group Shares which would be deemed to be outstanding or held by the TDS Group pursuant to the Retained Interest immediately after the completion of the Merger and the Transactions as contemplated (65,508,540) by the total number of outstanding shares of Aerial as of November 30, 1997 (71,606,081). Since the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger are expected to precede the Distribution, after such other Transactions but before the Distribution, the initial Retained Interest of the TDS Group in each Tracking Group would be approximately 80% for the Telecom Group, 81% for the Cellular Group and 83% for the Aerial Group. Of the total equity of each Tracking Group, not including shares issuable pursuant to Convertible Securities, approximately 15-25% of the Telecom Group would be represented by the Telecom Group Shares issued in the Telecom Public Offering, 19% of the Cellular Group would be represented by the Cellular Group Shares issued in the U.S. Cellular Merger, and 17% of the Aerial Group would be represented by the Aerial Group Shares issued in the Aerial Merger. VOTING FOR DIRECTORS:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares issued before The holders of the Preferred Shares issued The holders of the Preferred Shares issued October 31, 1981 and Common before October 31, 1981 and Common Shares before October 31, 1981 and Common Shares Shares vote as a group in the election of 25% of the would vote as a group together with the directors (I.E., three directors based on a holders of shares of Tracking Stock and any Board of twelve directors). In such vote, issued Special Common Shares in the election each Preferred Share issued before October of 25% of the directors plus one additional 31, 1981 and Common Share is entitled to one director (I.E., four directors based on a vote in the election of directors. Board of twelve directors). In such vote, each Preferred Share issued before October 31, 1981 and Common Share will continue to be entitled to one vote in the election of directors. Preferred Shares issued after The holders of the Preferred Shares issued The holders of Preferred Shares issued after October 31, 1981 and Series A after October 31, 1981 and Series A Common October 31, 1981 and Series A Common Shares Common Shares Shares vote as a group in the election of 75% would vote as a group in the election 75% of of the directors (I.E., nine directors based the directors less one director (I.E., eight on a Board of twelve directors). In such directors based on a Board of twelve vote, each Series A Common Share is entitled directors). In such vote, each Series A to ten votes and each Preferred Share issued Common Share will continue to be entitled to after October 31, 1981 is entitled to one ten votes and each Preferred Share issued vote. after October 31, 1981 will continue to be entitled to one vote.
-15-
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Tracking Stock (and Special N/A The holders of Tracking Stock (and any issued Common Shares, if issued) Special Common Shares) would vote as a group together with the holders of Preferred Shares issued before October 31, 1981 and Common Shares (the "Public Holders") in the election of 25% of the directors plus one additional director (I.E., four directors based on a Board of twelve directors). In such vote, holders of any issued Special Common Shares would have one vote per share. Holders of Tracking Stock would initially have one vote per share. Thereafter, the number of votes which shares of each class of Tracking Stock would have in such vote would vary based on the average Market Capitalization of such class compared to the average Market Capitalization of all shares held by the Public Holders, calculated over the twenty-Trading Day period ending ten Trading Days prior to the record date for each annual meeting of shareholders. It is anticipated that the Cellular Group Shares would have more than one vote per share, and that the Telecom Group Shares and Aerial Group Shares would have approximately one vote per share based on anticipated market values, although this may change over time.
VOTING ON MATTERS OTHER THAN THE ELECTION OF DIRECTORS: CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares As set forth in the designation. All issued Preferred Shares would have one vote per share. Common Shares The Common Shares have one vote per share. The Common Shares would continue to have one vote per share. Series A Common Shares The Series A Common Shares have ten votes per The Series A Common Shares would continue to share. have ten votes per share. Tracking Stock (and Special N/A The shares of Tracking Stock (and Special Common Shares, if issued) Common Shares, if issued), would have no vote, except in the election of certain directors as discussed above and as required by law.
-16- PRO FORMA VOTING POWER ON MATTERS OTHER THAN THE ELECTION OF DIRECTORS (based on shares outstanding as of November 30, 1997, assuming the Distribution):
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL ----------------------- ----------------------- Preferred Shares 0.2% 0.2% Common Shares 43.6% 43.6% Series A Common Shares 56.2%(6) 56.2%(6) Tracking Stock (and Special N/A -0- Common Shares, if issued)
- ------------ (6) The TDS Voting Trust holds over 90% of the Series A Common Shares, representing over 50% of the voting power of TDS on matters other than the election of directors. The TDS Voting Trust would continue to control over 50% of the voting power of TDS with respect to matters other than the election of directors if the Tracking Stock Proposal, the Merger and all of the Transactions are implemented. DIVIDENDS:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares Preferred Shares have a senior preference to Issued Preferred Shares would continue to all common stock. Dividends on Preferred have a senior preference to all common stock. Shares are payable out of all assets of the Dividends on Preferred Shares are payable out Company legally available for the payment of of all assets of the Company legally dividends. available for the payment of dividends. However, dividends paid on the issued Preferred Shares will be notionally allocated to the TDS Group. Common Shares and Series A Common Shares are entitled to per share Common Shares would be entitled to the same Common Shares (and Special dividends which are the same as or greater per share dividends as any issued Special Common Shares, if authorized than the per share dividends on the Series A Common Shares and to per share dividends and issued) Common Shares. Subject to the Preferred Share which are the same as or greater than the per dividend preference, dividends on Common share dividends on the Series A Common Shares and Series A Common Shares are payable Shares. Subject to the Preferred Share out of all assets of the Company legally dividend preference, dividends on Common available for the payment of dividends. Shares, Special Common Shares and Series A Common Shares are payable out of the lesser of (i) the assets of the Company legally available for the payment of dividends and (ii) the TDS Group's Available Dividend Amount. Tracking Stock N/A Subject to the Preferred Share dividend preference, dividends on issued shares of a class of Tracking Stock would be payable only out of the lesser of (i) the assets of the Company legally available for the payment of dividends and (ii) such Tracking Group's Available Dividend Amount. The Available Dividend Amount for a Tracking Group is intended to be similar to an amount equal to the product of the Outstanding Interest Fraction and the amount of assets that would be available for the payment of dividends under Delaware law if such Tracking Group were a separate subsidiary.
-17- DIVIDEND POLICY ON COMMON STOCK:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Common Shares and Series A The Board of Directors currently pays an The Board initially intends to establish a Common Shares (and Special annual dividend of $0.42 per Common Share and policy of declaring an annual dividend of Common Shares, if authorized Series A Common Share. approximately $0.10 per Common Share and and issued) Series A Common Share. Special Common Shares, if issued, would be entitled to the same per share dividend as the Common Shares.(7) Cellular Group Shares N/A The Board currently does not intend to pay dividends on the Cellular Group Shares. Telecom Group Shares N/A The Board of Directors initially intends to establish a policy of declaring an annual dividend of approximately $0.48 per Telecom Group Share.(7) Aerial Group Shares N/A The Board currently does not intend to pay dividends on the Aerial Group Shares.
- --------- (7) After giving effect to the proposed two-thirds of one share distribution ratio for the Telecom Group Shares, the dividend of $0.48 per Telecom Group Share is equivalent to approximately $0.32 per existing Common Share or Series A Common Share (the "Telecom Equivalent Dividend Rate"). In addition, the Board intends to establish an annual dividend rate on the Common Shares and Series A Common Shares of $0.10 per share. The sum of this amount plus the Telecom Equivalent Dividend Rate is $0.42 per share per annum, which is the same as the current annual dividend on the existing Common Shares and Series A Common Shares. The intent is that, immediately after the Distribution, a current shareholder of the Company would continue to receive an aggregate dividend which is at least equal to the aggregate dividend such shareholder currently receives from the Company. -18- SHARE DIVIDENDS ON COMMON STOCK:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Common Shares and Series A May be distributed only as follows: (i) May be distributed only as follows: (i) Common Shares (and Special Common Shares may be distributed to holders Common Shares may be distributed on an equal Common Shares, if authorized of Common Shares and proportionately to per share basis to holders of Common Shares and issued) holders of Series A Common Shares; (ii) and holders of Series A Common Shares, and Series A Common Shares may be distributed to Special Common Shares may be distributed on holders of Common Shares and proportionately an equal per share basis to holders of to holders of Series A Common Shares; and Special Common Shares; (ii) Series A Common (iii) Common Shares may be distributed to Shares may be distributed on an equal per holders of Common Shares and Series A Common share basis to holders of Common Shares and Shares may be distributed proportionately to holders of Series A Common Shares, and holders of Series A Common Shares. Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares; (iii) Common Shares may be distributed on an equal per share basis to holders of Common Shares, Series A Common Shares may be distributed on an equal per share basis to holders of Series A Common Shares and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares; (iv) Special Common Shares may be distributed on an equal per share basis to the holders of Common Shares, Series A Common Shares and any issued Special Common Shares, and (v) shares of any class of Tracking Stock may be distributed on an equal per share basis to the holders of Common Shares, Series A Common Shares and Special Common Shares up to the amount of the Retained Interest in such shares of Tracking Stock. In addition, shares of a new class or series of stock which represents a subdivision or new business of the TDS Group, or any assets attributed by the Board to the TDS Group, could be distributed to the holders of Series A Common Shares, Common Shares and any issued Special Common Shares on an equal per share basis.
-19-
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Tracking Stock N/A Holders of shares of a class of Tracking Stock may receive shares of that same Tracking Stock, as well as shares of any other Tracking Stock up to the amount of the Inter-Group Interest in such other Tracking Stock. Holders of Tracking Stock may not receive any TDS Group Shares since a Tracking Group may not have an Inter-Group Interest in the TDS Group. In addition, shares of a new class or series of stock which represents a subdivision or new business of a Tracking Group, or any assets attributed by the Board to such Tracking Group, could be distributed to the holders of shares related to such Tracking Group on an equal per share basis.
DISTRIBUTION OF A TDS GROUP SUBSIDIARY: CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares As specified in the designation. As specified in the designation. Common Shares and Series A To the extent practicable, holders of Common To the extent practicable, holders of Common Common Shares (and Special Shares would receive subsidiary shares Shares would receive subsidiary shares Common Shares, if authorized corresponding to Common Shares, and holders corresponding to Common Shares, holders of and issued) of Series A Common Shares would receive Series A Common Shares would receive subsidiary shares corresponding to Series A subsidiary shares corresponding to Series A Common Shares. Common Shares and any issued Special Common Shares would receive subsidiary shares corresponding to Special Common Shares. Tracking Stock N/A Holders of Tracking Stock are not entitled to participate in the distribution of a subsidiary which is included in the TDS Group.
DISTRIBUTION OF A SUBSIDIARY OF A TRACKING GROUP (other than a Qualifying Subsidiary): CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares N/A N/A
-20- CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Common Shares and Series A N/A With respect to the distribution of a Common Shares (and Special subsidiary that is attributed to a Tracking Common Shares, if authorized Group, other than a Qualifying Subsidiary and issued) that holds all of the assets and liabilities of such Tracking Group, holders of Common Shares and Series A Common Shares, as well as any issued Special Common Shares, may, in the sole discretion of the Board, receive subsidiary shares up to the amount of the Retained Interest by the TDS Group in such Tracking Group. In such event, to the extent practicable, holders of Common Shares would receive subsidiary shares corresponding to the Common Shares, holders of Series A Common Shares would receive subsidiary shares corresponding to Series A Common Shares and holders of Special Common Shares, if any, would receive subsidiary shares corresponding to Special Common Shares. The Series A Common Shares, Common Shares and any issued Special Common Shares would be entitled to receive the same number of subsidiary shares per share which are distributed in respect of the Retained Interest in such Tracking Group. Tracking Stock N/A With respect to the distribution of a subsidiary that is attributed to a Tracking Group, other than a Qualifying Subsidiary that holds all of the assets and liabilities of such Tracking Group, to the extent practicable, the holders of Tracking Stock of such Tracking Group would generally receive subsidiary shares corresponding to Special Common Shares. Holders of shares of Tracking Stock of any other Group may, at the sole discretion of the Board, receive subsidiary shares corresponding to Special Common Shares, up to the amount of any Inter-Group Interest of such Group in the Tracking Group making the distribution of subsidiary shares.
-21- LIQUIDATION OF THE COMPANY:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares In the event of a liquidation of the Company, In the event of a liquidation of the Company, the Preferred Shares have a senior claim as the issued Preferred Shares will continue to to liquidation value plus accumulated have a senior claim as to liquidation value dividends. plus accumulated dividends. Common Shares and Series A In the event of a liquidation of the Company, In the event of a liquidation of the Company, Common Shares (and Special the Common Shares and Series A Common Shares the Common Shares and Series A Common Shares, Common Shares, if authorized would share pari passu any assets remaining and any issued Special Common Shares, would and issued) for distribution to holders of common stock. share any assets remaining for distribution to holders of common stock based upon Liquidation Units, with Common Shares, Series A Common Shares and any issued Special Common Shares each having one Liquidation Unit per share. Tracking Stock N/A In the event of a liquidation of the Company, the issued shares of each class of Tracking Stock would share any assets remaining for distribution to holders of common stock based upon Liquidation Units, with each Cellular Group Share having 2.5 Liquidation Units, each Telecom Group Share having 0.9 Liquidation Units and each Aerial Group Share having 1.1 Liquidation Units.
DISPOSITION OF SUBSTANTIALLY ALL ASSETS OF A TRACKING GROUP:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares N/A N/A Common Shares and Series A N/A In the event of a disposition of any assets Common Shares (and Special of a Tracking Group, the holders of Common Common Shares, if authorized Shares, Special Common Shares and Series A and issued) Common Shares would indirectly share pari passu any proceeds allocable to the Retained Interest of the TDS Group in such Tracking Group.
-22-
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Tracking Stock N/A In the event of a Disposition of all or substantially all of the properties and assets attributed to a Tracking Group (I.E., 80% or more on a current market value basis), other than in a transaction in which the Company receives primarily equity securities of an entity engaged or proposing to engage primarily in a business similar or complementary to the business of the Affected Tracking Group and certain other circumstances, the Company must either: (i) distribute to the holders of the affected Tracking Stock--by special dividend or by redemption of shares of outstanding Affected Tracking Stock--an amount in cash, securities or other property or any combination thereof equal to the proportionate interest of the outstanding Affected Tracking Stock in the Fair Value of the Net Proceeds of the Disposition; or (ii) convert each outstanding share of the Affected Tracking Stock into a number (or fraction) of Special Common Shares or shares of any other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) equal to 110% (the "Disposition Conversion Percentage") of the average daily ratio (calculated to the nearest five decimal places) of the Market Value of (A) one share of Affected Tracking Stock to (B) the Market Value of one Special Common Share or such other share of Tracking Stock (or any combination thereof on a pro rata basis) during a forty-Trading Day period beginning on the 11th Trading Day after consummation of the transaction.
-23-
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- The Company may, at any time prior to the first anniversary of a dividend on, or partial redemption of, a class of Tracking Stock following a Disposition of all or substantially all of the properties and assets attributed to such Tracking Stock, convert each outstanding share of such Tracking Stock into a number (or fraction) of Special Common Shares or shares of another class or classes of Tracking Stock, equal to the product of the Disposition Conversion Percentage and the average daily ratio of the Market Value of one share of the affected Tracking Stock to the Market Value of one Special Common Share or one share of such other Tracking Stock (or a combination thereof on a pro rata basis), calculated over the twenty-Trading Day period ending five Trading Days prior to the date of notice of such conversion. If there is no public market for the Special Common Shares at the time of such conversion, the Market Value per share will be deemed to be the same as the Common Shares.
REDEMPTION AT THE OPTION OF THE COMPANY(8):
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares Certain Preferred Shares are redeemable by Issued Preferred Shares which are redeemable their terms. by their terms will continue to be redeemable. Common Shares Not redeemable. Not generally redeemable. Series A Common Shares Not redeemable. Not redeemable. Special Common Shares N/A Not generally redeemable. Tracking Stock N/A The Company may redeem any class of Tracking Stock of a Tracking Group for a number of shares of one or more Qualifying Subsidiaries (that hold all of the assets and liabilities attributed to such Tracking Group) equal to the product of the Adjusted Outstanding Interest Fraction of such Tracking Group and the total number of shares of each of such Qualifying Subsidiaries held by the Company.
- ------------ (8) In addition to the redemption provisions described above, the Restated Certificate of TDS Delaware will permit shares of capital stock, other than the Series A Common Shares, to be redeemed by the Company, generally at fair market value, to the extent necessary to prevent the loss or secure the reinstatement of, or prevent the denial of applications for the renewal of, any license or franchise from any governmental agency. -24- CONVERSION AT THE OPTION OF THE COMPANY:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares Not convertible at the option of the Company. Not convertible at the option of the Company. Common Shares Not convertible at the option of the Company. Not convertible at the option of the Company. Series A Common Shares Not convertible at the option of the Company. Not convertible at the option of the Company. Special Common Shares N/A Not convertible at the option of the Company. Tracking Stock N/A The Company may, at any time, convert each share of Tracking Stock of any class into a number of Special Common Shares or shares of another class or classes of Tracking Stock or any combination thereof, equal to the Optional Conversion Percentage of the average daily ratio of the Market Value of one share of such Tracking Stock to be converted to the Market Value of one Special Common Share or share of such other class of Tracking Stock (or a combination thereof on a pro rata basis), calculated over the twenty-Trading Day period ending five Trading Days prior to the date of notice of such conversion. The initial Optional Conversion Percentage will be 115% and will remain fixed for a period of five years, and then will decline annually at a rate of 1% per year until the Optional Conversion Percentage is 110% on the ninth anniversary of the initial issuance date of the applicable Tracking Stock. If there is no public market for the Special Common Shares, the Market Value per share will be deemed to be the same as the Common Shares.
CONVERSION AT THE OPTION OF THE HOLDER:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares Certain series of Preferred Shares are The series that are currently convertible convertible into Common Shares. into Common Shares would continue to be convertible into Common Shares. In the event of the Distribution, such Preferred Shares would be convertible into Common Shares and a number of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares as if such Preferred Shares had been converted immediately prior to the Distribution. Common Shares N/A Not convertible.
-25-
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Series A Common Shares Convertible on a share-for-share basis into Convertible on a share-for-share basis into Common Shares. Common Shares or Special Common Shares. Special Common Shares N/A Not convertible. Tracking Stock N/A Not convertible.
PREEMPTIVE RIGHTS:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares None None Common Shares None None Series A Common Shares Series A Common shareholders have a Series A Common shareholders would continue preemptive right to purchase additional to have a preemptive right to purchase Series A Common Shares for cash. additional Series A Common Shares for cash. Special Common Shares N/A None Tracking Stock N/A None
PAR VALUE:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares No par value $0.01 Undesignated Shares N/A $0.01 Common Shares $1.00 $0.01 Series A Common Shares $1.00 $0.01 Special Common Shares N/A $0.01 Telecom Group Shares N/A $0.01 Cellular Group Shares N/A $0.01 Aerial Group Shares N/A $0.01
AMERICAN STOCK EXCHANGE ("AMEX") LISTING:
CURRENT CAPITAL STRUCTURE TRACKING STOCK PROPOSAL --------------------------------------------- --------------------------------------------- Preferred Shares Not Listed Not Listed Common Shares Listed on the AMEX under the symbol "TDS". Would continue to be listed on the AMEX under the symbol "TDS". Series A Common Shares Not listed, but convertible into Common Not listed, but convertible into Common Shares, which are listed. Shares, which are listed. Tracking Stock N/A Application is being filed to list all shares of Tracking Stock on the AMEX.
-26- SIGNIFICANT DIFFERENCES BETWEEN IOWA AND DELAWARE LAW THE FOLLOWING SUMMARIZES THE RIGHTS OF SHAREHOLDERS UNDER DELAWARE LAW AS COMPARED TO THE RIGHTS OF SHAREHOLDERS UNDER IOWA LAW:
PROVISION IOWA ARTICLES RESTATED DELAWARE CERTIFICATE - ------------------------ ------------------------------------ ------------------------------------ Increase in Authorized An increase or decrease in the As permitted by Delaware law, the Shares number of authorized shares of any Restated Certificate provides that class requires approval by the an increase or decrease in the holders of a majority of the number of authorized shares of any outstanding shares of such class and class may be approved by the holders any other class which is prior, of a majority of the voting power of superior or substantially equal to the outstanding shares of the such class, each voting as a Company entitled to vote in matters separate group (even if such shares other than the election of are nonvoting), and by the holders directors, voting as a single group. of the voting power of all shares of capital stock. Redemption of Shares to Iowa has no statute permitting the As permitted by Delaware law, the Protect Licenses redemption of shares to protect Restated Certificate provides that licenses. the Company may redeem certain shares of capital stock, generally at fair market value, to the extent necessary to prevent the loss or secure the reinstatement of, or to prevent the denial of applications for or the renewal of any license or franchise from any governmental agency. Voting Trust Under current Iowa law, a voting Delaware has no limitation on the trust cannot be established with a term of a voting trust. term of more than ten years after its effective date, unless extended. Election of Directors The election of a director requires The election of a director requires the affirmative vote of a majority the affirmative vote of a plurality of the votes cast by shares entitled of the voting power of shares to vote with respect to such present in person or represented by director. proxy at the meeting and entitled to vote with respect to such director. Removal of Directors Shareholders may remove one or more Unless the certificate of directors, with or without cause, incorporation provides otherwise, unless the articles of incorporation the shareholders may remove provide that directors may be directors of a corporation with a removed only for cause. The Articles classified board only for cause. The do not provide that directors may be Restated Certificate provides that removed only for cause. directors may be removed with cause by a majority vote of the shares entitled to vote in the election of such directors, or without cause upon a vote by 80% of the voting power of the shares entitled to vote in the election of such directors.
-27-
PROVISION IOWA ARTICLES RESTATED DELAWARE CERTIFICATE - ------------------------ ------------------------------------ ------------------------------------ Meetings of Shareholders Special meetings of shareholders may Special meetings of shareholders may be called by the board of directors, be called by the board of directors a person or persons so authorized by or such other person as may be the articles of incorporation or authorized by the certificate of bylaws, or by holders of at least incorporation or the bylaws. The fifty percent of the votes entitled Delaware Bylaws will authorize the to be cast on any issue proposed to Chairman, President or holders of at be considered at the special least fifty percent of the votes meeting. The TDS Iowa Bylaws provide entitled to be cast at a special that the principal executive officer meeting to call a special meeting. is authorized to call special meetings of shareholders. Shareholder Action by Unless otherwise provided in the Unless otherwise provided in the Written Consent articles of incorporation, certificate of incorporation, shareholder action may be taken shareholder action may be taken without a meeting or vote if a without a meeting or vote if a written consent is signed by the written consent is signed by the holders of outstanding shares having holders of outstanding shares having 90% of the votes entitled to be cast a majority of votes entitled to be at a meeting. The Articles do not cast at a meeting. The Restated provide otherwise. Certificate does not provide otherwise. Amendments to Charter An amendment to the articles of An amendment to the certificate of incorporation must be approved by a incorporation generally requires majority of the votes entitled to be approval by holders of a majority of cast by any voting group with the voting power of all outstanding respect to which the amendment would shares. Holders of shares of a class create dissenters' rights and a are entitled to vote as a class of majority of the votes cast by every capital stock on a proposed other voting group entitled to vote amendment if the amendment would on the amendment. In general, increase or decrease the par value holders of shares of a class of or alter the powers, preferences or capital stock are entitled to vote special rights of the shares of such as a separate group if the amendment class so as to affect them has any effect on such class, even adversely. if the articles provide that such shares are nonvoting. Share Exchanges, Mergers A share exchange or merger must be A merger or consolidation must be and Consolidations approved by holders of a majority of approved by the holders of a the voting power of all shares of majority of the voting power of the capital stock entitled to vote with outstanding shares entitled to vote respect to such matter and, in with respect to such matter. A general, by a majority of the shares merger or consolidation does not of each class of capital stock which require a separate class vote by any is affected in some manner by the class of capital stock. Delaware law share exchange or merger. Iowa law does not provide for mandatory share does not provide for consolidations. exchanges.
-28-
PROVISION IOWA ARTICLES RESTATED DELAWARE CERTIFICATE - ------------------------ ------------------------------------ ------------------------------------ Appraisal Rights Shareholders are entitled to dissent Shareholders are entitled to dissent from and obtain the fair value of and obtain the fair value of their their shares in the event of certain shares in connection with mergers or amendments to the articles of consolidations, provided that incorporation which materially and appraisal rights do not apply (i) to adversely affect rights in respect shareholders of a surviving of a dissenter's shares, and sales corporation if shareholder approval of all or substantially all of a is not required or (ii) as to any corporation's assets, share class of stock which is either exchanges and mergers which require listed on a national securities a shareholder vote. exchange or the Nasdaq national market, or held of record by more than 2,000 holders, unless shareholders are required to accept for their shares anything other than shares in the surviving corporation, shares in any other corporation that is similarly listed or held, and/or cash in lieu of fractional shares. Anti-Takeover Law A corporation is prohibited from A corporation is prohibited from engaging in a business combination engaging in a business combination with an interested shareholder for a with an interested shareholder for a period of three years following the period of three years following the time such person became interested time such person became interested unless approved by the board of unless approved by the board of directors before the shareholder directors before the shareholder became an interested shareholder, became an interested shareholder, approved by the board of directors approved by the board of directors and the holders of 66 2/3% of the and the holders of 66 2/3% of the outstanding voting stock not owned outstanding voting stock not owned by the interested shareholder after by the interested shareholder the shareholder became an interested (except by written consent) after shareholder or the interested the shareholder became an interested shareholder owned at least 85% of shareholder or the interested the voting stock outstanding upon shareholder owned at least 85% of consummation of the interested the voting stock outstanding upon shareholder transaction. TDS is consummation of the interested currently subject to this provision. shareholder transaction. As permitted by Delaware law, the Restated Certificate provides that TDS elects not to be governed by this provision. Dividends and Stock No distribution can be made if, Dividends may be paid out of any Repurchases after giving it effect, the surplus and, if none, any net corporation would not be able to pay profits for the fiscal year in which its debts as they become due in the the dividend was declared or the usual course of business or the preceding fiscal year. A corporation corporation's total assets would be may purchase or redeem shares only less than the sum of its total when its capital is not impaired and liabilities plus the amount that such purchase or redemption would would be needed to satisfy the not cause any impairment of the superior preferential rights of capital. shareholders upon dissolution. Transactions Involving A conflict of interest transaction A conflict of interest transaction Officers and Directors can be authorized, approved or can be authorized, approved or ratified by a committee of two or ratified by a committee of one or more disinterested directors or by a more disinterested directors or by a majority of the shares entitled to majority of the shares entitled to vote (excluding shares owned by or vote (including shares owned by or under the control of any interested under the control of any interested director). director).
-29- DISSENTERS' RIGHTS Shareholders of the Company whose shares are not voted in favor of the Tracking Stock Proposal and who otherwise duly take all action required by Iowa law will have statutory dissenters' rights under Iowa law. See "Proposal 1--Tracking Stock Proposal--Rights of Dissenting Shareholders." If, in the judgment of the Board, an excessive number of shareholders assert dissenters' rights, it is contemplated that the Board may abandon the Tracking Stock Proposal, even if it is approved by shareholders. SUMMARY SELECTED CONSOLIDATED AND GROUP FINANCIAL INFORMATION We are providing the following financial information to aid you in your analysis of the financial aspects of the Tracking Stock Proposal. We derived this information from audited financial statements for 1993 through 1997. The information is only a summary and you should read it in conjunction with the financial statements (and related notes) contained in Annexes I through V of this Proxy Statement/Prospectus. See also "Where You Can Find More Information" for information about other financial information incorporated by reference herein. SUMMARY TDS CONSOLIDATED FINANCIAL INFORMATION
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Operating Revenues............................................ $1,471,533 $1,179,857 $ 942,307 $ 726,036 $ 553,829 Net Income (Loss) Available to Common......................... (11,441) 126,182 101,469 57,362 31,510 Earnings Per Common Share - Basic............................. (.19) 2.09 1.77 1.08 0.67 Earnings per Common Share - Diluted........................... (.19) 2.07 1.74 1.06 .67 Dividends Per Common Share and Series A Common Share.......... .42 .40 .38 .36 .34 Total Assets.................................................. 4,971,601 4,200,969 3,469,082 2,790,127 2,259,182 Notes Payable................................................. 527,587 160,537 184,320 98,608 6,309 Long-term Debt (including current portion).................... 1,279,034 1,018,851 894,584 562,165 537,566 Redeemable Preferred Shares (including current portion)....... 1,479 1,858 15,093 25,001 27,367 Common Stockholders' Equity................................... $1,968,119 $2,032,941 $1,684,365 $1,473,038 $1,224,285
SUMMARY FINANCIAL INFORMATION OF TDS GROUP
YEAR ENDED OR AT DECEMBER 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) Net Income...................................................... $ 52,968 $ 47,540 $ 22,691 $ 26,052 $ 30,972 Net Income Available to Common and Series A Common Shares....... 51,076 45,583 20,182 23,594 28,586 Total Assets.................................................... 1,519,829 1,079,975 1,006,728 1,038,484 802,280 Notes Payable - Affiliates...................................... 165,686 201,641 186,786 128,530 123,511 Notes Payable - Other........................................... 530,175 159,162 182,625 97,724 6,059 TDS Group Equity................................................ $ 602,471 $ 642,005 $ 509,421 $ 683,783 $ 613,607
-30- SUMMARY FINANCIAL INFORMATION OF CELLULAR GROUP
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Operating Revenues............................................ $ 876,965 $ 680,068 $ 480,316 $ 327,630 $ 210,344 Net Income (Loss)............................................. 111,539 129,929 99,742 16,393 (25,441) Total Assets.................................................. 2,508,916 2,085,899 1,880,144 1,534,787 1,245,396 Long-term Debt (including current portion).................... 515,330 353,761 355,748 302,218 204,455 Cellular Group Equity......................................... $1,629,320 $1,476,202 $1,329,454 $1,093,967 $ 940,128
SUMMARY FINANCIAL INFORMATION OF TELECOM GROUP
YEAR ENDED OR AT DECEMBER 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) Operating Revenues.............................................. $ 444,203 $ 395,602 $ 354,841 $ 306,341 $ 268,122 Net Income...................................................... 30,388 35,694 34,155 32,654 25,134 Total Assets.................................................... 1,406,048 1,352,929 1,228,232 1,138,242 959,582 Notes Payable................................................... 28,181 25,039 15,784 15,059 12,080 Long-term Debt (including current portion)...................... 563,374 560,844 536,379 492,946 470,257 Long-term Debt-affiliated....................................... 255,302 239,538 233,176 224,742 228,540 Telecom Group Equity............................................ $ 383,759 $ 343,816 $ 265,387 $ 228,800 $ 107,298
SUMMARY FINANCIAL INFORMATION OF AERIAL GROUP
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ---------- ---------- ---------- --------- (DOLLARS IN THOUSANDS) Operating Revenues............................................. $ 55,952 $ -- $ -- $ -- $ -- Net (Loss)..................................................... (247,057) (37,921) (6,468) (1,283) (67) Total Assets................................................... 960,648 672,827 360,444 21,320 512 Long-term Debt (Revolving Credit Agreement--TDS)............... 448,234 -- 60,238 22,659 650 Long-term Debt................................................. 196,439 103,743 -- -- -- Aerial Group Equity (Deficit).................................. $ 192,427 $ 437,785 $ 281,282 $ (1,444) $ (161)
-31- RISK FACTORS You should consider the following factors, in addition to the other information contained elsewhere in this Proxy Statement/Prospectus and the Exhibits and Appendices hereto, in connection with the Tracking Stock Proposal. For definitions of certain defined terms, see "Proposal 1--Tracking Stock Proposal--Certain Definitions" and Exhibit G--Index of Certain Defined Terms. SHAREHOLDERS OF ONE COMPANY; FINANCIAL EFFECTS OF ONE GROUP COULD ADVERSELY AFFECT THE OTHER GROUPS Notwithstanding the attribution of assets and liabilities (including contingent liabilities) and shareholders' equity among the Groups for the purpose of preparing their respective financial statements, the change in the capital structure of the Company contemplated by the Tracking Stock Proposal will not affect legal title to such assets or responsibility for such liabilities of the Company or any of its subsidiaries, except that TDS Delaware will succeed to all of the franchises, rights, assets and liabilities of TDS Iowa. Financial impacts arising from the TDS Group, the Cellular Group, the Telecom Group or the Aerial Group that affect the consolidated results of operations or financial position of the Company could affect the results of operations or financial position of the other Groups. Moreover, any net losses of the TDS Group, the Cellular Group, the Telecom Group or the Aerial Group, and any distributions on, or repurchases of, any shares of capital stock will reduce the funds of the Company legally available for the payment of dividends on all classes and series of common stock of the Company. Accordingly, the TDS Group, Cellular Group, Telecom Group and Aerial Group financial information should be read in conjunction with the Company's consolidated financial information. The Company will continue to prepare consolidated financial statements and also provide such consolidated financial statements to the holders of each of the Tracking Stocks. If the Tracking Stock Proposal is approved, the Company will provide to shareholders of each of the TDS Group, Cellular Group, Telecom Group and Aerial Group separate financial statements, financial reviews, descriptions of businesses and other relevant information for the respective Group, together with the Company's consolidated financial statements. Upon request, the Company will provide to any shareholder of a Group a copy of the separate combined financial statements related to any of the other Groups. LIMITED SEPARATE SHAREHOLDER RIGHTS Under the Tracking Stock Proposal, holders of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares would not have any legal rights specifically related to the assets attributed to the Cellular Group, Telecom Group or Aerial Group, respectively, and the holders of Common Shares and Series A Common Shares would not have any legal rights specifically related to the TDS Group, except as described herein. Holders of Tracking Stock will be common shareholders of the Company, and will continue to be subject to all the risks associated with an investment in the Company and all of its businesses and liabilities. The Company and its subsidiaries will continue to be responsible for each of their respective liabilities. CHANGES IN VOTING FOR DIRECTORS At present, the holders of Series A Common Shares and Preferred Shares issued after October 31, 1981 which have voting rights, voting as a group, elect all of the directors (nine out of twelve directors) who are not elected by the holders of Common Shares and Preferred Shares issued prior to October 31, 1981 (three out of twelve directors). After the Merger, holders of Preferred Shares issued before October 31, 1981 and Common Shares will vote as a group with the holders of any issued Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as any issued Special Common Shares, in the election of 25% of the directors (rounded up) plus one additional director (or four of the twelve present directors). As a result, holders of Preferred Shares issued after October 31, 1981 and Series A Common Shares as such will be entitled to vote in the election of one less director (I.E., eight of the twelve present directors). See "Proposal 1--Tracking Stock Proposal--Description of Restated Certificate of Incorporation of TDS Delaware--Voting Rights." LIMITED VOTING RIGHTS; VARIABLE VOTING RIGHTS Under the Tracking Stock Proposal, holders of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares will not have any right to vote on matters other than the election of certain directors, except as otherwise required by law. Accordingly, actions submitted to a vote of shareholders other than the election of directors will generally be voted on only by holders of Common Shares, Series A Common Shares and series of Preferred Shares which have voting rights. Under the Restated Certificate, only the affirmative vote of the holders of a majority of the -32- outstanding voting power of the Common Shares, Series A Common Shares and such voting Preferred Shares, voting as a group, will be required to amend the Restated Certificate, approve any merger or consolidation of TDS with or into any other corporation, approve the dissolution of TDS or approve any other matter required to be voted on by shareholders, except as required under the DGCL. Under the DGCL, the holders of the outstanding shares of a class are entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the Restated Certificate, if the amendment would increase or decrease the par value of the shares of such class or alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely. As permitted by the DGCL, the Restated Certificate will permit the number of authorized shares of any class of capital stock to be increased or decreased (but not below the number of shares then outstanding in such class, respectively) by the affirmative vote of a majority of the voting power of the shares of capital stock entitled to vote with respect to such matter, voting together as one group. When a vote is taken on any matter as to which all stock is voting together as one group, any one or more classes entitled to more than the number of votes required to approve such matter will be in a position to control the outcome of the vote on such matter. Certain matters on which holders of common stock would vote together as a single class could involve a divergence or the appearance of a divergence of the interests between the holders of classes of common stock. The Restated Certificate does not require that a merger or consolidation of the Company requiring the approval of the Company's shareholders be approved by a separate class vote of holders of any class of capital stock. As a result, the TDS Voting Trust, as the holder of Series A Common Shares representing a majority of the voting power of the Company, could approve a merger of the Company without a class vote by any class of capital stock. The relative voting power of shares of Tracking Stock in the election of directors elected by the Public Holders would fluctuate from time to time, with each share of a class of Tracking Stock having a variable number of votes, based upon the ratio, over a specified period, of the average Market Capitalization of such class of Tracking Stock to the average Market Capitalization of all classes of stock voting in the election of directors elected by the Public Holders. This formula is intended to equate the proportionate voting rights of each class of stock to their respective Market Capitalizations at the time of each annual meeting of shareholders. The Market Capitalization of the classes of stock could be influenced by many factors, including the results of operations of the Company and each of the Groups, the regulatory environment, trading volume, share issuances and repurchases and general economic and market conditions. Such changes in the aggregate votes or relative voting power of the Tracking Stock could result from the market's reaction to a decision by the Company's management or Board that is perceived to disparately affect one class of common stock in comparison to another. See "Proposal 1--Tracking Stock Proposal--Description of Terms of Tracking Stock--Voting Rights." POTENTIAL DIVERGENCE OF INTERESTS; NO SPECIFIC PROCEDURES FOR RESOLUTION Occasions may arise when the interests of the holders of one Tracking Stock and the holders of the other Tracking Stocks or Common Shares and Series A Common Shares, or some combination thereof, may diverge or appear to diverge. Examples include, among others, determinations by the Board to (i) redeem the shares of a class of Tracking Stock, (ii) approve the disposition of all or substantially all of the properties and assets of one of the Tracking Groups, (iii) allocate consideration to be received by holders of common stock in connection with a merger or consolidation involving the Company among holders of different classes of common stock, (iv) allocate resources and financial support to or pursue business opportunities or operational strategies through one Group instead of one or more of the other Groups, (v) if and to the extent there is either a Retained Interest or an Inter-Group Interest, allocate the proceeds of future issuances of the Tracking Stock as a reduction (a) in a Retained Interest or Inter-Group Interest (as the case may be) in the issuing Tracking Group or (b) to the equity of the issuing Tracking Group, (vi) pay or omit dividends on any class of common stock or (vii) approve transactions involving the transfer of funds or assets from one Group to one or more of the other Groups or make other operational or financial decisions with respect to one Group that could be considered to be detrimental to one or more of the other Groups. As described under "Management and Allocation Policies," procedures have been adopted for consideration of matters involving a divergence of interests among the holders of the Company's common stock; however, these policies could be modified or rescinded by the Board, in its sole discretion, without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies. The Board intends to exercise its judgment from time to time, depending on the circumstances, as to how best to obtain information regarding the divergence (or potential divergence) of interests, under what circumstances to seek the assistance of outside advisors, whether a committee of the Board should be appointed to address the matter and how to assess which available alternative is in the best interests of the Company and all of its shareholders. The Board believes the -33- advantages of retaining flexibility in determining how best to fulfill its responsibilities in such circumstances as they may arise outweigh any perceived advantages from attempting to adopt specific procedures in advance to cover all conceivable circumstances. Disproportionate ownership interests of members of the Board in one or more classes of common stock of the Company or disparate values of the classes of common stock of the Company held by directors could create or appear to create potential conflicts of interest when directors are faced with decisions that could have different implications for different classes. Nevertheless, the Company believes that a director would be able to discharge his or her fiduciary duties even if his or her interests in shares of the classes of common stock were disproportionate and/or had disparate values. The Company's counsel has advised the Company that there is no definitive precedent directly concerning the manner in which Delaware law would be applied to a board of directors' duties in the context of a capital structure which includes tracking stock with divergent interests. The Company has been advised by counsel that, in general, under existing Delaware case law, disinterested directors would be deemed to have satisfied their duty of care to the Company and its shareholders if they act in good faith with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner such directors reasonably believe to be in the best interests of the Company. Based on the advice of counsel, the Company believes that, under Delaware law, a good faith determination by a disinterested and adequately informed Board, or a committee thereof, which discharges such duty, and which the directors honestly believe is in the best interests of the Company and its shareholders, would be a defense to any challenge by or on behalf of the holders of any class of common stock to any determination by the Board that could have a disparate effect on any class of common stock. NO ASSURANCE OF PAYMENT OF DIVIDENDS Dividends on each of the classes of common stock would be payable out of the lesser of assets of the Company legally available therefor and the Available Dividend Amount for that Group. Subject to the foregoing provisions, and notwithstanding the Available Dividend Amount for any Group, the respective amounts of prior dividends paid on, or liquidation rights of, any shares of common stock, or any other factor, dividends may be declared and paid on the Common Shares, the Series A Common Shares, any Special Common Shares that may be issued in the future, the Telecom Group Shares, the Cellular Group Shares and/or the Aerial Group Shares in equal or unequal amounts (with the exception that dividends paid on Common Shares and any Special Common Shares that may be issued in the future must always be the same per share and equal to or greater than the per share dividend on the Series A Common Shares). Any decision to pay dividends will depend on the financial condition, results of operations and business requirements of the Company as a whole. In making a determination as to the allocation of any dividends among the classes or series of common stock, the Board expects to follow a policy under which it will consider, among other factors, the relative financial condition, results of operations and business requirements of the respective Groups. See "Dividend Policy." If any of the TDS Group, the Telecom Group, the Cellular Group or the Aerial Group incurs a net loss, the assets legally available for payment of dividends on all classes of common stock would be reduced. In addition, payment of dividends or distributions on any class of common stock will decrease the amount of funds available under the limitations described above for the payment of dividends on all classes of common stock. ALLOCATION OF PROCEEDS OF MERGERS OR CONSOLIDATIONS The Restated Certificate does not contain any provisions governing how consideration to be received by the Company's shareholders in connection with a merger or consolidation involving the Company (in which the common stock is to be converted into other securities, cash or other property) is to be allocated among holders of the various classes or series of common stock, except that, in general, holders of Common Shares and Special Common Shares are entitled to receive the same consideration per share in any merger or consolidation of TDS. In any such merger or consolidation, the allocation of consideration would be determined by the Board and would be subject to approval by a majority of the voting power of all shares of capital stock of the Company, voting together as one group. At the present time, the TDS Voting Trust controls a majority of the voting power of all shares of capital stock. See "--Control by Voting Trust." OPTIONAL CONVERSION OF TRACKING STOCK The Company could, at any time, in the sole discretion of its Board, determine to convert each outstanding share of a class of Tracking Stock for shares of another class or classes of Tracking Stock or Special Common -34- Shares at a predetermined premium. The determination by the Board to redeem shares of a class of Tracking Stock for shares of another class or classes of Tracking Stock or Special Common Shares or a combination thereof could be made at a time when any class of the Company's stock may be considered to be overvalued or undervalued, or at a time when there is no public market for any class of stock. In addition, any such redemption would preclude holders of the redeemed Tracking Stock from retaining their investment in a security that is intended to reflect separately the performance of the related Tracking Group. See "Proposal 1--Tracking Stock Proposal--Description of Terms of Tracking Stock--Conversion at Option of Company." DISPOSITION OF TRACKING GROUP ASSETS As long as the assets of a Group continue to represent less than substantially all of the properties and assets of the Company, the Board may approve sales and other dispositions of any amount of the properties and assets of such Group without shareholder approval, because under the DGCL and the Restated Certificate shareholder approval is required only for a sale or other disposition of all or substantially all of the properties and assets of the Company as a whole. In the event of a Disposition of substantially all of the properties or assets attributed to a Tracking Group, except under certain circumstances, the Company must distribute the Fair Value of the Net Proceeds from the Disposition or exchange each share of that Tracking Stock for shares of another class or classes of Tracking Stock or Special Common Shares or a combination thereof at a predetermined premium, at the option of the Board. The determination by the Board to exchange shares of Tracking Stock for shares of another class or classes of Tracking Stock and/or Special Common Shares could be made at a time when any class of the Company's stock may be considered to be overvalued or undervalued, or at a time when there is no public market for any class of stock. Any consideration which holders of Tracking Stock may receive in connection with the Disposition of all or substantially all of the properties or assets attributed to a Tracking Group may not correspond to what such holders would receive if they held equity interests directly in the Tracking Group. In addition, any such exchange would preclude holders of the redeemed Tracking Stock from retaining their investment in a security that is intended to reflect separately the performance of that Tracking Group. The term "Fair Value of the Net Proceeds" means the fair value of the gross proceeds of a Disposition after payment of or provision for certain specified costs, including taxes related to the Disposition or such dividend or redemption, transaction costs and liabilities and other obligations (contingent or otherwise), including obligations in respect of Preferred Shares and Convertible Securities (without duplication) attributed to the Tracking Group involved in the Disposition. See "--Certain Definitions." If such Tracking Group were a separate independent company and its shares were acquired by another person, certain of those costs, including corporate and shareholder level taxes, might not be payable in connection with such an acquisition. As a result, the consideration that would be received by shareholders of such a separate independent company in connection with such a stock acquisition might be greater than the Fair Value of the Net Proceeds that would be received by holders of Tracking Stock if all or substantially all of the properties and assets of the related Tracking Group were sold. In addition, no assurance can be given that the Fair Value of the Net Proceeds per share of Tracking Stock to be received in connection with a Disposition of all or substantially all of the properties and assets of a Tracking Group will be equal to or more than the Market Value per share of such Tracking Stock prior to or after announcement of such Disposition. See "Proposal 1--Tracking Stock Proposal--Description of Terms of Tracking Stock--Disposition of Assets of Tracking Group." ALLOCATION OF PROCEEDS UPON SUBSEQUENT ISSUANCES OF TRACKING STOCK If and to the extent that, at the time of any issuance of shares of Tracking Stock, (i) the TDS Group has a Retained Interest in a Tracking Group or (ii) another Tracking Group has an Inter-Group Interest in a Tracking Group, the Board would determine the allocation of the proceeds of such issuance among the TDS Group, the other Tracking Group which holds the Inter-Group Interest and the shareholders' equity of the Tracking Group, the shares of which are being issued. Any such allocation of net proceeds to the TDS Group would reduce the Retained Interest and any allocation to a Tracking Group holding an Inter-Group Interest would reduce the Inter-Group Interest. See "Proposal 1--Tracking Stock Proposal--Description of Terms of Tracking Stock." PUBLIC POLICY DETERMINATIONS Because of the nature of the Company's businesses, the Groups may have diverging interests as to the position the Company should take with respect to various regulatory issues. For example, Federal Communications Commission regulations which may advance the interests of the Telecom Group may not advance the interests of -35- the Cellular Group or Aerial Group. In addition, increasing overlap between the businesses of the two Groups resulting from regulatory changes and technological advancements may increase such conflicts. The Board will cause policies and procedures to be implemented to resolve any such conflicts. In the event any such conflict cannot be resolved or otherwise requires resolution by the Board, the Board would resolve such conflict in accordance with its good faith business judgment of the best interests of the Company and all of its shareholders. MANAGEMENT AND ALLOCATION POLICIES The Board has adopted certain management and allocation policies described herein with respect to cash management, corporate expenses and inter-Group transactions, any and all of which could be modified or rescinded by the Board, in its sole discretion, without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. The Board could decide to modify or rescind such policies, or to adopt additional policies, and any such decision could have disparate effects upon holders of shares of any class or series of common stock. The Board could also allocate resources and financial support to or pursue business opportunities or operational strategies through one Group instead of the other Groups. The decision to allocate resources and financial support to one Group may adversely affect the ability of the other Groups to obtain funds sufficient to implement their business strategies. In making such determination, the Board may also consider regulatory requirements, including those imposed by the public utility commissions of various states and the Federal Communications Commission. See "Proposal 1--Tracking Stock Proposal--Management and Allocation Policies." TERMINATION OF EXISTING INTERCOMPANY AGREEMENTS Subject to the consummation of the U.S. Cellular Merger and the Aerial Merger, or other transactions pursuant to which U.S. Cellular or Aerial become wholly-owned subsidiaries of the Company, the Company intends to terminate certain intercompany agreements between the Company and U.S. Cellular and Aerial, respectively. Thereafter, all of the relationships between the Company and such subsidiaries would be determined solely under the management and allocation policies described herein, similarly to TDS Telecom, which is currently a wholly-owned subsidiary of TDS. Many of such policies would continue the arrangements which presently exist between the Company and U.S. Cellular or Aerial pursuant to the intercompany agreements, but the Company would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. See "Proposal 1--Tracking Stock Proposal--Management and Allocation Policies." TRANSFER OF FUNDS AMONG GROUPS; EQUITY CONTRIBUTIONS If the Tracking Stock Proposal is approved by shareholders, all debt incurred or preferred stock issued by the Company and its subsidiaries following the issuance by the Company of the Tracking Stock would be (unless the Board otherwise provides) specifically attributed to and reflected in the combined financial statements of the Tracking Group that includes the entity which incurred the debt or issued the preferred stock or, in case of debt or preferred stock that is not specifically attributed to one of the Tracking Groups, the TDS Group. The Board could, however, determine from time to time that debt incurred or preferred stock issued by entities included in a Group should be specifically attributed to and reflected in the combined financial statements of one of the other Groups to the extent that the debt is incurred or the preferred stock is issued for the benefit of such other Group. To the extent cash needs of one Group exceed cash provided by such Group, one of the other Groups may transfer funds to such other Group. The Company has provided and will continue to provide centralized cash management functions under which cash receipts of certain entities included in the Groups are remitted to the TDS Group and certain cash disbursements of the other Groups will be funded by the TDS Group on a daily basis. Such transfers of funds between the Groups will be reflected as borrowings or, if determined by the Board, in the case of a transfer from the TDS Group or one of the other Groups, as the case may be, to another Group, reflected as the creation of a Retained Interest or Inter-Group Interest, as the case may be, in the recipient Group, or as an increase or decrease in any such existing interest. There are no specific criteria for determining when a transfer will be reflected as a borrowing or as the creation of, or an increase or reduction in, a Retained Interest or an Inter-Group Interest. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. -36- Generally, it is expected that the entities included in each of the Groups will seek their own long-term debt financing. However, the Board may permit a Group with excess funds to lend such funds to another Group which requires funds. Loans from one Group to another Group would bear interest at such rates and have such repayment schedules and other terms as are established from time to time by, or pursuant to procedures established by, the Board. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the use of proceeds by and creditworthiness of the recipient Group, the capital expenditure plans and investment opportunities available to each Group and the availability, cost and time associated with alternative financing sources. Although the creation of or any increase in a Retained Interest or an Inter-Group Interest resulting from an equity contribution by the TDS Group or another Group to a particular Tracking Group (or any decrease in such Retained Interest or Inter-Group Interest) would be determined by reference to the Market Value of the applicable Tracking Stock as of the date of such event, an increase (or decrease) could occur at a time when such Tracking Group's shares could be considered undervalued or overvalued. ABSENCE OF APPROVAL RIGHTS WITH RESPECT TO FUTURE ISSUANCES OF AUTHORIZED SHARES The authorized but unissued shares of capital stock of the Company will be available for issuance from time to time at the sole discretion of the Board for any proper corporate purpose. Such issuances could include Common Shares, Series A Common Shares, Cellular Group Shares, Telecom Group Shares, Aerial Group Shares, Special Common Shares, or a combination thereof, as well as the issuance of such shares upon the conversion or exercise of securities of the Company that are convertible into or exercisable or exchangeable for such shares. In addition, the Board will be able to designate and issue series of common or preferred stock from the authorized but unissued Undesignated Shares. The approval of the shareholders of the Company will not be sought by the Company for the issuance of authorized but unissued shares of any class of capital stock (or the reissuance of previously issued shares that have been reacquired by the Company) or securities of the Company that are convertible into or exercisable or exchangeable for such shares, unless deemed advisable by the Board or required by applicable law, regulation or AMEX requirements. The Company has no current plans to issue any shares of Tracking Stock except in connection with the Transactions and as otherwise described herein. The Company has no current plans to issue any Special Common Shares or to designate any series of Undesignated Shares. In addition, as permitted by Delaware law, the Restated Certificate will permit the number of authorized shares of any class of capital stock to be increased or decreased (but not below the number of shares then outstanding in such class, respectively) by the affirmative vote of the holders of a majority of the voting power of the shares of capital stock of the Company entitled to vote with respect to such matter. No similar authority exists under Iowa law. The TDS Voting Trust (as defined below) presently holds a majority of the voting power of the Company. This provision could allow TDS Delaware to authorize and issue shares of capital stock under circumstances which could preserve the ability of the TDS Voting Trust to continue to exercise control over a majority of the voting power of TDS Delaware and, therefore, could deprive shareholders of TDS of an opportunity to sell their shares at a premium over market prices or make it more difficult to replace the current Board and management of TDS Delaware. The Company has no current intention to take any action to authorize any additional shares of capital stock, other than as described herein. See "Proposal 1--Tracking Stock Proposal--Description of Restated Certificate of Incorporation of TDS Delaware." CONTROL BY VOTING TRUST A substantial majority of the outstanding Series A Common Shares are held in a voting trust which expires on June 30, 2009 (herein referred to as the "TDS Voting Trust"). See "Security Ownership of Management." The TDS Voting Trust was created to facilitate the long-standing relationships among the trustees' certificate holders. By virtue of the number of shares held by them, the voting trustees have the power to elect approximately 75% of the directors, or nine directors based on the current size of the Board, and control a majority of the voting power of the Company with respect to matters other than the election of directors. The Tracking Stock Proposal will not alter the TDS Voting Trust's present control of TDS. However, assuming adoption of the Tracking Stock Proposal, after the Merger the voting trustees would have the power to elect eight, rather than nine, directors, based on the current size of the Board. As of November 30, 1997, the TDS Voting Trust had voting or dispositive power over an aggregate of 6,334,473 Series A Common Shares, representing approximately 51.8% of the voting power of TDS with respect to matters other than the election of directors. Based on such shares, the TDS Voting Trust would receive 6,334,473 Delaware -37- Series A Common Shares in the Merger and an aggregate of 6,334,473 Cellular Group Shares, 4,222,982 Telecom Group Shares and 4,222,982 Aerial Group Shares in connection with the Distribution. Under the current terms of the TDS Voting Trust, such shares of Tracking Stock will be distributed by the trustees to the beneficiaries. Following the Distribution, and after the distribution of all of the Cellular Group Shares, Telecom Group Shares and Aerial Group Shares received by the TDS Voting Trust to the beneficiaries thereof, the TDS Voting Trust would continue to have at least 51.8% of the aggregate voting power of the Company with respect to all matters other than the election of directors and will be able to elect eight of the twelve directors, assuming no other changes. ANTI-TAKEOVER CONSIDERATIONS The existence of the TDS Voting Trust is likely to deter any potential unsolicited or hostile takeover attempts or other efforts to obtain control of TDS and may make it more difficult for shareholders to sell shares of TDS at higher than market prices. Regardless of whether the Tracking Stock Proposal is implemented, the trustees of the TDS Voting Trust have advised the Company that they intend to maintain the ability to keep or dispose of voting control of TDS. Implementation of the Tracking Stock Proposal will allow TDS to issue Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as Special Common Shares, which would not vote except in the election of certain directors and as required by law. This may preserve the ability of the TDS Voting Trust to continue to exercise control over a majority of TDS's voting power. Assuming TDS were to continue to issue additional common stock, implementation of the Tracking Stock Proposal and the Distribution is likely to limit or deter a merger proposal or tender offer that is not acceptable to the TDS Voting Trust. Consequently, the Tracking Stock Proposal and the Distribution might deprive shareholders of TDS of an opportunity to sell their shares at a premium over prevailing market prices and make it more difficult to replace the current Board and management of TDS. The Restated Certificate and the Company's Bylaws also contain provisions which may serve to discourage or make more difficult a change in control of the Company without the support of the Board or without meeting various other conditions. In particular, the Restated Certificate includes a provision, similar to a provision currently included in the Articles, which authorizes the Board to consider various factors, including effects on customers, taxes, and the long-term and short-term interests of the Company, in the context of a proposal or offer to acquire or merge the corporation, or to sell its assets, and to reject such offer if the Board determines that the proposal is not in the best interests of the corporation based on such factors. In addition, the existence of the Tracking Stocks could present complexities and could in certain circumstances pose obstacles, financial and otherwise, to an acquiring person. The provisions of the Restated Certificate and the Bylaws of TDS Delaware and the existence of the Tracking Stocks could, under certain circumstances, prevent shareholders from profiting from an increase in the market value of their shares as a result of a change in control of the Company by delaying or preventing such change in control. Like the Articles, the Restated Certificate divides the Board into three classes, with staggered terms of office. Each year, one class is elected for a three-year term. This may have the effect of limiting or deterring a proxy contest for the removal of incumbent directors. TDS is not aware of any current intention of the TDS Voting Trust to dispose of any significant amount of Series A Common Shares of TDS or of any existing or planned effort on the part of any party to accumulate material amounts of Common Shares or Series A Common Shares, or to acquire control of TDS by means of a merger, tender offer, solicitation in opposition to management or otherwise, or to change TDS's management. NO ASSURANCES AS TO MARKET PRICE Because there has been no prior market for the Cellular Group Shares, the Telecom Group Shares or the Aerial Group Shares, there can be no assurance as to the market price of such shares following issuance thereof. There can be no assurance that the combined market values of the Common Shares, Cellular Group Shares, Telecom Group Shares and Aerial Group Shares held by a shareholder immediately following the Distribution of the Tracking Stocks will equal or exceed the market value of the Common Shares held by such shareholder prior to the Company's announcement of the Tracking Stock Proposal, and the combined market value could be less than such market value of the Common Shares. Until an orderly market develops for the Tracking Stocks, their respective trading prices may fluctuate significantly. If an active trading market does develop in any of such shares, there can be no assurance that it will be maintained. The prices at which the shares of Tracking Stock will trade will be determined in the trading markets and may be influenced by many factors, including the consolidated results of the Company, as well as the respective performance of the TDS Group, Cellular Group, Telecom Group and Aerial Group, investors' expectations for the Company and each Group, trading volume and general economic and market conditions. There is no assurance that investors will assign value to each of the Tracking Stocks based on the reported financial results and fundamental operating prospects of the related Group. Financial effects of the -38- Groups that affect the Company's consolidated results of operations or financial condition could affect the market prices of the Common Shares, Cellular Group Shares, Telecom Group Shares and Aerial Group Shares. In addition, the Company cannot predict the impact on the market values of each of the Tracking Stocks of certain terms of the securities, such as the ability of the Company to convert or redeem shares of the Tracking Stocks, the discretion of the Board to make various determinations or the impact on the market value of each of the Tracking Stocks of its voting power. LIMITATIONS AND QUALIFICATIONS IN FINANCIAL ADVISOR OPINIONS The Company has received an opinion from each of the Financial Advisors which states that, assuming the proposed Telecom Public Offering, U.S. Cellular Merger, Aerial Merger, Distribution and Merger (collectively the "Recapitalization") had been effective as of the date of such opinion, the Recapitalization would not have a material adverse effect from a financial point of view on (i) the aggregate market value on a fully-distributed basis of the Common Shares and shares of Tracking Stock to be distributed in the Distribution with respect thereto (the "Proposed Common Equity") outstanding after such Recapitalization as compared with the aggregate market value of the Common Shares outstanding immediately prior to the announcement of such Recapitalization or (ii) the Company's ability to raise equity capital through offerings of shares of common equity or securities convertible into common equity ("Equity Market Access") after such Recapitalization as compared to the Company's Equity Market Access prior to the announcement of such Recapitalization. Such opinions are limited to such aspects of the Recapitalization and do not address other aspects of the Recapitalization and are subject to material qualifications and limitations. In particular, the Financial Advisors did not express any opinion as to what the actual value of the Tracking Stocks will be when issued to the Company's shareholders pursuant to the Recapitalization or the prices at which such Tracking Stocks will trade subsequent to the Recapitalization. In addition, the Financial Advisors did not express any opinion whatsoever as to the individual merits of the U.S. Cellular Merger, the Aerial Merger, or the Telecom Public Offering, or any opinion whatsoever with respect to the Reincorporation. The opinions of the Financial Advisors do not address the Company's underlying business decision to effect the Recapitalization and do not constitute a recommendation to any shareholder of the Company as to how such shareholder should vote with respect to the Recapitalization. The opinions also state that the Recapitalization may cause a change in perception by some investors of the future plans of the Company or the holders of Series A Common Shares. Consequently, the opinions assume that the market has had a reasonable opportunity to understand and evaluate the Recapitalization. In addition, the opinions state that the Tracking Stocks which would be issued to the public shareholders of the Company in the proposed Distribution might trade initially at market prices below those at which they would trade on a fully distributed basis. The opinions of the Financial Advisors also depend on the accuracy of certain assumptions and other factors considered by the Financial Advisors, as described in their opinions. Shareholders should carefully consider and evaluate the opinions of the Financial Advisors in view of such qualifications, limitations, assumptions and other factors. See "Proposal 1 -- Tracking Stock Proposal --Opinions of Financial Advisors." See also Exhibits C-1 and C-2 for copies of the full text of such opinions. NO ASSURANCE OF COMPLETION OF TRANSACTIONS This Proxy Statement/Prospectus describes the U.S. Cellular Merger, the Aerial Merger, the Telecom Public Offering and the Distribution as currently contemplated by the Board. Such Transactions are subject to various conditions and uncertainties and there can be no assurance that all or any of such Transactions will be completed or, if any are completed, that they will be completed on the terms described in the Proxy Statement/Prospectus. TAX CONSIDERATIONS Subsequent to the Distribution, the Company might engage in one or more transactions involving shares of Tracking Stock (see "Proposal 1--Tracking Stock Proposal--Description of Terms of Tracking Stock"). Such a transaction might be tax-free, partially tax-free or fully taxable to the shareholder of Tracking Stock involved in such transaction. -39- LITIGATION On December 29, 1997, Airmont Plaza Associates, which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, U.S. Cellular, and the directors of U.S. Cellular. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the U.S. Cellular Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. On January 30, 1998, a virtually identical complaint was also filed by John G. Guillemont, Trustee of the John G. Guillemont Living Trust, who subsequently withdrew as plaintiff and was substituted with Marcus Galt. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. On January 5, 1998, Richard Greenfield, who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, Aerial and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. On February 6, 1998, a virtually identical complaint was also filed by Jess Colvin. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. -40- GENERAL DATE, TIME AND PLACE OF SPECIAL MEETING The Special Meeting of Shareholders of the Company will be held at Harris Trust and Savings Bank, 111 West Monroe Street, 8th Floor, Chicago, Illinois, in the Auditorium, on , , 1998, at 10:00 a.m. Chicago time (the "Special Meeting"), for the following purposes: (1) to consider and approve the Tracking Stock Proposal; (2) to consider and approve certain amendments or adjustments to employee benefit plans as a result of the Tracking Stock Proposal; (3) to consider and approve the 1998 Long-Term Incentive Plan of the Company; and (4) to transact such other business as may properly come before the Special Meeting or any and all adjournments thereof. If Proposal 1 is not approved, Proposal 2 and Proposal 3 will not be implemented even if they are approved. If Proposal 1 is approved, it will be implemented even if Proposal 2 and Proposal 3 are not approved. The Board of Directors has fixed the close of business on , 1998 as the record date for the determination of shareholders entitled to notice of, and to vote at, the Special Meeting or any adjournment thereof. If you do not expect to be present, please sign and mail your proxy in the enclosed self-addressed envelope to Harris Trust and Savings Bank, 311 West Monroe Street, Chicago, Illinois 60606. If you hold more than one class of the Company's shares, you will receive a separate proxy for each holding. To assure that all of your shares are represented, you must return a proxy printed in black ink for Common Shares, including Common Shares owned through the TDS dividend reinvestment plan and through the TDS Tax-Deferred Savings Plan; a proxy printed in green ink for Series A Common Shares, including Series A Common Shares owned through the dividend reinvestment plan; a proxy printed in red ink for Preferred Shares issued before October 31, 1981; and a proxy printed in blue ink for Preferred Shares issued after October 31, 1981. Proxies given pursuant to this solicitation may be revoked at any time prior to the closing of polls at the Special Meeting (by written notice to the Secretary of the Company or attendance at the Special Meeting of Shareholders and notice to the Secretary of such revocation). Once the polls are closed, however, proxies may not be retroactively revoked. VOTING INFORMATION To be approved, the Tracking Stock Proposal must receive the affirmative vote of the holders of a majority of the votes entitled to be cast by holders of Common Shares, Series A Common Shares and Preferred Shares, voting together as one group, and the affirmative vote of the holders of a majority of the votes entitled to be cast by the holders of Common Shares, Series A Common Shares, Preferred Shares issued before October 31, 1981 and Preferred Shares issued after October 31, 1981, each voting separately as a group. Abstentions from voting on such proposal and non-votes will not represent affirmative votes and will, therefore, effectively constitute votes against the matter for purposes of such vote. A majority of the votes entitled to be cast on the proposal by each voting group constitutes a quorum of that voting group for action on that proposal. The proposal to approve amendments and adjustments to employee stock plans and agreements related to the Tracking Stock Proposal will be approved if votes favoring the proposal cast by holders of Common Shares, Series A Common Shares and Preferred Shares, voting together as one group, exceed the votes cast within such group opposing such proposal, assuming that a quorum exists. A majority of the votes entitled to be cast on the proposal constitutes a quorum of that voting group for action on that proposal. Votes to abstain from voting on such proposal and non-votes will not represent votes cast in favor of or opposing such matter and will not affect the determination of whether such proposal is approved for purposes of such vote. The proposal to approve the 1998 Long-Term Incentive Plan of the Company will be approved if votes favoring the proposal cast by holders of Common Shares, Series A Common Shares and Preferred Shares, voting together as one group, exceed the votes cast within such group opposing such proposal, assuming that a quorum exists. A majority of the votes entitled to be cast on the proposal constitutes a quorum of that voting group for action on that proposal. Votes to abstain from voting on such proposal and non-votes will not represent votes cast in favor of or opposing such matter and will not affect the determination of whether such proposal is approved for purposes of such vote. On December 31, 1997, the Company had outstanding and entitled to vote 53,648,683 Common Shares, par value $1.00 per share (excluding 794,575 treasury shares and 484,012 shares held by a subsidiary of the Company); 6,936,277 Series A Common Shares, par value $1.00 per share; and 324,667 Preferred Shares, without par value, of which 8,899 Preferred Shares were issued before October 31, 1981 (Series A, B, D, G, H and N), and 315,768 Preferred Shares were issued after October 31, 1981 (Series O, S, U, BB, DD, EE, GG, HH, II, JJ, KK, LL, QQ, RR, SS and TT). Each of the outstanding Common Shares and Preferred Shares is entitled to one vote on all -41- matters to come before the Special Meeting and each of the outstanding Series A Common Shares is entitled to ten votes on all matters to come before the Special Meeting. The trustees of the TDS Voting Trust intend to vote in favor of all of the proposals, subject to approval by a vote of 75% in interest of the beneficiaries of record of the Tracking Stock Proposal. It is anticipated that the beneficiaries will approve the Tracking Stock Proposal by the requisite vote. A complete list of shareholders entitled to vote at the Special Meeting, arranged in alphabetical order and by voting group, showing the address of and number of shares held by each shareholder, will be kept open at the offices of the Company, 30 North LaSalle Street, 40th Floor, Chicago, Illinois 60602, for examination by any shareholder, beginning at least two business days after this notice of meeting and continuing through the Special Meeting. -42- DIVIDENDS AND PRICE RANGES OF COMMON SHARES The following table sets forth the high and low sales prices of the Common Shares on the AMEX as reported by the Dow Jones News Service, and the dividends paid per Common Share during the periods indicated:
SALES PRICES -------------------- DIVIDENDS HIGH LOW PAID --------- --------- ----------- 1995 First Quarter............................................................................... $ 46.38 $ 36.13 $ .095 Second Quarter.............................................................................. 39.38 36.00 .095 Third Quarter............................................................................... 42.88 36.38 .095 Fourth Quarter.............................................................................. 43.25 35.63 .095 1996 First Quarter............................................................................... $ 48.75 $ 39.00 $ .10 Second Quarter.............................................................................. 48.88 43.38 .10 Third Quarter............................................................................... 45.63 37.75 .10 Fourth Quarter.............................................................................. 40.50 34.75 .10 1997 First Quarter............................................................................... $ 42.00 $ 34.50 $ .105 Second Quarter.............................................................................. 40.50 36.25 .105 Third Quarter............................................................................... 46.44 36.56 .105 Fourth Quarter.............................................................................. 48.50 42.00 .105
On December 17, 1997, the trading day prior to the Company's announcement of the Tracking Stock Proposal, the closing sale price of the Common Shares was $45.56 per share, and on , 1998, the closing price of the Common Shares was per share, as reported on the AMEX composite transactions. On December 31, 1997, there were 4,087 record holders of the Company's Common Shares, 98 record holders of the Company's Series A Common Shares and 173 record holders of the Preferred Shares. No public market exists for the Series A Common Shares or Preferred Shares. -43- DIVIDEND POLICY The Company has paid cash dividends on its Common Shares since 1974. The holders of Common Shares are currently entitled to receive the same or greater dividends on a per share basis as are paid to the holders of Series A Common Shares. It is the current policy of the Board to declare dividends on the Common Shares and Series A Common Shares at the same rate per share. The Company currently pays a quarterly dividend of $0.105 per Common Share and Series A Common Shares on a quarterly basis, or $0.42 annually per share. Following the Distribution, subject to the restrictions on the payment of dividends described above, the Board currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, this dividend rate would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share (the "Telecom Equivalent Dividend Rate"). Following the Distribution, the Board also currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share. The total of this rate and the Telecom Equivalent Dividend Rate is equal to $0.42 per share per annum, which is the same as the current annual dividend rate on the existing Common Shares and Series A Common Shares. The intent is that, immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is at least equal to the aggregate dividend which such shareholder currently receives from the Company (not considering reductions in shares which may occur due to the payment of cash in lieu of fractional shares in the Distribution). With regard to the Cellular Group Shares and the Aerial Group Shares, the Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. The Company is a legal entity separate and distinct from its various subsidiaries. As a company with no significant operations of its own, the principal sources of its funds are dividends or other distributions from its operating subsidiaries, borrowings and sales of equity. The ability of U.S. Cellular, TDS Telecom, Aerial and other subsidiaries of the Company to pay dividends or make distributions to the Company and, accordingly, the ability of the Company to pay dividends on any class of its common stock, will depend on the respective earnings, financial requirements and contractual restrictions of such subsidiaries. SELECTED FINANCIAL INFORMATION Set forth below is certain selected financial information on a consolidated basis for the Company and on a separate basis for each of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group. This information is qualified by reference to the more complete financial information set forth in Annexes I through V of this Proxy Statement/Prospectus. -44- SELECTED CONSOLIDATED FINANCIAL INFORMATION The following table sets forth selected consolidated financial information for the Company for each of the fiscal years in the five-year period ended December 31, 1997. The information for each of the five years ended December 31, 1997 has been derived from the audited Consolidated Financial Statements contained in Annex I and other financial information contained in TDS's Annual Reports on Form 10-K for such years. See "Where You Can Find More Information."
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) INCOME STATEMENT DATA: Operating Revenues (1)........................................ $1,471,533 $1,179,857 $ 942,307 $ 726,036 $ 553,829 Operating Income (Loss)....................................... (3,702) 153,448 131,998 108,822 69,733 Other Income.................................................. 113,979 141,190 103,857 33,686 28,126 Interest Expense.............................................. 89,744 42,853 50,848 41,251 37,466 Income Taxes.................................................. 28,559 123,646 81,029 40,713 26,497 Net Income (Loss) Before Cumulative Effect of Accounting Change...................... (9,549) 128,139 103,978 60,544 33,896 Cumulative Effect of Accounting Change (2).................... -- -- -- (723) -- Net Income (Loss)............................................. (9,549) 128,139 103,978 59,821 33,896 Net Income (Loss) Available to Common......................... $ (11,441) $ 126,182 $ 101,469 $ 57,362 $ 31,510 Weighted Average Common Shares (000s)......................... 60,211 60,464 57,456 53,295 46,995 Earnings Per Common Share--Basic: Before Cumulative Effect of Accounting Change............... $ (.19) $ 2.09 $ 1.77 $ 1.09 $ 0.67 Net Income (Loss)........................................... $ (.19) $ 2.09 $ 1.77 $ 1.08 $ 0.67 Earnings Per Common Share--Diluted: Before Cumulative Effect of Accounting Change............... $ (.19) $ 2.07 $ 1.74 $ 1.08 $ .67 Net Income (Loss)........................................... $ (.19) $ 2.07 $ 1.74 $ 1.06 $ .67 Dividends Per Common and Series A Common Share................ $ .42 $ .40 $ .38 $ .36 $ .34 OTHER DATA: Capital Expenditures.......................................... $ 786,317 $ 550,204 $ 359,996 $ 319,701 $ 200,984 BALANCE SHEET DATA: Cash and Cash Equivalents and Temporary Investments........... $ 75,567 $ 119,297 $ 80,851 $ 44,566 $ 73,385 Property, Plant and Equipment (Net)........................... 2,465,653 1,828,889 1,293,410 1,063,656 846,089 Total Assets.................................................. 4,971,601 4,200,969 3,469,082 2,790,127 2,259,182 Notes Payable................................................. 527,587 160,537 184,320 98,608 6,309 Long-term Debt (including current portion)(3)................. 1,279,034 1,018,851 894,584 562,165 537,566 Redeemable Preferred Shares (including current portion)....... 1,479 1,858 15,093 25,001 27,367 Common Stockholders' Equity................................... $1,968,119 $2,032,941 $1,684,365 $1,473,038 $1,224,285
- ------------ (1) Effective January 1, 1997, U.S. Cellular changed its financial reporting presentation for certain credits given to cellular customers on their monthly bills. Amounts for the years 1993-1996 have been reclassified to conform to the 1997 presentation. (2) Effective January 1, 1994, TDS adopted Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Post employment Benefits." The cumulative effect of the change on years prior to 1994 has been reflected in 1994 net income. Prior years' financial information has not been restated. Effective January 1, 1993, TDS adopted SFAS 109, "Accounting for Income Taxes." The cumulative effect of the change on years prior to 1993 did not have a material effect on net income or earnings per share. Prior years' financial information has not been restated. (3) Long-term Debt does not reflect $150 million of Company-Obligated Mandatorily Redeemable Preferred Securities of a Subsidiary Trust Holding Solely Company Subordinated Debentures, or the repayment of certain Notes Payable with the proceeds thereof, which occurred on February 10, 1998. -45- SELECTED FINANCIAL INFORMATION OF THE UNITED STATES CELLULAR GROUP The following table sets forth selected financial information for the Cellular Group for each of the fiscal years in the five-year period ended December 31, 1997. The information for each of the five years ended December 31, 1997 has been derived from the audited Financial Statements contained in Annex II and other financial information.
YEAR ENDED OR AT DECEMBER 31, --------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS) OPERATING FINANCIAL DATA: Operating Revenues(1)(2)................................... $ 876,965 $ 680,068 $ 480,316 $ 327,630 $ 210,344 Operating Income (Loss).................................... 129,543 87,366 42,755 17,385 (8,656) Other Income............................................... 95,306 177,314 116,766 25,808 19,097 Interest Expense........................................... 29,362 23,111 27,287 21,883 33,190 Income Taxes............................................... 83,948 111,640 32,492 4,917 2,692 Net Income (Loss).......................................... $ 111,539 $ 129,929 $ 99,742 $ 16,393 $ (25,441) OTHER DATA: Capital Expenditures....................................... $ 318,748 $ 248,123 $ 206,182 $ 168,095 $ 90,328 BALANCE SHEET DATA: Cash and Cash Equivalents and Temporary Investments........ $ 13,851 $ 14,377 $ 38,404 $ 5,800 $ 6,274 Property, Plant and Equipment (Net)........................ 940,253 650,754 530,027 368,181 246,414 Total Assets............................................... 2,508,916 2,085,899 1,880,144 1,534,787 1,245,396 Notes Payable.............................................. 1,302 1,375 1,375 637 -- Long-term Debt (including current portion)................. 515,330 353,761 355,748 302,218 204,455 United States Cellular Group Equity........................ $ 1,629,320 $ 1,476,202 $ 1,329,454 $ 1,093,967 $ 940,128
- ------------ (1) Beginning on January 1, 1997, the Company changed its financial reporting presentation for certain credits given to customers on their monthly bills. As of that date, the Company reported the foregone revenues resulting from these credits as a reduction of local retail revenue. Prior to that date, these foregone revenues were reported as marketing and selling expense (for new customers) and general and administrative expense (for current customers). 1993-1996 amounts have been reclassified to conform to 1997 presentation. (2) Beginning on January 1, 1994, the Company changed its financial reporting presentation for outbound, or pass-through, roaming revenue. Pass-through roaming revenue is now treated as an offset to the expense charged by other cellular carriers, with the net amount included in system operations expense. 1993 amounts have been reclassified to conform to 1994 presentation. -46- SELECTED FINANCIAL INFORMATION OF THE TDS TELECOMMUNICATIONS GROUP The following table sets forth selected financial information for the Telecom Group for each of the fiscal years in the five-year period ended December 31, 1997. The information for each of the five years ended December 31, 1997 has been derived from the audited Financial Statements contained in Annex III and other financial information.
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) INCOME STATEMENT DATA Operating Revenue............................................. $ 444,203 $ 395,602 $ 354,841 $ 306,341 $ 268,122 Operating Income.............................................. 98,613 102,708 98,240 91,605 78,585 Other Income.................................................. 17,529 20,243 20,794 15,254 10,223 Interest Expense.............................................. 63,151 61,572 60,648 50,676 47,016 Income Taxes.................................................. 22,603 25,685 24,231 22,806 16,658 Net Income Before Cumulative Effect of Accounting Change...... 30,388 35,694 34,155 33,377 25,134 Cumulative Effect of Accounting Changes (1)................... -- -- -- (723) -- Net Income.................................................... $ 30,388 $ 35,694 $ 34,155 $ 32,654 $ 25,134 OTHER DATA Capital Expenditures.......................................... $ 151,460 $ 144,440 $ 104,372 $ 115,483 $ 80,818 BALANCE SHEET DATA Cash and Cash Equivalents and Temporary Investments................................... $ 206,239 $ 222,918 $ 215,979 $ 163,267 $ 159,699 PP&E--Net..................................................... 830,767 769,361 659,339 611,450 524,322 Total Assets.................................................. 1,406,048 1,352,929 1,228,232 1,138,242 959,582 Notes Payable................................................. 28,181 25,039 15,784 15,059 12,080 Long-term debt (including current portion).................... 563,374 560,844 536,379 492,946 470,257 Long-term debt--affiliated.................................... 255,302 239,538 233,176 224,742 228,540 TDS Telecommunications Group Equity........................... $ 383,759 $ 343,816 $ 265,387 $ 228,800 $ 107,298
- ------------ (1) Effective January 1, 1994, TDS adopted Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Postemployment Benefits." The cumulative effect of the change on years prior to 1994 has been reflected in 1994 net income. Prior years' financial information has not been restated. -47- SELECTED FINANCIAL INFORMATION OF THE AERIAL COMMUNICATIONS GROUP The following table sets forth selected financial information for the Aerial Group for each of the fiscal years in the five-year period ended December 31, 1997. The information for each of the five years ended December 31, 1997 has been derived from the audited Financial Statements contained in Annex IV and other financial information.
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) OPERATING FINANCIAL DATA: Operating Revenues............................................ $ 55,952 $ -- $ -- $ -- $ -- Operating (Loss).............................................. (196,551) -- -- -- -- Investment and Other Income (Expense)......................... (21,635) (36,026) (7,513) (1,975) (63) Interest Expense, Net......................................... 27,065 2,762 1,051 50 40 Income Tax Expense (Benefit).................................. 1,806 (867) (2,096) (742) (36) Net (Loss).................................................... $ (247,057) $ (37,921) $ (6,468) $ (1,283) $ (67) BALANCE SHEET DATA: Cash and Cash Equivalents..................................... $ 5,012 $ 35,284 $ 261 $ 10 $ 4 Property, Plant and Equipment (Net)........................... 604,104 322,723 12,087 -- -- Investment in PCS Licenses (Net).............................. 297,043 304,354 305,818 20,401 -- Total Assets.................................................. 960,648 672,827 360,444 21,320 512 Long-term Debt (Revolving Credit Agreement--TDS).............. 448,234 -- 60,238 22,659 650 Long-term Debt................................................ 196,439 103,743 -- -- -- Aerial Communications Group Equity (Deficit).................. 192,427 437,785 281,282 (1,444) (161) Capital Expenditures.......................................... $ 274,709 $ 112,940 $ 12,134 $ -- $ --
-48- SELECTED FINANCIAL INFORMATION OF THE TDS GROUP The following table sets forth selected financial information for the TDS Group for each of the fiscal years in the five-year period ended December 31, 1997. The information for each of the five years ended December 31, 1997 has been derived from the audited Financial Statements contained in Annex V and other financial information.
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) INCOME STATEMENT DATA: Net Income.................................................... $ 52,968 $ 47,540 $ 22,691 $ 26,052 $ 30,972 Net Income Available to Common and Series A Common Shares..... 51,076 45,583 20,182 23,594 28,586 OTHER DATA: Cash and Cash Equivalents and Temporary Investments........... $ 11,990 $ 43,798 $ 13,487 $ 7,194 $ 30,527 Working Capital............................................... (611,596) (256,049) (362,086) (231,858) (84,894) Property, Plant and Equipment, net............................ 90,528 86,051 91,693 84,120 75,485 Total Assets.................................................. 1,519,829 1,079,975 1,006,728 1,038,484 802,280 Notes Payable-Affiliates...................................... 165,686 201,641 186,786 128,530 123,511 Notes Payable-Other(2)........................................ 530,175 159,162 182,625 97,724 6,059 TDS Group Equity.............................................. 602,471 642,005 509,421 683,783 613,607 Capital Expenditures.......................................... $ 41,400 $ 44,560 $ 36,905 $ 37,737 $ 29,267
- ------------ (1) The TDS Group includes Telephone and Data Systems, Inc. and all of its subsidiaries and their respective properties and assets other than (except with respect to the Retained Interests): United States Cellular and its subsidiaries (which are included in the United States Cellular Group), TDS Telecom and its subsidiaries (which are included in the TDS Telecommunications Group), Aerial and its subsidiaries (which are included in the Aerial Communications Group) and any other assets or liabilities or subsidiaries of Telephone and Data Systems, Inc. attributed to the United States Cellular Group, the TDS Telecommunications Group or the Aerial Communications Group. The TDS Group reflects primarily the TDS Group's Retained Interest in the United States Cellular Group, the TDS Telecom Group and the Aerial Group, the Corporate operations (including corporate management, intercompany financing, cash management and intercompany income tax allocation activities) and the operations of American Paging, Inc., an 81.9%-owned subsidiary. Under the Tracking Stock Proposal, prior to the Telecom Public Offering, the U.S. Cellular Merger, the Aerial Merger and the Distribution, the TDS Group would have an approximately 81% Retained Interest in the Cellular Group, a 100% Retained Interest in the TDS Telecom Group, and an approximately 83% interest in the Aerial Group. Following completion of the Tracking Stock Proposal, it is currently anticipated that the TDS Group would have an approximately 20% Retained Interest in each of the Groups. For purposes of the TDS Group financial statements, the TDS Group's Retained Interest in the equity value of the Groups has been reflected on "Investments In Affiliated Groups." Similarly, the net income or loss of the Groups attributable to the TDS Group Retained Interest is reflected as "Equity in Net Income of Cellular Group, Equity in Net Income of Telecom Group and Equity in Net (Loss) of Aerial Group" in the Statements of Operations. (2) Does not reflect the repayment of $150 million Notes Payable--Other on February 10, 1998, related to the issuance of Company-Obligated Mandatorily Redeemable Preferred Securities of a Subsidiary Trust Holding Solely Company Subordinated Debentures. -49- PROPOSAL 1 TRACKING STOCK PROPOSAL GENERAL The Tracking Stock Proposal would, among other things, create three new classes of common stock which are intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications services businesses, and change the state of incorporation of the Company from Iowa to Delaware. Capitalized terms used in the following description of the Tracking Stock Proposal and not otherwise defined have the meanings ascribed to them elsewhere in this Proxy Statement/Prospectus. See "-- Certain Definitions" and Exhibit G--Index of Certain Defined Terms. Under the Tracking Stock Proposal, you are being asked to approve the Merger Agreement between the Company and TDS Delaware, which contemplates the Merger of the Company with and into TDS Delaware, with TDS Delaware continuing as the surviving corporation. A copy of the Merger Agreement is attached hereto as EXHIBIT A. TDS Delaware has been organized for the sole purpose of effecting the Merger. For purposes of the following discussion, the Company prior to the effectiveness of the Merger (the "Effective Time") is hereinafter sometimes referred to as "TDS Iowa." At the Effective Time, the separate existence of TDS Iowa will cease and TDS Delaware will succeed to the business of TDS Iowa, and TDS will cease to be subject to the Iowa Business Corporation Act ("IBCA") and become subject to the Delaware General Corporation Law ("DGCL"). If the Tracking Stock Proposal is approved, immediately prior to the Effective Time, the Certificate of Incorporation of TDS Delaware would be amended and restated (the "Restated Certificate"). A copy of the proposed Restated Certificate is attached hereto as EXHIBIT B. The Restated Certificate would, among other things, authorize 475,000,000 shares of capital stock, and establish the rights, limitations and preferences of such shares. The Restated Certificate will authorize 326,664 Preferred Shares, $.01 par value ("Delaware Preferred Shares"), representing the number of issued Preferred Shares of TDS Iowa, and reclassify the 4,673,336 authorized but unissued Preferred Shares of TDS Iowa as Undesignated Shares, par value $.01 per share ("Undesignated Shares"). The authorized shares of capital stock would also include 470,000,000 shares of common stock, to consist of 100,000,000 Common Shares, $.01 par value ("Delaware Common Shares"); 25,000,000 Series A Common Shares, $.01 par value ("Delaware Series A Common Shares"); 20,000,000 Special Common Shares, $.01 par value ("Special Common Shares"); 140,000,000 Cellular Group Shares, $.01 par value; 90,000,000 Telecom Group Shares, $.01 par value; and 95,000,000 Aerial Group Shares, $.01 par value. The Cellular Group Shares, when issued, are intended to reflect the separate performance of the Cellular Group, which consists of the Company's interest in U.S. Cellular, a subsidiary of the Company which operates and invests in cellular telephone companies and properties; the Telecom Group Shares, when issued, are intended to reflect the separate performance of the Telecom Group, which consists of the Company's interest in TDS Telecom, a subsidiary of the Company which operates landline telephone companies and includes the notional allocation of certain TDS debt; and the Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Group, which consists of the Company's interest in Aerial, a subsidiary of the Company which is developing broadband personal communications services. Except as provided below under "Dissenting Shareholders' Rights," at the Effective Time, by virtue of the Merger, each of the Common Shares, $1.00 par value, of TDS Iowa consists of ("Iowa Common Shares") issued and outstanding immediately prior to the Effective Time will be converted into one fully paid Delaware Common Share; each of the Series A Common Shares, $1.00 par value, of TDS Iowa ("Iowa Series A Common Shares") issued and outstanding immediately prior to the Effective Time will be converted into one fully paid Delaware Series A Common Share, and each of the Preferred Shares of TDS Iowa, without par value ("Iowa Preferred Shares"), issued and outstanding immediately prior to the Effective Time will be converted into one fully paid share of a corresponding class of Delaware Preferred Shares. At the Effective Time, certificates which immediately prior to the Effective Time represented Iowa Common Shares, Iowa Series A Common Shares or Iowa Preferred Shares ("Iowa Shares"), other than certificates held by holders of Iowa Shares who have properly taken action to perfect dissenters' rights, will be deemed for all corporate purposes to represent the number of Delaware Common Shares, Delaware Series A Common Shares or Delaware Preferred Shares ("Delaware Shares"), into which such Iowa Shares shall have been converted. IT WILL NOT BE NECESSARY FOR YOU TO EXCHANGE YOUR EXISTING STOCK CERTIFICATES REPRESENTING IOWA SHARES FOR STOCK CERTIFICATES REPRESENTING DELAWARE SHARES. YOU SHOULD RETAIN ALL CERTIFICATES WHICH REPRESENT SHARES OF THE COMPANY SINCE SUCH -50- CERTIFICATES WILL CONTINUE TO REPRESENT SHARES OF THE SAME CLASS OR SERIES OF TDS DELAWARE FOLLOWING THE MERGER. The reincorporation of the Company in Delaware will not result in any change in the business, management, board of directors, assets, liabilities or net worth of the Company, and the business of the Company will continue to be managed from its corporate headquarters in Chicago, Illinois. It will, however, allow the Company to benefit from Delaware's well-developed corporate laws, which are periodically updated and revised to meet changing business needs. Delaware courts have developed considerable expertise in dealing with corporate issues and a substantial body of case law has been established construing Delaware law and establishing public policies with respect to Delaware corporations. As a consequence, a greater measure of predictability is possible in Delaware with respect to corporate legal affairs than is available in other states. In addition, the Company believes that Delaware law will offer clearer guidance with respect to legal issues that may arise as a result of the existence of separate classes of Tracking Stock. There will be no change in control of the Company as a result of the Merger or the related Transactions. After the Merger, the TDS Voting Trust will continue to control the election of a majority of the Board and a majority of the voting power of TDS Delaware. However, if the Tracking Stock Proposal is approved, the number of directors that the TDS Voting Trust will elect will decrease by one director, and the number of directors that will be elected by the voting group which includes the holders of Preferred Shares issued before October 31, 1981 and Common Shares will increase by one director. The Merger Agreement may be amended prior to the Effective Time, either before or after shareholder approval thereof; provided, however, that the Merger Agreement may not be amended after such shareholder approval if such amendment would (i) alter or change the amount or kind of shares or other consideration to be received by shareholders in the Merger, (ii) alter or change any of the terms and conditions of the Merger Agreement if such alteration or change would adversely affect the shareholders or (iii) otherwise violate applicable law. If the Tracking Stock Proposal is approved by the shareholders, the Merger will become effective following the filing of the Certificate of Merger with the Secretary of State of Delaware and Articles of Merger with the Secretary of State of Iowa. Subject to the receipt of all necessary regulatory consents and approvals, as discussed below, it is anticipated that this will take place promptly after the Special Meeting. However, the Merger Agreement provides that the Merger may be abandoned by the Board prior to the Effective Time, either before or after shareholder approval. Shareholders of the Company whose shares are not voted in favor of the Tracking Stock Proposal and who otherwise duly take all action required by statute will have statutory dissenter's rights under Iowa law. See "Dissenting Shareholders' Rights." If, in the judgment of the Board, an excessive number of shareholders assert dissenters' rights, it is contemplated that the Board may abandon the Tracking Stock Proposal, even if it is approved by shareholders. THE TRANSACTIONS Subject to the approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, the Board intends to effect the Transactions discussed below. The Transactions will not require approval by shareholders of the Company. The Transactions are subject to various conditions and there can be no assurance that all or any of the Transactions will take place or that they will take place in the manner currently contemplated. TELECOM PUBLIC OFFERING. Promptly after approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, the Company intends to offer and sell Telecom Group Shares in a public offering for cash, and to allocate the net proceeds thereof to the Telecom Group. The Company intends to file with the SEC a registration statement on Form S-3 relating to the registration of between 10,000,000 and 17,000,000 Telecom Group Shares. This offering is expected to commence promptly after the approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, subject to prevailing market conditions and other factors. See "--The Telecom Group." U.S. CELLULAR MERGER. The Company has made an offer to issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by the Company pursuant to a merger between a subsidiary of the Company and U.S. Cellular. The TDS offer to the Board of Directors of U.S. Cellular proposes to exchange 1.14613 Cellular Group Shares for each issued Common Share of U.S. Cellular (other than shares held by the Company) in the U.S. Cellular Merger. This merger is subject to various conditions, including approval of the Tracking Stock Proposal by shareholders of the Company, effectiveness of the Merger, the negotiation of the other -51- terms of a merger agreement between the Company and U.S. Cellular, approval of the U.S. Cellular Merger by a special committee of the board of directors, the full board of directors and the shareholders of U.S. Cellular, and final approval by the Board. The Common Shares of U.S. Cellular are currently traded on the AMEX under the symbol "USM." If the U.S. Cellular Merger is consummated as contemplated, U.S. Cellular would become a wholly-owned subsidiary of the Company and such Common Shares of U.S. Cellular would be delisted from the AMEX. In the U.S. Cellular Merger, holders of Common Shares of U.S. Cellular would receive Cellular Group Shares of TDS, which would be listed on the AMEX. If the U.S. Cellular Merger does not take place for any reason, U.S. Cellular may not become a wholly-owned subsidiary of the Company and the Common Shares of U.S. Cellular may continue to be publicly traded. Alternatively, although the Company has no current plans or intentions to do so, the Company may consider acquiring such Common Shares of U.S. Cellular in an exchange offer for Cellular Group Shares or other securities, in a tender offer for cash or through open market or private purchases, or taking other action to acquire some or all of the shares of U.S. Cellular not owned by the Company. See "--The Cellular Group." AERIAL MERGER. The Company has made an offer to issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by the Company pursuant to a merger between a subsidiary of the Company and Aerial. The TDS offer to the Board of Directors of Aerial proposes to exchange .91485 Aerial Group Shares for each issued Common Share of Aerial (other than shares held by the Company) in the Aerial Merger. This merger is subject to various conditions, including approval of the Tracking Stock Proposal by shareholders of the Company, effectiveness of the Merger, the negotiation of the other terms of a merger agreement between the Company and Aerial, approval of the Aerial Merger by a special committee of the board of directors, the full board of directors and the shareholders of Aerial, and final approval by the Board. The Common Shares of Aerial are currently traded on the Nasdaq National Market under the symbol "AERL." If the Aerial Merger is consummated as contemplated, Aerial would become a wholly-owned subsidiary of the Company and such Common Shares of Aerial would be delisted from the Nasdaq National Market. In the Aerial Merger, holders of Common Shares of Aerial would receive Aerial Group Shares of TDS, which would be listed on the AMEX. If the Aerial Merger does not take place for any reason, Aerial may not become a wholly-owned subsidiary of the Company and the Common Shares of Aerial may continue to be publicly traded. Alternatively, although the Company has no current plans or intentions to do so, the Company may consider acquiring such Common Shares of Aerial in an exchange offer for Aerial Group Shares or other securities, in a tender offer for cash or through open market or private purchases, or taking other action to acquire some or all of the shares of Aerial not owned by the Company. See "--The Aerial Group." THE DISTRIBUTION. After the completion of the Merger, the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, the Board intends to authorize the Distribution of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in the form of a stock dividend to holders of Series A Common Shares and Common Shares. It is currently expected that the Distribution would take place in June 1998 or later. The Board intends to distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share with respect to each Common Share and Series A Common Share outstanding on the record date for the Distribution. The Distribution will be made to all shareholders in proportion to the number of Common Shares and Series A Common Shares owned on the Distribution record date. Although the Board presently intends to make the Distribution if the Merger and the other Transactions take place, the Board reserves the right not to effect all or any part of the Distribution even if the Tracking Stock Proposal is approved by the shareholders and the Merger and the other Transactions take place. In addition, the Board reserves the right to effect all or any part of the Distribution regardless of whether or not such other Transactions have taken place. No fractional shares of any of the Tracking Stocks will be issued or distributed as part of the Distribution, except as discussed below under "-- Dividend Reinvestment Plans." If the number of shares of a particular Tracking Stock that a holder of Common Shares or Series A Common Shares is entitled to receive as part of the Distribution should include a fraction of a whole share, the Company will pay such holder the cash equivalent of such fractional share. As soon as practicable after the Distribution, Harris Trust and Savings Bank, the transfer agent for TDS, will mail to each record holder of Common Shares or Series A Common Shares on the Distribution record date three certificates, each representing the number of whole shares of each Tracking Stock Group, as the case may be, to which such holder is entitled and a check for any fractional shares. Because the Distribution is to be made to all shareholders of common stock in proportion to the number of Common Shares and Series A Common Shares owned on the Distribution record date by each shareholder, the relative ownership interest and voting power of each holder of whole Common Shares and Series A Common -52- Shares will be substantially the same immediately after effectiveness of the Merger and the Distribution as it was immediately prior thereto, except with respect to the election of one director. With respect to the election of directors, the holders of Preferred Shares issued after October 31, 1981 and Series A Common Shares as such will elect one fewer director, and the holders of Preferred Shares issued before October 31, 1981 and Common Shares will vote in the election of one additional director together with holders of shares of Tracking Stock. The shares of Tracking Stock which would be issued in the Distribution would represent an Outstanding Interest of approximately 75% in each Tracking Group. When considering the shares of Tracking Stock which are contemplated to be issued in the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, as well as the Distribution, the Outstanding Interest would initially represent in the aggregate an approximately 80% interest in each Tracking Group. Upon the completion of all of the Transactions as contemplated, the TDS Group would have a Retained Interest of approximately 20% in each Tracking Group, along with all other interests held by the Company. The common equity interests in the TDS Group would be represented by the Delaware Series A Common Shares and the Delaware Common Shares. The distribution ratios for the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares were determined by the Board in consultation with the Financial Advisors, and are based upon the desired initial trading ranges of such shares and other factors. The amount of the Retained Interest to be initially retained by the TDS Group with respect to each of the Tracking Groups was also established by the Board in consultation with the Financial Advisors, considering, among other factors, the desired initial trading range of the Common Shares. Since the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger are anticipated to precede the Distribution, after such other Transactions but before the Distribution, the Retained Interest of the TDS Group in each Tracking Group would initially be approximately 80% for the Telecom Group, 81% for the Cellular Group and 83% for the Aerial Group. Assuming completion of the Transactions as contemplated, approximately 20% of the common equity of the Company attributable to the Telecom Group would be represented by the Telecom Group Shares issued in the Telecom Public Offering, 19% of the common equity of the Company attributable to the Cellular Group would be represented by the Cellular Group Shares issued in the U.S. Cellular Merger, and 17% of the common equity of the Company attributable to the Aerial Group would be represented by the Aerial Group Shares issued in the Aerial Merger. In addition to the shares of each of the Tracking Stocks to be issued in the Transactions, shares of each of the Tracking Stocks are being reserved for issuance upon conversion, exercise or exchange subsequent to the Distribution of certain outstanding convertible securities issued by the Company, and certain options to purchase Common Shares that are outstanding under the Company's existing stock incentive plans. All such convertible securities and options will be adjusted upon the Distribution such that the security or option is convertible, or exercisable, as the case may be, into Common Shares and shares of each of the Cellular Group, Telecom Group and Aerial Group as if such convertible security, or option, was converted or exercised, as the case may be, immediately prior to the Distribution. The following table shows the number of shares of capital stock of TDS which would be issued in the Merger (based on shares outstanding as of November 30, 1997), the number of shares of TDS capital stock which would be issued if all of the Transactions are completed as contemplated, the number of shares which are expected to be reserved for issuance for certain purposes and the number of authorized shares which would be available for other purposes.
SHARES ISSUABLE TO AUTHORIZED AVAILABLE ISSUED IN ISSUED IN ISSUED IN OTHER THIRD FOR FOR MERGER DISTRIBUTION TRANSACTIONS(2) PARTIES(3) ISSUANCE(4) ISSUANCE ----------- ----------- --------------- ----------- ------------ ----------- Preferred Shares........................ 296,664 -- -- 30,000 -- -- Undesignated Shares..................... -- -- -- -- -- 4,673,336 Common Shares........................... 53,878,129(1) -- -- 2,111,463 6,048,845 37,961,563 Series A Common Shares.................. 6,933,233 -- -- -- 175,567 17,891,200 Special Common Shares................... -- -- -- -- -- 20,000,000 Total TDS Group Shares................ 60,811,362 -- -- 2,111,463 6,224,412 75,852,763 Cellular Group.......................... -- 60,811,362 18,897,187 10,912,966 7,291,826 23,927,668 Telecom Group........................... -- 40,540,908 13,500,000 1,407,642 5,913,809 16,531,647 Aerial Group............................ -- 40,540,908 11,453,996 2,779,917 5,116,534 23,002,651 RETAINED TOTAL INTEREST(5) AUTHORIZED ----------- ------------ Preferred Shares........................ -- 326,664 Undesignated Shares..................... -- 4,673,336 Common Shares........................... -- 100,000,000 Series A Common Shares.................. -- 25,000,000 Special Common Shares................... -- 20,000,000 Total TDS Group Shares................ -- 145,000,000 Cellular Group.......................... 18,158,991 140,000,000 Telecom Group........................... 12,105,994 90,000,000 Aerial Group............................ 12,105,994 95,000,000
- ------------ (1) Includes 484,012 Common Shares held by a subsidiary of the Company. (2) The other Transactions include the U.S. Cellular Merger, the Telecom Public Offering and the Aerial Merger. See "--The Cellular Group," "--The Telecom Group" and "--The Aerial Group" for a discussion of how these numbers were determined. -53- (3) Includes shares issuable as Committed Acquisition Shares and shares issuable pursuant to the Pre-Distribution Convertible Securities by TDS, and shares which would become issuable as a result of the U.S. Cellular Merger and the Aerial Merger. See "--Certain Definitions." (4) For further information with respect to the shares authorized for issuance, see "--The Cellular Group," "--The Telecom Group," "--The Aerial Group" and "--The TDS Group." (5) Net of shares issuable from Retained Interest. BACKGROUND AND REASONS FOR THE TRACKING STOCK PROPOSAL AND RELATED TRANSACTIONS; RECOMMENDATION OF THE BOARD THE BOARD HAS UNANIMOUSLY APPROVED THE TRACKING STOCK PROPOSAL AND BELIEVES ITS ADOPTION TO BE IN THE BEST INTERESTS OF THE COMPANY AND ITS SHAREHOLDERS. ACCORDINGLY, THE BOARD UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE "FOR" THE TRACKING STOCK PROPOSAL. TDS's management and Board have extensively studied the Tracking Stock Proposal and the Transactions, and have consulted with financial and legal advisors of TDS with respect to the advisability and terms of such proposal and the related Transactions. The Board, including directors who are not trustees or beneficiaries of the TDS Voting Trust, and directors who are not officers of TDS, has unanimously approved the adoption of the Tracking Stock Proposal BACKGROUND. In recent years, a number of publicly held companies have adopted tracking stock capital structures. The Board and TDS's management have, for several years, considered various alternatives regarding TDS's capital structure as a means to enhance shareholder value, including the possibility of (i) a spin-off to the Company's shareholders of all or part of one or more of its subsidiaries, (ii) public offerings of a portion of the Company's interests in one or more of its subsidiaries and (iii) the issuance of one or more tracking stocks which would be defined by reference to the performance of one or more of its subsidiaries. These deliberations resulted from the Board's and management's concern that the historical price performance of the Common Shares may not adequately reflect the value of the Company. The Board and management believed that the Company was being undervalued by the capital markets, in part because the capital markets focused primarily upon certain businesses and did not give full value to certain other businesses held by the Company. The Board believed that overall shareholder value could be enhanced if there was increased recognition in the investment community of the Company's subsidiaries and their individual lines of business and the value of the assets used in such businesses. Over the course of several months in 1997, management met with representatives of several investment banking firms and considered alternatives for enhancing shareholder value. Several investment banking firms outlined proposals involving tracking stocks. Following these meetings, management engaged the Financial Advisors and worked with such firms and with legal advisors in creating the preliminary terms of the Tracking Stock Proposal. The Telecom Public Offering, the U.S. Cellular Merger, the Aerial Merger and the Distributions were also conceived and developed during the course of the discussions with the Financial Advisors and legal advisors. The terms of the Tracking Stock Proposal and the Transactions were further refined and presented to the Board by management in October, 1997. On October 31, 1997 and November 17, 1997, the Board of TDS, including members of TDS's management, heard presentations from the Financial Advisors, and considered and discussed the proposal to create three new classes of Tracking Stock--the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares--as a means to enhance shareholder value as well as the financial flexibility of TDS and its shareholders. The possibility of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger were also discussed. The terms, likely benefits and possible disadvantages of the Tracking Stock Proposal and the related Transactions were discussed. Following these discussions, the Board authorized TDS management to proceed with finalizing the terms of the Tracking Stock Proposal and the related Transactions, with the assistance of the Financial Advisors and legal advisors, and to present such terms to the Board at a subsequent meeting. Following these meetings, the Company's management, the Financial Advisors and legal advisors developed the terms of the Tracking Stock Proposal and related Transactions and proposed them to the Board. At meetings of the Board on December 15 and December 17, 1997, the directors discussed the proposed terms of the Tracking Stock Proposal and the related Transactions. After discussion of the Tracking Stock Proposal and related Transactions, on December 17, 1997, the Board determined that the Tracking Stock Proposal was the best alternative available to TDS to enhance shareholder value and that it was in the best interests of the Company and its shareholders. The Board, including directors who are not trustees or beneficiaries of the TDS Voting Trust, and -54- directors who are not officers of TDS, unanimously approved the Tracking Stock Proposal and directed management to submit the proposal to the Company's shareholders at the Special Meeting. The Board also authorized the Telecom Public Offering, subject to approval of the Tracking Stock Proposal by the shareholders and the effectiveness of the Merger, and certain other conditions. In addition, the Board authorized management to make offers to U.S. Cellular and Aerial to acquire the Common Shares of U.S. Cellular and Aerial, respectively, which are not held by the Company pursuant to mergers between each of U.S. Cellular and Aerial and wholly-owned subsidiaries of the Company, subject to certain conditions, including approval by TDS shareholders of the Tracking Stock Proposal, the effectiveness of the Merger, the negotiation of the other terms of the merger agreements relating to such mergers and final TDS Board approval. The U.S. Cellular Merger and Aerial Merger are also subject to approval by the boards of directors and shareholders of U.S. Cellular and Aerial, respectively. REASONS. The Board believes that the division of the Company's interests in its principal businesses into the Tracking Groups would enable the Company to benefit in a variety of ways described below, while also maintaining the benefits of remaining a single entity, and would facilitate increased investor understanding of the different businesses. The Board believes that a capital structure which includes the three Tracking Stocks offers a number of potential benefits which outweigh its disadvantages, as described below, and that adoption of the Tracking Stock Proposal and the completion of the related Transactions is in the best interests of TDS and all of its shareholders. The Board did not find it practicable to, and did not, quantify or otherwise assign relative weights to the advantages or disadvantages of the proposal, although the following factors were considered important in its decision. GREATER MARKET RECOGNITION. The Tracking Stock Proposal is intended to result in greater market recognition of the value (individually and collectively) of the Company and the Company's three principal business groups, thereby enhancing shareholder value over the long term. The Board of Directors believes that overall shareholder value would be enhanced if there was increased recognition in the investment community of the Company's individual lines of business and the value of the assets used in such businesses. Additionally, a public market for each of TDS's three principal business groups should make it easier for the capital markets to understand and value the Company's businesses and assets. The Company should also be able to reduce its cost of capital because of the improved equity valuation that should result from the implementation of the Tracking Stock Proposal. INCREASED LIQUIDITY FOR U.S. CELLULAR AND AERIAL. The Board considered it important that the Tracking Stock Proposal would permit the Company to make offers to acquire the publicly-traded common equity of the Company attributable to U.S. Cellular and Aerial, subject to the conditions discussed above. Management believes that the Distribution of Cellular Group Shares and Aerial Group Shares would serve to increase the liquidity of the publicly-traded equity related to U.S. Cellular and Aerial. In order to maintain the benefits of consolidating U.S. Cellular and Aerial with TDS for tax purposes, including the preservation of the ability to spin-off such companies on a tax-free basis to shareholders, the publicly-traded Common Shares of U.S. Cellular and Aerial have been limited to less than 20% of the common equity of U.S. Cellular and Aerial. Management believes that the liquidity for U.S. Cellular and Aerial has been below the liquidity for many of their respective cellular and PCS peers and that this may have adversely affected the public market value of their equity. The Board has been advised by the Financial Advisors that the liquidity of the Cellular Group Shares and Aerial Group Shares should be superior to that of the Common Shares of U.S. Cellular and Aerial. Since the Cellular Group Shares and Aerial Group Shares would represent approximately 80% of the Company's equity interest in U.S. Cellular and Aerial (assuming the completion of the Transactions as contemplated), as compared to less than 20% currently, the Cellular Group Shares and the Aerial Group Shares should have greater liquidity than the existing U.S. Cellular and Aerial Common Shares. The Financial Advisors have advised the Company that this increased liquidity may increase the valuation of the Cellular Group Shares and Aerial Group Shares as compared to the recent public market values of the Common Shares of U.S. Cellular and Aerial. FINANCING FLEXIBILITY. The Tracking Stock Proposal should provide the Company with greater flexibility in raising capital and making acquisitions, with equity securities specifically related to the Tracking Groups. Because the Board does not expect to declare a dividend on the Cellular Group Shares or Aerial Group Shares for the foreseeable future, any issuance of such stock, in connection with an acquisition or otherwise, would not reduce cash flow that would otherwise be available for capital investments. The Tracking Stock Proposal would provide the Company greater flexibility with regard to raising capital or making acquisitions for a Tracking Group's businesses, including strategic partnering transactions, independent of the other Groups by using equity securities specifically related to one of the Tracking Groups. The Tracking Stocks may also be used, rather than Common Shares, for TDS's employee stock purchase plans, stock option plans and other employee benefit plans. The listing of the Tracking Stocks on the AMEX will create a trading market, the -55- existence of which would be an important factor in assessing the value of such stock in connection with and facilitating any such acquisition, financing or employee plan. SHAREHOLDER FLEXIBILITY. The issuance and sale of the Tracking Stocks would also provide shareholders with the opportunity to continue to invest in all of the TDS businesses through the TDS Group or any one or more of the Tracking Groups individually, depending upon their investment objectives. While investors currently have the opportunity to invest directly in U.S. Cellular or Aerial, the Telecom Group Shares would offer investors the opportunity to separately participate in the performance of TDS Telecom, as well as U.S. Cellular and Aerial. The Tracking Stock Proposal creates investment vehicles that meet the requirements of distinct investor groups--those looking for yield and income of a relatively mature business, in the case of the Telecom Group Shares; those looking for the growth potential of a less mature business, in the case of Cellular Group Shares; those looking to capitalize on the possible opportunities offered by new technologies, in the case of the Aerial Group Shares; and those interested in owning an interest in a diversified telecommunications company, in the case of the Common Shares--which should encourage proper valuation of the assets in each of the Groups. CONSOLIDATED ENTERPRISE. The Tracking Stock Proposal will retain for the Company the advantages of doing business as a single company. As part of a single entity, each Group would be in a position to benefit from synergies with the other, including synergies that may result from the eventual convergence of the telecommunications and wireless industries. In addition, by remaining a single entity, the Company will continue to enjoy certain strategic, financial and operational benefits that would not be available if the Groups were separate legal entities. It would also permit the Company to retain the advantages of tax consolidation and economies of scale. Furthermore, the Tracking Stock Proposal is not expected to have any material adverse impact on the Company's credit rating and cost of borrowing, which would occur if the Groups were divided into separate entities. ACCEPTANCE OF TRACKING STOCK CAPITAL STRUCTURES. The use by other companies of equity securities intended to reflect separately the performance of specific businesses has increased in the last several years and several large, well-known companies have adopted capital structures involving tracking stocks. The Financial Advisors have advised the Company that, in general, the market performance of many of such securities has been favorable and has been comparable to industry peers that are separate companies. The market appears to value such securities based on the performance of the underlying business, and tracking stocks are now generally well-followed by financial analysts and accepted by investors. TAX FACTORS. Implementation of the Tracking Stock Proposal should not be taxable to the Company or its shareholders. In comparison to a spin-off of the Company's shares of U.S. Cellular, TDS Telecom or Aerial to the holders of Common Shares and Series A Common Shares, implementation of the Tracking Stock Proposal allows for a tax-free distribution to the Company's shareholders without the significant limitations imposed by Section 355 of the Internal Revenue Code. Furthermore, the issuance of the Tracking Stocks will not prevent the Company from consolidating the operating results of the Tracking Groups for tax and accounting purposes. FUTURE ALTERNATIVES. The Tracking Stock Proposal will not preclude other alternatives to increase shareholder value. The Board will continue to review other alternatives that may be available to the Company to realize additional value from the assets attributed to each of the Groups. In determining whether to pursue a particular alternative, the Board, in exercising its business judgment, will consider various factors, including market conditions, the financial and other effects of any such alternative on the Company and the Groups, and the preservation of its ability to engage in other restructuring options at such time as such alternatives become desirable. ELECTION OF DIRECTORS. The Board also considered it significant that, as a result of the Tracking Stock Proposal, the election of one fewer director would be determined by the TDS Voting Trust, and that holders of Common Shares and, when issued, shares of the Tracking Stock, would be permitted to vote in the election of such one director. SUPPORT OF HOLDERS OF COMMON SHARES AND PREFERRED SHARES. A very important consideration for the Board was the fact that the holders of Common Shares, Preferred Shares issued before October 31, 1981 and Preferred Shares issued after October 31, 1981, would each vote separately as groups on the Tracking Stock Proposal. Therefore, the Merger and the Transactions, including the Distribution, will not take place unless the Tracking Stock Proposal is approved by a majority of the votes entitled to be cast by the holders of each of the -56- Common Shares, Preferred Shares issued before October 31, 1981 and Preferred Shares issued after October 31, 1981, as well as the Series A Common Shares, each voting as a separate group. Although the TDS Voting Trust controls a majority of the votes of the Series A Common Shares, the TDS Voting Trust does not own or vote any Common Shares or Preferred Shares. In addition, management beneficially owns only about 1% of the Common Shares and owns no Preferred Shares. As a result, the Tracking Stock Proposal will not be approved unless it is supported by a majority of the shareholders who are not affiliated with the TDS Voting Trust or management. SUPPORT OF TDS VOTING TRUST. The Board also considered it important that the Tracking Stock Proposal would have the support of the trustees of the TDS Voting Trust which controls over 90% of the Series A Common Shares and a majority of the voting power of the Company. The trustees of the TDS Voting Trust have indicated to TDS's management that they would be unwilling to vote in favor of any proposal as shareholders of TDS which could result in the voting power of the TDS Voting Trust declining below 50%. On the other hand, the trustees of the TDS Voting Trust have indicated that they would support the Tracking Stock Proposal since it would enable TDS to issue shares of Tracking Stock, or other debt or equity securities convertible into shares of Tracking Stock, in acquisitions, public or private securities offerings or for other purposes, without reducing the voting power of the TDS Voting Trust below 50%. CONTINUITY OF LONG-TERM PLANS. The adoption of the Tracking Stock Proposal would reduce the risk of a disruption in the continuity of TDS's long-term plans and objectives that could otherwise result if the TDS Voting Trust should find it necessary to sell or distribute a significant block of stock for diversification, estate tax obligations or for other reasons. Implementation of the Tracking Stock Proposal would allow the trustees of the TDS Voting Trust to continue to exercise control over a majority of TDS's voting power even after the TDS Voting Trust distributes the shares of the Tracking Stocks to the beneficiaries thereof, and would permit additional estate planning flexibility, including the determination of the succession of voting control through bequests of Series A Common Shares to the heirs of beneficial holders. Thus the Tracking Stock Proposal may provide a basis for continuity pursuant to such plans and objectives, if and when such circumstances arise, and should reduce the risk that TDS could at some future date be compelled to consider a potential acquisition of TDS in an environment that could be dictated to TDS and the Board by the financial circumstances of participants in the TDS Voting Trust or by third parties who may be anticipating or speculating about such circumstances. EMPLOYEE COMPENSATION AND CONTINUITY. The ability to issue shares of one or more of the Tracking Stocks would increase TDS's flexibility in structuring compensation plans to tailor stock incentives to employees. The creation of three classes of stock that are intended to reflect separately distinct businesses increases the Company's ability to focus the management of the respective Groups and provide incentives for employees of each Group that are tied directly to the stock price performance of the Group in which they are employed. Implementation of the Tracking Stock Proposal may also allow employees to continue to concentrate on their responsibilities without undue concern that the future of TDS could be affected by real or perceived succession issues or a change in control that could otherwise be triggered by any substantial divestiture by the TDS Voting Trust in the future. By reducing the uncertainty that could result if the TDS Voting Trust should dispose of a significant block of Series A Common Shares, the Tracking Stock Proposal may, therefore, enhance the ability of TDS to attract and retain highly qualified key employees. BUSINESS RELATIONSHIPS. Implementation of the Tracking Stock Proposal may facilitate strategic partnering transactions and may enhance the existing and potential business relationships of TDS with parties who may in the future become concerned about changes in control of TDS in the event that the voting power of the TDS Voting Trust is ever diluted. TDS may be better able to attract joint venture and marketing partners willing to make long-term plans and commitments if TDS is perceived to not be vulnerable to a takeover or disruption due to uncertainty concerning TDS's control. BENEFITS OF DELAWARE REINCORPORATION. The Tracking Stock Proposal also contemplates that the Company will be reincorporated from Iowa to Delaware. The Company's Board believes that the best interests of the Company and its shareholders will be served by changing the Company's state of incorporation from Iowa to Delaware. The Board believes that the General Corporation Law of Delaware affords desirable flexibility and simplicity in the exercise of corporate powers which are not available to corporations that are organized under the laws of Iowa. Delaware is generally recognized as having a modern, flexible and nationally recognized corporate statute and a well-developed body of case law that provides predictability and certainty in business planning. Cases involving corporate law issues are decided in a separate Court of Chancery in Delaware, -57- where judges have substantial experience and precedent in making their decisions. Due to the importance of corporate law in Delaware, the Delaware legislature puts a high priority on corporate law matters and is at the forefront of keeping the Delaware corporate statutes current in the face of changing business practices and legal developments. Corporate formalities and administrative procedures have been designed to be relatively simple and flexible in Delaware. Due to such factors, reincorporating in Delaware may reduce the impediments and increase the opportunities for structuring securities and financial transactions, which would facilitate acquisitions, raising capital and other financing transactions. Delaware law and courts are also more familiar to foreign investors and their advisors. As a result, foreign investment and financing opportunities may also be facilitated by reincorporating in Delaware. The Board therefore believes that the activities of the Company can be carried on to better advantage if the Company is able to operate under the corporate laws of Delaware. In addition, the Company believes that Delaware law will offer clearer guidance with respect to legal issues that may arise as a result of the existence of separate classes of Tracking Stock. However, shareholders in some instances may have fewer rights and less protection under Delaware law than under Iowa law. See "--Description of Restated Certificate of Incorporation of TDS Delaware" and "--Comparison of Shareholders' Rights Under Iowa and Delaware Law." CONSIDERATION OF POTENTIAL ADVERSE ASPECTS. While the Board has determined that implementation of the Tracking Stock Proposal is in the best interests of TDS and its shareholders, the Board recognizes that implementation of the Tracking Stock Proposal may have certain potentially adverse consequences, including the lack of assurance as to the degree to which the market price of the Tracking Stock will reflect the separate performance of the related Tracking Group and the uncertainty as to the impact of the proposal on the market price of the Common Shares, as well as the fact that implementation of the Tracking Stock Proposal will, to an extent, make the capital structure of the Company more complex, and may give rise to occasions when the interests of the holders of the various classes of common stock may diverge or appear to diverge. See "Risk Factors." The Board has given extensive consideration to the Tracking Stock Proposal and has determined that the positive aspects of the Tracking Stock Proposal outweigh any potentially adverse aspect and believes that the Tracking Stock Proposal would be in the best interests of TDS and its shareholders. OPINIONS OF FINANCIAL ADVISORS Credit Suisse First Boston ("C.S. First Boston") and Salomon Brothers Inc and Smith Barney Inc. (collectively doing business as "Salomon Smith Barney") are acting as co-financial advisors to the Company in connection with the Tracking Stock Proposal and each is assisting the Company in the solicitation of proxies therefor (the "Financial Advisors"). Each of C.S. First Boston and Salomon Smith Barney was asked to provide advice to the Board of Directors with respect to the effect of the Tracking Stock Proposal on (i) the market value of the Common Shares and the shares of Tracking Stock to be distributed in the Distribution with respect to the Common Shares (the "Proposed Common Equity") and (ii) the ability of TDS to raise equity capital through an offering or offerings of shares of common equity or securities convertible into common equity ("Equity Market Access"). The Telecom Public Offering, U.S. Cellular Merger, Aerial Merger, Distribution and Merger are herein collectively referred to as the "Recapitalization." Based upon and subject to the assumptions, limitations and qualifications discussed below, the opinion of each Financial Advisor states that, assuming the proposed Recapitalization had been effective as of the date of such opinion, the Recapitalization would not have a material adverse effect from a financial point of view on (i) the aggregate market value on a fully-distributed basis of the Proposed Common Equity outstanding after such Recapitalization as compared with the aggregate market value of the Common Shares of the Company outstanding immediately prior to the announcement of such Recapitalization or (ii) the Company's Equity Market Access after such Recapitalization as compared to the Company's Equity Market Access prior to the announcement of such Recapitalization. The Financial Advisors assumed, with the consent of the Board, that, immediately prior to the proposed Recapitalization, the Company's Common Shares, the Series A Common Shares, the Preferred Shares, the U.S. Cellular Common and Series A Common Shares and the Aerial Common and Series A Common Shares (the "Initial Shares") will continue to be the only classes of capital stock of the Company, U.S. Cellular and Aerial, respectively, which are outstanding; that, other than in connection with the proposed Recapitalization, there will be no material change in the number of Initial Shares outstanding prior to the implementation of the proposed Recapitalization; and that, immediately after the proposed Recapitalization, the Company Common Shares, the Series A Common Shares, the Preferred Shares and the Tracking Stocks will be the only classes of capital stock then outstanding. They also assumed that the U.S. Cellular Merger and the Aerial Merger are consummated on the terms set forth in the Proxy Statement/Prospectus. They further assumed that, prior to the proposed Recapitalization, the Initial Shares which are currently listed will continue to be listed on their respective exchanges or trading markets, and -58- that, following the proposed Recapitalization, the Company's Common Shares and the Tracking Stocks will be eligible for, and will be the only capital stock of the Company listed on, the American Stock Exchange. In arriving at their opinions, the Financial Advisors reviewed certain publicly available business and financial information relating to the Company, as well as the Proxy Statement/Prospectus. They also reviewed certain other information, including financial forecasts, provided to them by the Company, and met with the Company's management to discuss the business and prospects of the Company and the Tracking Groups and the potential impact of changes in the competitive environment and in the Company's and the Tracking Groups' business plans and strategies on those forecasts, businesses and prospects. The Financial Advisors also considered certain financial and stock market data of the Company, and compared those data with similar data for other publicly-held companies which have multiple classes of stock outstanding which reflect the performance of specific lines of business, and considered the financial terms of the different classes of stock of such companies. The Financial Advisors also considered such other information, financial studies, analyses and investigations, and financial, economic and market criteria which they deemed relevant. In particular, the Financial Advisors considered the following financial and other quantified information to be significant in arriving at their opinions. In their analysis for the October 31, 1997 board meeting (the "October Analysis"), the Financial Advisors compared TDS' existing stock price to the sum of the implied estimated values of its constituent businesses and found a public market discount of 26% and, assuming that U.S. Cellular or Aerial trade at a discount to their respective peers solely due to liquidity factors, and if such liquidity factors were eliminated, a discount of 38%. The Financial Advisors compared the enterprise value of U.S. Cellular as a multiple of population equivalents ("POPs"), subscribers, 1997 estimated revenue, last twelve months operating cash flow, and 1997 and 1998 estimated operating cash flow to that of several other cellular companies (360 DEG. Communications, Air Touch Communications, Centennial, CommNet Cellular, Palmer Wireless, Inc., PriCellular Corporation and Vanguard Cellular) and found that, in all categories (other than last 12 months operating cash flow) that U.S. Cellular traded at a lower multiple than the mean and medium for the comparable companies. The Financial Advisors compared Aerial with Omnipoint Corp. and Powertel Inc. on the basis of adjusted license value per POP and found that Aerial traded at a discount to Omnipoint and Powertel in this regard. The Financial Advisors' October Analysis included a comparison of existing tracking stocks with peer comparables, a relative liquidity analysis of U.S. Cellular and Aerial to their industry peers, and a "value pick up" analysis (all of which were also repeated in December 1997 (with similar results) and are summarized below). To analyze the implied equity value of TDS Telecom, assumed EBITDA multiples were applied to the financial forecasts of 1997 EBITDA (earnings before interest, taxes, depreciation and amortization) for TDS Telecom ($195.8 million). In both the October Analysis and the analysis for the December 15, 1997 board meeting (the "December Analysis"), the Financial Advisors compared nine tracking stocks (Pittson Burlington, TCI, Pittston Minerals, US West Communications, GM-Hughes Electronics, CMS Energy, USX-US Steel, Pittston Brinks and USX-Marathon) with the common stock of other companies in their industry groups on the basis of their estimated 1997 price/ earnings ratios and (for certain industries) as a ratio of enterprise value to last 12-month EBITDA and concluded they were neither consistently at the bottom nor consistently at the top of their comparable groups. In both the October Analysis and the December Analysis, the Financial Advisors also performed a relative liquidity analysis, in which they compared the public float of TDS, U.S. Cellular and Aerial with six cellular companies (Air Touch Communications, 360 DEG. Communications, CommNet Cellular, PriCellular, Vanguard Cellular and Western Wireless) and two PCS companies (Omnipoint, Powertel) and developed an indexed liquidity formula for each company ("ILF"). The ILF compared the percentage of market value traded daily (1997 year to date) to the ratio of average daily stock price change (1997 year to date) to average share price (1997 year to date) and found that (indexing TDS as 1.0) the ILF of U.S. Cellular was 0.31 and Aerial was 0.32 compared to a mean of 1.27 for the cellular companies (a range of 0.29-3.97) and 0.91 for the PCS companies (0.46 and 1.35). The Financial Advisors' December Analysis also performed a comparison of the per share equity value of the tracking stocks to the existing TDS, U.S. Cellular and Aerial shares and found an implied potential per share "value pick up" in each of such shares, assuming, among other things, liquidity improvements and a 20% retained interest. In addition to the foregoing, the Financial Advisors reviewed certain other financial and other quantified information, including the Company's budget for 1997 and five-year forecasts. Except as discussed above, such information was not a significant factor to the Financial Advisors in arriving at their opinions. In connection with their review, the Financial Advisors did not assume any responsibility for independent verification of any of the foregoing information (including the information contained in the Proxy Statement/ -59- Prospectus) and relied on its being complete and accurate in all material respects. With respect to the financial forecasts, the Financial Advisors assumed that they had been reasonably prepared on bases reflecting the best currently available estimates and judgments of the Company's management as to the future financial performance of the Company and the Tracking Groups. In addition, the Financial Advisors were not requested to make, and did not make, an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of the Company or the Tracking Groups, nor were they furnished with any such evaluations or appraisals. The Financial Advisors did not express any opinion as to what the actual value of the Tracking Stocks will be when issued to the Company's shareholders pursuant to the Recapitalization or the prices at which such Tracking Stocks will trade subsequent to the Recapitalization. In addition, the Financial Advisors did not express any opinion whatsoever as to the individual merits of the U.S. Cellular Merger, the Aerial Merger, or the Telecom Public Offering, or any opinion whatsoever with respect to the Reincorporation. The opinions of the Financial Advisors do not address the Company's underlying business decision to effect the Recapitalization and do not constitute a recommendation to any shareholder of the Company as to how such shareholder should vote with respect to the Recapitalization. The opinions of the Financial Advisors state that their analyses are necessarily based on financial, economic, market and other conditions as they exist and can be evaluated on the date of their opinions, and assume the Recapitalization was effective as of the date of their opinions, and they note that such conditions may change prior to the expected date of consummation of the Recapitalization. The opinions also state that the Recapitalization may cause a change in perception by some investors of the future plans of the Company or the holders of Series A Common Shares. Consequently, the opinions assume that the market has had a reasonable opportunity to understand and evaluate the Recapitalization. In addition, the opinions state that the Tracking Stocks which would be issued to the public shareholders of the Company in the proposed Distribution might trade initially at market prices below those at which they would trade on a fully distributed basis. The Board considered and found the assumptions, limitations and qualifications in the opinions of the Financial Advisors to be reasonable and appropriate under the circumstances. The Company's financial and legal advisors also examined the prospectuses and/or proxy statements for each company which they identified as having implemented a tracking stock capital structure. Although most, if not all, of such companies were advised by financial advisors, the Company and its advisors did not identify any company which requested or received a written opinion from its financial advisors in connection with the adoption of a tracking stock capital structure. Accordingly, the Board did not believe that a written opinion from financial advisors was necessary or required for the Board to approve the Tracking Stock Proposal or the related proposals. The Board recognized the complexity of the Tracking Stock Proposal and the related transactions and understood that there was no precedent for an opinion from financial advisors under similar circumstances. Accordingly, the Board did not request the Financial Advisors to deliver written opinions with regard to all aspects of the transactions, nor did the Board believe that seeking such opinions was necessary. Instead, the Board considered the oral advice of the Financial Advisors regarding many aspects of the Recapitalization, in a manner consistent with other companies which have adopted tracking stock capital structures. The Board determined to seek letters from the Financial Advisors for the limited purpose of obtaining their written opinions to the effect that the Recapitalization would not have a material adverse effect on (i) shareholder value (as measured by the aggregate market value on a fully-distributed basis of the Proposed Common Equity outstanding after such Recapitalization as compared with the aggregate market value of the Company's Common Shares outstanding immediately prior to the announcement of such Recapitalization) or (ii) the Company's ability to obtain equity capital in the public markets (as measured by the Company's Equity Market Access after such Recapitalization as compared to the Company's Equity Market Access prior to the announcement of such Recapitalization). The Financial Advisors did not express any opinion as to what the actual value of the Tracking Stocks will be when issued to the Company's shareholders pursuant to the Recapitalization or the prices at which such Tracking Stocks will trade subsequent to the Recapitalization. In addition, the Financial Advisors did not express any opinion whatsoever as to the individual merits of the U.S. Cellular Merger, the Aerial Merger, or the Telecom Public Offering, or any opinion whatsoever with respect to the Reincorporation. The opinions of the Financial Advisors do not address the Company's underlying business decision to effect the Recapitalization and do not constitute a recommendation to any shareholder of the Company as to how such shareholder should vote with respect to the Recapitalization. The Board did not ask for a written opinion with respect to such other matters. The Board did not believe that a written opinion from the Financial Advisors was necessary or required for such other matters. The Board did, in connection with such matters, seek the advice of the Financial Advisors, legal counsel and management to the extent it considered appropriate. The opinions also state that "The Recapitalization may cause a change in perception by some investors of the future plans of the Company or the holders of Series A Common Shares. Consequently, [the opinions assume] that the market has had a reasonable opportunity to understand and evaluate the Recapitalization." This qualification in the opinion exists in part because SEC rules do not permit the Company to communicate with shareholders -60- regarding a proposed transaction prior to the filing of a proxy statement with the SEC and the delivery of the proxy statement to shareholders if such discussions would constitute the solicitation of proxies under the SEC's rules. Accordingly, the Company and its representatives could not communicate with shareholders relating to the plans of the Company or the holders of Series A Common Shares as they relate to the Recapitalization prior to the filing of this Proxy Statement/Prospectus with the SEC. Although the Company and the Financial Advisors considered the range of possible perceptions that existing or prospective investors might have with respect to the Tracking Stock Proposal, neither had any specific knowledge of the actual perceptions of such investors. In addition, both the Company and the Financial Advisors believed that, given the complex nature of certain aspects of the proposal, the market would require some time for complete information on the specific aspects of the proposals to be adequately disseminated and analyzed and for investor questions and reactions to be addressed. Therefore, the Financial Advisors believed that it was necessary to qualify their opinions with respect to a possible change in investors' perception of the future plans of the Company or the holders of Series A Common Shares and to assume that the market has had a reasonable opportunity to understand and evaluate the Recapitalization. This Proxy Statement/ Prospectus discloses the plans of the Company and the holders of the Series A Common Shares to the extent such plans are material to the proposed Recapitalization. The opinions of the Financial Advisors also state that the Tracking Stocks might trade initially at market prices below those at which they would trade on a fully distributed basis. The Financial Advisors qualified their opinions in this manner because they believed that there would be a period of up to several months following the Distribution in which holders of Common Shares who received Cellular Group Shares, Aerial Group Shares and Telecom Group Shares may rebalance their portfolios based on their individual investment objectives. The Financial Advisors believed that, during this time, sales by shareholders who desire to reduce their holdings of Common Shares, Cellular Group Shares, Telecom Group Shares or Aerial Group Shares could cause the market prices to be below those at which they would trade on a fully distributed basis. The Board understood this possibility in approving the Tracking Stock Proposal. Nevertheless, the Board believes that this possible temporary adverse effect is outweighed by the positive aspects of the Tracking Stock Proposal to long-term shareholder value. See "--Reasons." The Company has agreed to pay the Financial Advisors (i) an advisory fee of $2,000,000, to be split equally between C.S. First Boston and Salomon Smith Barney, and payable upon the approval of the Tracking Stock Proposal by the Board, and public announcement thereof; (ii) an advisory fee of $2,000,000, to be split equally between C.S. First Boston and Salomon Smith Barney, payable upon the Distribution; and (iii) an incentive fee of no more than $3,000,000, to be split equally between C.S. First Boston and Salomon Smith Barney, payable 4 1/2 months after the Distribution. In general, an incentive fee is payable only if the post-Distribution value of the aggregate market value of the publicly-traded common equity exceeds 125% of the pre-announcement aggregate market value of the TDS Common Shares and, in such event, the amount of the fee which is payable is equal to $120,000 for each percentage point over 125%, up to a maximum of $3,000,000. The Company has also agreed to reimburse the Financial Advisors for reasonable out-of-pocket expenses (including fees and expenses of legal counsel) and has agreed to indemnify the Financial Advisors against certain liabilities, including liabilities under the Securities Act. C.S. First Boston and Salomon Smith Barney will also act as co-lead managers of the Telecom Public Offering. Each of C.S. First Boston and Salomon Smith Barney have also in the past provided services to one or more of the Company, U.S. Cellular and/or Aerial. INTERESTS OF CERTAIN PERSONS The TDS Voting Trust and its trustees and beneficiaries have an interest in the implementation of the Tracking Stock Proposal because it may enhance the ability of the TDS Voting Trust to retain voting control of TDS. The trustees of the voting trust are LeRoy T. Carlson, Jr., a director and the President of TDS and the son of LeRoy T. Carlson, Chairman of TDS; Walter C.D. Carlson, a director of TDS and the son of LeRoy T. Carlson, Chairman of TDS, and the brother of LeRoy T. Carlson, Jr.; Donald C. Nebergall, a director of TDS; Letitia G.C. Carlson, a director of TDS and the daughter of LeRoy T. Carlson, Chairman of TDS, and the sister of LeRoy T. Carlson, Jr. and Walter C.D. Carlson; and Melanie J. Heald, the daughter of Lester O. Johnson, director emeritus of TDS. Directors of TDS who are beneficiaries of the TDS Voting Trust are LeRoy T. Carlson, LeRoy T. Carlson, Jr., Walter C.D. Carlson, Letitia G.C. Carlson and Donald C. Nebergall. Walter C.D. Carlson is a partner of the law firm of Sidley & Austin, which is counsel to the Company and is advising the Company regarding the Tracking Stock Proposal and related matters. Donald C. Nebergall is a consultant to TDS. In addition, certain directors may be considered to have an interest in the Tracking Stock Proposal as officers of the Company or its subsidiaries. Directors of the Company who are officers or employees of the Company or its subsidiaries are: LeRoy T. Carlson (Chairman of TDS), LeRoy T. -61- Carlson, Jr. (President of TDS), Murray L. Swanson (Executive Vice President--Finance of TDS); Rudolph E. Hornacek (Vice President--Engineering of TDS); James Barr III (President of TDS Telecom); and Donald R. Brown (Senior Vice President of TDS Telecom). Shareholders are urged to carefully study and consider the Tracking Stock Proposal in light of the above interests. CHANGES TO BOARD OF DIRECTORS The Board has designated Mr. Kevin A. Mundt, age 43, to be Board's nominee for election as a Class II director by the Public Holders at the 1998 Annual Meeting of Shareholders. Mr. Mundt is a co-founder, and has been a director since 1984, of Corporate Decisions, Inc., a strategy consulting firm with 150 professionals in offices in North America and Europe. Corporate Decisions, Inc. recently merged with Mercer Management Consulting. Mr. Mundt's management consulting practice focuses on advising companies on strategies for profitable growth in changing markets. Prior to his association with Corporate Decisions, Mr. Mundt was associated with Bain and Company. Mr. Mundt holds a B.A. degree in economics from Brown University and an M.B.A. from the Harvard Graduate School of Business. Mr. Mundt has no current or prior relationships with the Company and is not related to any other director of the Company. If elected, Mr. Mundt will fill the directorship currently held by Mr. James Barr III, whose term will expire at the 1998 Annual Meeting of Shareholders. However, it is expected that Mr. Barr will be appointed as a director to fill a vacancy on the Board of Directors which is expected to occur following the 1998 Annual Meeting of Shareholders. Mr. Donald R. Brown, a current Class I director who was elected by the Series A Holders in 1997, retired as an employee of the Company in December 1997 and has advised the Board that he intends to resign from the Board following the 1998 Annual Meeting of Shareholders. It is expected that the Board of Directors will appoint Mr. Barr to fill the vacancy created by the resignation of Mr. Brown at the Board meeting which will follow the 1998 Annual Meeting of Shareholders. For further information about Messrs. Barr and Brown and the other current directors, and for information about director compensation and certain relationships and related transactions involving the directors, see the Company's Annual Report on Form 10-K for the year ended December 31, 1996 which is incorporated by reference herein. See "Where You Can Find More Information." THE COMPANY 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, 1997, the Company, through its subsidiaries, served approximately 3.2 million customer units in 37 states, including 1,710,000 cellular telephones, 515,500 telephone access lines, 125,000 PCS telephones, and 811,100 pagers. For the nine months ended December 31, 1997, cellular telephone operations provided 60% of the Company's consolidated revenues; telephone operations provided 30%; PCS operations provided 4%; and paging operations provided 6% of such revenues. 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 services. The Company conducts substantially all of its cellular operations through its majority-owned subsidiary U.S. Cellular (AMEX symbol "USM"), which is the eighth largest cellular telephone company in the United States, based on the aggregate number of population equivalents it owns. The Company conducts substantially all of its telephone operations through its wholly-owned subsidiary TDS Telecom. The Company conducts substantially all of its PCS business through its majority-owned subsidiary Aerial (NASDAQ National Market symbol "AERL"), which launched commercial service in the first half of 1997 and expects to complete initial construction of its PCS networks by the end of 1997. Notwithstanding the attribution of assets and liabilities, equity and items of income and expense among the Groups for the purpose of preparing the combined financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, the change in the capital structure of the Company contemplated by the Tracking Stock Proposal will not affect legal title to such assets or responsibility for such liabilities of the Company or any of its subsidiaries, except that TDS Delaware will succeed to the assets and liabilities of TDS Iowa. Holders of Cellular Group Shares, Telecom Group Shares, Aerial Group Shares, Common Shares and Series A Common Shares will be common shareholders of the Company and will be subject to risks associated with an investment in the Company and all of its businesses, assets and liabilities. The financial results of one or more of the Groups that affect the Company's consolidated results of operations or financial condition could affect the combined results of operations or financial condition of the TDS Group and the Tracking Groups and the market price of the Common -62- Shares, the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares. In addition, any net losses of any Group, dividends or distributions on, or repurchases of, any class of common stock, and dividends on, or certain repurchases of, Preferred Shares, will reduce funds of the Company legally available for the payment of dividends on all shares of common stock. Accordingly, the combined financial statements of the TDS Group, the Cellular Group, the Telecom Group and the Aerial Group should be read in conjunction with the consolidated financial statements of the Company. Reference is made to Annex I for a further description of the Company and the consolidated financial statements of the Company. THE CELLULAR GROUP The Cellular Group Shares, when issued, are intended to reflect the separate performance of the Cellular Group, which consists of the Company's interest in U.S. Cellular, an 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties. The Cellular Group would also include such other businesses, assets and liabilities of the Company as the Board may in the future determine to attribute to the Cellular Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the Cellular Group, as determined by the Board. The U.S. Cellular Restated Certificate of Incorporation currently provides that U.S. Cellular may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of cellular telephone systems (the "Cellular Business"), unless it first obtains the written consent of the Company. If U.S. Cellular becomes a wholly-owned subsidiary of the Company, this provision is expected to be eliminated from the U.S. Cellular Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Cellular Group. Accordingly, the Cellular Group will generally only engage in the Cellular Business, unless the Board determines to permit the Cellular Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Cellular Group in the future would not include businesses, opportunities, assets and liabilities of the TDS Group, the Telecom Group or the Aerial Group. The Company could determine to pursue future business opportunities through one Group instead of the other Groups, or jointly through more than one of the Groups. The decision to allocate certain resources and financial support to a Group other than the Cellular Group may adversely affect the ability of the Cellular Group to obtain funds sufficient to implement its business strategies. See "--Management and Allocation Policies." Holders of Cellular Group Shares will be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Cellular Group Shares will reflect the separate performance of either the Cellular Group or U.S. Cellular. The Board currently intends to retain future earnings of the Cellular Group for the development of the business of the Cellular Group, and does not anticipate paying dividends on the Cellular Group Shares in the foreseeable future. As of November 30, 1997, there were issued and outstanding 87,231,658 shares of common stock of U.S. Cellular. As of such date, the Company held 70,743,836 shares of common stock of U.S. Cellular, representing approximately 81.1% of the outstanding shares of common stock of U.S. Cellular, and 16,487,822 shares of common stock of U.S. Cellular were held by persons other than the Company. The Company has made an offer to issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by the Company pursuant to a merger between a subsidiary of the Company and U.S. Cellular. The Company has offered to exchange 1.14613 Cellular Group Shares for each outstanding Common Share of U.S. Cellular (other than shares held by the Company) in the U.S. Cellular Merger. This would represent an aggregate of 18,897,187 Cellular Group Shares based on Common Shares of U.S. Cellular outstanding as of November 30, 1997. This exchange ratio was determined by dividing (i) the sum of the number of Cellular Group Shares proposed to be distributed in the Distribution and the Number of Shares Issuable with Respect to Retained Interest considering only the Distribution by (ii) the number of shares of common stock of U.S. Cellular held by the Company as of November 30, 1997. The board of directors of U.S. Cellular has established a special committee consisting of an independent director to consider the TDS offer and to negotiate the terms of the merger agreement with TDS on behalf of the -63- minority shareholders of U.S. Cellular. The special committee has engaged independent financial and legal advisors in connection therewith. The U.S. Cellular Merger is subject to various conditions, including approval of the Tracking Stock Proposal by shareholders of the Company, effectiveness of the Merger, the negotiation of the other terms of a merger agreement between the Company and U.S. Cellular, approval of the U.S. Cellular Merger by the special committee of the board of directors, the full board of directors and the shareholders of U.S. Cellular and final approval by the Board. The Common Shares of U.S. Cellular are currently traded on the AMEX under the symbol "USM." If the U.S. Cellular Merger is consummated as contemplated, U.S. Cellular would become a wholly-owned subsidiary of the Company and such Common Shares would be delisted from the AMEX. In the U.S. Cellular Merger, holders of Common Shares of U.S. Cellular would receive Cellular Group Shares of TDS, which would be listed on the AMEX. If the U.S. Cellular Merger does not take place for any reason, U.S. Cellular may not become a wholly-owned subsidiary of the Company and the Common Shares of U.S. Cellular may continue to be publicly traded. Alternatively, although the Company has no current plans or intentions to do so, the Company may consider acquiring such Common Shares of U.S. Cellular in an exchange offer for Cellular Group Shares or other securities, in a tender offer for cash or through open market or private purchases, or taking other action to acquire some or all of the shares of U.S. Cellular not owned by the Company. On December 29, 1997, Airmont Plaza Associates, which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, U.S. Cellular, and the directors of U.S. Cellular. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the U.S. Cellular Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. On January 30, 1998, a virtually identical complaint was also filed by John G. Guillemont, Trustee of the John G. Guillemont Living Trust, who subsequently withdrew as plaintiff and was substituted with Marcus Galt. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. Subject to the effectiveness of the Merger, and after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, the Board intends to authorize the Distribution of Cellular Group Shares in the form of a stock dividend to holders of Series A Common Shares and Common Shares. It is currently expected that the Distribution would take place in July 1998 or later. The Board intends to distribute one Cellular Group Share with respect to each Common Share and Series A Common Share outstanding on the Distribution record date. The Distribution will be made to shareholders in proportion to the number of Common Shares and Series A Common Shares owned on the Distribution record date. The aggregate number of Cellular Group Shares proposed to be issued and distributed pursuant to the Distribution is intended initially to represent 75% of the common shareholders' equity value of the Company attributable to the Cellular Group. Accordingly, considering only the Distribution, the TDS Group would have a Retained Interest in the Cellular Group representing 25% of the common shareholders' equity value of the Company attributable to the Cellular Group. The number of Cellular Group Shares deemed to represent 100 percent of the common shareholders' equity value of the Company attributable to the Cellular Group is expected to be determined by the Board in connection with the U.S. Cellular Merger. This will be based on the number of outstanding Common Shares and Series A Common Shares at such time and the distribution ratio. If all of the Transactions are completed as contemplated, the issued Cellular Group Shares would initially reflect approximately 80% of the common shareholders' equity value of the Company attributable to the Cellular Group. The remaining 20% of the common shareholders' equity value of the Company initially attributable to the Cellular Group will be retained by the TDS Group as a Retained Interest. See "--Retained Interests." The Board reserves the right to effect all or any part of the Distribution of Cellular Group Shares even if the Telecom Public Offering, the U.S. Cellular Merger or the Aerial Merger have not been completed, or not to effect all or any part of the Distribution even if such other Transactions have taken place. The Board further reserves the right to modify the distribution ratio for the Cellular Group Shares or to modify the percentage interest to be retained by TDS through the Retained Interest in the Cellular Group. -64- The following table shows the Cellular Group Shares that would be issued in connection with the U.S. Cellular Merger and the Distribution considering the exchange ratio offered by the Company and the intended distribution ratio, and the number of Cellular Group Shares issuable, authorized for issuance for various purposes and available for issuance (based on shares outstanding at November 30, 1997).
PRO FORMA CELLULAR GROUP SHARES --------------------------------------------- RETAINED OUTSTANDING INTEREST TOTAL -------------- ------------- -------------- U.S. Cellular Merger................................................ 18,897,187 -- 18,897,187 Distribution........................................................ 60,811,362 20,270,454 81,081,816 -------------- ------------- -------------- Pro Forma Initial Shares...................................... 79,708,549 20,270,454 99,979,003 -------------- ------------- -------------- SHARES ISSUABLE TO THIRD PARTIES(1): Committed Acquisition Shares...................................... 567,412 (567,412) -- Pre-Distribution Convertible Securities: TDS Preferred Shares............................................ 969,025 (969,025) -- Existing Plans(1)............................................... 575,026 (575,026) -- -------------- ------------- -------------- Subtotal...................................................... 2,111,463 (2,111,463) -- -------------- ------------- -------------- ISSUABLE AS A RESULT OF U.S. CELLULAR MERGER: U.S. Cellular Employee Plans...................................... 711,387 -- 711,387 U.S. Cellular LYONs............................................... 8,090,116 -- 8,090,116 -------------- ------------- -------------- Subtotal...................................................... 8,801,503 -- 8,801,503 -------------- ------------- -------------- SHARES RESERVED FOR ISSUANCE: Existing Plans(2)................................................. 400,625 -- 400,625 1998 Long-Term Incentive Plan(3).................................. 2,888,613 -- 2,888,613 Tax-Deferred Savings Plan......................................... 70,000 -- 70,000 Acquisitions...................................................... 3,932,588 -- 3,932,588 -------------- ------------- -------------- Subtotal...................................................... 7,291,826 -- 7,291,826 -------------- ------------- -------------- PRO FORMA SHARES ISSUED, ISSUABLE AND RESERVED FOR ISSUANCE......... 97,913,341 18,158,991 116,072,332 Shares Available for Issuance....................................... 23,927,668 -- 23,927,668 -------------- ------------- -------------- Total......................................................... 121,841,009 18,158,991 140,000,000 -------------- ------------- -------------- -------------- ------------- --------------
- ------------ (1) These shares would be issuable from the Retained Interest. (2) See Proposal 2. (3) See Proposal 3. Reference is made to Annex II for a further description of the Cellular Group and the combined financial statements of the Cellular Group. THE TELECOM GROUP The Telecom Group Shares, when issued, are intended to reflect the separate performance of the Telecom Group, which includes the Company's interest in TDS Telecom, a wholly-owned subsidiary of the Company which operates landline telephone companies. The Telecom Group also includes the allocation of certain TDS debt. The Telecom Group would also include such other businesses, assets and liabilities of the Company as the Board may in the future determine to attribute to the Telecom Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the Telecom Group, as determined by the Board. The Board intends to adopt a policy providing that the Telecom Group may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of landline telephone systems (the "Telecom Business"), unless it first obtains the consent of the Board. At the present time, the Telecom Group operates certain businesses which are not considered Telecom Business. The Telecom Group will initially be permitted to continue to operate these existing businesses. Except with respect to such existing businesses, the Telecom Group will generally only engage in the Telecom Business, unless the Board determines to permit the Telecom Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any -65- businesses, opportunities, assets and liabilities attributed to the Telecom Group in the future would not include businesses, opportunities, assets and liabilities of the TDS Group, the Cellular Group or the Aerial Group. The Company could determine to pursue future business opportunities through one Group instead of the other Groups, or jointly through more than one of the Groups. The decision to allocate certain resources and financial support to a Group other than the Telecom Group may adversely affect the ability of the Telecom Group to obtain funds sufficient to implement its business strategies. See "--Management and Allocation Policies." Holders of Telecom Group Shares will be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Telecom Group Shares will reflect the separate performance of either the Telecom Group or TDS Telecom. Following the Distribution, subject to the legal restrictions on the payment of dividends described below, the Board currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, this dividend rate would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share (the "Telecom Equivalent Dividend Rate"). Following the Distribution, the Board also currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share. The total of this rate and the Telecom Equivalent Dividend Rate is equal to $0.42 per share per annum, which is the same as the current annual dividend rate on the existing Common Shares and Series A Common Shares. The intent is that, immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is at least equal to the aggregate dividend which such shareholder currently receives from the Company (not considering reductions in shares which may occur due to the payment of cash in lieu of fractional shares in the Distribution). TDS currently holds 100% of the issued and outstanding capital stock of TDS Telecom. Promptly after approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, the Company intends to offer and sell Telecom Group Shares in a public offering for cash, and to allocate the net proceeds thereof to the Telecom Group. The Company intends to file with the SEC a registration statement on Form S-3 relating to the registration of between 10,000,000 and 17,000,000 Telecom Group Shares. This offering is expected to commence promptly after the approval of the Tracking Stock Proposal by shareholders and the effectiveness of the Merger, subject to prevailing market conditions and other factors. Subject to the effectiveness of the Merger, after the completion of the Merger, the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, the Board intends to authorize the Distribution of Telecom Group Shares in the form of a stock dividend to holders of Series A Common Shares and Common Shares. The Board intends to distribute two-thirds of a Telecom Group Share with respect to each Common Share and Series A Common Share outstanding on the Distribution record date. The Distribution will be made to shareholders in proportion to the number of Common Shares and Series A Common Shares owed on the Distribution record date. The aggregate number of Telecom Group Shares proposed to be issued and distributed pursuant to the Distribution is intended initially to represent 75% of the common shareholders' equity value of the Company attributable to the Telecom Group. Accordingly, considering only the Distribution, the TDS Group would have a Retained Interest in the Telecom Group representing 25% of the common shareholders' equity value of the Company attributable to the Telecom Group. The number of Telecom Group Shares deemed to represent 100 percent of the common shareholders' equity value of the Company attributable to the Telecom Group is expected to be determined by the Board in connection with the Telecom Public Offering. This will be based on the number of outstanding Common Shares and Series A Common Shares at such time and the distribution ratio. If all of the Transactions are completed as contemplated, the issued Telecom Group Shares would initially reflect approximately 80% of the common shareholders' equity value of the Company attributable to the Telecom Group. The remaining 20% of the common shareholders' equity value of the Company initially attributable to the Telecom Group will be retained by the TDS Group as a Retained Interest. See "--Retained Interests." The Board reserves the right to effect all or any part of the Distribution of Telecom Group Shares even if the Telecom Public Offering, the U.S. Cellular Merger or the Aerial Merger have not been completed, or not to effect all or any part of the Distribution even if such other Transactions have taken place. The Board further reserves the right to modify the distribution ratio for the Telecom Group Shares or to modify the percentage interest to be retained by TDS through the Retained Interest in the Telecom Group. -66- The following table shows the Telecom Group Shares that would be issued in connection with the Telecom Public Offering and the Distribution considering the number of Telecom Group Shares being offered by the Company and the intended distribution ratio, and the number of Telecom Group Shares issuable, authorized for various purposes and available for issuance (based on shares outstanding at November 30, 1997).
PRO FORMA TELECOM GROUP SHARES --------------------------------------------- RETAINED OUTSTANDING INTEREST TOTAL -------------- ------------- -------------- Telecom Public Offering(1).......................................... 13,500,000 -- 13,500,000 Distribution........................................................ 40,540,908 13,513,636 54,054,544 -------------- ------------- -------------- Pro Forma Initial Shares...................................... 54,040,908 13,513,636 67,554,544 -------------- ------------- -------------- SHARES ISSUABLE TO THIRD PARTIES(2): Committed Acquisition Shares...................................... 378,275 (378,275) -- Pre-Distribution Convertible Securities TDS Preferred Shares............................................ 646,017 (646,017) -- Existing Plans(3)............................................... 383,350 (383,350) -- -------------- ------------- -------------- Subtotal...................................................... 1,407,642 (1,407,642) -- -------------- ------------- -------------- SHARES RESERVED FOR ISSUANCE: Existing Plans(3)................................................. 267,084 -- 267,084 1998 Long-Term Incentive Plan(4).................................. 2,500,000 -- 2,500,000 Tax-Deferred Savings Plan......................................... 175,000 -- 175,000 Acquisitions...................................................... 2,821,725 -- 2,821,725 Dividend Reinvestment Plan........................................ 150,000 -- 150,000 -------------- ------------- -------------- Subtotal...................................................... 5,913,809 -- 5,913,809 -------------- ------------- -------------- PRO FORMA SHARES ISSUED, ISSUABLE AND RESERVED FOR ISSUANCE......... 61,362,359 12,105,994 73,468,353 Shares Available for Issuance....................................... 16,531,647 -- 16,531,647 -------------- ------------- -------------- Total......................................................... 77,894,006 12,105,994 90,000,000 -------------- ------------- -------------- -------------- ------------- --------------
- ------------ (1) The Company intends to offer between 10,000,000 and 17,000,000 Telecom Group Shares. For purposes of this Proxy Statement/ Prospectus, the midpoint of this amount is assumed for all purposes. (2) These shares would be issuable from the Retained Interest. (3) See Proposal 2. (4) See Proposal 3. Reference is made to Annex III for a further description of the Telecom Group and the combined financial statements of the Telecom Group. -67- THE AERIAL GROUP The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Group, which includes the Company's interest in Aerial, a subsidiary of the Company which is developing broadband personal communications services. The Aerial Group would also include such other businesses, assets and liabilities of the Company as the Board may in the future determine to attribute to the Aerial Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the Aerial Group, as determined by the Board. The Aerial Restated Certificate of Incorporation currently provides that Aerial may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of personal communications systems (the "PCS Business"), unless it first obtains the written consent of the Company. If Aerial becomes a wholly-owned subsidiary of the Company, this provision is expected to be eliminated from the Aerial Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Aerial Group. Accordingly, the Aerial Group will generally only engage in the PCS Business, unless the Board determines to permit the Aerial Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Aerial Group in the future would not include businesses, opportunities, assets and liabilities of the TDS Group, the Cellular Group or the Telecom Group. The Company could determine to pursue future business opportunities through one Group instead of the other Groups, or jointly through more than one of the Groups. The decision to allocate certain resources and financial support to a Group other than the Aerial Group may adversely affect the ability of the Aerial Group to obtain funds sufficient to implement its business strategies. See "--Management and Allocation Policies." Holders of Aerial Group Shares will be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Aerial Group Shares will reflect the separate performance of either the Aerial Group or Aerial. As of November 30, 1997, there were issued and outstanding 71,606,081 shares of common stock of Aerial. As of such date, the Company held 59,086,000 shares of common stock of Aerial, representing approximately 82.5% of the outstanding shares of common stock of Aerial, and 12,520,081 shares of common stock of Aerial were held by persons other than the Company. The Company has made an offer to issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by the Company pursuant to a merger between a subsidiary of the Company and Aerial. The Company has offered to exchange .91485 Aerial Group Shares for each outstanding Common Share of Aerial (other than shares owned by the Company) in the Aerial Merger. This would represent an aggregate of 11,453,996 Aerial Group Shares based on Common Shares of Aerial outstanding as of November 30, 1997. This exchange ratio was determined by dividing (i) the sum of the number of Aerial Group Shares proposed to be issued in the Distribution and the number of Shares Issuable with Respect to Retained Interest assuming only the Distribution by (ii) the number of shares of common stock of Aerial held by the Company as of November 30, 1997. The board of directors of Aerial has established a special committee consisting of two independent directors to consider the TDS offer and to negotiate the terms of the merger agreement with TDS on behalf of the minority shareholders of Aerial. The special committee has engaged independent financial and legal advisors in connection therewith. The Aerial Merger is subject to various conditions, including approval of the Tracking Stock Proposal by shareholders of the Company, effectiveness of the Merger, the negotiation of the other terms of a merger agreement between the Company and Aerial, approval of the Aerial Merger by the special committee of the board of directors, the full board of directors and the shareholders of Aerial and final approval by the Board. The Common Shares of Aerial are currently traded on the Nasdaq National Market under the symbol "AERL." If the Aerial Merger is consummated as contemplated, Aerial would become a wholly-owned subsidiary of the Company and such Common Shares would be delisted from the Nasdaq National Market. In the Aerial Merger, holders of Common Shares of Aerial would receive Aerial Group Shares of TDS, which would be listed on the AMEX. If the Aerial Merger does not take place for any reason, Aerial may not become a wholly-owned subsidiary of the Company and the Common Shares of Aerial may continue to be publicly traded. Alternatively, although the Company has no current plans or intentions to do so, the Company may consider acquiring such Common Shares of Aerial in an exchange offer for Aerial Group Shares or other securities, in a tender offer for cash or through open market or private purchases, or taking other action to acquire some or all of the shares of Aerial not owned by the Company. -68- On January 5, 1998, Richard Greenfield, who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, Aerial, and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. On February 6, 1998, a virtually identical complaint was also filed by Jess Colvin. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. Subject to the effectiveness of the Merger, and after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, the Board intends to authorize the Distribution of Aerial Group Shares in the form of a stock dividend to holders of Series A Common Shares and Common Shares. The Board intends to distribute two-thirds of an Aerial Group Share with respect to each Common Share and Series A Common Share outstanding on the Distribution record date. The Distribution will be made to shareholders in proportion to the number of Common Shares and Series A Common Shares owned on the Distribution record date. The aggregate number of Aerial Group Shares proposed to be issued and distributed pursuant to the Distribution is intended initially to represent 75% of the common shareholders' equity value of the Company attributable to the Aerial Group. Accordingly, considering only the Distribution, the TDS Group would have a Retained Interest in the Aerial Group representing 25% of the common shareholders' equity value of the Company attributable to the Aerial Group. The number of Aerial Group Shares deemed to represent 100 percent of the common shareholders' equity value of the Company attributable to the Aerial Group is expected to be determined by the Board in connection with the Aerial Merger. This will be based on the number of outstanding Common Shares and Series A Common Shares at such time and the distribution ratio. If all of the Transactions are completed as contemplated, the issued Aerial Group Shares would initially reflect approximately 80% of the common shareholders' equity value of the Company attributable to the Aerial Group. The remaining 20% of the common shareholders' equity value of the Company initially attributable to the Aerial Group will be retained by the TDS Group as a Retained Interest. See "--Retained Interests." The Board reserves the right to effect all or any part of the Distribution of Aerial Group Shares even if the Telecom Public Offering, the U.S. Cellular Merger or the Aerial Merger have not been completed, or not to effect all or any part of the Distribution even if such other Transactions have taken place. The Board further reserves the right to modify the distribution ratio for the Aerial Group Shares or to modify the percentage interest to be retained by TDS through the Retained Interest in the Aerial Group. The Board currently intends to retain future earnings of the Aerial Group, if any, for the development of the Aerial Group, and does not anticipate paying dividends on the Aerial Group Shares in the foreseeable future. -69- The following table shows the Aerial Group Shares that would be issued in connection with the Aerial Merger and the Distribution considering the exchange ratio offered by the Company and the intended distribution ratio, and the number of Aerial Group Shares issuable, authorized for various purposes and available for issuance (based on shares outstanding at November 30, 1997).
PRO FORMA AERIAL GROUP SHARES ------------------------------------------- RETAINED OUTSTANDING INTEREST TOTAL ------------- ------------- ------------- Aerial Merger................................................................... 11,453,996 -- 11,453,996 Distribution.................................................................... 40,540,908 13,513,636 54,054,544 ------------- ------------- ------------- Pro Forma Initial Shares.................................................. 51,994,904 13,513,636 65,508,540 ------------- ------------- ------------- SHARES ISSUABLE TO THIRD PARTIES: Committed Acquisition Shares.................................................. 378,275 (378,275) -- Pre-Distribution Convertible Securities....................................... TDS Preferred Shares........................................................ 646,017 (646,017) -- Existing Plans(1)........................................................... 383,350 (383,350) -- ------------- ------------- ------------- Subtotal.................................................................. 1,407,642 (1,407,642) -- ------------- ------------- ------------- ISSUABLE AS A RESULT OF AERIAL MERGER: Aerial Employee Plans......................................................... 1,372,275 -- 1,372,275 ------------- ------------- SHARES RESERVED FOR ISSUANCE: Existing Plans(1)............................................................. 267,084 -- 267,804 1998 Long-Term Incentive Plan(2).............................................. 1,827,725 -- 1,827,725 Tax-Deferred Savings Plan..................................................... 200,000 -- 200,000 Acquisitions.................................................................. 2,821,725 -- 2,821,725 ------------- ------------- ------------- Subtotal.................................................................. 5,116,534 -- 5,116,534 ------------- ------------- ------------- PRO FORMA SHARES ISSUED, ISSUABLE AND RESERVED FOR ISSUANCE..................... 59,891,355 12,105,994 71,997,349 Shares Available for Issuance................................................... 23,002,651 -- 23,002,651 ------------- ------------- ------------- Total Authorized.......................................................... 82,894,006 12,105,994 95,000,000 ------------- ------------- ------------- ------------- ------------- -------------
- ------------ (1) These shares would be issuable from the Retained Interest. (2) See Proposal 2. (3) See Proposal 3. Reference is made to Annex IV for a further description of the Aerial Group and the combined financial statements of the Aerial Group. THE TDS GROUP Upon the completion of all of the Transactions as contemplated, the Series A Common Shares and the Common Shares of TDS Delaware would represent an equity interest in the TDS Group, which would have a Retained Interest of approximately 20% of the common shareholders' equity value of the Company attributable to each Tracking Group, along with all other interests held by the Company. The TDS Group would also include such other assets and liabilities of the Company as the Board may in the future determine to attribute to the TDS Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the TDS Group, as determined by the Board. The Board intends to adopt a policy providing that the TDS Group may own, invest or otherwise have an interest in, lease, operate or manage any business other than a Cellular Business, a Telecom Business or a PCS Business. At the present time, the TDS Group owns interests in businesses which may be considered to include such other businesses. The TDS Group will continue to be permitted to operate these existing businesses. Except with respect to such existing businesses, the TDS Group will generally not engage in the Cellular Business, the Telecom Business or the PCS Business, except through the Retained Interests, unless the Board determines to permit the TDS Group to pursue such opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the TDS Group in the future would not include businesses, opportunities, assets and liabilities of the Cellular Group, the Telecom Group or the Aerial Group. The Company could determine to pursue future business opportunities through one Group -70- instead of the other Groups, or jointly through more than one of the Groups. The decision to allocate certain resources and financial support to a Group other than the TDS Group may adversely affect the ability of the TDS Group to obtain funds sufficient to implement its business strategies. See "--Management and Allocation Policies." The Board expects to adopt a policy pursuant to which the benefits of tax deductions which cannot be utilized by any Tracking Group would be allocated to the TDS Group. The TDS Group would be required to compensate such Tracking Group for such tax benefits at such time as such Tracking Group would be able to utilize such tax benefits as a stand-alone entity. For example, the TDS Group will derive the benefits of the tax losses of Aerial until such time as Aerial would be able to utilize such tax benefits as a stand-alone entity. In structuring the terms of the Tracking Stock Proposal, the Board determined that the retention by the TDS Group of Retained Interests in the Cellular Group, the Telecom Group and the Aerial Group was appropriate. In making this determination, the Board concluded that it would be desirable for shareholders to have the option of continuing to maintain a common equity investment in all of the businesses of the Company and its subsidiaries by retaining ownership of the Common Shares and Series A Common Shares. The Board also determined that it would be desirable for the Company to have a Group which could enter into new ventures and possibly create additional tracking stocks for such ventures by designating series of Undesignated Shares. Such new shares of tracking stock could be distributed to the holders of Common Shares and Series A Common Shares upon the creation or separation of a business, sold for cash in a public or private offering to finance a new business for the benefit of the TDS Group or delivered in connection with the acquisition of a business by the TDS Group. The Company has no current plans to create any additional tracking stocks or to make any material investments in any new businesses. Holders of Common Shares and Series A Common Shares will be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Common Shares will reflect the separate performance of either the TDS Group or its Retained Interests in the Tracking Groups. Following the Distribution, the Board currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share (the "TDS Group Dividend Rate"). Following the Distribution, the Board also intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, this dividend rate would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share (the "Telecom Equivalent Dividend Rate"). The total of the TDS Group Dividend Rate and the Telecom Equivalent Dividend Rate is equal to $0.42 per share per annum, as compared to the current annual dividend rate on the existing Common Shares and Series A Common Shares of $0.42 per share. The intent is that, immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is at least equal to the aggregate dividend which such shareholder currently receives from the Company (not considering reductions in shares which may occur due to the payment of cash in lieu of fractional shares in the Distribution). The following table shows the TDS Group Shares that would be issued in the Merger and the number of TDS Group Shares issuable, authorized for issuance for various purposes and available for issuance (based on shares outstanding at November 30, 1997).
SERIES A SPECIAL TOTAL TDS COMMON SHARES COMMON SHARES COMMON SHARES GROUP SHARES --------------- --------------- --------------- -------------- To Be Issued in Merger.................................. 6,933,233 53,878,129(1) -- 60,811,362 --------------- --------------- --------------- -------------- SHARES ISSUABLE TO THIRD PARTIES: Committed Acquisition Shares.......................... -- 567,412 -- 567,412 Pre-Distribution Convertible Securities TDS Preferred Shares................................ -- 969,025 -- 969,025 Existing Plans...................................... -- 575,026 -- 575,026 --------------- --------------- --------------- -------------- Subtotal.......................................... -- 2,111,463 -- 2,111,463 --------------- --------------- --------------- --------------
-71-
SERIES A SPECIAL TOTAL TDS COMMON SHARES COMMON SHARES COMMON SHARES GROUP SHARES --------------- --------------- --------------- -------------- AUTHORIZED FOR ISSUANCE(2): Existing Plans(3)..................................... -- 400,625 -- 400,625 1998 Long Term Incentive Plan(4)...................... -- 1,800,000 -- 1,800,000 Other TDS Benefit Plans............................... -- 361,027 -- 361,027 Acquisitions.......................................... -- 1,442,235 -- 1,442,235 Issuance for Cash..................................... -- 1,580,000 -- 1,580,000 Dividend Reinvestment Plan............................ 175,567 464,958 -- 640,525 --------------- --------------- --------------- -------------- Subtotal.......................................... 175,567 6,048,845 -- 6,224,412 --------------- --------------- --------------- -------------- PRO FORMA SHARES ISSUED, ISSUABLE AND RESERVED FOR ISSUANCE............................................... 7,108,800 62,038,437 -- 69,147,237 Shares Available for Issuance........................... 17,891,200 37,961,563 20,000,000 75,852,763 --------------- --------------- --------------- -------------- Total Authorized.................................. 25,000,000 100,000,000 20,000,000 145,000,000 --------------- --------------- --------------- -------------- --------------- --------------- --------------- --------------
- ------------ (1) Includes 484,012 shares held by a subsidiary of TDS. (2) Does not include shares authorized for issuance upon conversion of Series A Common Shares, based on the assumption that such shares will not be converted. (3) See Proposal 2. (4) See Proposal 3. Reference is made to Annex V for a further description of the TDS Group and the combined financial statements of the TDS Group. EFFECT OF PRE-DISTRIBUTION CONVERTIBLE SECURITIES AND COMMITTED ACQUISITION SHARES After the Distribution, the Pre-Distribution Convertible Securities outstanding will be adjusted so that such Pre-Distribution Convertible Securities will be convertible into, or exercisable or exchangeable for, as the case may be, immediately after the Distribution, such number of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in addition to the Common Shares such Pre-Distribution Convertible Securities were already convertible into, exercisable or exchangeable for, as the case may be, as if such conversion, exercise or exchange had occurred immediately prior to the Distribution. In addition, pursuant to the provisions of the acquisition agreements relating to the delivery of Committed Acquisition Shares, after the Distribution, Common Shares that are issuable as Committed Acquisition Shares will, immediately upon issuance and without any notice or any other action on the part of the Company or its Board or otherwise, include Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in addition to each Common Share issuable in such acquisition as if such acquisition had occurred immediately prior to the Distribution. Approval of the Tracking Stock Proposal will also constitute approval by shareholders of the full adjustment of all Pre-Distribution Convertible Securities and obligations to deliver Committed Acquisition Shares as described in this paragraph, including shares reserved for issuance therefor. The obligations to deliver shares of common stock upon the conversion, exercise or exchange of Pre-Distribution Convertible Securities and with respect to any pre-Distribution Committed Acquisition Shares will be attributed to the TDS Group. As indicated above, the Pre-Distribution Convertible Securities that are currently convertible into Common Shares will become convertible into Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as Common Shares, as a result of the Distribution, and Committed Acquisition Shares will require the delivery of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as Common Shares, as a result of the Distribution. If and when such Pre-Distribution Convertible Securities are converted, exercised or exchanged, or upon the delivery of Committed Acquisition Shares, the shares to be issued upon such conversion, exercise, exchange or delivery will be issued from the Retained Interest of the TDS Group, or from authorized but unissued Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, provided that if shares of any Tracking Stock are issued from authorized but unissued shares for such purposes, the TDS Group will be charged, and such other Groups will be credited, with an amount equal to the product of the number of shares of Tracking Stock of such Groups which are issued upon such conversion, exercise, exchange or delivery, and the Market Value of one share of such Tracking Stock over the twenty-Trading Day period ending five Trading Days prior to the issuance of such shares. The consideration received by the Company upon the conversion, exercise or exchange of any Pre-Distribution Convertible Securities and with respect to the issuance of Committed Acquisition Shares will be attributed to the TDS Group. If any such consideration attributed to the TDS Group which -72- is received in connection with the delivery of pre-Distribution Committed Acquisition Shares includes assets related to the Cellular Business, the Telecom Business or the Aerial Business, the TDS Board may cause the TDS Group to transfer such assets to the appropriate Tracking Group in consideration for an increase in the Number of Shares Issuable with Respect to Retained Interest or other consideration. DESCRIPTION OF ARTICLES OF INCORPORATION OF TDS IOWA The Articles of Incorporation of the Company, as amended (the "Articles"), provide that the authorized capital stock consists of 100,000,000 Common Shares, $1.00 par value, 25,000,000 Series A Common Shares, $1.00 par value, and 5,000,000 Preferred Shares, without par value. PREFERRED SHARES. The Board is authorized by the Articles to issue Preferred Shares from time to time in series and to establish as to each series the designation and number of shares to be issued, the dividend rate, the redemption price and terms, if any, the amount payable upon voluntary or involuntary dissolution of TDS, sinking fund provisions, if any, voting rights, if any, and the terms of conversion into Common Shares, if provided for. The current number of authorized Preferred Shares is 5,000,000, of which 296,664 were issued and 30,000 shares were issuable as of November 30, 1997. VOTING RIGHTS. The Articles provide that the Board is divided into three classes. Each class is elected for a three-year term. With respect to the election of directors, the holders of Common Shares, and the holders of Preferred Shares issued before October 31, 1981 (all of which have voting rights), voting as a group, are entitled to elect 25% of the Board of TDS, rounded up to the nearest whole number. The holders of Series A Common Shares, and the holders of Preferred Shares issued after October 31, 1981 which have voting rights, voting as a group, currently elect the remaining members of the Board of TDS. The Board currently consists of twelve directors. Accordingly, the holders of Common Shares and the holders of Preferred Shares issued before October 31, 1981 currently elect three directors and the holders of Series A Common Shares and Preferred Shares issued after October 31, 1981 which have voting rights, currently elect nine directors. There is no provision in the Articles permitting cumulative voting. The holders of Common Shares and all currently outstanding series of Preferred Shares are entitled to one vote per share. The holders of Series A Common Shares are entitled to ten votes per share. The holders of Common Shares, Series A Common Shares and Preferred Shares which have voting rights vote as a single class, except with respect to the election of directors as discussed above and with respect to certain amendments to the Articles (E.G., amendments having an effect on the holders of a class), as to which the IBCA grants class voting rights. If the number of Series A Common Shares issued and outstanding at any time falls below 500,000, because of the conversion of Series A Common Shares or otherwise, the holders of Series A Common Shares would lose the right to vote as a separate class (with the holders of Preferred Shares issued after October 31, 1981 which have voting rights) in the election of approximately 75% of the directors, and thereafter the holders of Series A Common Shares (with ten votes per share) would vote with the holders of Common Shares (with one vote per share) and all Preferred Shares which have voting rights, as a single class in the election of directors. It is unlikely that the number of outstanding Series A Common Shares will fall below 500,000, because more than 6,000,000 Series A Common Shares are held in the TDS Voting Trust, and the trustees of the TDS Voting Trust have indicated that they have no present intention of converting Series A Common Shares into Common Shares. DIVIDENDS. Subject to the satisfaction of all Preferred Share dividend preference and redemption provisions, holders of Common Shares are entitled to receive such dividends as may be declared from time to time by the Board. Unless the same, or greater, dividends, on a per share basis, are declared and paid at the same time on the Common Shares, no dividends may be declared or paid on the Series A Common Shares. SHARE DIVIDENDS. In the case of share dividends, the Articles provide that Common Shares may be paid to holders of Common Shares and proportionately to holders of Series A Common Shares; Series A Common Shares may be paid to holders of Common Shares and proportionately to holders of Series A Common Shares; and Common Shares may be paid to holders of Common Shares and Series A Common Shares may be paid proportionately to holders of Series A Common Shares. The Board is authorized to permit both the holders of Common Shares and Series A Common Shares to elect to receive cash in lieu of stock. DISTRIBUTION OF SUBSIDIARY IN DIVIDEND OR LIQUIDATION. The Articles provide that if a TDS subsidiary has classes of capital stock with relative rights, preferences and limitations vis-a-vis each other that, in the judgment of the Board, are similar in all material respects to the relative rights, preferences and limitations of the Common -73- Shares vis-a-vis the Series A Common Shares, except for certain limited matters, then the Board will distribute the subsidiary shares in a dividend or upon liquidation to the extent practicable by distributing the subsidiary shares which correspond to the Common Shares, to the holders of Common Shares, and the subsidiary shares which correspond to the Series A Common Shares, to the holders of Series A Common Shares, provided that the same number of shares of subsidiary common stock on a combined basis must be distributed per Series A Common Share and Common Share. LIQUIDATION. Upon liquidation, holders of Common Shares and Series A Common Shares are entitled to receive a pro rata share of all assets available to shareholders after payment to holders of the Preferred Shares of the liquidation value thereof, plus a sum equal to the amount of all accumulated and unpaid dividends thereon at the dividend rate fixed for each series of cumulative Preferred Shares by the Board, except as discussed above with respect to the distribution of a subsidiary in liquidation. PREEMPTIVE RIGHTS. The holders of Series A Common Shares have a preemptive right to purchase any additional Series A Common Shares sold for cash, including treasury shares. Holders of Common Shares and Preferred Shares have no preemptive rights under the Articles. CONVERSION RIGHTS. The Common Shares have no conversion rights. The Series A Common Shares are convertible, on a share-for-share basis, into Common Shares. CONSIDERATION OF COMMUNITY INTERESTS IN ACQUISITION PROPOSALS. Article IX of the Iowa Articles provides that, when evaluating any offer of another party to (i) make a tender or exchange offer for any equity of the Company; (ii) merge or consolidate the Company with another corporation; or (iii) purchase or otherwise acquire all or substantially all of the properties and assets of the Company, the Board may, in connection with the exercise of its judgment in determining what is in the best interests of the Company and its shareholders, give due consideration to all factors the directors deem relevant, including, without limitation, (a) the effects on the customers of the Company or any of its subsidiaries, (b) not only the consideration being offered in relation to the then current market price for the Company's outstanding shares of capital stock, but also the Board's estimate of the future value of the Company (including the unrealized value of its properties and assets) as an independent going concern, and (c) the purpose of the Company and any of its subsidiaries to provide quality products and services on a long-term basis. DESCRIPTION OF RESTATED CERTIFICATE OF INCORPORATION OF TDS DELAWARE The Restated Certificate will authorize 475,000,000 shares of capital stock, to consist of 326,664 Preferred Shares, par value $0.01 per share, 4,673,336 Undesignated Shares, par value $0.01 per share, 25,000,000 Series A Common Shares, par value $0.01 per share, 100,000,000 Common Shares, par value $0.01 per share, 20,000,000 Special Common Shares, par value $0.01 per share, 90,000,000 Telecom Group Shares, par value $0.01 per share, 140,000,000 Cellular Group Shares, par value $0.01 per share, and 95,000,000 Aerial Group Shares, par value $0.01 per share. The numbers of Preferred Shares and Undesignated Shares is estimated based on the number of Iowa Preferred Shares which are issued and issuable on November 30, 1997. The actual numbers will be based on the number of Iowa Preferred Shares which will be outstanding shortly prior to the Merger. The total of the Preferred Shares and Undesignated Shares will equal 5,000,000. The following describes the terms of the capital stock under the Restated Certificate in comparison to the Articles in general terms. In addition, the terms of the Tracking Stock are described in greater detail below under "--Description of Terms of Tracking Stock." PAR VALUE. The par value per share of each class of common stock will be changed from $1.00 under the Articles to $.01 and the par value per share of the Preferred Shares will be changed from no par value to par value of $.01 per share. This is being done solely for the purposes of reducing the amount of Delaware filing fees TDS Delaware will be required to pay in connection with the reincorporation. AUTHORIZED SHARES. The following table shows, with respect to each class of capital stock, the number of shares which would be issued in the Merger, the Distribution and the other Transactions as contemplated, the number of shares which would be reserved for issuance for certain purposes and the number of shares which -74- would be available for issuance for other proper corporate purposes, of the shares of common stock (based on shares outstanding as of November 30, 1997).
SERIES A SPECIAL CELLULAR TELECOM AERIAL COMMON COMMON COMMON GROUP GROUP GROUP SHARES SHARES SHARES SHARES SHARES SHARES ---------- ----------- ---------- ----------- ---------- ---------- Issued in Merger............................... 6,933,233 53,878,129(1) Issued in Distribution......................... -- -- -- 60,811,362 40,540,908 40,540,908 Issued in Other Transactions(2)................ -- -- -- 18,897,187 13,500,000 11,453,996 ---------- ----------- ---------- ----------- ---------- ---------- Pro Forma Outstanding........................ 6,933,233 53,878,129 -- 79,708,549 54,040,908 51,994,904 Shares Issuable by TDS to Third Parties(3)..... -- 2,111,463 -- 2,111,463 1,407,642 1,407,642 Shares Issuable Due to Other Transactions(2)... -- -- -- 8,801,503 -- 1,372,275 Reserved for Issuance.......................... 175,567 6,048,845 -- 7,291,826 5,913,809 5,116,534 Available for Issuance......................... 17,891,200 37,961,563 20,000,000 23,927,668 16,531,647 23,002,651 Retained Interest(4)........................... -- -- -- 18,158,991 12,105,994 12,105,994 ---------- ----------- ---------- ----------- ---------- ---------- Total Authorized............................. 25,000,000 100,000,000 20,000,000 140,000,000 90,000,000 95,000,000 ---------- ----------- ---------- ----------- ---------- ---------- ---------- ----------- ---------- ----------- ---------- ----------
- ------------ (1) Includes 484,012 shares held by a subsidiary of the Company. (2) The other Transactions include the U.S. Cellular Merger, the Aerial Merger and the Telecom Public Offering. (3) Represents shares issuable as Committed Acquisition Shares and pursuant to Pre-Distribution Convertible Securities. (4) Net of shares issuable from Retained Interest In addition, there would be authorized and issued 326,664 Preferred Shares, and there would be authorized and available for issuance 4,673,000 Undesignated Shares, based on Preferred Shares issued and issuable as of November 30, 1997. The actual number of Preferred Shares and Undesignated Shares to be included in the Restated Certificate will be based on the number of Iowa Preferred Shares which are outstanding shortly prior to the Merger. The total of the Preferred Shares and Undesignated Shares will equal 5,000,000, which is the number of Iowa Preferred Shares which are authorized under the Articles. The shares proposed to be authorized pursuant to the Restated Certificate are necessary to implement the Tracking Stock Proposal and the related Transactions. Although most of the shares of Tracking Stock being authorized would be issued in the Transactions, the Tracking Stock Proposal would authorize a greater number of shares than is required for the Transactions as well as authorize Special Common Shares. The Board of TDS believes that it is desirable to have the additional authorized shares of common stock available for future financing and acquisition transactions, for conversions and for other general corporate purposes. Having such additional authorized shares of common stock available for issuance in the future will give TDS greater flexibility and may allow such shares to be issued without the expense and delay of a special shareholders' meeting. Unissued shares of common stock could be issued in circumstances that would serve to preserve control of TDS's then existing management. See "Risk Factors." The authorized but unissued shares of capital stock would be available for issuance by the Company from time to time, as determined by the Board, for any proper corporate purpose, which could include raising capital, payment of stock dividends, stock splits, providing compensation or benefits to employees, or acquiring or investing in other companies or businesses. Generally, no further action or authorization by the shareholders would be necessary prior to the issuance of the additional shares of the Tracking Stocks or any other shares of capital stock authorized pursuant to the Tracking Stock Proposal unless applicable laws or regulations would require such approval in a given instance. The Company has no current plans to issue any shares of Tracking Stock except in connection with the Transactions and as otherwise described herein. The Special Common Shares are being authorized in connection with the possible future conversion of shares of any class of Tracking Stock, as discussed herein. The Board has no current plans or intentions to convert any shares of Tracking Stock or to issue any Special Common Shares. INCREASES IN AUTHORIZED SHARES. As permitted by Delaware law, the Restated Certificate will permit the number of authorized shares of any class of capital stock to be increased or decreased (but not below the number of shares then outstanding in such class, respectively) by the affirmative vote of the holders of a majority of the shares of capital stock of the Company entitled to vote with respect to matters other than the election of directors. No similar authority exists under Iowa law. This provision in the Restated Certificate will give the Company increased flexibility to authorize additional shares of any class of capital stock for use for any corporate purpose, without the need to obtain the approval of a majority of the affected class or classes (as is the case under Iowa law), by obtaining the approval of the holders of a majority of the voting power of the shares of capital stock of the Company -75- entitled to vote with respect to matters other than the election of directors, voting as a single group. The TDS Voting Trust presently holds a majority of the voting power of the Company. This provision may allow TDS Delaware to authorize and issue shares of capital stock under circumstances which could preserve the ability of the TDS Voting Trust to continue to exercise control over a majority of the voting power of TDS Delaware and, therefore, could deprive shareholders of TDS of an opportunity to sell their shares at a premium over market prices or make it more difficult to replace the current Board and management of TDS Delaware. See "Risk Factors." The TDS Voting Trust has no current intention to take any action to authorize any additional shares of capital stock, other than as described herein. ISSUED PREFERRED SHARES; REDESIGNATION OF AUTHORIZED BUT UNISSUED PREFERRED SHARES. The Articles presently authorize 5,000,000 Preferred Shares, of which 326,664 are issued and issuable, and 4,673,336 are authorized but unissued and available for issuance as of November 30, 1997. The Restated Certificate will authorize up to 326,664 Preferred Shares, having substantially the same rights, limitations and privileges as the issued Preferred Shares, except as described herein. As a result of the Distribution, the outstanding Preferred Shares which are convertible into Common Shares will be adjusted so that such convertible Preferred Shares will be convertible into Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in addition to the Common Shares as if such shares had been converted immediately prior to such action. All obligations with respect to the issued Preferred Shares will be attributed to the TDS Group. As indicated above, the Preferred Shares which are currently convertible into Common Shares will become convertible into Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as well as Common Shares, as a result of the Distribution. If and when such Preferred Shares are converted, the shares to be issued upon such conversion will be issued either from the Retained Interest, or from authorized but unissued Cellular Group Shares, Telecom Group Shares and Aerial Group Shares, as the case may be, provided that, if such shares are issued from authorized but unissued shares, the TDS Group will be charged, and such other Groups will be credited, with an amount equal to the product of the number of shares of Tracking Stock of such Groups which are issued upon conversion and the Market Value of one share of such Tracking Stock over the twenty-Trading Day period ending five Trading Days prior to the issuance of such shares. The Restated Certificate would reclassify all of the authorized but unissued Preferred Shares (4,673,336 as of November 30, 1997) as Undesignated Shares. The Board would be authorized by the Restated Certificate to designate and issue Undesignated Shares in one or more classes or series of preferred or common stock from time to time, and to establish as to each class or series the designation and number of shares to be issued, the dividend rate, the redemption price and terms, if any, the amount payable upon voluntary or involuntary dissolution of TDS, sinking fund provisions, if any, voting rights, if any, the terms of conversion into shares of common stock, if provided for, and such other rights, preferences or limitations as may be provided in such designation. The Undesignated Shares will thereafter be available for designation and issuance as common or preferred stock from time to time for any proper corporate purpose, including issuances for cash, acquisitions, stock splits, stock dividends, stock option plans and funding of employee benefit plans. Generally, no further action or authorization by the shareholders would be necessary prior to the designation or issuance of the additional Undesignated Shares authorized pursuant to the Restated Certificate unless applicable laws or regulations would require such approval in a given instance. Having such additional authorized shares of stock available for designation and issuance in the future will give TDS greater flexibility and may allow such shares to be issued without the expense and delay of a special shareholders' meeting. Shares of common or preferred stock could be issued in circumstances that would serve to preserve control of TDS's then existing management. See "Risk Factors." The reclassification of the authorized but unissued Preferred Shares as Undesignated Shares would continue to permit classes or series of preferred stock to be designated and issued, and would also permit classes or series of common stock to be designated and issued to track new businesses or to separate existing businesses by any of the Groups. For instance, shares of tracking stock could be designated and issued for the benefit of the TDS Group. Such new shares of tracking stock could be distributed to the holders of Common Shares and Series A Common Shares upon the creation or separation of a business, sold for cash in a public or private offering to finance a new business for the benefit of the TDS Group or delivered in connection with the acquisition of a business by the TDS Group. Undesignated Shares could also be designated with respect to any other Group. For instance, a series of Undesignated Shares could be designated to represent the cellular telephone markets in which U.S. Cellular has a minority interest. These shares could then be sold for cash to obtain additional funds for the Cellular Group or distributed on a pro rata basis to the holders of Cellular Group Shares. The Company has no current plans to create any additional tracking stocks or to make any material investments in any new businesses. -76- Any future designation and issuance of Undesignated Shares as preferred or common stock will be attributed to one or more of the Groups as may be determined by the Board at such time, taking into consideration the use of the proceeds of the issuance of such shares and any other relevant factors. VOTING RIGHTS. The Restated Certificate continues to provide that the Board will be divided into three classes and that each class will be elected for a three-year term. Each director of TDS Iowa at the time of the Merger will continue as a director of TDS Delaware of the same class immediately following the Merger. In the election of directors, the holders of Preferred Shares issued before October 31, 1981 and Common Shares would vote together with the holders of Tracking Stocks and any issued Special Common Shares, in the election of 25% of the directors (rounded up) plus one additional director (or four directors based on a Board of twelve directors). The Preferred Shares issued before October 31, 1981 and Common Shares would have one vote per share in the election of such directors and all other matters (other than the election of the directors described in the following paragraph). Accordingly, the holders of Preferred Shares issued before October 31, 1981 and Common Shares would have the power to vote in the election of one additional director in addition to the directors which they currently elect. The Tracking Stocks would have no votes except in the election of such directors and as otherwise required by law. In the election of such directors, each class of Tracking Stock would initially have one vote per share. Thereafter, the number of votes which shares of each class of Tracking Stock would have in the election of such directors would be adjusted or "float" based on the Market Capitalization of such class as compared to the aggregate Market Capitalization of all shares of Tracking Stock and the Common Shares and Preferred Shares issued before October 31, 1981, calculated over a twenty-Trading Day period ending ten Trading Days prior to the record date for each annual meeting of shareholders. See "--Description of Terms of Tracking Stock--Voting Rights." After adjustment of the voting power to reflect the relative market values, it is expected that the Cellular Group Shares would initially have more than one vote per share and that the Telecom Group Shares and Aerial Group Shares would have approximately one vote per share based on presently anticipated market values, although this may change over time. Under the Tracking Stock Proposal, the holders of Preferred Shares issued after October 31, 1981 and Series A Common Shares would vote in the election of 75% of the directors (rounded down), less one director. Based on a Board of twelve directors, the Series A Group would vote in the election of eight directors, as compared to nine directors currently. Each of the currently outstanding Preferred Shares issued after October 31, 1981 would continue to have one vote and Series A Common Shares would continue to have ten votes per share in the election of such directors, as well as all other matters (other than the election of the directors elected by the voting group described in the preceding paragraph). If the number of Series A Common Shares issued and outstanding at any time falls below 500,000, because of the conversion of Series A Common Shares or otherwise, the holders of Series A Common Shares would lose the right to vote as a separate class (with the holders of Preferred Shares issued after October 31, 1981 which have voting rights) in the election of approximately 75% of the directors less one director, and thereafter the holders of Series A Common Shares (with ten votes per share) would vote with the holders of all other classes of capital stock as a single class in the election of all directors. In such election, holders of Common Shares and any issued Special Common Shares would have one vote per share, holders of Tracking Stock would have per share voting rights which would float, as discussed above, and Preferred Shares would have the voting rights specified in the Restated Certificate or designation. It is unlikely that the number of outstanding Series A Common Shares will fall below 500,000, because more than 6,000,000 Series A Common Shares are held in the TDS Voting Trust, and the trustees of the TDS Voting Trust have indicated that they have no present intention of converting Series A Common Shares into Common Shares. Actions submitted to a vote of shareholders other than the election of directors will generally be voted on only by holders of Common Shares, Series A Common Shares and series of Preferred Shares which have voting rights. Under the Restated Certificate, except as required under the DGCL, only the affirmative vote of the holders of a majority of the outstanding voting power of the Common Shares, Series A Common Shares and such voting Preferred Shares, voting as a group, will be required to amend the Restated Certificate, approve any merger or consolidation of TDS with or into any other corporation, approve the dissolution of TDS or approve any other matter required to be voted on by shareholders. Under Delaware law, the holders of the outstanding shares of a class are entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the par value of the shares of such class or alter or change the powers, preferences or -77- special rights of the shares of such class so as to affect them adversely. As discussed above, the Restated Certificate will permit the number of authorized shares of any class of capital stock to be increased or decreased (but not below the number of shares then outstanding in such class, respectively) by the affirmative vote of a majority of the voting power of the shares of capital stock entitled to vote with respect to matters other than the election of directors, without a class vote of the affected class. DIVIDENDS. Subject to the satisfaction of all Preferred Share dividend preference and redemption provisions, holders of common stock are entitled to receive such dividends as may be declared from time to time by the Board. Dividends on each of the Common Shares, the Series A Common Shares and any issued Special Common Shares would be payable out of the lesser of assets of the Company legally available therefor and the Available Dividend Amount for the TDS Group. See "--Certain Definitions." Dividends on each class of Tracking Stock would be payable out of the lesser of assets of the Company legally available therefor and the Available Dividend Amount related to that Tracking Group, which is intended to be similar to the product of the Outstanding Interest Fraction and the amount that would be legally available for the payment of dividends on the particular Tracking Stock under the DGCL if that Tracking Group were a separate Delaware corporation. See "--Description of Terms of Tracking Stock." Subject to the provisions in the preceding paragraph, notwithstanding the Available Dividend Amount for any Group, the respective amounts of prior dividends paid on, or liquidation rights of any shares of common stock, or any other factor, dividends may be declared and paid with respect to any class or series of common stock in equal or unequal amounts, provided that, except as described below, unless the same dividends, on a per share basis, are declared and paid at the same time on any issued Special Common Shares, no dividends may be declared or paid on the Common Shares and, unless the same, or greater, dividends, on a per share basis, are declared and paid at the same time on the Common Shares and any issued Special Common Shares, no dividends may be declared or paid on the Series A Common Shares. Any decision to pay dividends in the future will depend on the financial condition, results of operations and business requirements of the Company as a whole. In making a determination as to the allocation of any future dividends among the classes or series of common stock, the Board expects to follow a policy under which it will consider, among other factors, the relative financial condition, results of operations and business requirements of the respective Groups. See "Dividend Policy." Following the Distribution, the Board currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share (the "TDS Group Dividend Rate"). Following the Distribution, the Board also intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, this dividend rate would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share (the "Telecom Equivalent Dividend Rate"). The total of the TDS Group Dividend Rate and the Telecom Equivalent Dividend Rate is equal to $0.42 per share per annum, which is the same as the current annual dividend rate on the existing Common Shares and Series A Common Shares. The intent is that, immediately after the Distribution, a current holder of Common Shares and Series A Common Shares who retains the Telecom Group Shares received in the Distribution would continue to receive an aggregate dividend which is at least equal to the aggregate dividend which such shareholder currently receives from the Company (not considering reductions in shares which may occur due to the payment of cash in lieu of fractional shares in the Distribution). With regard to the Cellular Group Shares and the Aerial Group Shares, the Board currently intends to retain future earnings of the Cellular Group and Aerial Groups, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. SHARE DISTRIBUTIONS. In the case of dividends of shares of capital stock of the Company, the Restated Certificate provides that shares of common stock (or in each case, Convertible Securities convertible into or exercisable or exchangeable for such common stock) may be distributed only as follows: (i) Common Shares may be distributed on an equal per share basis to holders of Common Shares and holders of Series A Common Shares, and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares; -78- (ii) Series A Common Shares may be distributed on an equal per share basis to holders of Common Shares and holders of Series A Common Shares, and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares; (iii) Common Shares may be distributed on an equal per share basis to holders of Common Shares, Series A Common Shares may be distributed on an equal per share basis to holders of Series A Common Shares and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares; (iv) Special Common Shares may be distributed on an equal per share basis to holders of Series A Common Shares, Common Shares and Special Common Shares; (v) shares of any class of Tracking Stock may be distributed on an equal per share basis to the holders of Common Shares, Series A Common Shares and Special Common Shares up to the amount of the Number of Shares Issuable with Respect to Retained Interest in such shares of Tracking Stock; (vi) Cellular Group Shares may be distributed pro rata to the holders of Cellular Group Shares, in which case the Number of Shares Issuable with Respect to Retained Interest and the Number of Shares Issuable with Respect to Inter-Group Interest (if any) in the Cellular Group would also be proportionately adjusted; (vii) Telecom Group Shares may be distributed pro rata to the holders of Telecom Group Shares, in which case the Number of Shares Issuable with Respect to Retained Interest and the Number of Shares Issuable with Respect to Inter-Group Interest (if any) in the Telecom Group would also be proportionately adjusted; (viii) Aerial Group Shares may be distributed pro rata to the holders of Aerial Group Shares, in which case the Number of Shares Issuable with Respect to Retained Interest and the Number of Shares Issuable with Respect to Inter-Group Interest (if any) in the Aerial Group would also be proportionately adjusted; (ix) shares of a new class or series of capital stock which is intended to represent a subdivision or new business of a Group, or any assets attributed by the Board to such Group, may be distributed on an equal per share basis to holders of common stock representing an interest in such Group; or (x) shares of Tracking Stock of the Tracking Group (the "Issuer Group") may be distributed to the holders of shares of Tracking Stock of another Tracking Group (the "Investor Group") up to the amount of the Number of Shares Issuable with Respect to Inter-Group Interest attributed to the Investor Group in the Issuer Group. Holders of Tracking Stock may not receive any TDS Group Shares as a dividend since a Tracking Group may not have an Inter-Group Interest in the TDS Group. The Board is authorized to permit the holders of common stock to elect to receive cash in lieu of stock. DISTRIBUTION OF TDS GROUP SUBSIDIARY IN DIVIDEND. The Restated Certificate provides that if the Board intends to distribute a subsidiary included in the TDS Group to the holders of shares of the Company in a dividend, the Board shall, to the extent practicable, distribute subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, distribute subsidiary shares corresponding to Common Shares to the holders of Common Shares, and distribute subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares, provided that the same number of shares of subsidiary common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. Holders of Tracking Stock will not be entitled to participate in a distribution of any shares of a subsidiary in a dividend or otherwise which is attributable to the TDS Group, since a Tracking Group may not hold an Inter-Group Interest in the TDS Group. The Restated Certificate provides that, if practicable, the Board must recapitalize such subsidiary through an amendment to its charter or otherwise, so that the shares of capital stock of such subsidiary substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Company, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. The Restated Certificate provides further that, if Special Common Shares are outstanding but the subsidiary has no shares corresponding to Special Common Shares and it is impracticable to recapitalize the subsidiary as provided in the preceding sentence, the Board must distribute subsidiary shares corresponding to Common Shares to the holders of Special Common Shares. DISTRIBUTION OF TRACKING GROUP SUBSIDIARY IN DIVIDEND. The Restated Certificate provides that if the Board intends to distribute a subsidiary included in a Tracking Group other than a Qualifying Subsidiary or Qualifying Subsidiaries (See "--Certain Definitions") which hold all of the assets and liabilities of a Tracking Group to the holders of shares of Tracking Stock of such Tracking Group in a dividend, and if there is a Retained Interest in such -79- Tracking Group, the Board shall, to the extent practicable, distribute subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such Tracking Group with respect to the outstanding shares of such Tracking Group. Holders of TDS Group Shares and shares of any other Tracking Stock will not be entitled to participate in such distribution of any shares of a subsidiary in a dividend or otherwise which is attributable to another class of Tracking Stock, except with respect to a Retained Interest by the TDS Group or an Inter-Group Interest by another Tracking Group. The subsidiary shares relating to any Retained Interest or Inter-Group Interest may be retained by the Company for the benefit of the TDS Group or the other Tracking Group, respectively, or distributed pro rata to the holders of the TDS Group Shares or the applicable Tracking Stock, at the sole discretion of the Board. If the Board determines to distribute subsidiary shares with respect to such a Retained Interest or Inter-Group Interest, it must, to the extent practicable, distribute subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of another Tracking Group with respect to any such Inter-Group Interest, and distribute subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, subsidiary shares corresponding to Common Shares to the holders of Common Shares, and subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group, provided that the same number of shares of subsidiary common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. The Restated Certificate provides that, if practicable, the Board must recapitalize such subsidiary through an amendment to its charter or otherwise, so that the shares of capital stock of such subsidiary and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Company and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. The Restated Certificate provides further that, if the subsidiary has no shares corresponding to Special Common Shares and it is impracticable to recapitalize the subsidiary as provided in the preceding sentence, the Board must distribute subsidiary shares corresponding to Common Shares to the holders of Special Common Shares and to holders of Tracking Stock who would otherwise be entitled to receive subsidiary shares corresponding to Special Common Shares. LIQUIDATION RIGHTS. Subject to the following paragraph, in the event of a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, after payment or provision for payment of the debts and other liabilities of the Company and subject to the prior payment in full of the preferential amounts to which any class or series of Preferred Shares or Undesignated Shares is entitled, the holders of the outstanding shares of common stock will be entitled to receive the remaining assets of the Company, regardless of the Group to which such assets are attributed, divided among the holders of common stock in accordance with the per share "Liquidation Units" attributable to each class of Common Stock. Each Series A Common Share, Common Share and Special Common Share is attributed one Liquidation Unit, each Cellular Group Share is attributed 2.5 Liquidation Units, each Telecom Group Share is attributed 0.9 of a Liquidation Unit and each Aerial Group Share is attributed 1.1 Liquidation Units. The Liquidation Units per share were determined by the Board in consultation with the Financial Advisors, based on the anticipated initial trading ranges of the shares of common stock and other factors. The Liquidation Unit of each class or series of common stock will be adjusted by the Board as appropriate to reflect equitably any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of such class of common stock or any dividend or other distribution of shares with respect to such class of common stock. Whenever a change in the Liquidation Units with respect to any class or series of common stock occurs, the Company will prepare and distribute a notice of such change to all holders of shares of such class or series of common stock, together with a notice of such stock split, reverse split, distribution or other transaction requiring such change. Prior to the distribution of the remaining assets of the Company as set forth in the preceding paragraph, the Board may redeem all shares of Tracking Stock of all Tracking Groups in exchange for shares of a Qualifying Subsidiary or Qualifying Subsidiaries holding all of the assets and liabilities of the related Tracking Group, as described under "--Redemption in Exchange for Stock of Subsidiary." In such event, all shares of Tracking Stock would be redeemed immediately prior to the liquidation, dissolution or winding-up and the Series A Common Shares, Common Shares and any issued Special Common Shares would share pari passu in any assets remaining for distribution after such redemptions. A consolidation, merger, or reorganization of the Company with any other corporation or corporations, or a sale of all or substantially all of the assets of the Company, will not be considered a dissolution, liquidation, or winding up of the Company within the meaning of these provisions. -80- CONVERSION RIGHTS. None of the Common Shares, Cellular Group Shares, Telecom Group Shares, Aerial Group Shares nor Special Common Shares will be convertible at the option of the holder into another class of common stock or any other security of TDS. The Series A Common Shares will continue to be convertible on a share-for-share basis into Common Shares at any time and will be convertible on a share-for-share basis into Special Common Shares. PREEMPTIVE RIGHTS. None of the Common Shares, Cellular Group Shares, Telecom Group Shares, Aerial Group Shares nor Special Common Shares will carry any preemptive rights enabling a holder to subscribe for or receive shares of any class of stock of TDS or any other securities convertible into shares of any class of stock of TDS under the Restated Certificate. The Series A Common Shares will continue to have a preemptive right to acquire additional Series A Common Shares for cash, including treasury shares. MERGER CONSIDERATION. The Restated Certificate provides that in the event of a merger or consolidation of the Company, whether or not the Company is the surviving entity, the holders of Special Common Shares and Common Shares are entitled to receive the same per share consideration. For this purpose, the foregoing will be deemed to be satisfied if the consideration received by the holders of Special Common Shares consists of securities which have relative rights, preferences and limitations vis-a-vis the securities received by the holders of Common Shares that, in the judgment of the Board of Directors, are substantially similar to the relative rights, preferences and limitations of the Special Common Shares vis-a-vis the Common Shares, respectively. DISPOSITION OF ASSETS OF A TRACKING GROUP. The Restated Certificate provides that, in the event of a Disposition of all or substantially all of the properties and assets of a Tracking Group in one transaction or a series of related transactions, other than a transaction in which the Company receives primarily equity securities of an entity engaged or proposing to engage primarily in a similar or complementary business, and certain other circumstances, the Company must either: (i) distribute to holders of the affected Tracking Stock an amount in cash, securities or other property or any combination thereof equal to the product of (A) the Outstanding Interest Fraction (in the case of a Disposition involving substantially all, but not all of the assets of the Affected Tracking Group) or the Adjusted Outstanding Interest Fraction (in the case of a Disposition involving not less than all of the assets of the affected Tracking Group) and (B) the Fair Value of the Net Proceeds of such Disposition, either by special dividend or by redemption of all or part of the outstanding shares of the affected Tracking Stock; or (ii) convert each outstanding share of the affected Tracking Stock into a number (or fraction) of Special Common Shares or shares of any other Tracking Stock (or any combination thereof on a pro rata basis) equal to 110% (the "Disposition Conversion Percentage") of the average daily ratio (calculated to the nearest five decimal places) of the Market Value of (A) one share of Affected Tracking Stock to (B) the Market Value of one Special Common Share or such other share of Tracking Stock (or any combination thereof on a pro rata basis) during a forty-Trading Day period beginning on the 11th Trading Day after consummation of the Disposition. See "--Description of Terms of Tracking Stocks--Disposition of Assets of Tracking Group." The ratio of the Market Value of one share of Tracking Stock to be converted into such Special Common Share and/or share of another class of Tracking Stock could be influenced by many factors, including the results of operation of the Company and each of the Groups, the regulatory environment, trading volumes, share issuances and repurchases, and general economic and market conditions. Such a conversion could be effected at a time when the market value of the converted Tracking Stock or the shares issued in conversion thereof may be considered to be overvalued or undervalued. Such conversion would also have the effect of precluding holders of the converted Tracking Group from retaining their investment in a security intended to reflect separately the businesses and assets attributed to the converted Tracking Group. See "Risk Factors." CONVERSION AT OPTION OF COMPANY. The Company may, in the sole discretion of the Board, elect at any time to convert each outstanding share of any class of Tracking Stock into a number (or fraction) of Special Common Shares or shares of any other class of Tracking Stock, or any combination thereof on a pro rata basis, equal to the Optional Conversion Percentage of the average daily ratio of the Market Value of one share of Tracking Stock to be converted to the Market Value of one Special Common Share or such other share of Tracking Stock, calculated over the twenty-Trading Day period ending five Trading Days prior to the date of notice of such conversion. The Optional Conversion Percentage will initially be 115% and will be fixed for five years after the initial issuance date of the applicable Tracking Stock. Beginning on the fifth anniversary of such date, the Optional Conversion Percentage will decrease by one percent per year, until it is equal to 110% percent on the ninth anniversary of the initial issuance -81- date and for all periods thereafter. See "--Description of Terms of Tracking Stocks--Conversion at Option of Company." The ratio of the Market Value of one share of Tracking Stock to be converted to such Special Common Share or share of another class of Tracking Stock could be influenced by many factors, including the results of operation of the Company and each of the Groups, the regulatory environment, trading volumes, share issuances and repurchases, and general economic and market conditions. Such a conversion could be effected at a time when the market value of the converted Tracking Stock or the shares issued in conversion thereof may be considered to be overvalued or undervalued. Such conversion would also have the effect of precluding holders of the converted Tracking Group from retaining their investment in a security intended to reflect separately the businesses and assets attributed to the converted Tracking Group. See "Risk Factors." REDEMPTION IN EXCHANGE FOR STOCK OF QUALIFYING SUBSIDIARY. Subject to certain restrictions, the Company could at any time, in the sole discretion of the Board, redeem without premium all outstanding shares of any class of Tracking Stock of a Tracking Group, in exchange for shares of a Qualifying Subsidiary or Qualifying Subsidiaries which hold all of the assets and liabilities of such Tracking Group. See "--Description of Terms of Tracking Stocks-- Redemption in Exchange for Stock of Subsidiary." REDEMPTION TO PROTECT LICENSES. As permitted by Delaware law, the Restated Certificate also includes a provision permitting the Company to redeem shares of capital stock (other than Series A Common Shares) to the extent necessary to prevent the loss or secure the reinstatement of any license or franchise from any governmental agency. No similar provision is included in the Articles because of differences in Iowa law. See "--Comparison of Shareholder's Rights Under Iowa and Delaware Law." Substantially similar provisions are included in the current Certificates of Incorporation of each of U.S. Cellular and Aerial, each of which is a Delaware corporation. The Board considers this provision important in order to permit the redemption of shares, if necessary, to avoid the loss of any franchise or license under the Communications Act of 1934, as amended (the "Communications Act") and the rules and regulations of the Federal Communications Commission (the "FCC"). Failure to comply with the requirements of the Communications Act and the FCC may result in denial or revocation of FCC licenses. The Restated Certificate would permit TDS Delaware to redeem any shares of capital stock (other than Series A Common Shares) from disqualified holders at their fair market value to the extent necessary to prevent the loss of or secure the reinstatement of, or to prevent the denial of applications for or the renewal of any governmental license or franchise held by TDS Delaware or any of its subsidiaries, or any person in which TDS has any direct or indirect ownership or voting interest, if the license or franchise is conditioned upon some or all of the holders of the corporation's stock, or persons entitled to vote such stock, possessing prescribed qualifications or any other condition. A disqualified holder is any holder of shares of capital stock of TDS Delaware whose holding of such shares on behalf of such holder or on behalf of any other person, either individually or when taken together with the holding or voting of shares of capital stock of TDS Delaware by any other holders or persons entitled to vote such shares, may result, in the good faith judgment of the Board, in the loss of, or the failure to secure the reinstatement of, or the denial of applications for or the renewal of, any license or franchise from any governmental agency held by TDS Delaware or any of its subsidiaries, or any person in which TDS has any direct or indirect ownership or voting interest. The redemption price of the shares to be redeemed will be equal to the lesser of (i) the fair market value of such shares or (ii) if such shares were purchased by the disqualified holder within one year of the redemption date, the disqualified holder's purchase price for such shares (the "Required Price"). The fair market value of a share of capital stock of any class or series of TDS Delaware means the average closing price for such a share for each of the 20 most recent days on which shares of capital stock of such class or series have traded preceding the day on which notice of redemption is given, except that if shares of capital stock of such class or series are not traded on any securities exchange or in the over-the-counter market, "fair market value" will be determined by the Board in good faith. The redemption price of such shares may be paid in cash, securities or any combination thereof. TDS Delaware may redeem any shares in exchange for any debt or equity securities (other than Series A Common Shares or securities convertible into or exchangeable for, or carrying a right to subscribe to or acquire, Series A Common Shares) of TDS Delaware, any of its subsidiaries or any other corporation, or any combination thereof, having such terms and conditions as may be approved by the Board and which, together with any cash to be paid as part of the redemption price, in the opinion of any nationally recognized investment banking firm selected by the Board, has a value at the time of notice of redemption at least equal to the Required Price. -82- If less than all the shares held by disqualified holders are to be redeemed, the shares to be redeemed will be selected in a manner to be determined by the Board, which may include selection first of the most recently purchased shares thereof, selection by lot or selection in any other manner determined by the Board. At least 30 days' written notice of the redemption date will be given to the record holders of the shares selected to be redeemed (unless waived in writing by any such holder), except that the redemption date may be the date on which written notice is given to record holders if the cash or securities necessary to effect the redemption is deposited in trust for the benefit of such record holders and subject to immediate withdrawal by them upon surrender of the stock certificates for their shares to be redeemed. INDEMNIFICATION. The Restated Certificate provides that TDS Delaware shall indemnify directors and officers of TDS Delaware, its consolidated subsidiaries and certain other related entities generally in the same manner and to the extent permitted by the DGCL, as more specifically provided in the Bylaws of TDS Delaware. No similar provision presently exists in the Iowa Articles. However, the indemnification provision included in the Restated Certificate is substantially similar to a provision included in the Iowa Bylaws, which provides that TDS shall indemnify directors and officers of TDS, its consolidated subsidiaries and certain other related entities, generally in the same manner and to the extent permitted by Iowa law. The Delaware Bylaws provide for indemnification and permit the advancement of expenses by TDS generally in the same manner and to the extent permitted by the DGCL, subject to compliance with certain requirements and procedures specified in the Delaware Bylaws. In general, the Delaware Bylaws require that any person seeking indemnification must provide TDS Delaware with sufficient documentation as described in the Bylaws and, if an undertaking to return advances is required, to deliver an undertaking in the form prescribed by TDS Delaware and provide security for such undertaking if considered necessary by TDS Delaware. In addition, the Delaware Bylaws specify that, except to the extent required by law, TDS Delaware does not intend to provide indemnification to persons under certain circumstances, such as where the person was not acting in the interests of TDS Delaware or was otherwise involved in a crime or tort against TDS Delaware. For a comparison of the indemnification permitted under Delaware law and Iowa law, see "--Comparison of Shareholder's Rights Under Iowa and Delaware Law." CONSIDERATION OF COMMUNITY INTERESTS IN ACQUISITION PROPOSALS. Article IX of the Restated Certificate will include a provision similar to Article IX of the Iowa Articles and will also address certain matters presently addressed by Iowa law which are not addressed by Delaware Law. See "--Comparison of Shareholder's Rights Under Iowa and Delaware Law." Article IX of the Delaware Articles provides that, when evaluating any proposal or offer of another party to (i) make a tender or exchange offer for any equity of the Company; (ii) merge or consolidate the Company with another corporation; or (iii) purchase or otherwise acquire all or substantially all of the properties and assets of the Company, the Board may, in connection with the exercise of its judgment in determining what is in the best interests of the Company and its shareholders, give due consideration to all factors the directors deem relevant. Such factors may include, without limitation, (a) the effects on the customers of the Company or any of its subsidiaries or on such other constituencies of the Company or its subsidiaries that the Board considers relevant under the circumstances, (b) not only the consideration (after taking into account corporate and shareholder taxes) being offered in relation to the then current market price for the Company's outstanding shares of capital stock, but also the Board's estimate of the future value of the Company (including the unrealized value of its properties and assets) as an independent going concern, (c) the purpose of the Company and any of its subsidiaries to provide quality products and services on a long-term basis and (d) the long-term as well as short-term interests of the corporation and its shareholders, including the possibility that such interests may be best served by the continued independence of the corporation. If, on the basis of such factors, the Board determines that a proposal or offer to acquire or merge the corporation, or to sell its assets, is not in the best interests of the corporation, it may reject the proposal or offer. If the Board determines to reject any such proposal or offer, the Board shall have no obligation to facilitate, to remove any barriers to, or to refrain from impeding, the proposal or offer, except as may be required by applicable law. Except to the extent required by applicable law, the consideration of any or all of such factors shall not be a violation of any duty of the directors to the shareholders or a group of shareholders, even if the directors reasonably determine that any such factor or factors outweigh the financial or other benefits to the corporation or a shareholder or group of shareholders. -83- This provision may serve to discourage or make more difficult a change in control of the Company without the support of the Board and could, under certain circumstances, prevent shareholders from profiting from an increase in the market value of their shares as a result of a change in control of the Company by delaying or preventing such change in control. See "Risk Factors." BYLAWS. The Restated Certificate provides that, in furtherance and not in limitation of the powers conferred by Delaware law, the Board of TDS Delaware is expressly authorized to adopt, amend or repeal the Bylaws of TDS Delaware, subject to any specific limitations on such power provided by any Bylaws adopted by the shareholders. Due to differences in Delaware and Iowa law, this provision is necessary in order to continue to permit the Company's Board to adopt, amend or repeal the Bylaws of the Company. See "--Comparison of Shareholders' Rights Under Iowa and Delaware Law." The Bylaws of TDS Delaware will be adopted by the Board of TDS Delaware. SECTION 203 OF DGCL. As permitted by Delaware law, the Restated Certificate will provide that TDS Delaware elects not to be governed by Section 203 of the DGCL. TDS is currently subject to a similar statute under the IBCA. See "--Comparison of Shareholder's Rights Under Iowa and Delaware Law." Since Section 203 will not be applicable to TDS, it may be possible for a person to acquire the Series A Common Shares held by the TDS Voting Trust and to immediately complete a business combination with TDS, without complying with any of the exceptions to Section 203. The trustees of the TDS Voting Trust have advised the Company that they have no current plans or intentions of disposing of such Series A Common Shares. OTHER RIGHTS. The Restated Certificate expressly permits the Board to issue and sell shares of any class of capital stock even if the consideration which could be obtained by issuing or selling any other class of capital stock would be greater. The Restated Certificate also expressly permits the Board to purchase shares of any class of capital stock, even if the consideration which would be paid by purchasing another class of capital stock would be less. In no event will any of the Common Shares, Series A Common Shares, or Special Common Shares be split, subdivided or combined unless all such classes are proportionately split, subdivided or combined. The full text of the proposed Restated Certificate is set forth as EXHIBIT B to this Proxy Statement/Prospectus and is incorporated herein by reference. The above summary should be read in conjunction with, and is qualified in its entirety by reference to, such EXHIBIT B. See also "--Description of Terms of Tracking Stock." Shareholder approval of the Tracking Stock Proposal will also constitute approval of the Restated Certificate and the provisions thereof, including those which differ from or are in addition to those which are in the Iowa Articles, as described in this Proxy Statement/Prospectus. DESCRIPTION OF TERMS OF TRACKING STOCK The following summarizes certain terms of the Tracking Stock which would be created by the Tracking Stock Proposal. See EXHIBIT F--ILLUSTRATION OF CERTAIN TERMS, for illustrations of certain of the provisions described under this section. VOTING RIGHTS. In the election of directors, the holders of Tracking Stock would vote together with the holders of Preferred Shares issued before October 31, 1981, Common Shares and any issued Special Common Shares, as well as any issued Undesignated Shares which have been designated to vote in such group (collectively, the "Public Holders"), in the election of 25% of the directors plus one additional director (or four directors based on a Board of twelve directors). Each of the Preferred Shares issued before October 31, 1981 and Common Shares, as well as any issued Special Common Shares (the "One-Vote Holders"), would have one vote per share in the election of such directors. In the election of such directors, each share of Tracking Stock would initially have one vote per share. Thereafter, the number of votes which shares of each class of Tracking Stock would have in the election of such directors would be adjusted or "float" in proportion to the aggregate Market Capitalization of such class as compared to the aggregate Market Capitalization of the shares held by the Public Holders, and would be calculated using Market Values over the twenty-Trading Day period ending ten Trading Days prior to the record date for each annual meeting of shareholders. In the election of directors elected by the Public Holders, the proportion of the total votes of the Public Holders which a class of Tracking Stock will have would be equal to the percentage (the "Voting Percentage") equal to 100% multiplied by the average daily ratio (calculated to three decimal places) of the aggregate Market Capitalization of the applicable class of Tracking Stock to the aggregate Market Capitalization of the Preferred Shares issued before October 31, 1981, Common Shares, Cellular Group Shares, Telecom Group Shares, Aerial Group Shares -84- and Special Common Shares, if any are outstanding, and any outstanding Undesignated Shares which have been designated to vote with the Public Holders, calculated for the twenty-Trading Day period (the "Calculation Period") ending ten Trading Days prior to the record date for each annual meeting of shareholders (the "Adjustment Date"). In the election of such directors, the per share voting power of each class of Tracking Stock will be calculated on the basis that all shares of stock held by the One Vote Holders have one vote per share for such purposes. As an illustration, if on any Adjustment Date, the One-Vote Holders represent 20% of the Market Capitalization of the Public Holders, the shares of Tracking Stock in the aggregate would have 80% of the voting power of the Public Holders in the election of directors elected by the Public Holders. If there were 53,000,000 shares held by the One Vote Holders, each with one vote per share, the total voting power of the Public Holders would be 265,000,000 votes, determined by dividing 53,000,000 by 20%. The aggregate voting power of the shares of Tracking Stock would be 212,000,000 votes, determined by subtracting 53,000,000 from 265,000,000. The proportion of votes which each class of Tracking Stock would have in the aggregate would be determined by multiplying 265,000,000 by the Voting Percentage of that class of Tracking Stock. The number of votes per share of a class of Tracking Stock would be determined by dividing the aggregate voting power of such class, determined pursuant to the preceding sentence, by the average number of issued and outstanding shares of that class of Tracking Stock during the Calculation Period. Any shares held in the Retained Interest or Inter-Group Interest would not have any votes. See "--Retained Interest" and "--Inter-Group Interest." Accordingly, in the election of directors elected by the Public Holders, beginning on the first Adjustment Date prior to the record date for an annual meeting of shareholders after issuance of the Tracking Stock, each Cellular Group Share, Telecom Group Share and Aerial Group Share may have more or less than one vote per share. It is expected that the Cellular Group Shares would initially have more than one vote per share and that the Telecom Group Shares and Aerial Group Shares would initially have approximately one vote per share based on anticipated market values. The Market Capitalization of the classes of stock could be influenced by many factors, including the results of operations of the Company and each of the Groups, the regulatory environment, trading volume, share issuances and repurchases and general economic and market conditions. Such changes in the aggregate votes or relative voting power of the Tracking Stock could result from the market's reaction to a decision by the Company's management or Board that is perceived to disparately affect one class of common stock in comparison to another. See "Risk Factors." The periodic adjustments in the number of votes of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares will reduce the opportunity of investors in one Tracking Stock to acquire for the same aggregate consideration relatively greater voting power per share in the election of directors elected by the Public Holders than investors in the other classes. Because the adjustment of voting power will occur only annually, some disparity in the voting power purchasable for a specified dollar amount may exist among the Tracking Stocks from time to time. The "Market Capitalization" of any class or series of capital stock of the Company on any Trading Day means the product of (i) the Market Value of one share of such class or series on such trading day and (ii) the number of shares of such class or series outstanding on such Trading Day. The per share Market Value of the Preferred Shares shall be the liquidation value per share. For this purpose, if on any Adjustment Date with respect to an annual meeting, Special Common Shares are issued and outstanding but are not listed on a stock exchange or otherwise traded in the over-the-counter market, Special Common Shares will be deemed to have a Market Value per share equal to the per share Market Value of Common Shares with respect to that record date. The Tracking Stock will not be entitled to any votes per share except in the election of certain directors and to the extent that separate class or series votes are required by the DGCL. Actions submitted to a vote of shareholders other than the election of directors will generally be voted on only by holders of Common Shares, Series A Common Shares and series of Preferred Shares which have voting rights. Under the Restated Certificate, except as required under the DGCL, only the affirmative vote of the holders of a majority of the outstanding voting power of the Common Shares, Series A Common Shares and such voting Preferred Shares, voting as a group, will be required to amend the Restated Certificate, approve any merger or consolidation of TDS with or into any other corporation, approve the dissolution of TDS or approve any other matter required to be voted on by shareholders. However, under Delaware law, the holders of the outstanding shares of a class are entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the par value of the shares of such class or alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely. -85- DIVIDENDS. Following the Distribution, subject to the legal restrictions on the payment of dividends described below, the Board currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $0.48 per share. Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, this dividend rate would equate to a per share annual dividend of $0.32 per existing Common Share and Series A Common Share (the "Telecom Equivalent Dividend Rate"). Following the Distribution, the Board also currently intends to establish an annual dividend on the Common Shares and Series A Common Shares in an amount equal to $0.10 per share. The total of this rate and the Telecom Equivalent Dividend Rate is equal to $0.42 per share per annum, which is the same as the current annual dividend rate on the existing Common Shares and Series A Common Shares. The intent is that, immediately after the Distribution, a current holder of Common Shares and Series A Common Shares would continue to receive an aggregate dividend which is at least equal to the aggregate dividend which such shareholder currently receives from the Company (not considering reductions in shares which may occur due to the payment of cash in lieu of fractional shares in the Distribution). With regard to the Cellular Group Shares and the Aerial Group Shares, the Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. Any decision to pay dividends in the future will depend on the financial condition, results of operations and business requirements of the Company as a whole. In making a determination as to the allocation of any future dividends between the Cellular Group Shares, the Telecom Group Shares and the Aerial Group Shares, as well as the Common Shares, the Series A Common Shares and any issued Special Common Shares, the Board expects to follow a policy under which it will consider, among other factors, the relative financial condition, results of operations and business requirements of the respective Groups. The Company's assets consist almost entirely of investments in its subsidiaries. Furthermore, the initial assets of each of the Tracking Groups consist almost entirely of the Company's investment in a subsidiary (i.e., U.S. Cellular, TDS Telecom and Aerial). As a result, the Company's ability to pay dividends on any class of Tracking Stock is dependent in part on the earnings of, or other funds available to, such subsidiaries and the distribution or other payment of such earnings or other funds from such subsidiaries to the Company in the form of dividends, loans or other advances, payment or reimbursement of management fees and expenses and repayment of loans and advances from the Company. Such subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay the dividends on any class or series of preferred stock of the Company or to make any funds available therefor, whether by dividends, loans or other payments. The payment of dividends or the making of loans and advances to the Company by such subsidiaries may be subject to statutory or regulatory restrictions, are contingent upon the earnings of those subsidiaries and are subject to various business considerations. Dividends on all classes of capital stock are limited to the assets of the Company legally available for the payment of dividends. The amount of assets of the Company legally available for the payment of dividends will be reduced by the amount of any net losses of the Groups and any dividends or distributions on, or repurchases of, any class of common stock, and dividends on, or certain repurchases of, Preferred Shares. Additionally, the assets of the Company available for the payment of dividends may be restricted by future loan agreements to which certain subsidiaries of the Company may enter into, or become subject to, and such loan agreements may contain provisions that restrict or otherwise limit the amount of dividends that those companies may pay. In addition to the limitations set forth in the foregoing paragraph, dividends will be further limited to an amount not in excess of the applicable Available Dividend Amount, which, in the case of a Tracking Group, is intended to be similar to the amount that would be legally available for the payment of dividends on a Tracking Group under the DGCL if the Tracking Group were a separate Delaware corporation. There can be no assurance that there will be an Available Dividend Amount with respect to any Group. The "Available Dividend Amount" for a Tracking Group, as of any date, means the product of the Outstanding Interest Fraction and either (i) the excess of (a) an amount equal to the total assets of the Tracking Group less the total liabilities (not including preferred stock) of the Tracking Group as of such date over (b) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding shares of the applicable Tracking Stock, each class or series of Preferred Shares attributed to the Tracking Group; or (ii) in case there is no such excess, an amount equal to the Company Earnings (Losses) attributable to the Tracking Group (if positive) for the -86- fiscal year in which such date occurs and/or the preceding fiscal year. The "Company Earnings (Losses)" attributable to the Group, for any period, means the net earnings or losses of the Group for such period determined on a basis consistent with the determination of the net earnings or losses of the Group for such period as presented in the combined financial statements of the Group, including income and expenses of the Company attributed to the operations of the Group on a substantially consistent basis, including, without limitation, corporate administrative costs, net interest and income taxes. The "Available Dividend Amount," as of any date, means, with respect to the TDS Group, the greater of (i) the amount of all surplus (as defined in the DGCL) of the Company or, if there is no surplus, the net profits (as contemplated by the DGCL) of the Company for the fiscal year in which such date occurs and/or the preceding fiscal year, less the sum of the Available Dividend Amount of all of the Tracking Groups, or (ii) an amount equal to the sum of the product of the Retained Interest Fraction and the Available Dividend Amount (if positive) with respect to each Tracking Group plus, without duplication, either (a) the excess of (i) an amount equal to the total assets of the TDS Group less the total liabilities (not including preferred stock) of the TDS Group as of such date over (ii) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding Series A Common Shares, Common Shares and any issued Special Common Shares, and each class or series of Preferred Shares or Undesignated Shares attributed to the TDS Group or (b) in case there is no such excess, an amount equal to Company Earnings (Losses) attributable to the TDS Group (if positive) for the fiscal year in which such date occurs and/or the preceding fiscal year. At the time of any dividend or other distribution on the outstanding Tracking Stock (including any dividend of the Fair Value of the Net Proceeds from the Disposition of all or substantially all of the properties and assets of a Tracking Group as described under "--Disposition of Assets of Tracking Group"), the TDS Group (if at such time there is a Retained Interest), or another Tracking Group (if at such time there is an Inter-Group Interest by such other Tracking Group in the Tracking Group making the dividend or distribution), will be credited, and the Tracking Group making the dividend or distribution be charged (in addition to the charge for the dividend or other distribution paid or distributed in respect of outstanding shares of Tracking Stock), with an amount equal to the product of (i) the aggregate amount of such dividend or distribution paid or distributed in respect of outstanding shares of Tracking Stock times (ii) a fraction, the numerator of which is (a) the Retained Interest Fraction or (b) any Inter-Group Interest Fraction in such Tracking Group, as the case may be, and the denominator of which is the Outstanding Interest Fraction for such Tracking Group, respectively. SHARE DISTRIBUTIONS. The right of holders of any class of Tracking Stock to receive a distribution of shares of capital stock of the Company is limited to the right to receive a (i) distribution of shares of Tracking Stock of such Tracking Group (or Convertible Securities convertible into or exercisable or exchangeable for such Tracking Stock), (ii) shares of Tracking Stock of another Tracking Group (or Convertible Securities convertible into or exercisable or exchangeable for such Tracking Group) up to the amount of any Inter-Group Interest in such other Tracking Group or (iii) shares of a new class or series of capital stock which is intended to represent a subdivision or new business of such Tracking Group or any assets attributed by the Board to such Tracking Group. Holders of Tracking Stock may not receive any TDS Group Shares as a dividend since a Tracking Group may not have an Inter-Group interest in the TDS Group. DISTRIBUTION OF TRACKING GROUP SUBSIDIARY IN DIVIDEND. The Restated Certificate provides that if the Board intends to distribute a subsidiary included in a Tracking Group (other than a Qualifying Subsidiary or Qualifying Subsidiaries which hold all of the assets and liabilities of a Tracking Group) to the holders of shares of Tracking Stock of such Tracking Group in a dividend, and there is a Retained Interest in such Tracking Group, the Board shall, to the extent practicable, distribute subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such Tracking Group with respect to the outstanding shares of such Tracking Group. Holders of TDS Group Shares and shares of any other Tracking Stock will not be entitled to participate in such distribution of any shares of a subsidiary in a dividend or otherwise which is attributable to another class of Tracking Stock, except with respect to a Retained Interest by the TDS Group or an Inter-Group Interest by another Tracking Group. The subsidiary shares relating to any Retained Interest or Inter-Group Interest may be retained by the Company for the benefit of the TDS Group or the other Tracking Group, respectively, or distributed pro rata to the holders of the TDS Group Shares or the applicable Tracking Stock, at the sole discretion of the Board. If the Board determines to distribute subsidiary shares with respect to such a Retained Interest or Inter-Group Interest, it must, to the extent practicable, distribute subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of another Tracking Group with respect to any such Inter-Group Interest, and distribute subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, subsidiary shares corresponding to Common Shares to the holders of Common Shares, and subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any -87- Retained Interest in such Tracking Group, provided that the same number of shares of subsidiary common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. The Restated Certificate provides that, if practicable, the Board must recapitalize such subsidiary through an amendment to its charter or otherwise, so that the shares of capital stock of such subsidiary and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Company and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. The Restated Certificate provides further that, if the subsidiary has or will have shares corresponding to Series A Common Shares and Common Shares but does not have and will not have shares corresponding to Special Common Shares and it is impracticable to recapitalize the subsidiary as provided in the preceding sentence to create Special Common Shares, the Board must distribute subsidiary shares corresponding to Common Shares to the holders of Special Common Shares and to holders of Tracking Stock who would otherwise be entitled to receive subsidiary shares corresponding to Special Common Shares. DISTRIBUTION OF SUBSIDIARY OF TDS GROUP OR ANOTHER TRACKING GROUP. Holders of any class of Tracking Stock will not be entitled to participate in a distribution of any shares of a subsidiary in a dividend or otherwise which is attributable to the TDS Group. Holders of a class of Tracking Stock may, at the sole discretion of the Board, participate in a distribution of a subsidiary of any other Tracking Group, up to the amount of any Inter-Group Interest in such other Tracking Group. If there is a Retained Interest in the Tracking Group which is distributing subsidiary shares, all holders of Tracking Stock receiving a distribution of subsidiary shares would normally receive subsidiary shares corresponding to Special Common Shares. LIQUIDATION RIGHTS. Subject to the following paragraph, in the event of a liquidation, dissolution or winding up of the Company, whether voluntary or involuntary, after payment or provision for payment of the debts and other liabilities of the Company and subject to the prior payment in full of the preferential amounts to which any class or series of Preferred Shares or Undesignated Shares is entitled, the holders of the outstanding shares of common stock will be entitled to receive the remaining assets of the Company, regardless of the Group to which such assets are attributed, divided among the holders of common stock in accordance with the per share "Liquidation Units" attributable to each class of Common Stock. Each Series A Common Share, Common Share and Special Common Share is attributed one Liquidation Unit, each Cellular Group Share is attributed 2.5 Liquidation Units, each Telecom Group Share is attributed 0.9 of a Liquidation Unit and each Aerial Group Share is attributed 1.1 Liquidation Units. However, in the event of a liquidation, dissolution or winding-up of the Company, the amount to be received by each holder of the respective classes may not bear any relationship to the relative fair market values or the relative voting rights of the classes. The Liquidation Units per share were determined by the Board in consultation with the Financial Advisors, based on the anticipated initial trading ranges of the shares as common stock and other factors. The Liquidation Unit of each class or series of common stock will be adjusted by the Board as appropriate to reflect equitably any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of such class of common stock or any dividend or other distribution of shares with respect to such class of common stock. Whenever a change in the Liquidation Units with respect to any class or series of common stock occurs, the Company will prepare and distribute a notice of such change to all holders of shares of stock of such class or series of common stock, together with a notice of such stock split, reverse split, distribution or other transaction requiring such change. Prior to the distribution of the remaining assets of the Company as set forth in the preceding paragraph, the Board may redeem all shares of Tracking Stock of all Tracking Groups in exchange for shares of a Qualifying Subsidiary or Qualifying Subsidiaries holding all of the assets and liabilities of the related Tracking Group, as described under "--Redemption in Exchange for Stock of Subsidiary." In such event, all shares of Tracking Stock would be redeemed immediately prior to the liquidation, dissolution or winding-up and the Series A Common Shares, Common Shares and any issued Special Common Shares would share pari passu in any assets remaining for distribution after such redemptions. A consolidation, merger, or reorganization of the Company with any other corporation or corporations, or a sale of all or substantially all of the assets of the Company, will not be considered a dissolution, liquidation, or winding up of the Company within the meaning of these provisions. -88- CONVERSION AT THE OPTION OF THE HOLDER. No shares of any class of Tracking Stock are convertible into shares of any other class of common stock by the holder. PREEMPTIVE RIGHTS. No holders of shares of any class of Tracking Stock will have any preemptive right under the terms of the Restated Certificate to acquire or subscribe for any additional shares of capital stock or other obligations convertible into or exercisable for shares of capital stock that may hereafter be issued by the Company. DISPOSITION OF ASSETS OF A TRACKING GROUP. If the Company disposes of all or substantially all of the properties and assets of a Tracking Group (defined as 80% or more of the then current market-value (as determined by the Board) of the properties and assets of such Tracking Group as of such date) (a "Disposition") in one transaction or a series of related transactions with any one or more persons, entities or groups, other than in a transaction referred to in the following sentence, the Company is required to take one of the actions listed in the fourth paragraph of this Section on or prior to the 90th Trading Day following the consummation of a Disposition. The requirement in the preceding paragraph does not apply to a Disposition (i) in connection with the disposition by the Company of all of the Company's properties and assets in one transaction or a series of related transactions or in connection with the liquidation, dissolution or winding up of the Company, (ii) by dividend, other distribution or redemption in accordance with any provision described under "--Dividends," "--Share Distributions," "--Distribution of Tracking Group Subsidiary in Dividend," "--Redemption in Exchange for Stock of Subsidiary" or "--Liquidation," (iii) to any person, entity or group which the Company, directly or indirectly, after giving effect to the Disposition, controls or (iv) in connection with a Related Business Transaction. For purposes of this Section, the Tracking Group affected by the Disposition of its assets is referred to as the "Affected Tracking Group," and the Tracking Stock of such Affected Tracking Group is referred to as the "Affected Tracking Stock." The Related Business Transaction exception to the requirements in the following paragraph would enable the Company to enter into transactions in which the properties or assets of the Affected Tracking Group may be considered to be "disposed of " in exchange for equity securities of an entity engaged or proposing to engage in similar or complementary business areas to those of the Affected Tracking Group while maintaining the capital structure and delineation of the Tracking Stocks contemplated by the Tracking Stock Proposal. See "--Certain Definitions" for a definition of Related Business Transaction. Other than as described above, the Company is required to take one of the following actions in the event of a Disposition: (i) subject to the limitations described above under "--Dividends," declare and distribute a special dividend in cash, securities or other property or any combination thereof (other than a dividend or distribution of common stock of the Company) to the holders of the outstanding shares of the Affected Tracking Stock, in an aggregate amount equal to the product of the applicable Outstanding Interest Fraction as of the record date for determining the holders entitled to receive such dividend and the Fair Value of the Net Proceeds of such Disposition; (ii) provided that there are assets of the Company legally available therefor and the Available Dividend Amount for the Affected Tracking Stock would have been sufficient to pay a dividend in lieu thereof as described in clause (i) of this paragraph, then: (A) if such Disposition involves all (not merely substantially all) of the properties and assets of the Affected Tracking Group, redeem all outstanding shares of the Affected Tracking Stock in exchange for cash, securities or other property (other than common stock of the Company) or any combination thereof in an aggregate amount equal to the product of the Adjusted Outstanding Interest Fraction for the Affected Tracking Group as of the date of such complete redemption and the Fair Value of the Net Proceeds of such Disposition; or (B) if such Disposition involves substantially all (but not all) of the properties and assets of the Affected Tracking Group, apply an aggregate amount of cash, securities or other property (other than common stock of the Company) or any combination thereof equal to the product of the Affected Tracking Group's Outstanding Interest Fraction as of the date shares are selected for redemption and the Fair Value of the Net Proceeds of such Disposition to the redemption of outstanding shares of the Affected Tracking Stock, on a pro rata basis or by lot; or (iii) convert each outstanding share of the Affected Tracking Stock of the Affected Tracking Group into a number (or fraction) of fully paid and nonassessable Special Common Shares or shares of any other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) equal to the Disposition Conversion -89- Percentage of the average daily ratio (calculated to the nearest five decimal places) of the Market Value of (A) one share of Affected Tracking Stock to (B) the Market Value of one Special Common Share or share of such other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) during a forty-Trading Day period beginning on the 11th Trading Day after consummation of the Disposition. In the event of conversion of the Affected Tracking Stock into Special Common Shares or shares of another class of Tracking Stock, the Fair Value of the Net Proceeds of such Disposition will be attributed to the Group related to the shares which are issued upon such conversion (on a pro rata basis if a combination of such shares are issued). In the event there is no public market price for the Special Common Shares, the Market Value per share will be deemed to be the same as the per share Market Value of Common Shares. The Company may elect to pay the dividend or redemption price referred to in clause (i) or (ii) of the preceding paragraph either in the same form as the proceeds of the Disposition were received or in any other combination of cash or securities or property (other than common stock of the Company), on a pro rata basis, that the Board determines will have an aggregate market value on a fully distributed basis, of not less than the amount of the Fair Value of the Net Proceeds of such Disposition. If the dividend or redemption is paid in securities of an issuer other than the Company (the "Successor"), and if there is a Retained Interest in the Tracking Group at such time, the Board shall, to the extent practicable, distribute Successor shares corresponding to Special Common Shares to the holders of Tracking Stock of such Tracking Group with respect to the outstanding shares of such Tracking Group. Holders of TDS Group Shares and shares of any other Tracking Stock will not be entitled to participate in such distribution of any shares of a Successor in a dividend or redemption which is attributable to another class of Tracking Stock, except with respect to a Retained Interest by the TDS Group or an Inter-Group Interest attributed to another Tracking Group. The Successor shares relating to any Retained Interest or Inter-Group Interest may be retained by the Company and attributed to the TDS Group or the other Tracking Group, respectively, or distributed pro rata to the holders of the TDS Group Shares or the applicable Tracking Stock, at the sole discretion of the Board. If the Board determines to distribute Successor shares with respect to such a Retained Interest or Inter-Group Interest, it must, to the extent practicable, distribute Successor shares corresponding to Special Common Shares to the holders of Tracking Stock of another Tracking Group with respect to any such Inter-Group Interest, and distribute Successor shares corresponding to Series A Common Shares to the holders of Series A Common Shares, Successor shares corresponding to Common Shares to the holders of Common Shares, and Successor shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group, provided that the same number of shares of Successor common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. If practicable, the Board must cause such Successor to be recapitalized through an amendment to its charter or otherwise, so that the issued and authorized shares of capital stock of such Successor and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Company and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. The option to convert the Affected Tracking Stock into Special Common Shares or shares of another class of Tracking Stock in the event of a Disposition provides the Company with additional flexibility by allowing the Company to deliver consideration in the form of Special Common Shares or shares of another class or classes of Tracking Stock rather than cash or securities or other properties. This alternative could be used, for example, in circumstances when the Company did not have sufficient legally available assets under the DGCL to pay the full amount of an otherwise required dividend or redemption or when the Company desired to retain such proceeds. In addition, under current tax laws, the conversion of Affected Tracking Stock into Special Common Shares or shares of another class of Tracking Stock should not be taxable to shareholders, whereas a dividend or redemption would be taxable to shareholders. See "--Certain Federal Income Tax Considerations." The "Fair Value of the Net Proceeds" means the fair value of the gross proceeds of such Disposition after payment of or provision for certain specified costs, including taxes related to the Disposition or a dividend or -90- redemption in connection therewith, transaction costs and liabilities and other obligations (contingent or otherwise), including obligations in respect of committed acquisitions, Preferred Shares or Convertible Securities attributed to such Tracking Group (without duplication). See "--Certain Definitions." The Board has complete discretion as to which option to select. However, once the disposition option selected by the Board is publicly announced, the selection becomes irrevocable. The Board is not required to select the disposition option which would result in the distribution with the highest value to the holders of the shares of the Affected Tracking Stock or with the smallest effect on the remaining classes and series of the Company's common stock. In the event of a Disposition, the Company is not required to make any payment or other distributions to the holders of Common Shares, Series A Common Shares, Special Common Shares or shares of any class of Tracking Stock other than the Affected Tracking Stock. However, the Company may, at the option of the Board, make a distribution to such other shareholders in respect of any Retained Interest or any Inter-Group Interest in the Affected Tracking Group existing at the time of a Disposition. The Company may, at any time prior to the first anniversary of a dividend on, or partial redemption of, a class of the Affected Tracking Stock following a Disposition, convert each remaining outstanding share of Affected Tracking Stock into a number (or fraction) of Special Common Shares or shares of any other class or classes of Tracking Stock equal to the product of the Disposition Conversion Percentage and the average daily ratio (calculated to the nearest five decimal places) of the Market Value of one Special Common Share or share of such other class or classes of Tracking Stock during a twenty-Trading Day period ending on the fifth Trading Day prior to the date of notice of such conversion. The effect of using the Adjusted Outstanding Interest Fraction, instead of the Outstanding Interest Fraction, in the determination of amounts to be paid in redemption of shares of the Affected Tracking Stock following a Disposition of all of the properties and assets of the Affected Tracking Group is to allocate to the TDS Group a portion of the Fair Value of the Net Proceeds of the Disposition, in addition to the amount so allocated in respect of the Retained Interest, sufficient to provide for the delivery of the portion of the consideration deliverable by the Company with respect to Shares Issuable to Third Parties. To the extent such Shares Issuable to Third Parties are included in the determination of the Adjusted Outstanding Interest Fraction, the Company's obligations in respect of such securities would not be a reduction in the calculation of the Fair Value of the Net Proceeds. In the event any redemption of Tracking Stock is made in circumstances in which cash, securities or property are allocated to the TDS Group in respect of Shares Issuable to Third Parties (such cash, securities or other property, the "Reserved Property"), the Company will be permitted to segregate and hold such property separate (in the case of any Reserved Property other than Special Common Shares or shares of another class of Tracking Stock). In the event the Reserved Property is, for any reason, not delivered with respect to the obligations under the Shares Issuable to Third Parties, then the former holders of Tracking Stock shall have no interest in such Reserved Property, and such Reserved Property shall revert to the TDS Group, subject to escheat laws. In the event of any conversion of Tracking Stock into Special Common Shares or shares of any other Tracking Stock, the Company will reserve Special Common Shares or shares of such other class of Tracking Stock issuable with respect to Shares Issuable to Third Parties. If less than substantially all of the properties and assets of a Tracking Group are disposed of by the Company in one transaction, the Company would not be required to pay a dividend on, redeem or convert the outstanding shares of Tracking Stock related to such Group even if an additional transaction were consummated at a later time in which additional properties and assets of such Group were disposed of by the Company, which, together with the properties and assets disposed of in the first transaction, would have constituted substantially all of the properties and assets of such Group at the time of the first transaction, unless such transactions constituted a series of related transactions. The second transaction, however, could trigger such a requirement if, at the time of the second transaction, the properties and assets disposed of in such transaction constituted at least substantially all of the properties and assets of such Group at such time. If less than substantially all of the properties and assets of any Tracking Group were disposed of by the Company, the proceeds would be allocated to such Tracking Group, but the holders of Tracking Stock of such Group would not be entitled to receive any dividend or have their shares redeemed or converted for Special Common Shares or shares of any other Tracking Stock, although the Board could determine, in its sole discretion, to pay a dividend to the holders of shares of Tracking Stock of such Group in an amount related to the proceeds of such a disposition. At the time of any dividend made as a result of a Disposition referred to above, the TDS Group will be credited, and the Affected Tracking Group will be charged (in addition to the charge for the dividend paid in respect of outstanding shares of Affected Tracking Stock), with an amount equal to the product of (i) the aggregate amount -91- paid in respect of such dividend times (ii) a fraction the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction of such Group. If any Inter-Group Interests in a Tracking Group exist at the time of any dividend made as a result of a Disposition referred to above, the Tracking Group holding such an Inter-Group Interest will be credited, and the Affected Tracking Group will be charged (in addition to the charge for the dividend paid in respect of outstanding shares of Affected Tracking Stock) with an amount equal to the product of (i) the aggregate amount paid in respect of such dividend times (ii) a fraction the numerator of which is the Inter-Group Interest Fraction and the denominator of which is the Outstanding Interest Fraction of the Affected Group. PROCEDURES RELATING TO DISPOSITION RIGHTS. Not later than the fifth Trading Day following the consummation of a Disposition referred to above, the Company will announce publicly by press release (i) the Fair Value of the Net Proceeds of such Disposition, (ii) the number of outstanding shares of Affected Tracking Stock, (iii) information describing and indicating the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of such shares into or for which Convertible Securities are then convertible, exercisable or exchangeable, and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iv) the Disposition Conversion Percentage, (v) the Outstanding Interest Fraction for the Affected Tracking Stock as of a recent date preceding the date of such notice and (vi) the Adjusted Outstanding Interest Fraction for the Affected Tracking Stock as of a recent date preceding the date of such notice. Not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such Disposition, the Company will announce publicly by press release which of the redemption options or combinations thereof described under "--Disposition of Assets of Tracking Group" it has irrevocably determined to take. As noted under "--Disposition of Assets of Tracking Group," the Board has complete discretion to select which disposition option or combination thereof to employ in the event of a Disposition. NOTICE OF DIVIDEND FOLLOWING DISPOSITION. If the Company determines to pay a dividend of cash, securities or other property or any combination thereof following a Disposition, as described in clause (i) of the fourth paragraph under "--Disposition of Assets of Tracking Group," the Company will, not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such Disposition, cause to be sent to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) the record date for determining holders entitled to receive such dividend, which will be not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition, (ii) the anticipated payment date of such dividend (which will not be more than 90 Trading Days following the consummation of such Disposition), (iii) the kind and amount of cash, securities or property or combination thereof to be distributed in respect of each share of the Affected Tracking Stock, (iv) the amount of the Fair Value of the Net Proceeds of such Disposition, (v) the Outstanding Interest Fraction as of a recent date preceding the date of such notice, and (vi) the number of outstanding shares of the Affected Tracking Stock subject to the Disposition and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). NOTICE OF REDEMPTION OF ENTIRE CLASS FOLLOWING DISPOSITION. If the Company determines to undertake a redemption of a class of Tracking Stock following a Disposition of all (not merely substantially all) of the properties and assets of the Affected Tracking Group with respect to the Fair Value of the Net Proceeds, as described in clause (ii)(A) of the third paragraph under "--Disposition of Assets of Tracking Group," the Company will cause to be given to each holder of outstanding shares of Tracking Stock of the Affected Tracking Group a notice setting forth (i) a statement that all of the shares of the Affected Tracking Stock outstanding on the redemption date will be redeemed, (ii) the anticipated redemption date (which will not be more than 90 Trading Days following the consummation of such Disposition), (iii) the kind and amount of cash, securities or property or combination thereof to be paid as a redemption price in respect of shares of the Affected Tracking Stock outstanding on the redemption date, (iv) the amount of the Fair Value of the Net Proceeds of such Disposition, (v) the Adjusted Outstanding Interest Fraction as of a recent date preceding the date of such notice, (vi) the place or places where certificates for shares of Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered for cash, securities or property or combination thereof, and (vii) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are -92- then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice will be sent not less than 51 Trading Days nor more than 55 Trading Days following the consummation of the Disposition and not less than 25 Trading Days prior to the redemption date. NOTICE OF PARTIAL REDEMPTION FOLLOWING DISPOSITION. If the Company determines to undertake a partial redemption of Tracking Stock following a Disposition of substantially all (but not all) of the properties and assets of the Affected Tracking Group, as described in clause (ii)(B) of the fourth paragraph under "--Disposition of Assets of Tracking Group," such partial redemption will be done on a pro rata basis or by lot. The Company will, not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such a Disposition, cause to be given to each holder of record of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that some of the shares of the Affected Tracking outstanding on the redemption date will be redeemed, specifying the number of such shares or how such number will be determined, (ii) a date not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition which will be the date on which shares of the Affected Tracking Stock then outstanding will be selected for redemption, (iii) the anticipated redemption date (which will not be more than 90 Trading Days following the consummation of such Disposition), (iv) the kind and amount of cash, securities or property or combination thereof to be paid as a redemption price in respect of the shares of the Affected Tracking Stock, (v) the amount of the Fair Value of the Net Proceeds of such Disposition, (vi) the Outstanding Interest Fraction as of a recent date preceding the date of such notice, (vii) the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), and (viii) a statement that the Company will not be required to register a transfer of any shares of the Affected Tracking Stock for a period of up to 15 Trading Days next preceding the date referred to in clause (ii) of this sentence. Promptly following the date referred to in clause (ii) of the preceding sentence, but not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition, the Company will cause to be given to each holder of shares of the Affected Tracking Stock, a notice setting forth (i) the number of shares of Affected Tracking Stock held by such holder to be redeemed, (ii) a statement that such shares of Affected Tracking Stock will be redeemed, (iii) the redemption date (which will not be more than 90 Trading Days following the consummation of such Disposition), (iv) the kind and per share amount of cash, securities or property or combination thereof to be received by such holder with respect to each share of Affected Tracking Stock to be redeemed, including details as to the calculation thereof, and (v) the place or places where certificates for such shares of Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered for delivery of cash, securities or property or combination thereof. NOTICES UPON CONVERSION FOLLOWING DISPOSITION. In the event of any conversion following a Disposition, as described above in clause (iii) of the fourth paragraph under "--Disposition of Assets of Tracking Group," the Company will cause to be given to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that some or all of the outstanding shares of the Affected Tracking Stock will be converted, specifying the number of such shares or how such number shall be determined, (ii) the anticipated conversion date (which will not be more than 90 Trading Days following the consummation of such Disposition), (iii) the per share number (or fraction) of Special Common Shares or shares of another class or classes of Tracking Stock, as applicable, to be received with respect to each share of Affected Tracking Stock, specifying the shares or the combination of such shares to be delivered, the Disposition Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of the Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered, and (v) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). Such notice will be sent not less than 51 Trading Days nor more than 55 Trading Days following the consummation of the Disposition and not less than 25 Trading Days prior to the conversion date. Upon the Company's decision to convert all of the remaining outstanding shares of the Affected Tracking Stock at any time prior to the first anniversary of a dividend on, or partial redemption of, shares of Affected Tracking Stock -93- following a Disposition, as described above under "--Disposition of Assets of Tracking Group," the Company will announce publicly by press release (i) the number of outstanding shares of Affected Tracking Stock to be converted, (ii) the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and into or for which Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iii) the Disposition Conversion Percentage and (iv) the Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice. The Company will subsequently announce publicly by press release whether the shares of such Tracking Stock are being converted in exchange for Special Common Shares, shares of another Tracking Stock or a combination thereof on a pro rata basis. In the event of any conversion at any time prior to the first anniversary of a dividend on, or partial redemption of, shares of Affected Tracking Stock following a Disposition, as described in the preceding paragraph, the Company will cause to be given to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that all of the outstanding shares of the Affected Tracking Stock will be converted into a number or fraction of Special Common Shares or shares of any other class of Tracking Stock or combination thereof on a pro rata basis, (ii) the anticipated conversion date (which will not be more than 90 Trading Days following the following the press release that publicly announces such conversion), (iii) the per share number (or fraction) of Special Common Shares or shares of another class of Tracking Stock or combination thereof, as applicable, to be received with respect to each share of Affected Tracking Stock, specifying such number or fraction of shares or combination thereof, the Disposition Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of the Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered, and (v) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). Such notice will be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the conversion date. CONVERSION AT OPTION OF THE COMPANY. The Company may, at the sole discretion of the Board, at any time convert each outstanding share of any class of Tracking Stock (the "Converted Tracking Stock"), of any Tracking Group (the "Converted Tracking Group"), into a number of fully paid and nonassessable Special Common Shares or shares of another class of Tracking Stock or any combination thereof, equal to the applicable percentage set forth below (the "Optional Conversion Percentage") on the conversion date, of the average daily ratio (calculated to the nearest five decimal places) of the Market Value of one share of Converted Tracking Stock to the Market Value of one Special Common Share or share of such other class or classes of Tracking Stock (or any combination thereof on a pro rata basis), during a twenty-Trading Day period ending on the fifth Trading Day prior to the date of notice of such conversion:
12-MONTH PERIOD PRIOR TO OPTIONAL CONVERSION ANNIVERSARY OF INITIAL ISSUANCE DATE PERCENTAGE - --------------------------------------------------------------------------- ------------------- First through Fifth........................................................ 115% Sixth...................................................................... 114% Seventh.................................................................... 113% Eighth..................................................................... 112% Ninth...................................................................... 111% Thereafter................................................................. 110%
In the event of the conversion of any class of Tracking Stock into Special Common Shares or shares of another class or classes of Tracking Stock, the assets and liabilities of the Converted Tracking Group will be attributed to the Group related to the shares which are issued upon such conversion (on a pro rata basis if a combination of such shares are issued). In the event there is no public market for the Special Common Shares, the Market Value per share will be deemed to be the same as the per share Market Value of the Common Shares. The foregoing provisions would provide the Company the flexibility to recapitalize the capital structure of the Company in several ways. For instance, one Tracking Group could be combined with another Tracking Group. As an example, the Aerial Group Shares could be converted into Cellular Group Shares, in which case the resulting -94- Cellular Group Shares would thereafter represent an equity interest in the Cellular Business and the PCS Business. In addition, the Company could convert any or all classes of Tracking Stock into Special Common Shares. For example, if the Telecom Group Shares were converted into Special Common Shares, the TDS Group would thereafter include the Telecom Business. If all shares of Tracking Stock were converted into Special Common Shares, the Special Common Shares, together with Common Shares and Series A Common Shares, would thereafter represent a common equity interest in all of the Company's businesses and all Tracking Groups would cease to exist. The optional conversion could be exercised at any time in the future if the Board determines that, under the circumstances, a combination of some or all of the businesses of the Company would be in the best interests of the Company and its shareholders. However, such conversion may be exercised by the Company at a time that is disadvantageous to holders of one or more of the shares of capital stock of the Company. See "Risk Factors." The Company has no current intentions or plans to convert any of the shares of Tracking Stock into Special Common Shares or shares of any other Tracking Stock or to combine any of the Groups. REDEMPTION IN EXCHANGE FOR STOCK OF SUBSIDIARY. The Company, in the sole discretion of the Board, may at any time, redeem (at no premium) all of the outstanding shares of any class of Tracking Stock of a Tracking Group, for a number of outstanding shares of common stock of a Qualifying Subsidiary or Qualifying Subsidiaries that hold all of the assets and liabilities attributed to such Tracking Group equal to the product of the Adjusted Outstanding Interest Fraction multiplied by the number of all of the outstanding shares of the Qualifying Subsidiaries owned directly or indirectly by the Company, on a pro rata basis, provided that there are funds of the Company legally available therefor. The Company may retain the balance of the outstanding shares of the common stock of the Qualifying Subsidiaries in respect of the Retained Interest and any Inter-Group Interest in the Tracking Stock to be redeemed, or distribute such shares in respect thereof as discussed below. In the event that the Board, in its sole discretion, decides to redeem all of the outstanding shares of a class of Tracking Stock in exchange for a proportionate interest in the outstanding shares of any one or more Qualifying Subsidiaries that hold all of the assets and liabilities attributed to such Tracking Group, the percentage of the stock of the Qualifying Subsidiary or Qualifying Subsidiaries owned by the Company that is distributable in the redemption would be based on the Adjusted Outstanding Interest Fraction for that Tracking Stock. The effect of using the Adjusted Outstanding Interest Fraction, instead of the Outstanding Interest Fraction, for the shares of Tracking Stock to be redeemed, in the determination of shares of the Qualifying Subsidiaries deliverable in such a redemption, is to allocate to the TDS Group a portion of the shares of the Qualifying Subsidiaries, in addition to the number of such shares so allocated in respect of the Retained Interest, sufficient to provide for the delivery of the consideration deliverable by the Company with respect to Shares Issuable to Third Parties of the Affected Tracking Stock. In the event the Board determines to redeem the shares of any class of Tracking Stock for shares of a Qualifying Subsidiary, and if there is a Retained Interest in such Tracking Group, the Board must, to the extent practicable, distribute Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such Tracking Group with respect to the Adjusted Outstanding Interest Fraction in such Tracking Group. In such event, if the Board determines to distribute shares of such Qualifying Subsidiary to other shareholders with respect to any Retained Interest or Inter-Group Interest must, to the extent practicable, distribute Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of any other Tracking Stock with respect to any such Inter-Group Interest in such Tracking Group, and distribute Qualifying Subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, Qualifying Subsidiary shares corresponding to Common Shares to the holders of Common Shares, and Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group, provided that the same number of shares of Qualifying Subsidiary common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. If practicable, the Board must recapitalize such Qualifying Subsidiary or Qualifying Subsidiaries through an amendment to its charter or otherwise, so that the shares of capital stock of such subsidiary and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Company and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. However, if the Qualifying Subsidiary has or will have shares corresponding to Series A Common and Common Shares but does not have and will not have shares corresponding to Special Common Shares and it is impracticable to recapitalize the subsidiary as provided in the preceding sentence to -95- create Special Common Shares, the Board must distribute Qualifying Subsidiary shares corresponding to Common Shares to the holders of Tracking Stock which would otherwise be entitled to receive Qualifying Subsidiary shares corresponding to Special Common Shares, and to the holders of Special Common Shares in respect of any Retained Interest. A "Qualifying Subsidiary" for this purpose is a subsidiary of the Company that is either wholly-owned, directly or indirectly, by the Company or in which the Company's direct or indirect ownership and voting interest is sufficient to satisfy the requirements of the Internal Revenue Service for a distribution of the Company's interest in such subsidiary to holders of the Company's common stock to be tax-free to such holders, and which holds all of the assets and liabilities attributed to a Tracking Group. A Qualifying Subsidiary for this purpose may include an existing subsidiary of the Company that may in the future hold all of the assets and liabilities attributed to a Tracking Group or any future subsidiary of the Company that meets the definition of Qualifying Subsidiary and holds such assets and liabilities, whether or not created exclusively for such purpose. To the extent that any Qualifying Subsidiary did not hold all assets and liabilities attributable to the Tracking Stock to be redeemed, it is expected that such assets and/or liabilities would be transferred to such Qualifying Subsidiary prior to the redemption. To the extent that any such Qualifying Subsidiary held assets and/or liabilities in addition to those attributed to a Tracking Group, it is expected that in connection with any such redemption such additional assets or liabilities would either be attributed to such Tracking Group or transferred by such Qualifying Subsidiary to the TDS Group or to a different Tracking Group. Alternatively, in any such case, any then existing Retained Interest or Inter-Group Interest could be appropriately adjusted or other consideration that the Board may determine in its discretion to be appropriate could be paid by one Tracking Group to the TDS Group or such other Tracking Group. See "--Management and Allocation Policies." The ability of the Company to exercise its right to redeem the outstanding shares of Tracking Stock in exchange for a proportionate interest in shares of one or more Qualifying Subsidiaries may be limited by the tax consequences to the Company. PROCEDURES RELATING TO CONVERSION OR REDEMPTION OF TRACKING STOCK. Upon the Company's decision to convert or redeem all of the outstanding shares of any class of Tracking Stock as described under "--Conversion at the Option of the Company" or "--Redemption in Exchange for Stock of Subsidiary," the Company will announce publicly by press release (i) the number of outstanding shares of the class of Tracking Stock which will be converted or redeemed, (ii) the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and into or for which Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iii) the Optional Conversion Percentage and details as to the calculation thereof and (iv) the Outstanding Interest Fraction and the Adjusted Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice. The Company will subsequently announce publicly by press release whether the shares of such Tracking Stock are being converted in exchange for Special Common Shares, shares of another class or classes of Tracking Stock or a combination thereof, or are being redeemed for shares of a Qualifying Subsidiary. Unlike the conversion feature described under "--Disposition of Assets of Tracking Group," the Company's decision to convert or redeem all of the outstanding shares of Tracking Stock as described under "--Conversion at the Option of the Company" or "--Redemption in Exchange for Stock of Subsidiary," is not an irrevocable decision, nor is its decision as to which securities the Company will use to redeem the Tracking Stock irrevocable. The conversion or redemption of all of the shares of Tracking Stock as described under "--Conversion at the Option of the Company" or "--Redemption in Exchange for Stock of Subsidiary" may be abandoned or modified by the Company at any time prior to the Company's delivery of the replacement securities in exchange for the converted or redeemed shares of Tracking Stock. NOTICE UPON OPTIONAL CONVERSION. If the Company determines to convert the shares of any class of Tracking Stock into Special Common Shares or shares of any other class or classes of Tracking Stock or any combination thereof, as described above under "--Conversion at the Option of the Company," the Company will promptly cause to be given to each holder of shares of Tracking Stock to be converted a notice setting forth (i) a statement that all outstanding shares of such class of Tracking Stock will be converted in exchange for Special Common Shares or shares of any other class of Tracking Stock or any combination thereof, (ii) the anticipated conversion date (which will not be more than 90 Trading Days following the press release that publicly announces such conversion), (iii) the per share number (or fraction) of Special Common Shares, shares of another class or classes of Tracking Stock or shares of a Qualifying Subsidiary as applicable, to be received with respect to each share of such Tracking Stock, -96- specifying the shares or the combination of such shares to be delivered, the Optional Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of such Tracking Stock to be redeemed, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered for delivery of certificates for Special Common Shares, shares of another class or classes of Tracking Stock or combination thereof, and (v) the number of outstanding shares of such Tracking Stock and the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of such Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice will be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the conversion date. NOTICE UPON REDEMPTION IN EXCHANGE FOR STOCK OF SUBSIDIARY. If the Company determines to redeem the shares of any class of Tracking Stock Shares into shares of a Qualifying Subsidiary as described above under "--Redemption in Exchange for Stock of Subsidiary," the Company will promptly cause to be given to each holder of shares of Tracking Stock to be redeemed a notice setting forth (i) a statement that all outstanding shares of such class of Tracking Stock will be redeemed in exchange for shares of a Qualifying Subsidiary, (ii) the anticipated redemption date (which will not be more than 90 Trading Days following the press release that publicly announces such redemption), (iii) the Adjusted Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice, (iv) the place or places where certificates for shares of such Tracking Stock to be redeemed, properly endorsed or assigned for transfer (unless the Company waives such requirement), are to be surrendered for delivery of certificates for shares of common stock of the Qualifying Subsidiary, and (v) the number of outstanding shares of such Tracking Stock and the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of such Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice will be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the redemption date. GENERAL PROVISIONS RELATING TO CONVERSIONS OR REDEMPTIONS. In each case in which a notice is required to be given to holders of outstanding shares of any class of Tracking Stock in accordance with the "--Procedures Relating to Disposition Rights" or "--Procedures Relating to Conversion or Redemption of Tracking Stock" (other than a notice to holders of shares selected for a partial redemption), notice shall also be given, within the required time period, to each holder of Convertible Securities that are convertible into or exercisable or exchangeable for shares of such Tracking Stock (unless provision for such notice is otherwise made pursuant to the terms of such Convertible Securities). Such notice shall include, in addition to all of the information set forth in the corresponding notice to holders of shares of such Tracking Stock, a statement to the effect that the holders of such Convertible Securities will be entitled to receive the dividend, participate in the redemption of shares following a Disposition with respect to such Tracking Stock or in the selection of shares for conversion or redemption, participate in the conversion of shares or participate in the redemption of shares only if such holder appropriately converts, exercises or exchanges such Convertible Securities on or prior to the record date for the dividend, redemption date, date fixed for selection of shares to be redeemed or conversion date, as applicable, set forth in such notice. In the case of a conversion or redemption of shares of any class of Tracking Stock, the notice to holders of Convertible Securities shall also state what, if anything, such holders will be entitled to receive pursuant to the terms of such Convertible Securities if such holders convert, exercise or exchange such Convertible Securities following the conversion date or redemption date, as applicable. All notices required to be given under this section and as described under "--Procedures Relating to Disposition Rights" and "--Procedures Relating to Conversion or Redemption of Tracking Stock," will be sent to a holder by first class mail, postage prepaid, at the holder's address as the same appears on the transfer books of the Company. Neither the failure to mail any notice to any particular holder of shares of Tracking Stock or of Convertible Securities nor any defect therein will affect the sufficiency thereof with respect to any other holder of outstanding shares of Tracking Stock or of Convertible Securities, or the validity of any redemption. The Company will not be required to issue or deliver fractional shares of any class of capital stock or any fractional securities to any holder of shares of Tracking Stock upon any conversion or redemption, dividend or other distribution described above. In connection with the determination of the number of shares of any class of capital stock that is issuable or the amount of securities that is deliverable to any holder of record upon any conversion or redemption, dividend or other distribution (including any fractions of shares or securities), the Company may -97- aggregate the number of shares of Tracking Stock held at the relevant time by such holder of record. If the number of shares of any class of capital stock or the amount of securities remaining to be issued or delivered to any holder of shares of Tracking Stock is a fraction, the Company will, if such fraction is not issued or delivered to such holder, pay a cash adjustment in respect of such fraction in an amount equal to the fair market value of such fraction on the fifth Trading Day prior to the date such payment is to be made (without interest). For purposes of the preceding sentence, "fair market value" of any fraction will be (i) in the case of any fraction of a share of capital stock of the Company, the product of such fraction and the Market Value of one share of such capital stock and (ii) in the case of any other fractional security, such value as is determined by the Board. No adjustments in respect of dividends will be made upon the conversion or redemption of any shares of Tracking Stock; provided, however, that if the conversion or redemption date with respect to a class of Tracking Stock is subsequent to the record date for the payment of a dividend or other distribution thereon or with respect thereto, the holders of shares of such class of Tracking Stock at the close of business on such record date will be entitled to receive the dividend or other distribution payable on or with respect to such shares on the date set for payment of such dividend or other distribution, notwithstanding a conversion or redemption by the Company of such shares or the Company's default in payment of the dividend or distribution due on such date. Before any holder of shares of any class of Tracking Stock will be entitled to receive certificates representing shares of any kind of capital stock, cash, securities or other property or combination thereof to be received by such holder with respect to any conversion or redemption of such Tracking Stock, such holder is required to surrender at such place as the Company will specify certificates for such shares, properly endorsed or assigned for transfer (unless the Company waives such requirement). The Company will as soon as practicable after surrender of certificates representing shares of such Tracking Stock deliver to the person for whose account such shares were so surrendered, or to the nominee or nominees of such person, certificates representing the number of whole shares of the kind of capital stock or cash, securities or other property or combination thereof to which such person is entitled, together with any payment for fractional securities referred to above. The Company will not be required to register (i) a transfer of any shares of Tracking Stock for a period of up to 15 Trading Days preceding the conversion or redemption date or (ii) any shares of Tracking Stock selected for redemption. From and after any applicable conversion or redemption date, all rights of a holder of shares of any class of Tracking Stock that were converted or redeemed will cease except for the right, upon surrender of the certificates representing such Tracking Stock, to receive certificates representing shares of the kind and amount of capital stock or cash, securities or other property or combination thereof for which such shares of Tracking Stock were converted or redeemed, together with any payment for fractional securities, and such holder will have no other or further rights in respect of the Tracking Stock so converted or redeemed, including, but not limited to, any rights with respect to any capital stock, cash, securities or other property which are reserved or otherwise designated by the Company as being held for the satisfaction of the Company's obligations to pay or deliver any capital stock, cash, securities or other property upon the conversion, exercise or exchange of any Convertible Securities outstanding or with respect to any other Shares Issuable to Third Parties related to the conversion or redemption of such Tracking Stock as of the date of such redemption. No holder of a certificate that, immediately prior to the applicable conversion or redemption date for any class of Tracking Stock, represented shares of Tracking Stock which were converted or redeemed will be entitled to receive any dividend or other distribution with respect to shares of any kind of capital stock or other securities into or in exchange for which the shares of such Tracking Stock were converted or redeemed until surrender of such holder's certificate for a certificate or certificates representing shares of such kind of capital stock or other securities. Upon such surrender, there will be paid to the holder the amount of any dividends or other distributions (without interest) which theretofore became payable with respect to a record date after the conversion date or redemption date, as the case may be, but that were not paid by reason of the foregoing, with respect to the number of whole shares of the kind of capital stock or other securities represented by the certificate or certificates issued upon such surrender. The Company will pay any and all documentary, stamp or similar issue or transfer taxes that may be payable in respect of the issue or delivery of any shares of capital stock or other securities on the conversion or redemption of any class of Tracking Stock. The Company will not, however, be required to pay any tax that may be payable in respect of any transfer involved in the issue and delivery of any shares of capital stock or other securities in a name other than that in which the shares of Tracking Stock so converted or redeemed were registered and no such issue or delivery will be made unless and until the person requesting such issue has paid to the Company the amount of any such tax, or has established to the satisfaction of the Company that such tax has been paid. EFFECT OF CONVERSION OR REDEMPTION ON SECURITIES CONVERTIBLE INTO TRACKING STOCK. Unless the provisions of the security provide specifically to the contrary, after any conversion or redemption date on which all outstanding -98- shares of any class of Tracking Stock were converted or redeemed by the Company, any shares of such Tracking Stock that would be issuable on conversion, exercise or exchange of any pre-conversion or pre-redemption securities which are convertible, exercisable or exchangeable for shares of such Tracking Stock will, immediately upon issuance pursuant to such conversion, exercise or exchange and without any notice or any other action on the part of the Company or its Board or the holder of such security, be converted or redeemed in exchange for, as applicable, the kind and amount of shares of capital stock, cash, securities or other property that a holder of such pre-conversion or pre-redemption securities would have been entitled to receive as a result of the conversion or redemption had such pre-conversion or pre-redemption securities been converted, exercised or exchanged immediately prior to such conversion or redemption. If Convertible Securities, as well as any other obligations to deliver shares of a class of Tracking Stock to third parties, including obligations to deliver Committed Acquisition Shares, remain outstanding at the time of any redemption of all outstanding shares of any one of the Tracking Stocks following the Disposition of all (not merely substantially all) of the properties and assets of the that Tracking Group, the proportionate interest in the Fair Value of the Net Proceeds of the Disposition to be distributed to the holders of Affected Tracking Stock will be determined on the basis of the Adjusted Outstanding Interest Fraction for the Affected Tracking Group. Such determination will result in the allocation to the TDS Group of a portion of such Fair Value of the Net Proceeds, in addition to the portion attributable to any Retained Interest, sufficient to provide for the post-redemption delivery of the portion of the consideration (if any) deliverable by the Company on any conversion, exercise, exchange or delivery of Convertible Securities, Committed Acquisition Shares or otherwise, that is in substitution for shares of the Affected Tracking Group that would have been issuable upon such conversion, exercise, exchange or delivery if it had occurred prior to the redemption of all outstanding shares of such Tracking Stock. Similarly, if Convertible Securities, as well as any other obligations to deliver shares of a class of Tracking Stock to third parties, including obligations to deliver Committed Acquisition Shares, remain outstanding at the time of any redemption of all the outstanding shares of any class of Tracking Stock in exchange for stock of any one or more Qualifying Subsidiaries of the Company which hold all of the assets and liabilities of the related Tracking Group, the number of shares of such subsidiaries deliverable in redemption of the outstanding shares of such Tracking Group will be determined on the basis of the Adjusted Outstanding Interest Fraction for such Tracking Group, resulting in the allocation to the TDS Group of a portion of the shares of such subsidiaries, in addition to the number of shares so allocated in respect of any Retained Interest, sufficient to provide for the post-redemption delivery of the portion of the consideration (if any) deliverable by the Company upon any conversion, exercise, or exchange or delivery of Convertible Securities, Committed Acquisition Shares or otherwise, that is in substitution for shares of such Tracking Stock that would have been issuable upon such conversion, exercise, exchange or delivery if it had occurred prior to such redemption of all outstanding shares of such Tracking Stock. THE RETAINED INTERESTS In structuring the terms of the Tracking Stock Proposal, the Board determined that the retention by the TDS Group of Retained Interests in the Cellular Group, Telecom Group and the Aerial Group was appropriate. In making this determination, the Board concluded that it would be desirable for shareholders to have the option of continuing to maintain a common equity investment in all of the businesses of the Company and its subsidiaries by retaining ownership of the Common Shares or Series A Common Shares. The Board also determined that it would be desirable for the Company to have a Group, such as the TDS Group, which could enter into new ventures and possibly create additional tracking stocks for such ventures by designating series of Undesignated Shares. Such new shares of tracking stock could be distributed to the holders of Common Shares and Series A Common Shares, sold for cash in a public or private offering for the benefit of the TDS Group or delivered in connection with the acquisition of a business by the TDS Group. If and when additional shares of one of the Tracking Stocks are issued (E.G., a public offering), the Board will identify whether the issuance is for the benefit of that Tracking Group or the TDS Group or both. If the issuance is for the benefit of the Tracking Group, the proceeds would be attributed to such Tracking Group and the shares issued would come from authorized but unissued shares of the Tracking Group, which would proportionately dilute the existing Outstanding Interest and the corresponding Retained Interest. If the issuance is for the benefit of the Retained Interest, the proceeds would be attributed to the TDS Group and the Retained Interest would be reduced accordingly. The Retained Interest in a Tracking Group may change pursuant to such issuances as well as any transfers of cash or other property between the TDS Group and the Tracking Group. With respect to transfers of cash or other property between the TDS Group and the Tracking Groups, there are no specific criteria for determining when such a transfer will be reflected as a borrowing or as an increase or -99- reduction in a Retained Interest. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. The Retained Interest in any Tracking Group may change pursuant to any subsequent transfers of cash or other property from the Company to the Tracking Group which are specifically designated by the Board as being made to alter the Retained Interest (in contrast to transfers made for other consideration such as transfers as loans or in purchase and sale transactions) or if outstanding shares of a Tracking Group are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group. The amount of the Retained Interest for a Tracking Group at any point in time would be expressed in terms of the "Number of Shares Issuable with Respect to Retained Interest," which is intended to provide a measure of any Retained Interest on a basis comparable to an investment in Tracking Stock. The full definition of "Number of Shares Issuable with Respect to Retained Interest" is set forth in "--Certain Definitions." The Retained Interest will not be represented by issued and outstanding shares of Tracking Stock. None of the Number of Shares Issuable with Respect to Retained Interest would be represented by outstanding Tracking Stock and, therefore, would not be entitled to any voting rights. Accordingly, the Company will not have any voting rights with respect to any Retained Interest, and the outcome of any vote of any class of Tracking Stock would be determined by the holders of the outstanding shares of such Tracking Stock. In addition, outstanding shares of Tracking Stock that are held by majority-owned subsidiaries of the Company (as to which the Company owns a majority of the shares entitled to vote in the election of directors) would not, in accordance with the DGCL, be entitled to vote on matters presented to shareholders or be counted for quorum purposes. The Board could, in its sole discretion, determine from time to time to have the Company contribute cash or other property as additional equity to any Tracking Group, and have this be reflected as an increase in the Number of Shares Issuable with Respect to Retained Interest. In such event, the Retained Interest Fraction with respect to such Tracking Group will increase and the related Outstanding Interest Fraction will decrease accordingly. The Board could, in its sole discretion, also determine from time to time to transfer cash or other property of a Tracking Group to the TDS Group and have such transfer reflected as a reduction in the Retained Interest, in which case the Number of Shares Issuable with Respect to Retained Interest would be decreased. In such event, such Retained Interest Fraction would decrease and the related Outstanding Interest Fraction would increase accordingly. The Board could, in its sole discretion, determine to make contributions or other transfers referred to in this paragraph after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of each of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. In general, if the Retained Interest is increased by a transfer of funds or other assets from the TDS Group to a Tracking Group, the Number of Shares Issuable with Respect to Retained Interest would be increased by an amount determined by dividing the amount of funds or value of assets transferred by the Market Value of a share of Tracking Stock of such Group as of the date of such transfer. Any transfer of funds or other assets from a Tracking Group to the TDS Group in respect of a decrease in the Number of Shares Issuable with Respect to Retained Interest would be similarly calculated. To the extent outstanding shares of Tracking Stock are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group, the Number of Shares Issuable with Respect to Retained Interest would increase on a share-for-share basis. Tracking Stock purchased with funds attributed to the TDS Group which remain outstanding (as a result of being held by a subsidiary included in the TDS Group) would not increase the Retained Interest but would represent an outstanding interest in the common shareholders' equity value of the TDS Group attributable to such Tracking Group. The Number of Shares Issuable with Respect to Retained Interest, if any, would also (i) be adjusted from time to time as appropriate to reflect (a) subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of any Tracking Stock, (b) dividends or distributions payable in shares of Tracking Stock to holders of such Tracking Stock and (c) reclassifications of Tracking Stock and (ii) be decreased by the number of shares of Tracking Stock (a) issued upon conversion, exercise or exchange of Convertible Securities that are attributed to the TDS Group or (b) issued by the Company as a dividend or distribution or by reclassification or exchange to holders of Common Shares, Series A Common Shares or Special Common Shares. For financial reporting purposes, shares of Tracking Stock acquired by subsidiaries of the TDS Group which remain outstanding following such acquisition would be combined with the Number of Shares Issuable with -100- Respect to Retained Interest, if any, and reported as part of the TDS Group's interest in the related Tracking Group. Any differences between such reported interest and any then existing Retained Interest would be reconcilable by adding to any then existing Retained Interest the number of outstanding shares of Tracking Stock held by subsidiaries of the TDS Group. Because these shares would still be outstanding for purposes of the receipt of dividends and payment of redemption or liquidation amounts, the TDS Group would obtain substantially the same economic benefits from such outstanding shares as it would have received had such shares been retired or otherwise ceased to be outstanding following their purchase and added to the Number of Shares Issuable with Respect to Retained Interest. The authorized shares of Tracking Stock in excess of the total number of shares outstanding will be available for issuance or sale without further approval by the Company's shareholders and may be issued at any time at prices that would dilute the value of the outstanding shares of Tracking Stock. Whenever shares of Tracking Stock are subsequently issued or sold by the Company, the Company will identify (i) the number of shares of Tracking Stock issued and sold that represent a Retained Interest, if any, the sale of which shares will reduce the Number of Shares Issuable with Respect to Retained Interest on a share-for-share basis and the net proceeds of which sale will be reflected entirely in the combined financial statements of the TDS Group, and (ii) the number of such shares that represent an additional equity interest in the Tracking Group, the sale of which shares will reduce the available shares of Tracking Stock and the net proceeds of which sale will be reflected entirely in the combined financial statements of the applicable Tracking Group. The Board expects to make such determination, in its sole discretion, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. In the event of any dividend or other distribution paid or distributed in respect of the outstanding shares of any class of Tracking Stock (other than in shares of Tracking Stock, which will result in the adjustment to the Number of Shares Issuable with Respect to Retained Interest ), the TDS Group's combined financial statements would be credited, and the related Tracking Group's combined financial statements would be charged (in addition to the charge for such dividend or other distribution paid upon outstanding shares of Tracking Stock), with an amount equal to the product of (i) the aggregate amount of such dividend or other distribution paid or distributed in respect of outstanding shares of Tracking Stock (including any dividend related to the Fair Value of the Net Proceeds from the Disposition of all or substantially all of the assets and properties of a Tracking Group), times (ii) a fraction, the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction for such Tracking Group. If shares of Tracking Stock are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group, the Number of Shares Issuable with Respect to Retained Interest would increase on a share-for-share basis and the related Retained Interest Fraction would increase and the related Outstanding Interest Fraction would decrease accordingly. If the purchase of shares of Tracking Stock were made with funds attributed to the Tracking Group, the Number of Shares Issuable with Respect to Retained Interest would not be increased, but the Retained Interest Fraction would increase and the Outstanding Interest Fraction would decrease accordingly. The Board would, in its sole discretion, determine whether purchases of Tracking Stock should be made with consideration attributed to the TDS Group or one of the Tracking Stock Groups, by considering such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. If the Number of Shares Issuable with Respect to Retained Interest is reduced to zero as a result of any combination of one or more of issuances or sales of shares of Tracking Stock for the benefit of the TDS Group or other events, shares of Tracking Stock could no longer be issued or sold by the Company for the benefit of the TDS Group unless a further Retained Interest is subsequently created or some other appropriate allocation is made. See "--Management and Allocation Policies." If the net proceeds of any issuance or sale by the Company of Tracking Stock are allocated to a Tracking Group, the Number of Shares Issuable with Respect to Retained Interest would not be reduced, but the Retained Interest Fraction would decrease and the Outstanding Interest Fraction would increase accordingly. The "Outstanding Interest Fraction" represents the percentage interest in the common shareholders' equity value of the Company attributable to a Tracking Group that is represented at any time by the outstanding shares of Tracking Stock, and the "Retained Interest Fraction" represents any remaining percentage interest in the common shareholders' equity value of the Company attributable to a Tracking Group that is attributed to the TDS Group by virtue of a Retained Interest. Assuming no Inter-Group Interest Fractions, the sum of the Outstanding Interest -101- Fraction and the Retained Interest Fraction for a Tracking Group will always equal 100%. Should an Inter-Group Interest Fraction exist, the sum of such Inter-Group Interest Fraction(s), the Outstanding Interest Fraction and the Retained Interest Fraction, if any, for a Tracking Group will always equal 100%. See "-- Certain Definitions." INTER-GROUP INTERESTS Initially, it is contemplated that no Tracking Group would have an Inter-Group Interest in any other Tracking Group. It is possible that one or more Inter-Group Interests could develop at some time in the future. For example, as the result of an inter-Group transfer of assets from the Cellular Group to the Aerial Group, the Cellular Group could acquire an interest in the Aerial Group. In such a hypothetical event, the Cellular Group would have an Inter-Group Interest in the Aerial Group for the benefit of the holders of the Cellular Group Shares. A Tracking Group may not have an Inter-Group Interest in the TDS Group. An Inter-Group Interest in a Tracking Group would be created only if a transfer of cash or other property from one of the Tracking Groups to another Tracking Group is specifically designated by the Board as being made to create an Inter-Group Interest (in contrast to transfers made for other consideration, such as cash transfers representing borrowings or in cash purchase or sale transactions) or if outstanding shares of a Tracking Group are retired or otherwise cease to be outstanding following their purchase with funds attributed to one of the Tracking Groups. With respect to transfers of cash or other property between the Tracking Groups, there are no specific criteria for determining when such a transfer will be reflected as an increase or reduction in borrowings between Tracking Groups or as a creation of, or an increase or reduction in, an Inter-Group Interest. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Tracking Groups, the investment objectives of the Tracking Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. For illustrative purposes hereof, the Tracking Group acquiring an Inter-Group Interest in one of the other Groups will be referred to as the "Investor Group" and the Tracking Group in which an Inter-Group Interest is being acquired will be referred to as the "Issuer Group." The amount of any Inter-Group Interest of the Investor Group in the Issuer Group (the "Inter-Group Interest in Issuer Group") at any point in time would be expressed in terms of the "Number of Shares Issuable with Respect to Inter-Group Interest" in the Issuer Group, which is intended to provide a measure of any Inter-Group Interest of the Investor Group in the Issuer Group on a basis comparable to an investment in shares of Tracking Stock of the Issuer Group (the "Issuer Group Shares"). The Board could, in its sole discretion, determine from time to time to have the Company contribute cash or other property of the Investor Group as additional equity to the Issuer Group, which would increase the Number of Shares Issuable with Respect to Inter-Group Interest in Issuer Group as described below. In such event, the Inter-Group Interest Fraction will increase and the Issuer Group Outstanding Interest Fraction will decrease accordingly. The Board could, in its sole discretion, also determine from time to time to transfer cash or other property of the Issuer Group from the Issuer Group to the Investor Group in respect of a reduction in its Inter-Group Interest in Issuer Group, in which case the Number of Shares Issuable with Respect to the Inter-Group Interest would be decreased as described below. In such event, the Inter-Group Interest Fraction would decrease and the Issuer Group Outstanding Interest Fraction would increase accordingly. The Board could, in its sole discretion, determine to make contributions or other transfers referred to in this paragraph after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the each of Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. If an Inter-Group Interest in Issuer Group is created by a transfer of funds or other assets from the Investor Group to the Issuer Group, the Number of Shares Issuable with Respect to Inter-Group Interest in Issuer Group would be increased by an amount determined by dividing the amount of funds or value of assets transferred by the Market Value of an Issuer Group Share as of the date of such transfer. In the event a subsequent transfer of funds or other assets from the Investor Group to the Issuer Group is determined by the Board to be made in respect of an increase in the Inter-Group Interest in Issuer Group, the Number of Shares Issuable with Respect to Inter-Group Interest in Issuer Group would be increased by an amount determined by dividing the amount of the additional funds or value of the additional assets transferred by the Market Value of an Issuer Group Share as of the date of -102- such transfer. Any decrease in the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group resulting from a transfer of funds or other assets from the Issuer Group to the Investor Group determined by the Board to be made in respect of such a transfer would be similarly calculated. To the extent outstanding Issuer Group Shares are retired or otherwise cease to be outstanding following their purchase with funds attributed to the Investor Group, the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group would increase on a share-for-share basis. Issuer Group Shares purchased with funds attributed to the Investor Group which remain outstanding (as a result of being held by a subsidiary included in the Investor Group) would not create an Inter-Group Interest or increase any then existing Inter-Group Interest in the Issuer Group but would represent an outstanding interest in the common shareholders' equity value of the Company attributable to the Issuer Group. The Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group, if any, would also (i) be adjusted from time to time as appropriate to reflect (a) subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of the Issuer Group Shares, (b) dividends or distributions payable in Issuer Group Shares to holders of Issuer Group Shares and (c) reclassifications of Issuer Group Shares and (ii) be decreased by the number of shares of Issuer Group Shares (a) issued upon conversion, exercise or exchange of Convertible Securities that are attributed to the Investor Group or (b) issued by the Company as a dividend or distribution or by reclassification or exchange to holders of Investor Group Shares. The Inter-Group Interest in the Issuer Group, if any, would not be represented by outstanding Issuer Group Shares and would have no voting rights. For financial reporting purposes, shares of Tracking Stock acquired by subsidiaries of the Company included in an Investor Group which remain outstanding following such acquisition would be combined with the Investor Group's Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group, if any, and reported as the Investor Group's interest in the Issuer Group. Any differences between such reported interest and any then existing Inter-Group Interest in the Issuer Group Shares would be reconcilable by adding to any then existing Inter-Group Interest the number of outstanding Issuer Group Shares held by the consolidated subsidiaries of the Company included in the Investor Group. Because these shares would still be outstanding for purposes of the receipt of dividends and payment of redemption or liquidation amounts, the Investor Group would obtain substantially the same economic benefits from such outstanding shares as it would have received had such shares been retired or otherwise ceased to be outstanding following their purchase and added to the Investor Group's Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group. The authorized Issuer Group Shares in excess of the total number of shares outstanding will be available for issuance or sale without further approval by the Company's shareholders and may be issued at any time at prices that would dilute the value of the outstanding Issuer Group Shares. If there is an Inter-Group Interest in the future, whenever Issuer Group Shares are subsequently issued or sold by the Company, the Company will identify (i) the number of Issuer Group Shares issued and sold that represent the Inter-Group Interest, if any, the sale of which shares will reduce the Number of Shares Issuable with Respect to Inter-Group Interest in Issuer Group on a share- for-share basis and the net proceeds of which sale will be reflected entirely in the combined financial statements of the Investor Group, and (ii) the number of such shares that represent an additional equity interest in the Issuer Group, the sale of which shares will reduce the available shares of the Issuer Group and the net proceeds of which sale will be reflected entirely in the combined financial statements of the Issuer Group. The Board expects to make such determination, in its sole discretion, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. In the event of any dividend or other distribution paid or distributed in respect of the outstanding Issuer Group Shares, (other than in Issuer Group Shares, which will result in the adjustment to the Number of Shares Issuable with Respect to Retained Interest in the Issuer Group ), an Investor Group's combined financial statements would be credited, and the Issuer Group's combined financial statements would be charged (in addition to the charge for such dividend or other distribution paid upon outstanding Issuer Group Shares), with an amount equal to the product of (i) the aggregate amount of such dividend or other distribution paid or distributed in respect of outstanding Issuer Group Shares (including any dividend related to the Fair Value of the Net Proceeds from the Disposition of all or substantially all of the assets and properties of the Issuer Group), times (ii) a fraction, the numerator of which is the Inter-Group Interest Fraction in the Issuer Group and the denominator of which is the Issuer Group Outstanding Interest Fraction. -103- If Issuer Group Shares are retired or otherwise cease to be outstanding following their purchase with funds attributed to the Investor Group, the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group would increase on a share-for-share basis and the Issuer Group Inter-Group Interest Fraction would increase and the Issuer Group Outstanding Interest Fraction would decrease accordingly. If the purchase of Issuer Group Shares were made with funds attributed to the Issuer Group, the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group would not be increased, but the Issuer Group Inter-Group Interest Fraction would increase and the Issuer Group Outstanding Interest Fraction would decrease accordingly. The Board would, in its sole discretion, determine whether purchases of Tracking Stock of one Group should be made with consideration attributed to such Group, the TDS Group or one of the other Tracking Groups, by considering such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. If the Number of Shares Issuable with Respect to Inter-Group Interest is reduced to zero as a result of any combination of one or more issuances or sales of Issuer Group Shares for the benefit of the Investor Group, Issuer Group Shares could no longer be issued or sold by the Company for the account of the Investor Group unless a further Inter-Group Interest in the Issuer Group is subsequently created or unless some other appropriate allocation is made. If the net proceeds of any issuance or sale by the Company of Issuer Group Shares are allocated to the Issuer Group, the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group would not be reduced, but the Inter-Group Interest Fraction in the Issuer Group would decrease and the Issuer Group Outstanding Interest Fraction would increase accordingly. The "Issuer Group Outstanding Interest Fraction" represents the percentage interest in the common shareholders' equity value of the Company attributable to the Issuer Group that is represented at any time by the outstanding Issuer Group Shares, and the "Issuer Group Inter-Group Interest Fraction" represents any percentage interest in the common shareholders' equity value of the Company attributable to the Issuer Group that is attributed to the Investor Group by virtue of an Inter-Group Interest. The sum of: (i) the Issuer Group Retained Interest, if any, (ii) Issuer Group Outstanding Interest Fraction and (iii) the Issuer Group Inter-Group Interest Fractions, would always equal 100% for any Issuer Group. See "--Certain Definitions." MANAGEMENT AND ALLOCATION POLICIES If the Tracking Stock Proposal is approved by shareholders, the Company will prepare and include in its filings with the SEC under the Exchange Act, consolidated financial statements of the Company and financial statements of the Cellular Group (for so long as shares of the Cellular Group are outstanding), the Telecom Group (for so long as shares of the Telecom Group are outstanding), the Aerial Group (for so long as shares of the Aerial Group are outstanding) and the TDS Group (for so long as any shares of Tracking Stock are outstanding). Except for the financial statements included in this Proxy Statement/Prospectus, the Company does not intend to provide separate financial statements for the TDS Group, Cellular Group, Telecom Group and Aerial Group until Cellular Group Shares, Telecom Group Shares or Aerial Group Shares are first issued, as applicable. The financial statements of each Group, taken together and after giving effect to inter-Group eliminations, would effectively comprise the consolidated financial statements of the Company. The financial statements of each Group will principally reflect the financial position, results of operations and cash flows of the businesses attributed thereto. Consistent with the Restated Certificate and applicable policies, the Group financial information could also include allocated portions of individual assets and liabilities that are not separately identified with the operations of a specific Group. Notwithstanding allocations of assets and liabilities for the purpose of preparing each Group's financial statements, holders of each series of common stock would continue to be subject to risks associated with an investment in the Company and all of its businesses, assets and liabilities. Subject to the consummation of the U.S. Cellular Merger and the Aerial Merger, or other transactions pursuant to which U.S. Cellular or Aerial become wholly-owned subsidiaries of the Company, the Company intends to terminate certain intercompany agreements between the Company and U.S. Cellular and Aerial, respectively. Thereafter, all of the relationships between the Company and such subsidiaries would be determined solely under the management and allocation policies described herein, similarly to TDS Telecom, which is currently a wholly-owned subsidiary of TDS. Many of such policies would continue substantially the same arrangements which presently exist between the Company and U.S. Cellular or Aerial pursuant to the intercompany agreements, but the Company would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. -104- If the Tracking Stock Proposal is approved by shareholders, upon initial issuance of the Cellular Group Shares, Telecom Group Shares or Aerial Group Shares, cash management, taxes and allocation of principal corporate activities among the Groups would be based upon methods that management of the Company believes to be reasonable and would be reflected in the respective Group financial information as follows: DEBT OR PREFERRED STOCK. Any debt incurred or preferred stock issued by the Company would be attributed to a Group by the Board based on the use of proceeds thereof and other factors. All debt incurred or preferred stock issued by the Company's subsidiaries would (unless the Board otherwise provides) be specifically attributed to and reflected on the financial statements of the Group that includes the entity which incurred the debt or issued the preferred stock. The Board could, however, determine from time to time that debt incurred or preferred stock issued by entities included in a Group should be specifically attributed to and reflected on the financial statements of one of the other Groups to the extent that the debt is incurred or the preferred stock is issued for the benefit of such other Group. ISSUANCE OF TRACKING STOCK. After the initial issuance of shares of Tracking Stock, (a) all financial impacts of issuances of additional shares of stock, the proceeds of which are attributed to the applicable Group, will be to such extent reflected in the financial statements of such Group, and (b) all financial impacts of issuances of stock, the proceeds of which are attributed to the TDS Group or one of the other Groups in respect of a reduction in any Retained Interest or Inter-Group Interest of another Tracking Group will be to such extent reflected in the financial statements of the TDS Group or such other Group, as the case may be. Financial impacts of dividends or other distributions on shares of a class of common stock will be attributed entirely to the Group making the dividend or distribution, except that dividends or other distributions will (if at the time there is a Retained Interest or an Inter-Group Interest in the Group making the dividend or distribution) result in the TDS Group or the Group with the Retained Interest or Inter-Group Interest, as the case may be, being credited, and the Group making the dividend or distribution being charged (in addition to the charge for the dividend or other distribution paid on the outstanding Tracking Stock), with an amount equal to the product of (x) the aggregate amount of such dividend or other distribution paid or distributed in respect of outstanding common stock and (y) a fraction, the numerator of which is the Retained Interest Fraction or the Inter-Group Interest Fractions (if any), as the case may be, and the denominator of which is the Outstanding Interest Fraction for such common stock. Financial impacts of repurchases of stock the consideration for which is charged to the related Group will be to such extent reflected in the financial statements of such Group, and financial impacts of repurchases of stock the consideration for which is charged to the TDS Group or another Group will be to such extent reflected in the financial statements of the TDS Group or such other Group and will result in the creation of a, or an increase in any then existing, Retained Interest or Inter-Group Interest, as the case may be, in such other Group. CASH TRANSFERS. To the extent cash needs of one Group exceed cash provided by such Group, one of the other Groups may transfer funds to such Group. The Company has provided and will continue to provide centralized cash management functions under which cash receipts of certain entities attributed to the other Groups will be remitted to the TDS Group and certain cash disbursements of the other Groups will be funded by the TDS Group on a daily basis. Such transfers of funds among the Groups will be reflected as borrowings or, if determined by the Board, reflected as the creation of a, or an increase in any then existing, Retained Interest or an Inter-Group Interest of the TDS Group or such other Group, as the case may be, in such recipient Group or, in the case of a reverse transfer from such recipient Group, reflected as a reduction in the Retained Interest or Inter-Group Interest in such recipient Group. There are no specific criteria for determining when a transfer will be reflected as borrowings or as an increase or reduction in a Retained Interest or an Inter-Group Interest. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. LOANS. Loans from one Group to another Group would bear interest at such rates and have such repayment schedules and other terms as are established from time to time by, or pursuant to procedures established by, the Board. The Board expects to make such determinations, either in specific instances or by setting generally applicable policies from time to time, after consideration of such factors as it deems relevant, including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. -105- RETAINED INTEREST OR INTER-GROUP INTEREST. In the event of a transfer of funds or other assets from one Group to another Group that the Board has determined to reflect as creating or increasing the Retained Interest or an Inter-Group Interest of such other Group, the Number of Shares Issuable with Respect to Retained Interest in such Tracking Group or the applicable Inter-Group Interest in the Issuer Group would be increased by an amount determined by dividing the amount of funds or the value of the assets transferred by the Market Value of an Issuer Group Share as of the date of such transfer, and the applicable Retained Interest Fraction or the applicable Inter-Group Interest Fraction, as the case may be, would be increased and the applicable Outstanding Interest Fraction would be decreased accordingly. In the event of a transfer of funds or other assets from one Group to another Group that the Board has determined to reflect as a decrease in the Retained Interest or an Inter-Group Interest of such other Group, the Number of Shares Issuable with Respect to Retained Interest or the applicable Inter-Group Interest in the Issuer Group would be decreased by an amount determined by dividing the amount of funds or the value of the assets transferred by the Market Value of an Issuer Group Share as of the date of such transfer, and the applicable Retained Interest Fraction or the applicable Inter-Group Interest Fraction, as the case may be, would be decreased and the applicable Outstanding Interest Fraction would be increased accordingly. FINANCIAL STATEMENT PRESENTATION. The balance sheets of each Group would reflect any net loans to or borrowings from the other Groups based on actual or estimated costs. Similarly, the respective statements of operations of each of the Groups would reflect interest income or expense, as the case may be, associated with any such loans or borrowings and the respective statements of cash flows of each of the Groups would reflect changes in the amounts of any such loans or borrowings deemed outstanding. Amounts borrowed by a Group from another Group, will be reflected on that Group's financial statements as indebtedness to the applicable lender. SERVICES BY TDS GROUP. Certain corporate general and administrative costs (including, but not limited to, certain corporate, legal, finance, accounting, tax, data processing, employee benefit and insurance costs) would be charged to the Tracking Groups at rates set at the beginning of each year based on projected utilization for that year, based on actual costs incurred or based on another reasonable method of allocation. The balance of such costs would be reflected in the financial statements of the TDS Group. The utilization-based or other allocation-based charges would be set at levels that corporate management believes to be reasonable, taking into account relevant factors, including the costs that the Groups might incur for comparable services on a stand-alone basis. Certain other corporate general and administrative costs related specifically to management of a Group would be allocated entirely to such Group. The scope of the services charged to the Groups on an allocated basis could be adjusted from time to time depending on various factors, including the extent to which it is determined that services should instead be performed directly by employees of entities attributed to such Group or by outside vendors. INTER-GROUP SERVICES. Certain companies with operations that would be attributed to one Group may from time to time provide services to companies attributed to one or more other Groups, and certain companies attributed to one Group may provide use of facilities to companies attributed to one or more other Group. Generally, services and rights to use facilities provided pursuant to contractual arrangements to which a member of one Group that is not a wholly-owned subsidiary of the Company is a party will continue to be provided in accordance with the terms of such arrangements. Charges for other services and rights to use facilities will be allocated at levels that corporate management believes to be reasonable, taking into account relevant factors, including the costs that the Groups might incur for comparable services on a stand-alone basis. TAXES. The Company has entered into Tax Allocation Agreements with each of U.S. Cellular and Aerial pursuant to which the Company and each of U.S. Cellular and Aerial have agreed to join in the filing of consolidated Federal income tax returns with TDS and its subsidiaries which are part of the TDS affiliated Group for tax purposes. Under such agreements, at the present time TDS does not reimburse U.S. Cellular or Aerial on a current basis for their respective losses or credits, if any, used by the TDS affiliated group. Instead, TDS is required to compensate (by an offset to amounts U.S. Cellular or Aerial would otherwise be required to reimburse TDS for Federal income taxes) for TDS's use of such tax benefits at such time as U.S. Cellular or Aerial could utilize such benefits as a stand-alone entity. After all loss and credit carryforwards have either been utilized or expired, U.S. Cellular and Aerial are required to reimburse TDS for Federal income taxes paid by the TDS affiliated group in an amount equal to the greater of the Federal income tax liability of U.S. Cellular or Aerial, as the case may be, calculated as if it were a separate affiliated group, or the tax calculated using the average tax rate (before taking into account tax credits) of the TDS affiliated group. -106- Under the Tax Allocation Agreements, if U.S. Cellular or Aerial ceases to be a member of the TDS affiliated group, and for a subsequent year U.S. Cellular or Aerial or its subsidiaries are required to pay a greater amount of federal income tax than they would have paid if they had not been members of the TDS group, after June 30, 1987 in the case of U.S. Cellular and after December 31, 1995 in the case of Aerial, TDS must reimburse U.S. Cellular or Aerial, as the case may be, for the excess amount of tax, without interest. In determining the amount of reimbursement, any profits or losses from new business activities acquired by either U.S. Cellular or Aerial or its subsidiaries after either U.S. Cellular or Aerial leaves the TDS group would be disregarded. No reimbursement will be required on account of the income of any subsidiary of U.S. Cellular or Aerial if more than 50% of the voting power of such subsidiary is held by a person or group other than a person or group owning more than 50% of the voting power of TDS. Rules similar to those described above are applied to any state or local franchise or income tax liabilities to which TDS and either U.S. Cellular or Aerial and its subsidiaries are subject and which are required to be determined on a unitary, combined or consolidated basis. These Tax Allocation Agreements will continue unless and until U.S. Cellular or Aerial become wholly-owned subsidiaries of TDS, in which event they may be terminated or amended. In any event, the terms of such agreements are expected to be continued to be followed as agreements or policies on substantially similar terms, except to the extent of changes in circumstances, or as otherwise determined to be appropriate by the Board. The benefits of tax deductions and the obligations to compensate such subsidiaries at such times as such subsidiaries are able to utilize tax benefits as a stand-alone entity, will be attributed to the TDS Group. The Board expects to follow a policy with respect to the Telecom Group which is similar to the policies which are expected to be followed for U.S. Cellular and Aerial based on the existing Tax Allocation Agreements. Under this policy, in general, TDS Telecom would continue to join in the filing of consolidated income tax returns with TDS and its subsidiaries which are part of the TDS affiliated group for tax purposes. Provided that the Telecom Group continues to have taxable income, the Telecom Group will be required to reimburse the TDS Group for Federal income taxes paid by the TDS affiliated group in an amount equal to the greater of the Federal income tax liability of the Telecom Group calculated as if it were a separate affiliated group, or the tax calculated using the average tax rate (before taking into account tax credits) of the TDS affiliated group. In the event that the Telecom Group incurs any tax losses which it cannot utilize, the tax benefits of such losses would be allocated to the TDS Group, and the TDS Group would be required to reimburse the Telecom Group at such time that it would be able to utilize such tax benefits as a stand-alone entity. The Board expects to determine, either in specific instances or by setting generally applicable policies from time to time, whether to allocate resources and financial support to or pursue business opportunities or operational strategies through one Group or one or more of the other Groups, after consideration of such factors as it deems relevant. Notwithstanding the policies described above, determinations with respect to the transfer of funds from one Group to one of the other Groups would be made at the discretion of the Board, except to the extent that the Company is contractually obligated to make a transfer of funds to an entity included in a Group. Nothing in the foregoing policies (as opposed to any such contractual obligation) obligates the Board to cause a Group to provide funds to one of the other Groups if the Board determines that it is in the best interests of the Company not to do so. The above management and allocation policies could be modified or rescinded by the Board, in its sole discretion, without approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. The Board intends that any determination it might make to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon holders of different classes or series of common stock, would be made by the Board considering the best interests of the Company and its shareholders. Any determinations made by the Board under any provision described above will be final and binding on all shareholders of the Company, except as may otherwise be required by law. Such a determination would not be binding only if it were established that the determination was made in breach of a fiduciary duty of the Board. COMPARISON OF SHAREHOLDER'S RIGHTS UNDER IOWA AND DELAWARE LAW In addition to the differences in the charter documents described above, the rights of shareholders under Delaware law and the Restated Certificate and Bylaws of TDS Delaware will differ in a number of respects from the rights of shareholders under Iowa law and the Articles and the Bylaws of TDS Iowa. Although it is impracticable to compare all of the aspects in which the rights of the shareholders of TDS Iowa and TDS Delaware will differ, the following is a summary of significant differences, as well as similarities, in such rights. -107- VOTING TRUST. The TDS Voting Trust, which became effective on June 30, 1989, provides by its terms that it will expire on June 30, 2009, unless extended. The TDS Voting Trust is presently governed by Iowa law. Under the current IBCA, a voting trust may not be established for more than ten years, unless extended. In connection with the Reincorporation, the TDS Voting Trust will be amended to be governed by Delaware law. After the Merger, it will be possible to amend the TDS Voting Trust to provide for a longer term or no expiration date since Delaware law does not have any limitation on the term of a voting trust. The trustees of the TDS Voting Trust have informed the Company that no decisions have been made with respect to the term thereof subsequent to the Merger. Although the Board was cognizant of this potential change, it was not one of the purposes of the Tracking Stock Proposal. BOARD OF DIRECTORS. Both Iowa and Delaware law permit the Board to be divided into up to three classes with staggered terms of office. Like the Articles, the Restated Certificate divides the Board into three classes, with staggered terms of office. Immediately after the Merger, the Board of TDS Delaware, like the Board of TDS Iowa, will consist of twelve members divided into three classes with terms of three years each. After the Merger, the Board of TDS Delaware will consist of the same persons who are directors of TDS Iowa at the time of the Merger. The initial terms of the directors of TDS Delaware will expire at the same time that the terms of such directors would have expired if the Reincorporation had not taken place. ELECTION OF DIRECTORS. Under Iowa law, the election of a director of TDS Iowa requires the affirmative vote of a majority of votes cast by Iowa Shares entitled to vote with respect to such matter. Iowa law provides that shareholders do not have a right to cumulate their votes for directors unless the articles of incorporation so provide. The Articles do not provide for cumulative voting in the election of directors. The election of a director of TDS Delaware will require the affirmative vote of a plurality of the voting power of the Delaware Shares present in person or represented by proxy at the meeting and entitled to vote on the election of such director. Under Delaware law, cumulative voting in the election of directors is not required unless provided in the certificate of incorporation. The Restated Certificate does not provide for cumulative voting. REMOVAL OF DIRECTORS. Under Iowa law, the shareholders may remove one or more directors, with or without cause, unless the articles of incorporation provide that directors may be removed only for cause. The Articles do not provide that directors may be removed only for cause. However, if a director of an Iowa corporation is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove that director. Under Delaware law, unless the certificate of incorporation provides otherwise, shareholders may remove directors of a corporation with a classified board only for cause. The Restated Certificate provides that directors may be removed with cause by a vote of holders of a majority of the voting power of shares entitled to vote in the election of such directors, and may be removed without cause only by a vote of holders of at least 80% of the voting power of the shares entitled to vote in the election of such directors. PERSONAL LIABILITY OF DIRECTORS. Both the IBCA and the DGCL permit corporations to adopt provisions in their certificates of incorporation to eliminate or limit the personal liability of corporate directors to the corporation or its shareholders for monetary damages for violations of their fiduciary duty. However, neither the Iowa statute nor the Delaware statute permits a corporation to eliminate or limit the liability of a director for any act or omission occurring before the effectiveness of the liability limitation provision and, thereafter, for any breach of the director's duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of a law, for any transaction from which the director derived an improper personal benefit or for approving an unlawful distribution by the corporation. In order to continue to give the directors substantially the same protection as they presently have under Iowa law, the Restated Certificate contains the provisions permitted by Delaware law as described in the preceding paragraph, which are substantially the same as the provisions included in the Articles. MEETINGS OF SHAREHOLDERS. Under Iowa law, special meetings of the shareholders of certain corporations, including TDS, may be called by the board of directors, a person or persons so authorized by the articles of incorporation or bylaws, or by holders of at least fifty percent of the votes entitled to be cast on any issue proposed to be considered at the special meeting. The TDS Iowa Bylaws authorize the principal executive officer to call special meetings of shareholders. Under Delaware law, special meetings of the shareholders may be called by the board of directors or such other person as may be authorized by the certificate of incorporation or the bylaws. The Delaware Bylaws will provide that special meetings of shareholders may be called by the Chairman or President, or by holders of at least fifty percent of the votes entitled to be cast thereat. -108- SHAREHOLDER ACTION BY WRITTEN CONSENT. Under Iowa law, unless otherwise provided in the articles of incorporation, any action required or permitted to be taken at a shareholders' meeting may be taken without a meeting or vote, if one or more written consents, describing the action taken, are signed by the holders of outstanding shares having not less than 90% of the votes entitled to be cast at a meeting at which all shares entitled to vote on the action were present and voted. The Iowa Articles do not modify this provision. In addition, prior notice of the action is not required, unless Iowa law requires that notice of any proposed action be given to shareholders not entitled to vote, in which case written notice must be given to all shareholders at least ten days before the action is taken. Under Delaware law, unless otherwise provided in the certificate of incorporation, any action which may be taken or is required to be taken at any annual meeting or special meeting of shareholders, may be taken without a meeting, without prior notice and without a vote, if one or more written consents, setting forth the action so taken, are signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. The Restated Certificate does not limit the ability of shareholders to take action by consent. As a result, Delaware law may provide greater flexibility for TDS shareholders to take action by consent, subject to SEC and AMEX requirements. ADVANCE NOTICE PROVISIONS FOR SHAREHOLDER PROPOSALS AND SHAREHOLDER NOMINATIONS OF DIRECTORS. The Bylaws of TDS Iowa include an advance notice procedure for shareholders to make nominations of candidates for election to the board of directors or to bring other business before an annual meeting of shareholders of TDS Iowa. The Bylaws of TDS Delaware will contain a substantially similar provision. PROXIES. Under Iowa law, a proxy is not valid after eleven months from its date unless a longer period is expressly provided in the form of proxy. Under Delaware law, a proxy is not valid after three years from its date, unless such proxy provides for a longer period. However, the Delaware Bylaws provide that a proxy will not be valid after eleven months from its date unless such proxy provides for a longer period. PREEMPTIVE RIGHTS. Under Iowa law, the shareholders of a corporation do not have a preemptive right to acquire unissued shares of the corporation, except to the extent the articles of incorporation so provide. The Iowa Articles provide that the holders of Series A Common Shares have a preemptive right to acquire additional Series A Common Shares for cash. Delaware law provides that no shareholder has any preemptive right to subscribe to additional shares of stock unless and except to the extent that such right is expressly granted in the certificate of incorporation. The Restated Certificate provides that the holders of Series A Common Shares will have the same preemptive rights as are currently provided under the Iowa Articles. AMENDMENTS TO CHARTER. Unless the IBCA or the articles of incorporation require a greater vote or a vote by voting groups, an amendment to the Articles must be approved by the affirmative vote of a majority of the votes entitled to be cast on the amendment by any voting group with respect to which the amendment would create dissenters' rights and the affirmative vote of a majority of the votes cast for or opposing the action by every other voting group entitled to vote on the amendment. Under the IBCA, shareholders of a class of capital stock are entitled to vote as a separate class (even such shares are nonvoting) on a proposed amendment to the Articles if such amendment would: (i) increase or decrease the aggregate number of authorized shares of the class; (ii) effect an exchange or reclassification of all or part of the shares of the class into shares of another class; (iii) effect an exchange or reclassification, or create the right of exchange, of all or part of the shares of another class into shares of that class; (iv) change the designation, rights, preferences or limitations of all or part of the shares of the class; (v) change the shares of all or part of the class into a different number of shares of the same class; (vi) create a new class of shares having rights or preferences with respect to distributions or to dissolution that are prior, superior or substantially equal to, the shares of the class; (vii) increase the rights, preferences or number of authorized shares of any class that, after giving effect to the amendment, have rights or preferences with respect to distributions or to dissolution that are prior, superior or substantially equal to the shares of the class; (viii) limit or deny an existing preemptive right of all or part of the shares of the class; or (ix) cancel or otherwise affect rights to distributions or dividends that have accumulated but not yet been declared on all or part of the shares of the class. As a result, in the case of an amendment to the Articles on any matter which falls into one of the foregoing categories, the holders of the Common Shares, Series A Common Shares and Preferred Shares, as the case may be, are entitled to vote as a class or voting group. -109- Amendments to the Restated Certificate require the approval of the holders of a majority of the voting power of all outstanding Delaware Shares. In addition, under Delaware law, the holders of the outstanding shares of a class are entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would increase or decrease the par value of the shares of such class or alter or change the powers, preferences or special rights of the shares of such class so as to affect them adversely. As permitted by Delaware law, the Restated Certificate will permit the number of authorized shares of any class of capital stock to be increased or decreased (but not below the number of shares then outstanding in such class, respectively) by the affirmative vote of a majority of the voting power of the shares of capital stock entitled to vote with respect to matters other than the election of directors. SHARE EXCHANGES, MERGERS AND CONSOLIDATIONS. Iowa law permits share exchanges and mergers but does not provide for consolidations. In general, under Iowa law, unless the articles of incorporation require a greater vote or a vote by voting groups, a share exchange or merger must be approved by each voting group entitled to vote separately on the plan by a majority of all the votes entitled to be cast on the plan by the voting group. Separate voting by voting groups is required on a plan of merger if the plan contains a provision that, if contained in a proposed amendment to articles of incorporation, would require action by one or more separate voting groups on the proposed amendment and, on a plan of share exchange, by each class or series of shares included in the exchange, with each class or series constituting a separate voting group. Under Iowa law, action by the shareholders of the surviving corporation on a plan of merger is not required if all of the following apply: (i) the articles of incorporation of the surviving corporation will not differ from its articles before the merger; (ii) each shareholder of the surviving corporation whose shares were outstanding immediately before the effective date of the merger will hold the same number of shares, with identical designations, preferences, limitations and relative rights, immediately after; (iii) the number of shares entitled to vote unconditionally in the election of directors outstanding immediately after the merger, plus the number of such voting shares issuable as a result of the merger, will not exceed by more than 20% the total number of such voting shares of the surviving corporation outstanding immediately before the merger; and (iv) the number of shares entitled to participate without limitation in distributions outstanding immediately after the merger, plus the number of such participating shares issuable as a result of the merger, will not exceed by more than twenty percent the total number of such participating shares outstanding immediately before the merger. Delaware law permits mergers and consolidations but does not provide for share exchanges as permitted by Iowa law. Under Delaware law, the approval of the holders of a majority of the voting power of the outstanding Delaware Shares entitled to vote with respect to such matter would be required to authorize mergers and consolidations. Unlike Iowa law, separate voting by class or voting group is not required for the approval of a merger under the DGCL. Under Delaware law, unless required by its certificate of incorporation, no vote of shareholders of the surviving corporation is necessary to approve a merger if all of the following apply: (i) the agreement of merger does not amend the certificate of incorporation of the surviving corporation; (ii) each share of stock of the surviving corporation outstanding immediately prior to the merger is to be an identical share of the surviving corporation after the merger; and (iii) either no shares or securities convertible into shares of common stock of the surviving corporation are to be issued under the plan of merger, or the shares of the common stock of the surviving corporation to be issued under the plan of merger or upon conversion of any other securities to be issued under such plan do not exceed 20% of the shares of common stock of the surviving corporation outstanding immediately prior to the merger. SALES OF ASSETS. Under Iowa law, unless the articles of incorporation require a greater vote or a vote by voting groups, a sale of substantially all assets not in the ordinary course of business must be approved by a majority of all the votes entitled to be cast on the transaction. Under Delaware law, the approval of the holders of a majority of the voting power of the outstanding Delaware Shares entitled to vote with respect to such matter would be required to authorize the sale of all or substantially all of the property or assets of TDS Delaware. DISSOLUTIONS. Under Iowa law, unless the articles of incorporation require a greater vote or a vote by voting groups, a proposal to dissolve must be approved by a majority of all the votes entitled to be cast on that proposal. Under Delaware law, the approval of the holders of a majority of the voting power of the outstanding Delaware Shares entitled to vote with respect to such matter would be required to authorize a dissolution. APPRAISAL RIGHTS. Under Iowa law, a shareholder is entitled to dissent from, and obtain payment of the fair value of the shareholder's shares in the event of, any of the following corporate actions: (i) consummation of a plan -110- of merger to which the corporation is a party if either (a) shareholder approval is required for the merger under Iowa law or the articles of incorporation and the shareholder is entitled to vote on the merger or (b) the corporation is a subsidiary that is merged with its parent under the short-form merger provisions of Iowa law; (ii) consummation of a plan of share exchange to which the corporation is a party as the corporation whose shares will be acquired, if the shareholder is entitled to vote on the plan; (iii) consummation of a sale or exchange of all, or substantially all, of the property of the corporation other than in the usual and regular course of business, if the shareholder is entitled to vote on the sale or exchange, including a sale in dissolution, but not including a sale pursuant to a court order or a sale for cash pursuant to which all or substantially all of the net proceeds of the sale will be distributed to the shareholders within one year after the date of sale; (iv) an amendment of the articles of incorporation that materially and adversely affects rights in respect of a dissenter's shares because it does any or all of (a) alters or abolishes a preferential right of the shares, (b) creates, alters or abolishes a right in respect of redemption, including a provision respecting a sinking fund for the redemption or repurchase of the shares, (c) alters or abolishes a preemptive right of the holder of the shares to acquire shares or other securities, (d) excludes or limits the right of the shares to vote on any matter or to cumulate votes, other than a limitation by dilution through issuance of shares or other securities with similar voting rights, or (e) reduces the number of shares owned by the shareholder to a fraction of a share if the fractional share so created is to be acquired for cash; or (v) any corporate action taken pursuant to a shareholder vote to the extent the articles of incorporation, bylaws or a resolution of the board of directors provides that voting or nonvoting shareholders are entitled to dissent and obtain payment for their shares. Under Delaware law, appraisal rights will be generally available for the shares of any class of stock of TDS Delaware only in connection with a merger or consolidation, provided that no appraisal rights will be available for the shares of any class or series of stock which, at the record date for the meeting held to approve such transaction, were either (i) listed on a national securities exchange or a national market system or (ii) held of record by more than 2,000 shareholders. However, if the shares of any class or series of stock meet the requirements of clause (i) or (ii) above, appraisal rights will be available for such class or series if the holders thereof receive in the merger or consolidation anything except: (i) shares of stock of the corporation surviving or resulting from such merger or consolidation; (ii) shares of stock of any other corporation which at the effective date of the merger or consolidation is either listed on a national securities exchange or a national market system or held of record by more than 2,000 shareholders; (iii) cash in lieu of fractional shares; or (iv) any combination of the foregoing. However, appraisal rights are not available if the corporation is the surviving corporation and no vote of its shareholders is required for the merger. ANTI-TAKEOVER LAW. The IBCA currently has a provision which restricts the completion of certain unsolicited or hostile business combinations. Under Iowa law, a corporation is prohibited from engaging in any "business combination" (which is broadly defined in the statute) with an "interested shareholder" (defined as a person beneficially owning 15% or more of a corporation's voting stock) for a period of three years following the time that such person became an interested shareholder unless: (i) before such person became an interested shareholder, the board of directors approved the transaction in which the shareholder became an interested shareholder; (ii) upon consummation of the transaction which resulted in the shareholder becoming an interested shareholder, the interested shareholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding shares owned by directors and officers or employee stock ownership plans that do not provide for confidential voting by plan participants); or (iii) at or following the time such person became an interested shareholder, the business combination is approved by the board of directors and authorized at a meeting of shareholders by the affirmative vote of the holders of 66 2/3% of the outstanding voting stock of the corporation not owned by the interested shareholder. Section 203 of the DGCL is substantially similar to the Iowa statute, as described above. However, as permitted by Delaware law, the Restated Certificate will provide that TDS Delaware elects not to be governed by such provision. Since Section 203 will not be applicable to TDS, it may be possible for a person to acquire the Series A Common Shares held by the TDS Voting Trust and to immediately complete a business combination with TDS, without complying with any of the exceptions to Section 203. The trustees of the TDS Voting Trust have advised the Company that they have no current plans or intentions of disposing of such Series A Common Shares. DIVIDENDS AND STOCK REPURCHASES. No distribution, including a purchase, redemption or other acquisition of the corporation's shares, may be made by an Iowa corporation if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business, or the corporation's total assets would be less than the sum of its total liabilities plus, unless the articles of incorporation permit otherwise, the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. -111- A Delaware corporation may pay dividends out of any surplus and, if it has no surplus, out of any net profits for the fiscal year in which the dividend was declared or for the preceding fiscal year (provided that such payment may not reduce capital below the amount of capital represented by all classes of shares having a preference upon the distribution of assets). Under Delaware law, a corporation may purchase or redeem shares of its own stock only when its capital is not impaired and such purchase or redemption would not cause any impairment of the capital of the corporation, except that a corporation may purchase or redeem out of capital any of its preferred shares if such shares will be retired upon their acquisition and the capital of the corporation will be reduced in accordance with Delaware law. Under Delaware law, a corporation may not purchase any of its redeemable shares for more than the price at which they may then be redeemed. TRANSACTIONS INVOLVING OFFICERS OR DIRECTORS. Under Iowa law, a conflict of interest transaction is not voidable by the corporation solely because of the director's interest in the transaction if any one of the following is true: (i) the material facts of the transaction and the director's interest were disclosed or known to the board of directors or a committee of the board of directors, and the board of directors or committee authorized, approved or ratified the transaction; (ii) the material facts of the transaction and the director's interest were disclosed or known to the shareholders entitled to vote and they authorized, approved or ratified the transaction; or (iii) the transaction was fair to the corporation. A conflict of interest transaction can be authorized, approved or ratified by the affirmative vote of a majority of the directors on the board of directors or on the committee, who have no direct or indirect interest in the transaction, but a transaction may not be authorized, approved or ratified by a single director. A conflict of interest transaction may also be authorized, approved or ratified if it receives the vote of a majority of the shares entitled to be counted under Iowa law. Shares owned or voted under the control of a director who has a direct or indirect interest in the transaction, and shares owned by or voted under the control of an entity in which an interested director has an interest may not be counted in a vote of shareholders to determine whether to authorize, approve or ratify a conflict of interest transaction. Under Delaware law, a corporation may make loans to, guarantee the obligations of or otherwise assist its officers or employees and those of its subsidiaries (including directors who are also officers or employees) without shareholder approval when such action, in the judgment of the directors, may reasonably be expected to benefit the corporation. With respect to any other contract or transaction between the corporation and one or more of its directors or officers, such contracts or transactions are neither void nor voidable if the material facts as to the director's or officer's interest are made known to the disinterested directors or the shareholders of the corporation, who thereafter approve the contract or transaction in good faith, or the contract or transaction is fair to the corporation as of the time it is approved or ratified by the board of directors, a committee thereof or the shareholders. Such a contract or transaction may be approved by only one disinterested director and all shares may be counted in a vote to approve such contract or transaction. As a result, TDS Delaware will have greater flexibility to approve contracts and other transactions with directors under Delaware law. BYLAWS. Under Iowa law, a corporation's board of directors may generally adopt, amend or repeal the corporation's bylaws unless the articles of incorporation reserve such power exclusively to the shareholders. The Iowa Articles do not reserve such power to the shareholders. As a result, the Company's Bylaws may be amended or repealed by the Board. Nevertheless, Iowa law provides further that a corporation's shareholders may amend or repeal the corporation's bylaws even though the bylaws may also be amended or repealed by its board of directors. Delaware law provides that the original bylaws of a corporation may be adopted, amended or repealed by the incorporators, by the initial directors if they were named in the certificate of incorporation or by the directors before a corporation has received any payment for any of its stock. After a corporation has received any payment for any of its stock, the power to adopt, amend or repeal bylaws is conferred on the shareholders entitled to vote, provided that a corporation may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors. Therefore, the Restated Certificate must expressly confer power upon the directors in order to permit the directors to amend or repeal the Bylaws of TDS Delaware. However, Delaware law provides that the fact that such power has been conferred upon the directors does not divest the shareholders of the power, nor limit their power, to adopt, amend or repeal bylaws. As a result, the Restated Certificate provides that, in furtherance and not in limitation of the powers conferred by Delaware law, the Board of TDS Delaware is expressly authorized to adopt, amend or repeal the Bylaws of TDS Delaware, subject to any specific limitations on such power provided by any Bylaws adopted by the shareholders. See "--Description of Restated Certificate of Incorporation of TDS Delaware." REDEMPTION TO PROTECT LICENSES. The DGCL expressly states that any stock of a corporation which holds (directly or indirectly) a license or franchise from a governmental agency to conduct its business or is a member of a -112- national securities exchange, which license, franchise or membership is conditioned upon some or all of the holders of its stock possessing prescribed qualifications, may be made subject to redemption by the corporation to the extent necessary to prevent the loss of such license, franchise or membership or to reinstate it. The IBCA has no similar provisions. As permitted by Delaware law, the Restated Certificate includes a provision permitting the Company to redeem shares of capital stock (other than Series A Common Shares) to the extent necessary to prevent the loss or secure the reinstatement of any license or franchise from any governmental agency. See "--Description of Restated Certificate of Incorporation of TDS Delaware." INDEMNIFICATION. Under Iowa law, a corporation may indemnify an individual made a party to a proceeding because the individual is or was a director, against liability incurred in the proceeding if the individual acted in good faith and reasonably believed that the individual's conduct was in or not opposed to the corporation's best interests and, with respect to any criminal action or proceeding, had no reasonable cause to believe the individual's conduct was unlawful. Nevertheless, a corporation may not indemnify a director in a derivative action (as defined below) in which the director was adjudged liable to the corporation, or in any other proceeding in which the director was adjudged liable, on the basis that a personal benefit was improperly received. Indemnification permitted in connection with a derivative action is limited to reasonable expenses incurred in connection with the proceeding. Iowa law also provides that, unless limited by its articles of incorporation, a corporation must indemnify a director or officer who was wholly successful on the merits or otherwise against reasonable expenses incurred in defending the proceedings. Iowa law provides that a court may order indemnification if the court determines that a director or officer is fairly and reasonably entitled to indemnification in view of all the relevant circumstances, whether or not the director or officer met the standard of conduct required or was adjudged liable, except that if the director or officer was adjudged liable, indemnification is limited to reasonable expenses incurred. Iowa law further permits a corporation to advance reasonable expenses incurred by a director, officer, employee or agent of a corporation if, among other things, such person undertakes to repay the advance if it is determined that such person did not meet the standard of conduct required for indemnification. An Iowa corporation may purchase and maintain insurance on individuals against liability arising from the individual's capacity as a director, officer, employee or agent, whether or not the corporation would have the power to indemnify that individual against the same liability. The Company has directors' and officers' liability insurance which provides, subject to certain policy limits, deductible amounts and exclusions, coverage for all persons who have been, are or may in the future be, directors or officers of the Company, against amounts which such persons must pay resulting from claims against them by reason of their being such directors or officers during the policy period for certain breaches of duty, omissions or other acts done or wrongfully attempted or alleged. The indemnification and advancement of expenses permitted by Iowa law is not exclusive of any other rights which a person may have under the articles of incorporation, bylaws, agreements or otherwise, provided that an Iowa corporation may not provide indemnification for any breach of the director's duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of a law, for approving a distribution which was unlawful, or for any transaction from which the director derived an improper personal benefit. Under the DGCL, directors and officers, as well as other employees or persons, may be indemnified against judgments, fines and amounts paid in settlement in connection with specified actions, suits or proceedings, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation--a "derivative action"), and against expenses (including attorney's fees) in any action (including a derivative action), if they acted in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe their conduct was unlawful. However, in the case of a derivative action, a person cannot be indemnified for expenses in respect of any matter as to which the person is adjudged to be liable to the corporation unless and to the extent a court determines that such person is fairly and reasonably entitled to indemnity for such expenses. Delaware law also provides that, to the extent a director or officer of a corporation has been successful on the merits or otherwise in defense of any action or matter, the corporation must indemnify such party against expenses (including attorneys' fees) actually and reasonably incurred by such party in connection therewith. Expenses incurred by a director or officer in defending any action may be paid by a Delaware corporation in advance of the final disposition of the action upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it is ultimately determined that such party is not entitled to be indemnified by the corporation. -113- The DGCL provides that the indemnification and advancement of expenses provided thereby are not exclusive of any other rights granted by bylaws, agreements or otherwise, and provides that a corporation shall have the power to purchase and maintain insurance on behalf of any person, whether or not the corporation would have the power to indemnify such person under Delaware law. TDS Delaware will continue the existing directors' and officers' liabilities policy of TDS Iowa. The Restated Certificate provides that TDS Delaware shall indemnify directors and officers of TDS Delaware, its consolidated subsidiaries and certain other related entities generally in the same manner and to the extent permitted by the DGCL, as more specifically provided in the Bylaws of TDS Delaware. See "--Description of Restated Certificate of Incorporation of TDS Delaware." CONSIDERATION OF COMMUNITY INTERESTS IN ACQUISITION PROPOSALS. Under Iowa law, in determining what is in the best interest of the corporation when considering a tender offer or proposal of acquisition, merger, consolidation or similar proposal, the board of directors may consider, in addition to considering the effects of any action on the shareholders, (i) the effects of the action on the corporation's employees, suppliers, creditors and customers; (ii) the effects of the action on the communities in which the corporation operates and/or (iii) the long-term as well as short-term interests of the corporation and its shareholders, including the possibility that such interests may be best served by the continued independence of the corporation. If, on the basis of such community interest factors, the board of directors determines that a proposal or offer to acquire or merge the corporation is not in the best interests of the corporation, it may reject the proposal or offer. If the board of directors determines to reject any such proposal or offer, the board of directors has no obligation to facilitate, to remove any barriers to, or to refrain from impeding, the proposal or offer. Under Iowa law, the consideration of any or all of the community interest factors is not a violation of the business judgment rule or of any duty of the directors to the shareholders, or a group of shareholders, even if the directors reasonably determine that a community interest factor or factors outweigh the financial or other benefits to the corporation or a shareholder or group of shareholders. Delaware law has no similar provision. However, the Restated Certificate includes a provision which includes substantially the provisions included under Iowa law. See "--Description of Restated Certificate of Incorporation of TDS Delaware." DISSENTING SHAREHOLDERS' RIGHTS Under Iowa law, all shareholders are entitled to assert dissenters' rights with respect to the Merger. However, even if the shareholders approve the Merger, the Board of TDS reserves the right not to effect the Merger if, in its sole determination, the number of dissenting shareholders is excessive so as to make the Merger inadvisable. In such event, the Tracking Stock Proposal would not be adopted and TDS would remain an Iowa corporation. The trustees of the TDS Voting Trust have advised the Company that they do not intend to exercise dissenters' rights with respect to the Merger. The TDS Voting Trust holds over 90% of the Series A Common Shares. A holder of Iowa Shares who dissents from the Merger and exercises dissenter's rights will be generally required to treat the difference between the tax basis of the Iowa Shares held by such shareholder and the amount received through the exercise of such appraisal rights as capital gain or loss, although depending on the holder's particular circumstances, the amount received through the exercise of such rights might be dividend income to the extent of TDS Iowa's current and accumulated earnings and profits. Any shareholder who wishes to assert dissenters' rights must (i) deliver to the Company before the vote on the actions proposed in this Proxy Statement/Prospectus is taken, written notice of the shareholder's intent to demand payment for the shareholder's shares if the proposed actions are effectuated and (ii) not vote his or her shares in favor of the proposal entitling such shareholder to the fair value of his or her shares. Within ten days after the proposed corporate action is authorized by the shareholders, the Company must send a written dissenters' notice to each dissenting shareholder who has delivered to the Company written notice of the shareholder's intent to demand payment for such shareholder's shares and who has not voted his or her shares in favor of the proposal. The written dissenters' notice must (i) state where the payment demand must be sent and where and when certificates for certificated shares must be deposited, (ii) inform holders of uncertificated shares of the extent to which transfer of the shares will be restricted after the payment demand is received, (iii) supply a form for demanding payment that meets statutory requirements, (iv) set a date by which the Company must receive the payment demand, which date shall not be fewer than 30 nor more than 60 days after the Company delivered the written dissenters' notice to the dissenting shareholder and (v) be accompanied by a copy of the Iowa statute pertaining to dissenters' rights. -114- Any shareholder sent a dissenters' notice must (i) demand payment, (ii) certify whether the shareholder acquired beneficial ownership of the shares before the date set forth in the dissenters' notice and (iii) deposit the shareholder's certificates in accordance with the terms of the notice. Except as otherwise required by law, as soon as the proposed action is taken by the Company, or upon receipt of a payment demand, whichever is later, the Company shall pay each dissenter who demanded payment the amount the Company estimates to be the fair value of the dissenter's shares, plus accrued interest. The payment by the Company must be accompanied by (i) the Company's financial statements for the latest fiscal year, as well as the Company's latest available interim statements, (ii) a statement of the Company's estimate of the fair value of the shares, (iii) an explanation of how the interest was calculated, (iv) a statement of the dissenter's right to demand payment under Iowa code section 490.1328 and (v) a copy of the IBCA section which sets forth the procedure to be followed by a shareholder in the event that such shareholder is dissatisfied with the Company's payment or offer. A dissenter may notify the Company within 30 days of the Company's offer for payment for the dissenter's shares in writing of the dissenter's own estimate of the fair value of the dissenter's shares and amount of interest due, and demand payment of the dissenter's estimate less any payment made by the Company or reject the Company's previously made offer and demand payment of the fair value of the dissenter's shares and interest due if (i) the dissenter believes that the amount paid or offered by the Company is less than the fair value of the dissenter's shares or that the interest due was incorrectly calculated, (ii) the Company fails to make payment within 60 days of the date set for demanding payment or (iii) the Company, having failed to take the proposed action, does not return deposited certificates or uncertificated shares within 60 days after the date set for demanding payment. If the Company and any dissenting shareholder are unable to agree on a fair value for such dissenting shareholder's shares, the Company shall commence a proceeding in the district court of Wapello County, Iowa asking for a judicial determination of the fair value of such shares and accrued interest. Such proceeding must be commenced by the Company within 60 days after receiving the dissenter's demand for payment of the dissenter's estimated fair value of such dissenter's shares. The Company shall notify all dissenters and make such dissenters, whether or not residents of the State of Iowa, whose demands remain unsettled, parties to the proceeding. Each dissenter made a party to the proceeding is generally entitled to judgment for the amount, if any, by which the court finds the fair value of the dissenter's shares, plus interest, exceeds the amount paid by the Company. The foregoing description of the rights of dissenting shareholders is qualified in its entirety by reference to the applicable provisions of the IBCA attached as EXHIBIT E to this Proxy Statement/Prospectus, which the shareholders are encouraged to carefully review. CERTAIN FEDERAL INCOME TAX CONSIDERATIONS The following discussion summarizes the material United States federal income tax consequences of the Merger and the Distribution. The discussion does not address all aspects of federal taxation that may be relevant to particular shareholders of the Company, and it may not be applicable to shareholders who, for federal income tax purposes, are subject to special tax treatment, such as insurance companies, corporations subject to the alternative minimum tax, banks, dealers in securities, tax-exempt organizations or, except as specifically discussed below, foreign persons or to shareholders who acquired their shares pursuant to the exercise of employee stock options or otherwise as compensation. The discussion does not address the effect of any applicable state, local or foreign laws or any federal tax laws other than those pertaining to the income tax. EACH SHAREHOLDER OF THE COMPANY SHOULD CONSULT SUCH SHAREHOLDER'S OWN TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO SUCH SHAREHOLDER OF THE MERGER AND THE DISTRIBUTION. The discussion is based on the Internal Revenue Code, regulations and rulings now in effect or proposed thereunder, current administrative rulings and practice, and judicial precedent, all of which are subject to change. Any such change, which may or may not be retroactive, could alter the tax consequences to shareholders of the Company discussed herein. This discussion is also based on certain assumptions regarding the factual circumstances that will exist at the Effective Time of the Merger and at the time of the Distribution, including certain representations made or to be made by the Company. This discussion assumes that shareholders of the Company hold their Preferred Shares, Series A Common Shares and Common Shares of the Company as capital assets within the meaning of Section 1221 of the Internal Revenue Code, and, except as specifically discussed below, assumes that such shareholders will not exercise appraisal rights as described above under "Dissenting Shareholders' Rights." -115- THE MERGER. In the opinion of Sidley & Austin, counsel to the Company, for United States federal income tax purposes: (i) The Merger will constitute a reorganization within the meaning of Section 368(a) of the Internal Revenue Code, and the Company and TDS Delaware will each be a party to the reorganization; (ii) no gain or loss will be recognized by the Company or TDS Delaware as a result of the Merger; (iii) no gain or loss will be recognized by the shareholders of the Company upon the conversion of their Preferred Shares, Series A Common Shares and Common Shares of the Company into Preferred Shares, Series A Common Shares and Common Shares of TDS Delaware, respectively, pursuant to the Merger; (iv) the aggregate tax bases of the Preferred Shares, Series A Common Shares and Common Shares of TDS Delaware received in exchange for Preferred Shares, Series A Common Shares and Common Shares of the Company, respectively, pursuant to the Merger will be the same as the aggregate tax bases of such Preferred Shares, Series A Common Shares and Common Shares of the Company, respectively; and (v) the holding periods for Preferred Shares, Series A Common Shares and Common Shares of TDS Delaware issued in exchange for Preferred Shares, Series A Common Shares and Common Shares of the Company, respectively, pursuant to the Merger will include the holder's holding periods for such Preferred Shares, Series A Common Shares and Common Shares of the Company, respectively. A shareholder of the Company who exercises appraisal rights as described above under "Dissenting Shareholders' Rights" should, in general, treat the difference between the tax basis of the Preferred Shares, the Series A Common Shares and Common Shares of the Company held by such shareholder with respect to which such rights are exercised and the amount received through the exercise of such rights (other than any interest awarded by a court with respect to such rights) as capital gain or loss for federal income tax purposes although, depending on the shareholder's particular circumstances, the amount received through the exercise of such rights (other than any interest awarded by a court with respect to such rights) might be treated for federal income tax purposes as dividend income. Any interest awarded by a court to a shareholder of the Company with respect to exercised appraisal rights generally will be includable in such shareholder's income as ordinary income. A shareholder of the Company that, for federal income tax purposes, is a non-resident alien individual, a foreign corporation, a foreign partnership or a foreign estate or trust (a "Non-U.S. Shareholder") generally will not be subject to federal income tax (by withholding or otherwise) on any gain realized on the receipt of Preferred Shares, Series A Common Shares or Common Shares of TDS Delaware in exchange for Preferred Shares, Series A Common Shares or Common Shares of the Company pursuant to the Merger. THE DISTRIBUTION. In the opinion of Sidley & Austin, counsel to the Company, for United States federal income tax purposes: (i) the Distribution will not result in income, gain or loss to the Company; (ii) the Distribution will not result in income, gain or loss to any shareholder of the Company, except with respect to cash, if any, received in lieu of fractional Cellular Group Shares, Telecom Group Shares or Aerial Group Shares; (iii) a shareholder's tax basis for Series A Common Shares prior to the Distribution will be allocated after the Distribution among such shareholder's Series A Common Shares and Cellular Group Shares, Telecom Group Shares and Aerial Group Shares (including fractional shares, if any, for which cash is received) received in the Distribution (pursuant to a deemed exchange for Series A Common Shares) in proportion to their relative fair market values at the time of the Distribution; (iv) a shareholder's tax basis for Common Shares prior to the Distribution will be allocated after the Distribution among such shareholder's Common Shares and Cellular Group Shares, Telecom Group Shares and Aerial Group Shares (including fractional shares, if any, for which cash is received) received in the Distribution (pursuant to a deemed exchange for Common Shares) in proportion to their relative fair market values at the time of the Distribution; (v) a shareholder's holding period for Cellular Group Shares, Telecom Group Shares and Aerial Group Shares received in the Distribution (pursuant to a deemed exchange for Series A Common Shares) will include such shareholder's holding period for the Series A Common Shares deemed surrendered therefor; (vi) a shareholder's holding period for Cellular Group Shares, Telecom Group Shares and Aerial Group Shares received in the Distribution (pursuant to a deemed exchange for Common Shares) will include such shareholder's holding period for the Common Shares deemed surrendered therefor; -116- (vii) a shareholder who receives cash in lieu of a fractional share will recognize gain or loss equal to the difference, if any, between such shareholder's basis in the fractional share (determined under clause (iii) or (iv) above) and the amount of cash received; and (viii) neither Cellular Group Shares, Telecom Group Shares nor Aerial Group Shares will be "section 306 stock" within the meaning of the Internal Revenue Code. The Internal Revenue Service (the "Service") announced in 1987 that it was studying and would not issue advance rulings on the classification of an instrument that has certain voting and liquidation rights in an issuing corporation but the dividend rights of which are determined by reference to the earnings of a segregated portion of the issuing corporation's assets, including assets held by a subsidiary. In 1995 the Service withdrew such stock from its list of matters under consideration and reiterated that it would not issue advance rulings regarding such stock. There are no court decisions or other authorities that bear directly on transactions similar to the Distribution. It is possible, therefore, that the Service could assert that the Cellular Group Shares, Telecom Group Shares and Aerial Group Shares represent property other than stock of the Company. If such shares were treated as property other than stock of the Company, (i) the Company or its subsidiaries would recognize a significant taxable gain on the Distribution of the Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in an amount equal to the excess of the fair market value of the distributed property over its federal income tax basis to the Company or its subsidiaries and (ii) the Company could lose its ability to file consolidated federal income tax returns with U.S. Cellular, TDS Telecom and Aerial (one consequence being that dividends paid or deemed to be paid by U.S. Cellular, TDS Telecom or Aerial to the Company would be taxable to the Company, subject to any applicable dividends received deduction). Furthermore, the receipt of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares by a shareholder of the Company might be treated as a fully taxable dividend to such shareholder in an amount equal to the fair market value of such stock (subject, in the case of shareholders of the Company that are corporations, to any applicable dividends received deduction). As indicated above, however, it is the opinion of counsel that the Service would not prevail in any such assertion. Dividend payments received by a Non-U.S. Shareholder of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares with respect to such shares will be subject to the withholding of United States federal income tax in the same manner as dividends received by such Non-U.S. Shareholder on Series A Common Shares and Common Shares. A Non-U.S. Shareholder will generally be subject to federal income tax on any gain realized on the taxable sale or exchange of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares if (i) the gain is effectively connected with the conduct of a trade or business of the Non-U.S. Shareholder within the United States, (ii) the gain is derived from sources within the United States and the Non-U.S. Shareholder is a non-resident alien individual who is present in the United States for 183 days or more in the taxable year of such sale or exchange, (iii) the Non-U.S. Shareholder is subject to tax pursuant to the provisions of federal tax law applicable to certain United States expatriates, or (iv) the Company is a "United States real property holding corporation" under the Foreign Investment in Real Property Tax Act of 1980 and the Non-U.S. Shareholder has owned, directly or indirectly, more than five percent of the value of all outstanding shares of the Tracking Group in question at any time during the five-year period ending at the time of the sale or exchange. The Company does not believe that it is a United States real property holding corporation as of the date hereof, although it has not determined or established whether it will be a United States real property holding corporation in the future. Certain non-corporate holders of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares might be subject to backup withholding at a rate of 31% on the payment of dividends on such stock. Backup withholding will apply only if the shareholder (i) fails to furnish his, her or its Taxpayer Identification Number ("TIN") which, for an individual, is his or her Social Security number, (ii) furnishes an incorrect TIN, (iii) is notified by the Service that he, she or it has failed properly to report payments of interest or dividends, or (iv) under certain circumstances, fails to certify under penalties of perjury that he, she or it has furnished a correct TIN and has not been notified by the Service that he, she or it is subject to backup withholding for failure to report payments of interest or dividends. Shareholders should consult their tax advisors regarding their qualifications for an exemption from backup withholding and the procedure for obtaining such an exemption if applicable. The amount of any backup withholding from a payment to a holder of Cellular Group Shares, Telecom Group Shares or Aerial Group Shares will be allowed as a credit against such shareholder's federal income tax liability and may entitle such shareholder to a refund, provided that the required information is furnished to the Service. The foregoing is for general information only. Shareholders should consult their own tax advisors as to the federal, state, local and foreign tax consequences of the Merger and the Distribution and of the holding of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares. -117- SECURITIES LAW CONSEQUENCES OF THE MERGER The Company has been advised by its counsel, Sidley & Austin, that shareholders who hold Iowa Shares which may be sold without registration under the Securities Act of 1933, as amended (the "Securities Act") before the Merger will have, after the Merger, Delaware Shares which may be sold without registration under the Securities Act. Shareholders holding restricted Iowa Shares, and affiliates of TDS Delaware (as defined in the Securities Act), will have Delaware Shares which are subject to the same restrictions on transfer as those to which their Iowa Shares are presently subject. For purposes of computing compliance with the holding period requirements of Rule 144 under the Securities Act, shareholders will be deemed to have acquired their Delaware Shares on the date they acquired their Iowa Shares. Cellular Group Shares, Telecom Group Shares and Aerial Group Shares received in the Distribution, other than any shares received by affiliates of TDS within the meaning of the Securities Act, may be offered for sale and sold without registration under the Securities Act in the same manner as the Common Shares or Series A Common Shares with respect to which they were distributed. Holders of restricted shares and affiliates of TDS, as defined in the Securities Act, including the TDS Voting Trust, will continue to be subject to the restrictions specified in Rule 144 under the Securities Act with respect to shares of Tracking Stock received in the Distribution. Executive officers, directors and holders of more than 10% of any class of registered equity securities of the Company will continue to be subject to the short-swing profit prohibitions and reporting obligations contained in Section 16 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as is the case presently with respect to the Common Shares, and the Series A Common Shares since they can be converted into Common Shares. Furthermore, because the Cellular Group Shares, Telecom Group Shares, Aerial Group Shares and Special Common Shares would be entitled to vote in the election of directors, holders of Cellular Group Shares, Telecom Group Shares, Aerial Group Shares and any issued Special Common Shares will be subject to Section 13(d) of the Exchange Act and the rules thereunder, which generally require public disclosure of acquisitions of more than five percent of a class of voting equity securities that is registered under the Exchange Act. Common Shares (and Series A Common Shares, since they are convertible into Common Shares) will continue to be subject to Section 13(d). Persons or groups who are not now subject to the requirements of Section 16 or 13(d) may, after the Distribution, become subject to such requirements with respect to the ownership of Cellular Group Shares, Telecom Group Shares, Aerial Group Shares or Special Common Shares, if and when issued. After the Merger, TDS Delaware will continue to be a publicly held company and its Common Shares, Cellular Group Shares, Telecom Group Shares and Aerial Group Shares will be registered under the Exchange Act with the SEC. TDS Delaware will file periodic reports and other documents with the SEC and provide to its shareholders the same types of information that TDS Iowa has previously filed and provided, as well as additional financial and other information related to the Groups. LISTING ON THE AMEX The Common Shares of TDS Iowa are listed on the AMEX under the symbol "TDS" and the Common Shares of TDS Delaware as the surviving company will continue to be listed on the AMEX immediately following the Merger under the symbol "TDS." Application is also being made to list each of the Tracking Stocks on the AMEX. STOCK TRANSFER AGENT AND REGISTRAR The Harris Trust and Savings Bank will continue to act as transfer agent and registrar for the Preferred Shares, Common Shares and Series A Common Shares and will also act as transfer agent for shares of Tracking Stock upon issuance thereof. ACCOUNTING TREATMENT For financial reporting purposes, the historical financial statements and accounts of TDS Iowa will be carried forward to TDS Delaware as a result of the Merger. The financial statements of TDS appearing elsewhere in this Proxy Statement/Prospectus have been restated to reflect the effects of the Tracking Stock Proposal. REGULATORY APPROVALS AND CONSENTS The Merger requires the consent of, or notice to, the FCC, several state utility regulatory commissions and certain other third parties. The Merger is expected to be consummated as soon as practicable after shareholder approval and following receipt of all regulatory approvals and other consents which are necessary for the transfer of -118- all material licenses, permits or franchises or other rights of the Company and its subsidiaries. Due to the fact that the Merger simply represents a change in the Company's state of incorporation rather than a change in control of the Company, it is expected that the Company will duly receive all necessary regulatory approvals and other consents. However, the Board reserves the right to abandon the Merger if, in the judgment of the Board, circumstances arise which make proceeding with the Merger inadvisable, such as the imposition of unacceptable conditions to the receipt of such approvals or consents. DIVIDEND REINVESTMENT PLANS The Company's Common Share Automatic Dividend Reinvestment and Stock Purchase Plan ("Common Share DRIP") and the Series A Common Share Automatic Dividend Reinvestment Plan ("Series A DRIP") will be adopted and continued by TDS Delaware on the effective date of the Merger. Shareholders then participating in such plans will automatically become participants in the corresponding TDS Delaware plans. TDS Delaware will adopt a similar dividend reinvestment plan for the holders of Telecom Group Shares ("Telecom DRIP") since the Board intends to pay dividends on the Telecom Group Shares. Shareholders participating in the Common Share DRIP or the Series A DRIP at the time of the Distribution will automatically become participants in the Telecom DRIP with respect to the Telecom Group Shares distributed to participants of such plans. Since the Board does not currently intend to pay dividends on the Cellular Group Shares or the Aerial Group Shares, no dividend reinvestment plans for such shares are expected to be adopted at this time. However, TDS Delaware has requested the Transfer Agent to create a bookkeeping entry facility for the Cellular Group Shares and the Aerial Group Shares so that Shareholders participating in the Common Share DRIP or the Series A DRIP will not be required to take possession of certificates for such shares received in the Distribution with respect to shares distributed under the Common Share DRIP or the Series A DRIP. Accordingly, shareholders receiving shares of Tracking Stock in the Distribution with respect to shares held in the Common Share DRIP or the Series A DRIP will automatically have all whole and fractional Telecom Group Shares credited to the Telecom DRIP and will have all whole and fractional Cellular Group Shares and Aerial Group Shares credited in bookkeeping entry form. Shareholders will be permitted to receive certificates representing whole shares plus cash in lieu of fractional shares at any time after the Distribution upon request to the Transfer Agent. EMPLOYEE BENEFIT PLANS The Company's 1996 Employee Stock Purchase Plan, 1988 Stock Option and Stock Appreciation Rights Plan, 1994 Long-Term Incentive Plan and certain Stock Option and Appreciation Rights Agreements were previously approved by shareholders. Each such TDS benefit plan and agreement, as amended, as well as all other employee benefit plans and agreements of TDS Iowa, will be assumed and adopted by TDS Delaware upon the effectiveness of the Merger. Approval of the Tracking Stock Proposal will also constitute approval by the shareholders of the adoption of such plans and agreements by TDS Delaware, including all shares reserved for issuance thereunder. In connection with the Merger, Shareholders are also being asked to approve the amendment and adjustment of certain of such plans and agreements to reflect the effects of the Tracking Stock Proposal and the Distribution, and to adopt a new plan which will permit the grant of stock awards relating to shares of Tracking Stock. See "Proposal 2" and "Proposal 3." CERTAIN DEFINITIONS As used in this Proxy Statement/Prospectus, unless the context requires otherwise, the following terms have the meanings specified below: "ADJUSTED OUTSTANDING INTEREST FRACTION," as of any date, means, with respect to a particular class of Tracking Stock, a fraction the numerator of which is the aggregate number of shares of such class of Tracking Stock outstanding on such date and the denominator of which is the sum of (a) such aggregate number of outstanding shares, (b) the Number of Shares Issuable with Respect to Retained Interest for such class of Tracking Stock as of such date, (c) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any, and (d) the Number of Shares Issuable to Third Parties with respect to such Tracking Stock. -119- "ADJUSTMENT DATE," means the date which is ten Trading Days before the record date for each annual meeting of shareholders of the Company. "AERIAL" means Aerial Communications, Inc., a Delaware corporation. "AERIAL GROUP" means, as of any date that any shares of Aerial Group Shares have been issued and continue to be outstanding: (a) the interest of the Company or of any of its subsidiaries in Aerial and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their businesses, assets and liabilities, (b) all businesses, assets and liabilities of the Company or any of its subsidiaries to the extent attributed to the Aerial Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of Aerial or its subsidiaries (or a successor as described in clause (a) of this sentence), (c) all businesses, assets and liabilities contributed or otherwise transferred to the Aerial Group from the TDS Group or any of the other Tracking Groups, (d) the interest of the Company or any of its subsidiaries in the businesses, assets and liabilities acquired by the Company or any of its subsidiaries for the Aerial Group, as determined by the Board, (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Aerial Group in such other Tracking Group and (f) such adjustments to the foregoing as may be contemplated by the Restated Certificate or which may be determined in good faith by the Board. "AERIAL MERGER" means the proposed merger between Aerial and a wholly-owned subsidiary of TDS pursuant to which Aerial Group Shares would be issued in exchange for all outstanding Common Shares of Aerial not owned by TDS and Aerial would become a wholly-owned subsidiary of TDS. "AFFECTED TRACKING GROUP" means a Tracking Group which is affected by a Disposition of all or substantially all of its assets, as provided under "--Disposition of Assets of Tracking Group." "AFFECTED TRACKING STOCK" means a class of Tracking Stock which is affected by a Disposition of all or substantially all of the assets of the related Group, as provided under "--Disposition of Assets of Tracking Group." "AMEX" means the American Stock Exchange. "AVAILABLE DIVIDEND AMOUNT," as of any date, means, with respect to any Tracking Group, the product of the Outstanding Interest Fraction of such Tracking Group and either (a) the excess of (i) an amount equal to the total assets of such Tracking Group less the total liabilities (not including preferred stock) of such Tracking Group as of such date over (ii) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding shares of such class of Tracking Stock and each class or series of Preferred Shares or Undesignated Shares attributed to such Tracking Group or (b) in case there is no such excess, an amount equal to Company Earnings (Losses) attributable to such Tracking Group (if positive) for the fiscal year in which such date occurs and/ or the preceding fiscal year. The Available Dividend Amount is intended to be similar to an amount equal to the product of the Outstanding Interest Fraction and the amount that would be legally available for the payment of dividends on shares of Tracking Stock under Delaware law if the related Tracking Group were a separate Delaware corporation. The "Available Dividend Amount" as of any date, means, with respect to the TDS Group, the greater of (x) the amount of all surplus (as defined in the DGCL) of the Company or, if there is no surplus, the net profits (as contemplated by the DGCL) of the Company for the fiscal year in which such date occurs and/or the preceding fiscal year (if positive), less the sum of the Available Dividend Amounts of all of the Tracking Groups, or (y) an amount equal to the sum of the Retained Interest Available Dividend Amounts (if positive) with respect to all of the Tracking Groups, plus, without duplication, either (a) the excess of (i) an amount equal to the total assets of the TDS Group less the total liabilities (not including preferred stock) of the TDS Group as of such date over (ii) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding Series A Common Shares, Common Shares and any issued Special Common Shares, and each class or series of Preferred Shares or Undesignated Shares attributed to the TDS Group or (b) in case there is no such excess, an amount equal to Company Earnings (Losses) attributable to the TDS Group (if positive) for the fiscal year in which such date occurs and/or the preceding fiscal year. "BOARD" means the Board of Directors of the Company. "CELLULAR GROUP" means, as of any date that any shares of Cellular Group Shares have been issued and continue to be outstanding: (a) the interest of the Company or of any of its subsidiaries in U.S. Cellular and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and -120- liabilities, (b) all businesses, assets and liabilities of the Company or any of its subsidiaries to the extent attributed to the Cellular Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of U.S. Cellular or any of its subsidiaries (or a successor as described in clause (a) of this sentence), (c) all businesses, assets and liabilities contributed or otherwise transferred to the Cellular Group from the TDS Group or any of the other Tracking Groups, (d) the interest of the Company or any of its subsidiaries in the businesses, assets and liabilities acquired by the Company or any of its subsidiaries for the Cellular Group, as determined by the Board, (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Cellular Group in such other Tracking Group and (f) such adjustments to the foregoing as may be contemplated by the Restated Certificate or which may be determined in good faith by the Board. "COMMITTED ACQUISITION SHARES" as of any date, means (a) Common Shares that the Company had, prior to such date, agreed to issue in connection with acquisitions, but as of such date had not been issued, and (b) Common Shares that are issuable upon conversion, exercise or exchange of Convertible Securities that the Company had, prior to such date, agreed to issue in connection with acquisitions, but as of such date had not been issued, in each case including obligations of the Company to issue Cellular Group Shares, Telecom Group Shares and Aerial Group Shares as a result of the Distribution pursuant to anti-dilution provisions in the acquisition agreements providing for the issuance of Common Shares or Convertible Securities which are convertible into or exercisable or exchangeable for Common Shares, without duplication of any Common Shares issuable upon conversion, exercise or exchange of Convertible Securities. "COMMON SHARES" means the Common Shares, par value $1.00 per share, of TDS Iowa, which will be converted into Common Shares, par value $.01 per share, of TDS Delaware in the Merger. "COMMON STOCK" means shares of capital stock of the Company designated as common stock, including Series A Common Shares, Common Shares, Special Common Shares, Cellular Group Shares, Telecom Group Shares and Aerial Group Shares. "COMPANY" means Telephone and Data Systems, Inc., an Iowa corporation, and unless the context requires otherwise, its successor, Telephone and Data Systems, Inc., a Delaware Corporation. "COMPANY EARNINGS (LOSS)" for any period, with respect to any Group, means the net earnings or loss of such Group for such period determined on a basis consistent with the determination of the net earnings or loss of such Group for such period as presented in the combined financial statements of such Group for such period, including income and expenses of the Company attributed to the operations of such Group on a substantially consistent basis, including without limitation, corporate, general and administrative costs, net interest and income taxes. "CONVERTED TRACKING STOCK" means a class of Tracking Stock which has been selected for conversion by the Company as provided under "--Optional Conversion by the Company." "CONVERTIBLE SECURITIES" means any securities of the Company, including preferred stock, options and other rights (other than common stock), that are convertible into, exchangeable for or evidence the right to purchase any shares of any series of common stock, whether upon conversion, exercise or exchange, pursuant to anti-dilution provisions of such securities or otherwise. "DGCL" means the Delaware General Corporation Law. "DISPOSITION" means the sale, transfer, assignment or other disposition (whether by merger, consolidation, sale or contribution of assets or stock or otherwise) of all or substantially all of the properties or assets of a Tracking Group, as described under "--Disposition of Assets of a Tracking Group." "DISTRIBUTION" means the contemplated distribution of all or any part of the Cellular Group Shares, Telecom Group Shares and/or Aerial Group Shares to be made to the holders of Common Shares and Series A Shares, as described in this Proxy Statement/Prospectus. "FAIR VALUE OF NET PROCEEDS" means, as of any date, with respect to any Disposition of any of the business, assets and liabilities of a Tracking Group, an amount, if any, equal to the fair value of the gross proceeds of such Disposition less any payment of, or reasonable provision for, (a) any taxes related to the Disposition or in respect of any resulting dividend or redemption, including deferred taxes, but not including any deductions or other offsets which may be available to the Company which are not attributed to such Tracking Group, (b) any transaction costs, including, without limitation, any legal, investment banking and accounting fees and expenses and (c) any liabilities -121- and other obligations (contingent or otherwise) of, or attributed to, that Tracking Group, including, without limitation, obligations with respect to committed acquisitions and Convertible Securities attributed to the Tracking Group, any indemnity or guarantee obligations incurred in connection with the Disposition or any liabilities for future purchase price adjustments, and any preferential amounts plus any accumulated and unpaid dividends and other obligations in respect of Preferred Shares attributed to such Tracking Group (without duplication). For purposes of this definition, any businesses, assets and liabilities of the affected Tracking Group which the Board determines to retain after such Disposition shall be deemed to constitute "reasonable provision" for such amount of taxes, costs and liabilities (contingent or otherwise). To the extent the proceeds of any Disposition include any securities or other property other than cash, the Board shall determine the fair value of such securities or property, including for the purpose of determining comparable value thereof if the Board determines to pay a dividend or redemption price in cash or securities or other property as provided under the terms of the Tracking Stock. "GROUP" means the Aerial Group, the Cellular Group, the Telecom Group and the TDS Group and any other Group so designated by the Board. "IBCA" means the Iowa Business Corporation Act. "INTER-GROUP INTEREST," as of any date, means that part of the Company's equity interest in a Tracking Group which is retained (or subsequently acquired) by the Company and attributed to a Group other than the TDS Group. "INTER-GROUP INTEREST FRACTION," as of any date, with respect to any Investor Group, means a fraction the numerator of which is the Number of Shares Issuable with Respect to Inter-Group Interest in an Issuer Group by such Investor Group as of such date, and the denominator of which is the sum of (a) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest in such Issuer Group by all Investor Groups as of such date, (b) the aggregate number of shares of Tracking Stock of such Issuer Group outstanding as of such date and (c) the Number of Shares Issuable with Respect to Retained Interest in such Issuer Group as of such date. "ISSUER GROUP" means a Tracking Group in which there is an Inter-Group Interest by an Investor Group. "INVESTOR GROUP" means a Tracking Group which holds an Inter-Group Interest in an Issuer Group. "LIQUIDATION UNIT" means the number or fraction associated with each share of common stock which determines the proportionate amount of assets such share is entitled to upon the liquidation, dissolution or winding-up of the Company as described under "--Description of Restated Certificate of Incorporation of TDS Delaware-- Liquidation Rights." "MARKET CAPITALIZATION" of any class or series of capital stock of the Company on any Trading Day means the product of (a) the Market Value of one share of such class or series on such Trading Day and (b) the number of shares of such class or series outstanding on such Trading Day. "MARKET VALUE" of a share of any class or series of capital stock of the Company on any day means the average of the high and low reported sale prices regular way of a share of such class or series on such day (if such day is a Trading Day, and if such day is not a Trading Day, on the Trading Day immediately preceding such day) or in case no such reported sale takes place on such Trading Day the average of the reported closing bid and asked prices regular way of a share of such class or series on such Trading Day, in either case on the American Stock Exchange or such other national securities exchange or the Nasdaq National Market on which such class or series is listed, or if the shares of such class or series are not quoted on the American Stock Exchange or any other national securities exchange or the Nasdaq National Market on such Trading Day, the average of the closing bid and asked prices of a share of such class or series in the over-the-counter market on such Trading Day as furnished by any New York Stock Exchange member firm selected from time to time by the Company, or if such closing bid and asked prices are not made available by any such New York Stock Exchange member firm on such Trading Day, the market value of a share of such class or series as determined by the Board; provided, that if the Special Common Shares or Series A Common Shares are not trading on a national securities exchange or the Nasdaq National Market, and if bid and asked prices are not available for the Special Common Shares or the Series A Common Shares, the Market Value of a Special Common Share or a Series A Common Share, as applicable, shall be deemed to be the same as a Common Share for purposes of determining Market Value under "Description of Terms of Tracking Stock--Voting Rights,--Dispositions of Assets of a Tracking Group,--Conversion at Option of the Company and--Liquidation"; and provided further, that for purposes of determining Market Values under "Description of Terms of Tracking Stock--Voting Rights,--Disposition of Assets of a Tracking Group,--Conversion at Option of the Company and-- Liquidation," (a) the "Market Value" of a share of any series of common stock on any day prior to the "ex" date or -122- any similar date for any dividend or distribution paid or to be paid with respect to such series of common stock will be reduced by the fair market value of the per share amount of such dividend or distribution as determined by the Board and (b) the "Market Value" of a share of any series of common stock on any day prior to (i) the effective date of any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of outstanding shares of such series of common stock or (ii) the "ex" date or any similar date for any dividend or distribution with respect to any such series of common stock in shares of such series of common stock, will be appropriately adjusted to reflect such subdivision, combination, dividend or distribution. "MERGER" means the proposed merger of TDS Iowa with and into TDS Delaware, with TDS Delaware as the surviving corporation, pursuant to which the Company would be reincorporated from Iowa to Delaware. "MERGER AGREEMENT" means the Agreement and Plan of Merger between TDS Iowa and TDS Delaware, with respect to the Merger. "NUMBER OF SHARES ISSUABLE WITH RESPECT TO INTER-GROUP INTEREST" means, with respect to any Tracking Group (for purposes of this definition, the "Issuer Group"), the number of Issuer Group Shares (the "Issuer Group Shares") which are attributed to, and that could be issued or sold by the Company for the benefit of, another Tracking Group (for purposes of this definition, the "Investor Group"). Initially, the Number of Shares Issuable with Respect to Inter-Group Interest in each Tracking Group shall be zero, and shall from time to time thereafter, as applicable, be: (a) adjusted as appropriate to reflect subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of the Issuer Group Shares and dividends or distributions of Issuer Group Shares to the holders thereof and other reclassifications of the Issuer Group Shares and similar transactions; (b) decreased (but not to less than zero) by (i) the aggregate number of Issuer Group Shares issued or sold by the Company, for cash, securities or other property, the proceeds of which are attributed to the Investor Group, (ii) the aggregate number of Issuer Group Shares issued or delivered upon conversion, exercise or exchange of Convertible Securities (other than Pre-Distribution Convertible Securities), the proceeds of which are attributed to the Investor Group, (iii) the aggregate number of Issuer Group Shares issued or delivered by the Company as a dividend or distribution to holders of shares of the Investor Group, (iv) the aggregate number of Issuer Group Shares issued or delivered upon the conversion, exercise or exchange of any Convertible Securities (other than Pre-Distribution Convertible Securities) issued or delivered by the Company as a dividend or distribution or by reclassification or exchange to holders of shares of the Investor Group, and (v) the aggregate number of Issuer Group Shares (rounded, if necessary, to the nearest whole number), equal to the aggregate fair value (as determined by the Board) of assets or properties attributed to the Issuer Group that are transferred from the Issuer Group to the Investor Group in consideration of a reduction in the Number of Shares Issuable with Respect to Inter-Group Interest by the Investor Group in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such transfer; (c) increased by (i) the aggregate number of any Issuer Group Shares which are retired or otherwise cease to be outstanding following their purchase with funds attributed to the Investor Group and (ii) a number (rounded, if necessary, to the nearest whole number) equal to the fair value (as determined by the Board) of assets or properties theretofore attributed to the Investor Group that are contributed to the Issuer Group in consideration of an increase in the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group by the Investor Group, divided by the Market Value of one Issuer Group Share as of the date of such contribution; and (d) adjusted as may be appropriate to reflect other transactions between the Issuer Group and the Investor Group, as determined in good faith by the Board. Whenever a change in the Number of Shares Issuable with Respect to Inter-Group Interest with respect to any Group occurs, the Company shall prepare and file a statement of such change with the Secretary of the Company. "NUMBER OF SHARES ISSUABLE WITH RESPECT TO RETAINED INTEREST" means the number of shares of a class of Tracking Stock of a Tracking Group (for purposes of this definition, the "Issuer Group") that are attributed to, and could be issued or sold by the Company for the account of, the TDS Group in respect of a Retained Interest by the TDS Group in such Issuer Group. The Number of Shares Issuable with Respect to Retained Interest shall initially be determined by the Board, and shall from time to time thereafter, as applicable, be: -123- (a) adjusted as appropriate to reflect subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of the Issuer Group Shares, and dividends or distributions of Issuer Group Shares to the holders thereof and other reclassifications of Issuer Group Shares and similar transactions; (b) decreased (but not to less than zero) by (i) the aggregate number of Issuer Group Shares issued or sold by the Company, for cash, securities or other property, the proceeds of which are attributed to the TDS Group, (ii) the aggregate number of Issuer Group Shares issued or delivered upon conversion, exercise or exchange of Convertible Securities (including Pre-Distribution Convertible Securities), the proceeds of which are attributed to the TDS Group, (iii) the aggregate number of Issuer Group Shares issued or delivered by the Company as a dividend or distribution to holders of Common Shares, Series A Shares or Special Common Shares, (iv) the aggregate number of Issuer Group Shares issued or delivered upon the conversion, exercise or exchange of any Convertible Securities issued or delivered by the Company as a dividend or distribution or by reclassification or exchange to holders of shares of Common Shares, Series A Shares or Special Common Shares, and (v) the aggregate number of Issuer Group Shares (rounded, if necessary, to the nearest whole number), equal to the aggregate fair value (as determined by the Board) of assets or properties attributed to the Issuer Group that are transferred from the Issuer Group to the TDS Group in consideration of a reduction in the Number of Shares Issuable with Respect to Retained Interest in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such transfer; (c) increased by (i) the aggregate number of any Issuer Group Shares which are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group and (ii) a number (rounded, if necessary, to the nearest whole number) equal to the fair value (as determined by the Board) of assets or properties theretofore attributed to the TDS Group that are contributed to the Issuer Group in consideration of an increase in the Number of Shares Issuable with Respect to Retained Interest in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such contribution; and (d) adjusted as may be appropriate to reflect other transactions between the Issuer Group and the TDS Group, as determined in good faith by the Board. Whenever a change in the Number of Shares Issuable with Respect to Retained Interest in any Tracking Group occurs, the Company shall prepare and file a statement of such change with the Secretary of the Company. "NUMBER OF SHARES ISSUABLE TO THIRD PARTIES" means, as of any date, the number of shares of any class of common stock which represent Shares Issuable to Third Parties, as may be determined in good faith by the Board, considering any relevant factors, including whether the holders of Convertible Securities would receive an economic benefit from the conversion, exercise or exchange of such Convertible Securities which exceeds the economic cost thereof, or the economic benefit of not converting, exercising or exchanging such Convertible Securities. "OUTSTANDING INTEREST," as of any date, means, with respect to any class of Tracking Stock, that part of the Company's interest in a Tracking Group which is represented by outstanding shares of such Tracking Stock. "OUTSTANDING INTEREST FRACTION," as of any date, shall mean, with respect to any class of Tracking Stock, a fraction the numerator of which is the aggregate number of shares of such class of Tracking Stock outstanding on such date and the denominator of which is the sum of (a) such aggregate number of shares, (b) the Number of Shares Issuable with Respect to Retained Interest of such class of Tracking Stock as of such date and (c) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any. "PRE-DISTRIBUTION CONVERTIBLE SECURITIES" means Convertible Securities that are outstanding on the record date for the Distribution and are, prior to such date, convertible into or exercisable or exchangeable for either Common Shares or Series A Common Shares, assuming the record date for the Distribution of Cellular Group Shares, Telecom Group Shares and Aerial Group shares is the same date. If the record date for any such shares is not the same date, the Board shall determine which Convertible Securities issued after the first record date relating to any part of the Distribution shall represent Pre-Distribution Convertible Securities. "PREFERRED SHARES" means the Preferred Shares, without par value per share, of TDS Iowa, which will be converted into Preferred Shares, par value $.01 per share, of TDS Delaware in the Merger. -124- "QUALIFYING SUBSIDIARY" or "QUALIFYING SUBSIDIARIES" means a Subsidiary or Subsidiaries of the Company (a) in which (i) the Company's ownership and voting interest is sufficient to satisfy the requirements of the Internal Revenue Service for a distribution of the Company's interest in such Subsidiary to the holders of common stock of the Company that is tax-free to such holders or (ii) the Company owns, directly or indirectly, all of the issued and outstanding capital stock and (b) which currently or at any time in the future hold(s) all of the assets and liabilities attributed to a Tracking Group. "RELATED BUSINESS TRANSACTION" means any Disposition of all or substantially all of the properties and assets of a Tracking Group in which the Company receives as proceeds of such Disposition primarily equity securities (including, without limitation, capital stock, convertible securities, partnership or limited partnership interests and other types of equity securities, without regard to the voting power or contractual or other management or governance rights related to such equity securities) of the purchaser or acquiror of such assets and properties of such Tracking Group, any entity which succeeds (by merger, formation of a joint venture enterprise or otherwise) to such assets and properties of such Tracking Group or a third party issuer, which purchaser, acquiror or other issuer is engaged or proposes to engage primarily in one or more businesses similar or complementary to the businesses conducted by such Tracking Group prior to such Disposition, as determined in good faith by the Board. "RESTATED CERTIFICATE" means the Restated Certificate of Incorporation of TDS Delaware. "RETAINED INTEREST," as of any date, means that part of the Company's equity interest in a Tracking Group, which is retained (or subsequently acquired) by the Company and attributed to the TDS Group for the benefit of the Common Shares, Series A Common Shares and any issued Special Common Shares. "RETAINED INTEREST AVAILABLE DIVIDEND AMOUNT," as of any date, means, with respect to any Tracking Group, an amount (not less than zero) which is equal to the product of (a) a fraction, the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction with respect to such Tracking Group multiplied by (b) the Available Dividend Amount of such Tracking Group. "RETAINED INTEREST FRACTION," as of any date, means, with respect to any class of Tracking Stock, a fraction the numerator of which is the Number of Shares Issuable with Respect to Retained Interest of such class of Tracking Stock as of such date and the denominator of which is the sum of (a) such Number of Shares Issuable with Respect to Retained Interest as of such date, (b) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any, and (c) the aggregate number of shares of such class of Tracking Stock outstanding as of such date. "SERIES A COMMON SHARES" means the Series A Common Shares, par value $1.00 per share, of TDS Iowa, which will be converted into Series A Common Shares, par value $.01 per share, of TDS Delaware in the Merger. "SHARES ISSUABLE TO THIRD PARTIES" means, as of any date, shares of any class of common stock which are issuable (a) as Committed Acquisition Shares, (b) pursuant to the conversion, exercise or exchange of Convertible Securities or (c) otherwise. "SUBSIDIARY" means, with respect to any person or entity, any corporation or partnership 50% or more of whose outstanding voting securities or partnership interests, as the case may be, are directly or indirectly owned by such person or entity. "TDS" or "TDS IOWA" means Telephone and Data Systems, Inc., an Iowa corporation. "TDS DELAWARE" means Telephone and Data Systems, Inc., a Delaware corporation and wholly-owned subsidiary of the Company. "TDS GROUP" means, as of any date that any shares of any class of Tracking Stock have been issued and continue to be outstanding: (a) the interest of the Company and all of its subsidiaries, (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets) and their respective businesses, assets and liabilities, other than (except as provided in clause (e) of this definition) the interest of the Company and its subsidiaries in Aerial and its subsidiaries, TDS Telecom and its subsidiaries, U.S. Cellular and its subsidiaries, and any other subsidiaries attributed by the Board to a Group other than the TDS Group (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and liabilities; (b) all businesses, assets and liabilities of the Company or any of its subsidiaries to the extent attributed to the TDS Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of the TDS Group or any of its -125- subsidiaries (or a successor as described in clause (a) of this sentence); (c) all businesses, assets and liabilities contributed or otherwise transferred to the TDS Group from any of the Tracking Groups; (d) the interest of the Company or any of its subsidiaries in the businesses, assets and liabilities acquired by the Company or any of its subsidiaries for the TDS Group, as determined by the Board; (e) a proportionate undivided interest in each and every business, asset and liability attributed to a Tracking Group equal to the Retained Interest Fraction of the TDS Group in such other Tracking Group; and (f) such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be approved by the Board. "TDS GROUP SHARES" means the Series A Common Shares, Common Shares and any issued Special Common Shares of the Company and any other shares designated as TDS Group Shares by the Board. "TDS TELECOM" means TDS Telecommunications Corporation, a Delaware corporation. "TDS VOTING TRUST" means the voting trust which expires June 30, 2009, that controls a majority of the voting power of TDS in the election of directors and all other matters. "TELECOM GROUP" means, as of any date that any shares of Telecom Group Stock have been issued and continue to be outstanding: (a) the interest of the Company or of any of its subsidiaries in TDS Telecom, and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and liabilities, (b) all businesses, assets and liabilities of the Company or any of its subsidiaries to the extent attributed to the Telecom Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of TDS Telecom or any of its subsidiaries (or a successor as described in clause (a) of this sentence), (c) all businesses, assets and liabilities contributed or otherwise transferred to the Telecom Group from the TDS Group or any other Tracking Group, (d) the interest of the Company or any of its subsidiaries in the businesses, assets and liabilities acquired by the Company or any of its subsidiaries for the Telecom Group, as determined by the Board, (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Telecom Group in such other Tracking Group and (f) such adjustments to the foregoing as may be contemplated by the Restated Certificate or which may be determined in good faith by the Board. "TRACKING GROUP" means the Aerial Group, the Cellular Group and the Telecom Group, and any other business group designated as a Tracking Group by the Board. "TRACKING STOCK" means the Aerial Group Shares, the Cellular Group Shares and the Telecom Group Shares, and any other shares of capital stock of the Company which the Board designates as Tracking Stock. "TRACKING STOCK PROPOSAL" means the proposal to reincorporate the Company from Iowa to Delaware and to authorize a capital structure which will permit the issuance of shares of Tracking Stock. "TRADING DAY" means each weekday other than a day on which the relevant class of common stock of the Company is not traded on any national securities exchange or quoted on the Nasdaq National Market or on the over-the-counter market. "TRANSACTIONS" means the Aerial Merger, the Distribution, the Telecom Public Offering and the U.S. Cellular Merger. "UNDESIGNATED SHARES" means the Undesignated Shares, par value $.01 per share, of TDS Delaware to be authorized by the Restated Certificate. "U.S. CELLULAR" means United States Cellular Corporation, a Delaware corporation. "U.S. CELLULAR MERGER" means the proposed merger between U.S. Cellular and a wholly-owned subsidiary of TDS pursuant to which Cellular Group Shares would be issued in exchange for all outstanding Common Shares of U.S. Cellular not owned by TDS and U.S. Cellular would become a wholly-owned subsidiary of TDS. -126- PROPOSAL 2 AMENDMENT AND ADJUSTMENT OF EMPLOYEE STOCK PLANS Subject to the approval of the Tracking Stock Proposal by the shareholders, the Board of Directors recommends approval of amendments and adjustments to the Company's employee stock plans and a stock option agreement (the "Existing Plans") to conform the Existing Plans to the changes in the Company's capital structure being made by the Tracking Stock Proposal. The amendments and adjustments to the Existing Plans would provide that options and stock appreciation rights granted under the Existing Plans would be adjusted so that, as a result of the Distribution, participants who are entitled to acquire one Common Share pursuant to the Existing Plans will be entitled to acquire one Common Share and such number or fraction of shares of Tracking Stock as were distributed with respect to each Common Share (the "Distribution Ratio") at the original exercise price. In order to permit the issuance of Tracking Stock pursuant to the Existing Plans, it is also necessary to authorize a proportionate amount of Tracking Stock for the Existing Plans. If this proposal is approved, in the event of the Distribution, shares of Tracking Stock will be authorized under the Existing Plans in an amount equal to the number of unissued Common Shares authorized under the Existing Plans times the Distribution Ratio. The amendments and adjustments to the Existing Plans will not make any changes to the terms of the Existing Plans except to authorize the issuance of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares in addition to the Common Shares previously authorized. The following table shows the number of Common Shares currently reserved for issuance under the Existing Plans, and the number of Cellular Group Shares, Telecom Group Shares and Aerial Group Shares proposed to be authorized for issuance pursuant to the Existing Plans based on the expected Distribution Ratio for such shares.
CURRENTLY AUTHORIZED BUT PROPOSED TO BE AUTHORIZED UNISSUED ------------------------------- ----------- CELLULAR TELECOM AERIAL COMMON GROUP GROUP GROUP SHARES SHARES SHARES SHARES ----------- --------- --------- --------- 1994 Long-Term Incentive Plan: Issuable.................................................................... 396,776 396,776 264,517 264,517 Authorized.................................................................. 400,625 400,625 267,084 267,084 ----------- --------- --------- --------- Subtotal.................................................................. 797,401 797,401 531,601 531,601 Issuable Pursuant to 1988 Stock Option and Stock Appreciation Rights Plan..... 124,250 124,250 82,833 82,833 Issuable Pursuant to Stock Option Agreement................................... 54,000 54,000 36,000 36,000 ----------- --------- --------- --------- Total..................................................................... 975,651 975,651 650,434 650,434 ----------- --------- --------- --------- ----------- --------- --------- --------- Distribution Ratio 1 2/3 2/3
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" APPROVAL OF THE AMENDMENTS AND ADJUSTMENTS TO THE EMPLOYEE STOCK PLANS AND AGREEMENTS. -127- PROPOSAL 3 APPROVAL OF 1998 LONG-TERM INCENTIVE PLAN Subject to the approval by shareholders of the Tracking Stock Proposal and the effectiveness of the merger of TDS Iowa into TDS Delaware, the Board has determined that it is in the best interest of the Company and the shareholders to approve the Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan (the "Plan"). The purposes of the Plan are (i) to align the interests of the shareholders of the Company and selected employees of the Company and certain of its affiliates who receive awards under the Plan by increasing the interest of such employees in the Company's growth and success, (ii) to advance the interests of the Company by attracting and retaining key executive and management employees of the Company and certain of its affiliates, and (iii) to motivate such employees to act in the long-term best interests of the Company's shareholders The Plan was adopted by the Board of Directors on December 17, 1997. DESCRIPTION OF THE PLAN GENERAL. Under the Plan, the Company may grant incentive stock options ("ISOs") and nonqualified options, stock appreciation rights ("SARs"), bonus stock awards which are vested upon grant, stock awards which may be subject to a restriction period or specified performance measures or both, performance shares and Employer match awards for deferred bonus payments, as described below. A total of 2,000,000 Common Shares, 3,200,000 Aerial Communications Group Common Shares, 3,600,000 United States Cellular Group Common Shares and 2,500,000 TDS Telecommunications Group Common Shares (collectively, "Plan Stock") have been reserved for issuance under the Plan, subject to adjustment in the event of a stock split, stock dividend or other changes in capital structure. No grants may be made under the Plan after ten years after its effective date. Certain employees of the Company and of affiliates of the Company who are selected by the Committee are eligible to participate in the Plan. The maximum number of shares of Plan Stock with respect to which options, SARs, bonus stock awards, stock awards and performance shares may be granted during any three-calendar year period to any participant in the Plan is 500,000. ADMINISTRATION. The Plan is administered by a committee (the "Committee") made up of two or more members of the Board of Directors, each of whom may be an "outside director" within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended and a "Non-Employee Director" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934, as amended. Subject to the terms of the Plan, the Committee is authorized to select employees for participation in the Plan and to determine the form, amount and timing of each grant of an award and, if applicable, the number of shares of Plan Stock subject to each award granted thereunder, the purchase price or base price per share of Plan Stock upon the exercise of the award, the time and conditions of exercise or settlement of the award, and all other terms and conditions of such award. The Committee may establish performance measures that must be attained (i) during a performance period in order for an employee eligible to participate in the Plan to be granted a performance stock option, (ii) during the applicable restriction period or performance period as a condition to the award recipient's receipt of shares of Plan Stock subject to the award in the case of a restricted stock award or receipt of shares of Plan Stock or cash in the case of performance share award, or (iii) as a condition to exercisability of all or a portion of an option or SAR. The performance measures are one or more of the following: the attainment by a share of stock of a specified fair market value for a specified period of time, earnings per share, return on equity, return on capital, earnings on investments, cash flows, revenues, sales, costs, market share, attainment of cost reduction goals, customer count, attainment of business efficiency measures (I.E., cost per gross or net customer addition, revenue per customer, customer turnover rate, ratios of employees to volume measures of business, and population in licensed or operating markets), financing costs, ratios of capital spending and investment to volume of business measures and customer satisfaction survey results. In the case of an option or SAR granted at fair market value on the date of grant, such performance measures also may include the attainment of individual performance objectives, or any other criteria and objectives established by the Committee or any combination thereof. The Committee may delegate some or all of its power and authority under the Plan to the Chairman of the Board and Chief Executive Officer or other executive officer of the Company as it deems appropriate; provided, however, that such Committee may not delegate its power and authority regarding (A) the selection for participation in the Plan of (i) the Chief Executive Officer of the Company (or any employee who is acting in such capacity), one of the four highest compensated officers of the Company (other than the Chief Executive Officer), or any other person deemed to be a "covered employee" within the meaning of section 162(m) of the Code or who, in the Committee's judgment, is likely to be a covered employee at any time during the exercise period of the option to be granted to such employee, or (ii) an officer or other person subject to section 16 of the Exchange Act, or (B) decisions concerning the timing, pricing or number of shares subject to an award granted to such an employee, officer or other person who is, or who in the Committee's judgment is likely to be, a covered employee. -128- EFFECTIVE DATE, TERMINATION AND AMENDMENT. The Plan will become effective as of the effective date of the merger of TDS Iowa into TDS Delaware and will terminate ten years thereafter, unless terminated earlier by the Board of Directors. The Board of Directors generally may amend the Plan at any time except that, without the approval of the shareholders of the Company, no amendment may, among other things, (i) increase the number of shares of any class of Plan Stock available under the Plan, or (ii) reduce the minimum purchase price of a share of Plan Stock subject to an option or base price of an SAR. EMPLOYEE STOCK OPTIONS. The Plan provides for the grant of ISOs and nonqualified stock, and that the Committee will determine the exercise period and the purchase price of shares of Plan Stock at the time of grant, provided that the purchase price per shares of Plan Stock subject to an ISO is not less than 100% of the fair market value of such shares of stock on the date of grant. The exercise of an option entitles the optionee thereof to receive (subject to withholding tax) whole shares of Plan Stock (which may be restricted stock). The aggregate fair market value (determined as of the date the option is granted) of the stock with respect to which ISOs are exercisable for the first time by the optionee in any calendar year (under the Plan and any other incentive stock option plan of the Company) may not exceed $100,000. ISOs granted under the Plan may not be exercised after ten years from the date of grant. In the case of any eligible employee who owns or is deemed to own stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or any of its subsidiaries, the exercise price of any ISOs granted under the Plan may not be less than 110% of the fair market value of the stock on the date of grant, and the exercise period may not exceed five years from the date of grant. ISOs granted under the Plan are not transferable other than pursuant to a beneficiary designation effective on the award recipient's death. Nonqualified options granted under the Plan are not transferable by the optionee other than (a) pursuant to a beneficiary designation effective on the award recipient's death, (b) pursuant to a court order entered in connection with a dissolution of marriage or child support, or (c) to the extent permitted under (i) securities laws relating to the registration of securities subject to employee benefit plans and (ii) the agreement evidencing the grant of such award, by transfer to a permitted transferee (determined under the terms of the Plan). All stock options will become immediately exercisable upon certain changes of control of the Company. STOCK APPRECIATION RIGHTS. The Plan provides for the grant of SARs. The number of shares of Plan Stock subject to an SAR, the period for the exercise of an SAR, the base price of an SAR and any performance measures applicable to an SAR will be determined by the Committee, provided that the base price per share of Plan Stock subject to an SAR shall not be less than 100% of the fair market value of a share of stock on the date of grant. The exercise of an SAR entitles the holder thereof to receive (subject to withholding taxes) whole shares of Plan Stock (which may be restricted stock), cash or a combination thereof with a value equal to the difference between the fair market value of the stock on the exercise date and the base price of the SAR, multiplied by the number of shares of Plan Stock with respect to which such SAR is issued. SARs granted under the Plan are not transferable by the award recipient other than (a) pursuant to a beneficiary designation effective on the award recipient's death, (b) pursuant to a court order entered in connection with a dissolution of marriage or child support or (c) to the extent permitted under (i) securities laws relating to the registration of securities subject to employee benefit plans and (ii) the agreement evidencing the grant of such award, by transfer to a permitted transferee (determined under the terms of the Plan). All SARs will become immediately exercisable upon certain changes of control of the Company. BONUS STOCK AND RESTRICTED STOCK AWARDS. The Plan provides for the grant of bonus stock awards, which are vested upon grant. The Plan also provides for stock awards which may be subject to a restriction period ("restricted stock"). An award of restricted stock may be subject to specified performance measures for the applicable restriction period. The terms of restricted stock, the restriction period and any performance measures will be determined by the Committee. Shares of restricted stock will be subject to forfeiture if the holder does not remain continuously in the employment of the Company or any affiliate or during the restriction period or, if the restricted stock is subject to performance measures, if such performance measures are not attained during the restriction period. Stock awards granted under the Plan are not transferable by the award recipient other than (a) pursuant to a beneficiary designation effective on the award recipient's death, (b) pursuant to a court order entered in connection with a dissolution of marriage or child support or (c) to the extent permitted under (i) securities laws relating to the registration of securities subject to employee benefit plans and (ii) the agreement evidencing the grant of such award, by transfer to a permitted transferee (determined under the terms of the Plan). Subject to the change in control provisions of the Plan and unless otherwise specified in the agreement with respect to a particular restricted stock award, (i) in the event of a termination of employment by reason of disability, retirement after age 65, resignation with prior consent of the board of directors of the award recipient's employer or death, any applicable restriction period will terminate and any applicable performance measures will be deemed satisfied at the target level and (ii) in the event of a termination of employment for any other reason, the portion of a restricted stock award which is then subject to a restriction period will be forfeited and canceled. All restriction periods applicable to -129- restricted stock awards will lapse and any performance measures will be deemed satisfied at the target level upon certain changes of control of the Company. PERFORMANCE SHARE AWARDS. The Plan provides for the grant of performance share awards. Each performance share is a right, contingent upon the attainment of performance measures within a specified performance period, to receive shares of Plan Stock, which may be a restricted stock, or the fair market value of such shares in cash or a combination thereof, as specified by the agreement evidencing the award. The number of shares of Plan Stock subject to a performance award, the applicable performance measures and performance period, and the terms of a performance share award will be determined by the Committee. If the specified performance measures are not attained during the applicable performance period, then the award recipient forfeits all rights to receive the shares of Plan Stock subject to the performance share award. Performance share awards granted under the Plan are not transferable by the award recipient other than (a) pursuant to a beneficiary designation effective on the award recipient's death, (b) pursuant to a court order entered in connection with a dissolution of marriage or child support or (c) to the extent permitted under (i) securities laws relating to the registration of securities subject to employee benefit plans and (ii) the agreement evidencing the grant of such award, by transfer to a permitted transferee (determined under the terms of the Plan). Subject to the change in control provisions of the Plan and unless otherwise specified in the agreement with respect to a performance share award, (i) in the event of a termination of employment by reason of disability, retirement after age 65, resignation with prior consent of the board of directors of the award recipient's employer or death, any applicable performance period will terminate and any applicable performance measures will be deemed satisfied at the target level and (ii) in the event of a termination of employment for any other reason, the portion of a performance share award which is then subject to a performance period will be forfeited and canceled. All performance periods applicable to performance share awards will lapse and any performance measures will be deemed satisfied at the target level upon certain changes of control of the Company. EMPLOYER MATCH AWARDS. The Plan permits an employee selected by the Committee to elect to defer all or a portion of his annual bonus under the Plan to a deferred compensation account, provided, however, that the amount subject to such deferral election with respect to any year shall not exceed $250,000. If a selected employee elects to defer all or a portion of his annual bonus under the Plan, an Employer match award will be allocated to the employee's deferred compensation account in an amount equal to a percentage specified by the Committee of the employee's deferred annual bonus amount, provided that such percentage shall not exceed 33 1/3%. An employee will be fully vested in the deferred bonus amounts credited to his deferred compensation account. One-third of the Employer match awards credited to the employee's deferred compensation account shall become vested on each of the first three anniversaries of the last day of the year for which the applicable bonus is payable, provided that such employee is an employee of the Company or an affiliate on such date and the amount credited to his deferred compensation account has not been distributed before such date. An employee's deferred compensation account will be deemed to be invested in phantom shares of the class of Plan Stock which reflects the performance of his employer at the time the employee earned the annual bonus. An employee will receive an amount equal to his vested deferred compensation account balance when he terminates employment with the Company and all of its affiliates, provided, however, that an employee may elect to receive all or a portion of his deferred annual bonus, any related vested Employer match awards and all deemed investment earnings on such amounts at an earlier date if (i) such election is made at the time the employee elects to defer the bonus amount and (ii) such earlier date is at least two years after the date of his deferral election. In addition, the Committee may approve a distribution of all or a portion of an employee's vested deferred compensation account in the event of an unforeseeable emergency causing severe financial hardship. Amounts credited to an employee's deferred compensation account under the Plan are not transferable by the award recipient other than (a) pursuant to a beneficiary designation effective on the award recipient's death or (b) pursuant to a court order entered in connection with a dissolution of marriage or child support. Subject to the change in control provisions of the Plan and unless otherwise specified in the agreement with respect to an Employer match award, (i) in the event of a termination of employment by reason of disability, retirement after age 65, resignation with prior consent of the board of directors of the award recipient's employer or death, any Employer match award will become vested and (ii) in the event of a termination of employment for any other reason, any unvested Employer match award will be forfeited. All Employer match awards will become fully vested upon certain changes of control of the Company. FEDERAL INCOME TAX CONSEQUENCES The following is a brief summary of the U.S. federal income tax consequences of awards made under the Plan. STOCK OPTIONS. An award recipient will not recognize any income upon the grant of a stock option. An award recipient will recognize compensation taxable as ordinary income (and subject to income tax withholding) upon exercise of a nonqualified stock option equal to the excess of the fair market value of the shares purchased over -130- their exercise price, and the Company will be entitled to a corresponding deduction. An award recipient will not recognize income (except for purposes of the alternative minimum tax) upon exercise of an ISO. If the shares acquired by exercise of an ISO are held for the longer of two years from the date the option was granted and one year from the date the shares were transferred, any gain or loss arising from a subsequent disposition of such shares will be taxed as long-term capital gain or loss, and the Company will not be entitled to any deduction. If, however, such shares are disposed of within such two or one year periods, then in the year of such disposition the award recipient generally will recognize compensation taxable as ordinary income equal to the excess of the lesser of (i) the amount realized upon such disposition and (ii) the fair market value of such shares on the date of exercise over the exercise price, and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. SARS. An award recipient will not recognize any taxable income upon the grant of an SAR. An award recipient will recognize compensation taxable as ordinary income (and subject to income tax withholding) upon exercise of an SAR equal to the fair market value of any unrestricted shares of Plan Stock delivered and the amount of cash paid by the Company upon such exercise, and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. If restricted stock is delivered upon exercise of an SAR, the tax consequences associated with such restricted stock shall be determined in accordance with the section below titled "Restricted Stock". BONUS STOCK. An award recipient will recognize compensation taxable as ordinary income (and subject to income tax withholding) in respect of an award of shares of bonus stock at the time such shares are awarded in an amount equal to the then fair market value of such shares and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. RESTRICTED STOCK. An award recipient will not recognize taxable income at the time of an award of shares of restricted stock, and the Company will not be entitled to a tax deduction at such time, unless the award recipient makes an election to be taxed at the time restricted stock is granted. If such election is made, the award recipient will recognize compensation taxable as ordinary income at the time of the grant equal to the excess of the fair market value of the shares at such time over the amount, if any, paid for such shares. If such election is not made, the award recipient will recognize compensation taxable as ordinary income at the time the restrictions lapse in an amount equal to the excess of the fair market value of the shares at such time over the amount, if any, paid for such shares. The Company is entitled to a corresponding deduction at the time the ordinary income is recognized by the award recipient, except to the extent the limit of Section 162(m) of the Code applies. In addition, an award recipient receiving dividends with respect to restricted stock for which the above-described election has not been made and prior to the time the restrictions lapse will recognize taxable compensation (subject to income tax withholding), rather than dividend income, in an amount equal to the dividends paid, and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. PERFORMANCE SHARES. An award recipient will not recognize taxable income upon the grant of performance shares and the Company will not be entitled to a tax deduction at such time. Upon the settlement of performance shares in the form of unrestricted shares of Plan Stock or cash or a combination of both, the award recipient will recognize compensation taxable as ordinary income (and subject to income tax withholding) in an amount equal to the fair market value of any shares delivered and any cash paid by the Company, and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. Upon the settlement of performance shares in the form of restricted stock, the tax consequences associated with such restricted stock shall be determined in accordance with the immediately preceding section titled "Restricted Stock". DEFERRAL OF ANNUAL BONUS AMOUNT AND EMPLOYER MATCH AWARD. An award recipient will not recognize taxable income (i) on any annual bonus amount which he elects not to receive currently by deferring such amount into a deferred compensation account or (ii) upon the grant of an Employer match award, and the Company will not be entitled to a tax deduction at such time. At the time the award recipient receive a distribution from his deferred compensation account, the award recipient will recognize the distributed amount as compensation taxable as ordinary income (and subject to income tax withholding), and the Company will be entitled to a corresponding deduction, except to the extent the limit of Section 162(m) of the Code applies. AWARDS GRANTED TO EXECUTIVES, EMPLOYEES AND EMPLOYEE GROUPS. No awards have been made under the Plan. It is anticipated that nonqualified stock option awards will be granted in 1998 to certain executives and employees of the Company based on the achievement of certain individual performance measures in 1997. It is also anticipated that Employer match awards will be made to executives' and employees' deferred compensation accounts as described above. -131- BENEFICIAL OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT SECURITY OWNERSHIP OF MANAGEMENT The following table sets forth at December 31, 1997, the number of Common Shares and Series A Common Shares beneficially owned, and the percentage of the outstanding shares of each such class so owned by each director and nominee for director of the Company, by the principal executive officer and the other four most highly compensated executive officers and by all directors and executive officers as a group.
AMOUNT AND NATURE OF NAME OF INDIVIDUAL OR BENEFICIAL PERCENT OF PERCENT OF NUMBER OF PERSONS IN GROUP TITLE OF CLASS OWNERSHIP(1) CLASS VOTING POWER - ------------------------------------------------------ ------------------------------ ------------- ----------- --------------- LeRoy T. Carlson, Jr., Walter C.D. Carlson, Letitia G.C. Carlson, Donald C. Nebergall and Melanie J. Heald(2)................................... Series A Common Shares 6,337,187 91.4% 51.4% LeRoy T. Carlson, Jr., C. Theodore Herbert and Michael G. Hron(3).................................... Common Shares 148,876 * * Series A Common Shares 1,008 * * LeRoy T. Carlson, Jr., C. Theodore Herbert and Michael G. Hron(4).................................... Common Shares 142,575 * * LeRoy T. Carlson(5)................................... Common Shares 62,407 * * Series A Common Shares 51,975 * * LeRoy T. Carlson, Jr. (6)(12)......................... Common Shares 157,760 * * Walter C.D. Carlson(7)................................ Common Shares 405 * * Letitia G.C. Carlson(8)............................... Common Shares 138 * * Murray L. Swanson(9)(12).............................. Common Shares 47,324 * * Series A Common Shares 2,506 * * Rudolph E. Hornacek(10)............................... Common Shares 22,410 * * Series A Common Shares 1,669 * * James Barr III(12).................................... Common Shares 19,958 * * Donald C. Nebergall(11)............................... Common Shares 1,463 * * Donald R. Brown(9).................................... Common Shares 4,001 * * Series A Common Shares 4,735 * * Herbert S. Wander..................................... Common Shares 334 * * George W. Off......................................... Common Shares 1,127 * * Martin L. Solomon..................................... Common Shares 15,000 * * Kevin A. Mundt........................................ -- -- -- -- H. Donald Nelson...................................... Common Shares 4,098 * * Series A Common Shares 5,308 * * Donald W. Warkentin(12)............................... Common Shares 29,566 * * Terrence T. Sullivan.................................. -- -- -- -- All directors, director nominee and executive officers as a group (25 persons)(12)........................... Common Shares 881,614 1.6% * Series A Common Shares 6,404,388 92.3% 51.9%
- ------------ * Less than 1% (1) The nature of beneficial ownership for shares in this column is sole voting and investment power, except as otherwise set forth in these footnotes. -132- (2) The shares listed are held by the persons named as trustees under a voting trust which expires June 30, 2009, created to facilitate longstanding relationships among the trust certificate holders. Under the terms of the voting trust, the trustees hold and vote the Series A Common Shares held in the trust. If the voting trust were terminated, the following persons would each be deemed to own beneficially more than 5% of the outstanding Series A Common Shares: Margaret D. Carlson (wife of LeRoy T. Carlson), LeRoy T. Carlson, Jr., Walter C.D. Carlson, Prudence E. Carlson, Letitia G.C. Carlson (children of LeRoy T. Carlson and Margaret D. Carlson) and Donald C. Nebergall, as trustee under certain trusts for the benefit of the heirs of LeRoy T. and Margaret D. Carlson and an educational institution. (3) Voting and investment control is shared by the persons named as members of the investment management committee of the Telephone and Data Systems, Inc. Employees' Pension Trust I and the Wireless Companies' Pension Plan. Such members disclaim beneficial ownership of such shares, which are held for the benefit of plan participants. (4) Voting and investment control with respect to Company-match shares is shared by the persons named as members of the investment management committee of the Telephone and Data Systems, Inc. Tax-Deferred Savings Trust. Does not include 55,125 shares acquired by trust employee contributions for which voting and investment control is passed-through to plan participants. (5) Includes 51,975 Series A Common Shares held by Mr. Carlson's wife. Mr. Carlson disclaims beneficial ownership of such shares. Does not include 252,668 Series A Common Shares held for the benefit of LeRoy T. Carlson, 630,525 Series A Common Shares held for the benefit of Mr. Carlson's wife or 50,526 Series A Common Shares held for the benefit of certain grandchildren of Mr. Carlson (an aggregate of 933,719 shares, or 13.5% of class) in the voting trust described in footnote (2). Beneficial ownership is disclaimed as to Series A Common Shares held for the benefit of his wife and grandchildren in such voting trust. (6) Does not include 1,068,186 Series A Common Shares (15.4% of class) held in the voting trust described in footnote (2), of which 1,037,084 shares are held for the benefit of LeRoy T. Carlson, Jr. Beneficial ownership is disclaimed with respect to an aggregate of 31,102 Series A Common Shares held for the benefit of his wife, his children and others in such voting trust. (7) Does not include 1,087,366 Series A Common Shares (15.7% of class) held in the voting trust described in footnote (2), of which 1,058,143 shares are held for the benefit of Walter C.D. Carlson. Beneficial ownership is disclaimed with respect to an aggregate of 29,223 Series A Common Shares held for the benefit of his wife and children in such voting trust. (8) Does not include 1,070,127 Series A Common Shares (15.4% of class) held in the voting trust described in footnote (2), of which 1,061,477 shares are held for the benefit of Letitia G.C. Carlson. Beneficial ownership is disclaimed with respect to an aggregate of 8,650 Series A Common Shares held for the benefit of her husband and child in such voting trust. (9) Includes shares as to which voting and/or investment power is shared, and/or shares held by spouse and/or children. (10) Does not include Series A Common Shares held as custodian for his children, for which beneficial ownership is disclaimed. (11) Does not include 641,540 Series A Common Shares (9.2% of class) held as trustee under trusts for the benefit of the heirs of LeRoy T. and Margaret D. Carlson and an educational institution, or 31 Series A Common Shares held for the benefit of Donald C. Nebergall, which are included in the voting trust described in footnote (2). (12) Includes the following number of Common Shares that may be purchased pursuant to stock options and/or stock appreciation rights which are currently exercisable or exercisable within 60 days: Mr. LeRoy T. Carlson, 55,978 shares; Mr. LeRoy T. Carlson, Jr., 152,297 shares; Mr. Swanson, 28,541 shares; Mr. Barr, 16,000 shares; Mr. Hornacek, 14,551 shares; Mr. Warkentin, 29,026 shares; all other executive officers, 151,508 shares; and all directors and officers as a group, 431,901 shares. -133- SECURITY OWNERSHIP BY CERTAIN BENEFICIAL OWNERS In addition to persons listed in the preceding table and the footnotes thereto, the following table sets forth as of December 31, 1997, information regarding each person who is known to the Company to beneficially own more than 5% of any class of voting securities of TDS, based on publicly available information and the Company's stock records as of such date. The nature of beneficial ownership in this table is sole voting and investment power except as otherwise set forth in footnotes thereto.
SHAREHOLDER'S NAME AND SHARES OF PERCENT OF PERCENT OF ADDRESS TITLE OF CLASS CLASS OWNED CLASS VOTING POWER - ------------------------- ---------------------- ------------- ----------- --------------- The Equitable Companies Inc.(1) 787 Seventh Avenue New York, New York 10019 Common Shares 10,988,100 20.5% 8.9% Franklin Mutual Advisers, Inc. (2) 51 John F. Kennedy Parkway Short Hills, New Jersey 07078 Common Shares 5,279,200 9.8% 4.3% William and Betty McDaniel 160 Stowell Road Salkum, Washington 98582 Preferred Shares 46,666 14.4% * Bennet R. Miller 1212 Wea Avenue Lafayette, Indiana 47905 Preferred Shares 30,000 9.2% * The Peterson Revocable Living Trust Kenneth M. & Audrey M. Peterson, Trustees 108 Avocado Lane Weslaco, Texas 78596 Preferred Shares 20,637 6.4% * Roland G. and Bette B. Nehring 5253 North Dromedary Road Phoenix, Arizona 85018 Preferred Shares 20,012 6.2% *
- ------------ * Less than 1% (1) Based on the most recent Schedule 13G (Amendment No. 11) filed with the SEC. Includes shares held by the following affiliates: The Equitable Life Assurance Society of the United States--4,176,200 shares; Alliance Capital Management, L.P.--6,782,543 shares; Wood, Struthers & Winthrop Management Corp.--28,976 shares; and Donaldson Lufkin & Jenrette Securities Corporation--381 shares. In such Schedule 13G, Equitable reported sole voting power with respect to 5,644,753 shares, shared voting power with respect to 5,255,600 shares, sole dispositive power with respect to 10,987,719 shares and shared dispositive power with respect to 381 shares. Alpha Assurance I.A.R.D. Mutuelle, Alpha Assurances Vie Mutuelle, AXA Assurances I.A.R.D. Mutuelle, AXA Assurances Vie Mutuelle, Uni Europe Assurance Mutuelle and AXA, corporations organized under the laws of France, are affiliates of The Equitable Companies, Inc. (2) Based on the most recent Schedule 13D filed with the SEC (Amendment No. 4). Such Schedule 13D reports that Franklin Mutual Advisers, Inc. exercised sole voting and investment power with respect to all such shares. Such Schedule 13D is also filed on behalf of Franklin Resources, Inc., the parent holding company of Franklin Mutual Advisers, Inc., and by Charles B. Johnson and Rupert H. Johnson, Jr., principal shareholders of such parent holding company. -134- SHAREHOLDER PROPOSALS Proposals of shareholders intended to be presented at the 1998 Special Meeting of Shareholders were required to have been received by the Company at its principal executive offices not later than December 19, 1997 for inclusion in the Company's proxy statement and form of proxy relating to that meeting. SOLICITATION OF PROXIES Your proxy is solicited by the Board of Directors and its agents and the cost of solicitation will be paid by the Company. Officers, directors and regular employees of the Company, acting on its behalf, may also solicit proxies by telephone, telegraph or personal interview. The Company has also retained MacKenzie Partners, Inc. to assist in the solicitation of proxies for a fee of $25,000 plus out-of-pocket expenses. The Company will, at its expense, request brokers and other custodians, nominees and fiduciaries to forward proxy soliciting material to the beneficial owners of shares held of record by such persons. The Company anticipates that certain employees of the Financial Advisors may communicate in person, by telephone or otherwise with certain institutions or other persons who are shareholders or representatives of shareholders of the Company for the purpose of assisting in the solicitation of proxies by the Board of Directors. The Financial Advisors will not receive any fees for or in connection with such solicitation apart from the fees they are otherwise entitled to receive as described above. EXPENSES The cost of adopting and implementing the Tracking Stock Proposal is estimated to be approximately $ , and such costs have been or will be charged against TDS's pre-tax earnings. The costs include the fees and expenses of the Financial Advisors, MacKenzie Partners, Inc., legal fees, AMEX listing fees, transfer agent fees, printing costs, stock certificate engraving, mailing costs, and FCC and state filing fees and taxes. EXPERTS The audited consolidated financial statements of TDS and the audited financial statements of each of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group included in this Proxy Statement/ Prospectus have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports included herein. The financial statements referred to above have been included in reliance upon the authority of such firm as an expert in accounting and auditing in giving said reports. LEGAL MATTERS Certain matters of Delaware law relating to the legality of the shares of common stock of TDS Delaware and certain United States federal income taxation matters will be passed upon by Sidley & Austin, Chicago. Walter C.D. Carlson, a director of TDS and a beneficiary and trustee of the voting trust which controls TDS, is a partner of Sidley & Austin. Michael G. Hron and William S. DeCarlo, the Secretary and Assistant Secretary of TDS and certain TDS subsidiaries, respectively, and Stephen P. Fitzell and Sherry S. Treston, the Secretary and Assistant Secretary of certain TDS subsidiaries, respectively, are partners of Sidley & Austin. OTHER BUSINESS It is not anticipated that any action will be asked of the shareholders other than that set forth above, but if other matters properly are brought before the Special Meeting, the persons named in the proxy will vote in accordance with their best judgment. By order of the Board of Directors Michael G. Hron SECRETARY ALL SHAREHOLDERS ARE URGED TO SIGN, DATE AND MAIL THEIR PROXIES PROMPTLY. -135- INDEX TO EXHIBITS EXHIBIT A -- Agreement and Plan of Merger................................................... A-1 EXHIBIT B -- Proposed Restated Certificate of Incorporation of TDS Delaware................. B-1 EXHIBIT C-1 -- Opinion of Credit Suisse First Boston.......................................... C1-1 EXHIBIT C-2 -- Opinion of Salomon Smith Barney................................................ C2-1 EXHIBIT D -- 1998 Long-Term Incentive Plan.................................................. D-1 EXHIBIT E -- Dissenters' Rights Under Iowa Law.............................................. E-1 EXHIBIT F -- Illustration of Certain Terms.................................................. F-1 EXHIBIT G -- Index of Certain Defined Terms................................................. G-1
INDEX TO ANNEXES ANNEX I -- THE COMPANY Description of the Company's Business.......................................... I-1 Management's Discussion and Analysis for Three Years Ended December 31, 1997... I-39 Consolidated Financial Statements for Three Years Ended December 31, 1997...... I-58 ANNEX II -- THE CELLULAR GROUP Description of Cellular Business............................................... II-1 Management's Discussion and Analysis for Three Years Ended December 31, 1997... II-19 Financial Statements for Three Years Ended December 31, 1997................... II-30 ANNEX III -- THE TELECOM GROUP Description of Telecom Business................................................ III-1 Management's Discussion and Analysis for Three Years Ended December 31, 1997... III-14 Financial Statements for Three Years Ended December 31, 1997................... III-22 ANNEX IV -- THE AERIAL GROUP Description of Aerial Business................................................. IV-1 Management's Discussion and Analysis for Three Years Ended December 31, 1997... IV-10 Financial Statements for Three Years Ended December 31, 1997................... IV-16 ANNEX V -- THE TDS GROUP Description of TDS Group....................................................... V-1 Management's Discussion and Analysis for Three Years Ended December 31, 1997... V-8 Financial Statements for Three Years Ended December 31, 1997................... V-16
-136- EXHIBIT A AGREEMENT AND PLAN OF MERGER This Agreement and Plan of Merger, dated as of March 6, 1998 (the "Merger Agreement"), between Telephone and Data Systems, Inc., an Iowa corporation ("TDS Iowa"), and Telephone and Data Systems, Inc., a Delaware corporation ("TDS Delaware"), (collectively, the "Constituent Corporations"); W I T N E S S E T H: WHEREAS, the Board of Directors of each of the Constituent Corporations deems it advisable and in the best interests of such corporation and its shareholders that TDS Iowa be merged with and into TDS Delaware, with TDS Delaware being the surviving corporation (the "Merger"); and, except as set forth herein, that in such Merger all outstanding shares of capital stock of TDS Iowa be converted into corresponding shares of capital stock of TDS Delaware as hereinafter provided; and WHEREAS, the Board of Directors of each of the Constituent Corporations has approved this Merger Agreement; NOW, THEREFORE, in consideration of the premises and of mutual covenants and agreements set forth herein, the parties hereto agree as follows: ARTICLE I THE MERGER SECTION 1.1 The effective time of the Merger (the "Effective Time") shall occur at the latest of (i) the time and date that a certificate of merger is duly filed with the Secretary of State of the State of Delaware with respect to the Merger or such later date and time as is set forth therein and (ii) the time and date that articles of merger are duly filed with the Secretary of State of the State of Iowa with respect to the Merger or such later date and time as is set forth herein. SECTION 1.2 At the Effective Time, TDS Iowa shall be merged with and into TDS Delaware, with TDS Delaware being the surviving corporation of the Merger (the "Surviving Corporation"). At the Effective Time, the corporate existence of TDS Iowa shall cease and TDS Delaware, as the Surviving Corporation, shall succeed to all the business, properties, assets and liabilities of TDS Iowa and TDS Delaware. The Merger shall have the effect set forth in Section 259(a) of the Delaware General Corporation Law; the Surviving Corporation shall possess all assets and property of every description, and every interest in the assets and property, wherever located, and the rights, privileges, immunities, powers, franchises and authority, of a public as well as a private nature, of each of the Constituent Corporations, and all obligations belonging to or due each of the Constituent Corporations, all of which shall be vested in the Surviving Corporation without further act or deed; title to any real estate or any interest in the real estate vested in either Constituent Corporation shall not revert or in any way be impaired by reason of the Merger; the Surviving Corporation shall thenceforth be liable for all the pre-existing obligations of each Constituent Corporation, including liabilities to dissenting shareholders. SECTION 1.3 From and after the Effective Time, the Certificate of Incorporation of TDS Delaware, as in effect immediately prior to the Effective Time, shall be the Certificate of Incorporation of the Surviving Corporation until altered, amended or repealed in accordance with the laws of the State of Delaware and the Certificate of Incorporation of the Surviving Corporation. SECTION 1.4 From and after the Effective Time, the Bylaws of TDS Delaware, as in effect immediately prior to the Effective Time, shall be the Bylaws of the Surviving Corporation, until altered, amended or repealed in accordance with the laws of the State of Delaware and the Certificate of Incorporation and Bylaws of the Surviving Corporation. SECTION 1.5 The number of directors in each class of directors of TDS Iowa immediately prior to the Effective Time shall be the number of directors in each class of directors of TDS Delaware from and after the Effective Time until such number is altered in accordance with the laws of the State of Delaware and the Certificate of Incorporation A-1 and Bylaws of the Surviving Corporation. The directors of TDS Iowa immediately prior to the Effective Time shall be the directors of TDS Delaware from and after the Effective Time and shall hold office from and after the Effective Time in the same classes as in effect immediately prior to the Effective Time in accordance with the Certificate of Incorporation and Bylaws of the Surviving Corporation until their respective successors are duly appointed or elected and qualified. SECTION 1.6 The officers of TDS Iowa immediately prior to the Effective Time shall be the officers of the Surviving Corporation from and after the Effective Time and shall hold the same offices from and after the Effective Time in accordance with the Bylaws of the Surviving Corporation until their respective successors are duly appointed or elected and qualified. SECTION 1.7 At the Effective Time, each agreement, option or other right to acquire shares of capital stock of TDS Iowa outstanding immediately prior to the Effective Time shall, automatically and without further act of TDS Iowa, TDS Delaware or any holder thereof, become an agreement, option or such other right to acquire shares of capital stock of TDS Delaware, as the Surviving Corporation, subject to the same terms and conditions and the same price applicable to such agreement, option or other right immediately prior to the Effective Time. SECTION 1.8 Except as contemplated herein, the assets, liabilities, reserves and accounts of TDS Iowa and TDS Delaware shall be taken up or continued on the books of the Surviving Corporation in the amounts at which such assets, liabilities, reserves and accounts shall have been carried on the books of TDS Iowa and TDS Delaware immediately prior to the Effective Time, subject to such adjustments, and such elimination of intercompany items, as may be appropriate to give effect to the Merger, including any Dissenting Shares (as hereinafter defined). SECTION 1.9 The Surviving Corporation hereby consents to be sued and served with process in the State of Iowa in any proceeding in the State of Iowa to enforce against the Surviving Corporation any obligation of TDS Iowa, or to enforce the rights of a dissenting shareholder of TDS Iowa, and the Surviving Corporation hereby irrevocably appoints the Secretary of the State of Iowa as its agent to accept service of process in any such proceeding in the State of Iowa. ARTICLE II CONVERSION OF SHARES SECTION 2.1 At the Effective Time, all of the shares of capital stock of TDS Delaware issued or outstanding immediately prior to the Effective Time shall, automatically and without further act of TDS Iowa, TDS Delaware or any holder thereof, be cancelled and cease to exist, without any consideration being payable therefor. SECTION 2.2 At the Effective Time and as a result of the Merger, each issued share of capital stock (including any such share held as a treasury share) of TDS Iowa shall, automatically and without further act of either of the Constituent Corporations or of the holder thereof, be extinguished and converted into corresponding issued shares of capital stock of the Surviving Corporation as follows:
EACH SHARE OF TDS IOWA SHARES OF SURVIVING CORPORATION - ------------------------------- ------------------------------------- Common Share One Common Share Series A Common Share One Series A Common Share Series A Preferred Share One Series A Preferred Share Series B Preferred Share One Series B Preferred Share Series D Preferred Share One Series D Preferred Share Series G Preferred Share One Series G Preferred Share Series H Preferred Share One Series H Preferred Share Series N Preferred Share One Series N Preferred Share Series O Preferred Share One Series O Preferred Share Series S Preferred Share One Series S Preferred Share Series U Preferred Share One Series U Preferred Share Series BB Preferred Share One Series BB Preferred Share Series DD Preferred Share One Series DD Preferred Share Series EE Preferred Share One Series EE Preferred Share
A-2
EACH SHARE OF TDS IOWA SHARES OF SURVIVING CORPORATION - ------------------------------- ------------------------------------- Series GG Preferred Share One Series GG Preferred Share Series HH Preferred Share One Series HH Preferred Share Series II Preferred Share One Series II Preferred Share Series JJ Preferred Share One Series JJ Preferred Share Series KK Preferred Share One Series KK Preferred Share Series LL Preferred Share One Series LL Preferred Share Series QQ Preferred Share One Series QQ Preferred Share Series RR Preferred Share One Series RR Preferred Share Series SS Preferred Share One Series SS Preferred Share Series TT Preferred Share One Series TT Preferred Share
SECTION 2.3 (a) Each person who, as a result of the Merger holds one or more certificates which theretofore represented one or more shares of TDS Iowa shall surrender such certificate to the Surviving Corporation (or to any agent designated for such purpose by it) and, upon such surrender, the Surviving Corporation shall, within a reasonable time, deliver to such person in substitution and exchange therefor one or more certificates evidencing the number of shares of any class of capital stock of the Surviving Corporation which such person is entitled to receive in accordance with the terms of this Merger Agreement in substitution for the number of shares of TDS Iowa theretofore represented by each certificate so surrendered; PROVIDED, HOWEVER, that such holders shall not be required to surrender any such certificates until such certificates would normally be surrendered for transfer on the books of the issuing corporation in the ordinary course of business. (b) If there be delivered to the Surviving Corporation (or to an agent designated for such purpose by it) by any person who is unable to produce a certificate for surrender to the Surviving Corporation in accordance with Section 2.3(a): (i) evidence to the satisfaction of the Surviving Corporation that such certificate has been lost, wrongfully taken or destroyed, and (ii) such security or indemnity as may be requested or required by the Surviving Corporation to save it harmless, and (iii) evidence to the satisfaction of the Surviving Corporation that such person was the owner of the shares theretofore represented by each certificate claimed by him to be lost, wrongfully taken or destroyed and that he is the person who would be entitled to present such certificate for exchange pursuant to this Merger Agreement, then the Surviving Corporation, in the absence of actual notice to it that any shares of TDS Iowa theretofore represented by any such certificate have been acquired by a bona fide purchaser, may deliver to such person one or more certificates evidencing the share of the Surviving Corporation, that such person would have been entitled to receive upon surrender of each such lost, wrongfully taken or destroyed certificate. (c) If one or more shares of the Surviving Corporation, issuable as provided in this Merger Agreement upon surrender of a certificate formerly representing shares of TDS Iowa, are to be issued to a person other than the person in whose name such surrendered certificate was registered on the books of TDS Iowa at the Effective Time, it shall be a condition precedent to the issuance of each such share of the Surviving Corporation that such surrendered certificate shall be properly endorsed and otherwise in proper form for transfer and accompanied by such documents as may be required by the Surviving Corporation, in its discretion, and that the person surrendering such certificate pay to the Surviving Corporation (or to any agent designated for such purpose by it) any transfer or other taxes required by reason of issuance of one or more shares of the Surviving Corporation to a person other than the registered holder of such surrendered certificate, or establish to the satisfaction of the Surviving Corporation (or of such agent) that such tax has been paid or is not payable. SECTION 2.4 The provisions of Sections 2.1 through 2.3 inclusive shall not apply to TDS Iowa Shares (the "Dissenting Shares") held by TDS Iowa shareholders who do not vote such TDS Iowa Shares in favor of the approval and adoption of this Merger Agreement and the Merger and who deliver a written notice to TDS Iowa in the manner required by Division XIII of the Iowa Business Corporation Act, stating the intention to demand payment of A-3 the fair value of such TDS Iowa Shares if the Merger is effected, and if such holders of TDS Iowa Shares take all other action required in the manner provided in Division XIII of the Iowa Business Corporation Act. Such holders shall be entitled to payment for such TDS Iowa Shares in accordance with the provisions of Division XIII of the Iowa Business Corporation Act if applicable. ARTICLE III TERMINATION AND ABANDONMENT; AMENDMENT SECTION 3.1 The Merger contemplated by this Merger Agreement may be terminated and abandoned by the Board of Directors of either of the Constituent Corporations at any time prior to the Effective Time and for any reason, without notice of such action to the other Constituent Corporation, notwithstanding approval of this Merger Agreement by the stockholders of one or both of the Constituent Corporations. SECTION 3.2 From time to time and at any time prior to the Merger Date, the Merger Agreement may be amended by an agreement in writing executed in the same manner as this Merger Agreement, after authorization of such action by the Boards of Directors of the Constituent Corporations, but no such amendment made subsequent to the adoption of this Merger Agreement by the stockholders of either of the Constituent Corporations shall (a) alter or change the amount or kind of shares or other consideration to be received by the stockholders in the Merger, (b) alter or change any of the terms and conditions of this Merger Agreement if such alternation or change would adversely affect the holders of any class or series of stock of such Constituent Corporation or (c) otherwise violate applicable law. ARTICLE IV MISCELLANEOUS SECTION 4.1 EXPENSES OF MERGER. From and after the Effective Time, TDS Delaware shall pay all unpaid expenses of carrying this Merger Agreement into effect and accomplishing the Merger. SECTION 4.2 FURTHER ASSURANCES. If, at any time from and after the Effective Time, TDS Delaware shall consider or be advised that if any further assignment or assurance in law is necessary or desirable to vest in TDS Delaware the title to any property or rights of TDS Iowa, the proper officers of TDS Delaware are hereby authorized, in the name of TDS Iowa, to execute and make all such proper assignments and assurances in law, and to do all other things necessary or proper to vest such property or rights in TDS Delaware and otherwise to carry out the purposes of this Merger Agreement. SECTION 4.3 APPROVAL. This Merger Agreement shall be submitted for approval by the shareholders of TDS Iowa at an annual or special meeting of shareholders. A-4 IN WITNESS WHEREOF, this Merger Agreement has been executed on behalf of the Constituent Corporations by their duly authorized officers on this 6th day of March, 1998.
TELEPHONE AND DATA SYSTEMS, INC., an Iowa corporation By: /s/ LEROY T. CARLSON ------------------------------------------- LeRoy T. Carlson Chairman Attest: By: /s/ MICHAEL G. HRON ------------------------------------------- Michael G. Hron Secretary TELEPHONE AND DATA SYSTEMS, INC. a Delaware corporation By: /s/ LEROY T. CARLSON, JR. ------------------------------------------- LeRoy T. Carlson, Jr. President Attest: By: /s/ MICHAEL G. HRON ------------------------------------------- Michael G. Hron Secretary
SIGNATURE PAGE TO AGREEMENT AND PLAN OF MERGER BETWEEN TDS IOWA AND TDS DELAWARE A-5 EXHIBIT B RESTATED CERTIFICATE OF INCORPORATION OF TELEPHONE AND DATA SYSTEMS, INC. Telephone and Data Systems, Inc., a corporation organized and existing under and pursuant to the provisions of the General Corporation Law of the State of Delaware (the "Corporation"), does hereby certify as follows: FIRST: The original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on December 12, 1997. The Corporation hereby restates and integrates and further amends the Certificate of Incorporation of the Corporation by revising such document in its entirety as follows: ARTICLE I The name of the Corporation is Telephone and Data Systems, Inc. ARTICLE II The period of its duration is perpetual. ARTICLE III The Corporation shall have unlimited power to engage in, and to do any lawful act concerning, any and all lawful business for which corporations may be organized under the Delaware General Corporation Law above mentioned. ARTICLE IV A. AUTHORIZED SHARES 1. Subject to paragraph 3 of this Section A and Section B.1, the aggregate number of shares of capital stock which the Corporation is authorized to issue is 475,000,000 shares, and the designation of each class or series, the number of shares of each class or series and the par value of the shares of each class or series, are as follows:
CLASS SERIES NO. OF SHARES PAR VALUE - ------------------------------------- ------------------- -------------- ----------------- Common Shares None 100,000,000 $.01 per share Series A Common Shares None 25,000,000 $.01 per share Special Common Shares None 20,000,000 $.01 per share United States Cellular Group Common None 140,000,000 $.01 per share Shares TDS Telecommunications Group Common None 90,000,000 $.01 par value Shares Aerial Communications Group Common None 95,000,000 $.01 par value Shares Undesignated Shares See Section B.1 4,673,336 $.01 par value Preferred Shares See below 326,664 $.01 par value
THE FOLLOWING SERIES OF PREFERRED SHARES ORIGINALLY ISSUED BY TDS IOWA (AS DEFINED IN SECTION B.19 OF THIS ARTICLE IV) BEFORE OCTOBER 31, 1981 ARE REFERRED TO AS THE "PRE-81 PREFERRED SHARES"
SERIES NO. OF SHARES - --------- --------------- A 1,395 B 1,955 D 646 G 1,368 H 1,188 N 3,134
B-1 THE FOLLOWING SERIES OF PREFERRED SHARES ORIGINALLY ISSUED BY TDS IOWA AFTER OCTOBER 31, 1981 ARE REFERRED TO AS THE "POST-81 PREFERRED SHARES"
SERIES NO. OF SHARES - --------- ------------- O 684 S 1,209 U 1,100 BB 18,500 DD 47,940 EE 8,667 GG 35,247 HH 2,627 II 3,946 JJ 1,310 KK 1,403 LL 1,487 QQ 8,368 RR 29,490 SS 125,000 TT 30,000
2. As of the effective date of this Restated Certificate of Incorporation, the series of Preferred Shares set forth above shall have the preferences, qualifications, limitations, restrictions and rights set forth in this Restated Certificate of Incorporation, including Attachment I hereto, which Attachment is incorporated herein and made a part hereof. 3. The number of authorized Common Shares, Series A Common Shares, Special Common Shares, Cellular Group Common Shares, Telecom Group Common Shares, Aerial Group Common Shares or Undesignated Shares may be increased or decreased at any time or from time-to-time (but not below the number of such shares then outstanding in such class, respectively) by the affirmative vote of the holders of a majority of the voting power of shares of capital stock of the Corporation entitled to vote on all matters (not including shares entitled to vote only in the election of directors or as otherwise required by law, including Section 242(b)(2) of the DGCL) pursuant to paragraph 8(c) of Section B of this Article IV. 4. The Board shall have the authority to designate, prior to the time of the first issuance of shares of any class or series of Tracking Stock (as defined in Section B.19), the number of such shares which shall initially constitute number of shares which shall represent 100% of the equity of the related Tracking Group, the Number of Shares Issuable with Respect to Retained Interest and the Number of Shares Issuable with Respect to Inter-Group Interest, if any. 5. As of the first date of issuance of any class of Tracking Stock, the outstanding series of Preferred Shares shall be attributed entirely to the TDS Group. After the first date of issuance of any class of Tracking Stock, any series of Undesignated Shares which are designated and issued, as preferred or common stock, shall be attributed entirely to one Group or among two or more Groups, as may be determined by the Board, taking into consideration the use of proceeds from and purposes for such issuance and other factors. 6. As of the first date of issuance of any class of Tracking Stock, all Pre-Distribution Convertible Securities (as defined in Section B.19) shall be attributed entirely to the TDS Group. After the first date of issuance of any class of Tracking Stock, any Convertible Securities which are issued shall be attributed entirely to one Group or among two or more Groups, as may be determined by the Board, taking into consideration the use of proceeds from and purposes for such issuance and other factors. 7. As of the first date of issuance of any class of Tracking Stock, any Committed Acquisition Shares shall be attributed entirely to the TDS Group. After the first date of issuance of any class of Tracking Stock, any Committed Acquisition Shares shall be attributed entirely to one Group or among two or more Groups, as may be determined by the Board, taking into consideration the use of proceeds from and purposes for such issuance and other factors. B. PREFERENCES, QUALIFICATIONS, LIMITATIONS, RESTRICTIONS AND RIGHTS OF SHARES. The preferences, qualifications, limitations, restrictions, and the special or relative rights of the Common, Series A Common, Special Common, Cellular Group Common, Telecom Group Common, Aerial Group Common, Undesignated and Preferred Shares are: B-2 1. ISSUE OF UNDESIGNATED SHARES IN SERIES. Authority is hereby vested in the Board to divide any or all of the Undesignated Shares into one or more classes or series of common or preferred stock, and to further divide any of those classes or series, and to fix and determine by resolution as to each class or series so established: (a) the designation of such class or series, the number of shares to constitute such class or series and par value or stated value thereof; (b) the rate of dividend and the terms thereof; (c) the price at and terms and conditions by which shares may be redeemed; (d) the amount payable upon shares in event of voluntary or involuntary liquidation; (e) sinking fund provisions for the redemption or purchase of shares; (f) the terms and conditions on which shares may be converted, if the shares of any series are issued with the privilege of, or subject to mandatory, conversion; (g) voting rights, if any, but in no event more than ten votes per share in connection with any matter; and (h) such other designations, preferences and relative, participating, optional or other special rights, and qualifications or restrictions thereof, as shall be stated and expressed in a resolution or resolutions providing for the issuance of such stock adopted by the Board. Any of the voting powers, designations, preferences, rights and qualifications, limitations or restrictions of any such class or series of stock may be made dependent upon facts ascertainable outside this Restated Certificate of Incorporation or of any amendment thereto, or outside the resolution or resolutions providing for the issue of such stock adopted by the Board pursuant to the foregoing authority vested in it by this Restated Certificate of Incorporation, provided that the manner in which such facts shall operate upon the voting powers, designations, preferences, rights and qualifications, limitations or restrictions of such class or series is clearly and expressly set forth in the resolution or resolutions providing for the issue of such stock adopted by the Board. The term "facts" as used in this paragraph includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the Corporation. 2. DIVIDENDS. (a) Except as otherwise set forth in Attachment I hereto or as otherwise provided in any designation of a class or series of Undesignated Shares at the time that such class or series is originally established: (i) the holders of Preferred Shares and of each class or series of Undesignated Shares which has been designated as preferred stock shall be entitled to receive, when and as declared by the Board, dividends at the rate fixed for such series, and no more, payable in quarterly installments on the first days of March, June, September and December in each year; (ii) dividends on all series of Preferred Shares and all classes and series of Undesignated Shares which have been designated as preferred stock shall be cumulative from and after the respective dates of issuance; (iii) no dividends shall be declared on the shares of any series of Preferred Shares or any class or series of Undesignated Shares which have been designated as preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all Preferred Shares, and all classes and series of Undesignated Shares which have been designated as preferred stock, outstanding during such prior dividend periods; (iv) no dividends shall be declared on the shares of any series of Preferred Shares, or any class or series of Undesignated Shares which have been designated as preferred stock, unless a dividend for the same period shall be declared at the same time upon all series of Preferred Shares and all classes and series of Undesignated Shares which have been designated as preferred stock, outstanding during said period, in like proportion to the dividend rate upon such shares; and (v) no dividends shall be paid on any shares of Common Stock unless full dividends on all series of Preferred Shares, and all classes and series of Undesignated Shares which have been designated as preferred stock, for all past dividend periods and for the current dividend period, shall have been declared and the Corporation shall have paid such dividends or shall have set apart a sum sufficient for the payment thereof. (b) Dividends on any class or series of Common Stock may be declared and paid only out of the lesser of (i) assets of the Company legally available therefor and (ii) the Available Dividend Amount (as defined in paragraph 19 of this Section B) with respect to such class or series. Subject to the foregoing, the Board shall have the authority to declare and pay dividends on all or less than all of the classes or series of Common Stock in equal or unequal amounts, notwithstanding the amount of assets available for dividends on any class or series, the respective voting and liquidation rights of any class or series, the amount of prior dividends declared on any class or series or any other factor; PROVIDED, HOWEVER, that no dividends shall be declared or paid on the B-3 Series A Common Shares unless the same, or greater, dividends, on a per share basis, are declared and paid at the same time on the Common Shares and the Special Common Shares, and if dividends shall be declared or paid on the Common Shares or the Special Common Shares, the same dividends, on a per share basis, shall be declared and paid at the same time on the Special Common Shares and the Common Shares, respectively, except, in each case, as otherwise expressly provided in this Restated Certificate of the Corporation. 3. SHARE DISTRIBUTIONS. Notwithstanding anything to the contrary herein, if at any time a dividend or other distribution is to be paid in shares of Common Stock on shares of Common Stock, such dividend or other distribution shall be paid as only as follows (including, in each case, Convertible Securities which are exercisable for or convertible or exchangeable into such shares to be distributed): (a) Common Shares may be distributed on an equal per share basis to holders of Common Shares, Series A Common Shares may be distributed on an equal per share basis to holders of Series A Common Shares, and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares (if any are then outstanding); (b) Common Shares may be distributed on an equal per share basis to holders of Common Shares and Series A Common Shares, and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares (if any are then outstanding); (c) Series A Common Shares may be distributed on an equal per share basis to holders of Common Shares and Series A Common Shares, and Special Common Shares may be distributed on an equal per share basis to holders of Special Common Shares (if any are then outstanding); (d) Special Common Shares may be distributed on an equal per share basis to holders of Common Shares, Series A Common Shares and Special Common Shares (if any are then outstanding); (e) shares of a class or series of Tracking Stock may be distributed on an equal per share basis to holders of that class or series of Tracking Stock; (f) shares of a new class or series of capital stock which is intended to represent a subdivision or new business of a Group, or any assets attributed by the Board to such Group, may be distributed on an equal per share basis to holders of common stock representing an interest in such Group; (g) shares of any class or series of Tracking Stock of a Tracking Group may be distributed on an equal per share basis to holders of Common Shares, Series A Common Shares and Special Common Shares (if any are then outstanding), but only if the sum of (i) the number of shares of such class or series of Tracking Stock to be so distributed (or the number of such shares which would be issuable at such time upon the exercise, conversion or exchange of any Convertible Securities to be so distributed) and (ii) the Number of Shares Issuable to Third Parties related to such class or series of Tracking Stock which are then are attributable to the TDS Group, is less than or equal to the Number of Shares Issuable with Respect to Retained Interest in such Tracking Group; and (h) shares of any class or series of Tracking Stock of a Tracking Group (for this purpose, the "Issuer Group"), may be distributed on an equal per share basis to holders of a class or series of Tracking Stock of any other Tracking Group (for this purpose, the "Investor Group"), but only if the sum of (i) the number of shares of such class or series of Tracking Stock of the Issuer Group to be so distributed (or the number of such shares which would be issuable at such time upon the exercise, conversion or exchange of any Convertible Securities to be so distributed) and (ii) the Number of Shares Issuable to Third Parties related to the class or series of Tracking Stock of the Issuer Group which are then are attributable to the Investor Group, is less than or equal to the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group by the Investor Group. In the case of any such share dividend the Board may permit the holders of Common Stock to elect to receive cash in lieu of shares of stock. In any dividend or distribution of Common Stock, the same number of shares of Common Stock on a per share basis shall be distributed with respect to Common Shares, Series A Common Shares and Special Common Shares. 4. DISTRIBUTION OF TDS GROUP SUBSIDIARY IN DIVIDEND. Subject to paragraph 2(b) of Section B of Article IV, if at any time a distribution is to be made of shares of capital stock of a subsidiary included in the TDS Group (for this purpose, a "TDS Group Subsidiary"), such TDS Group Subsidiary shares may only be distributed to the holders of Series A Common Shares, Common Shares and any issued Special Common Shares and, in such event, the Board shall, to the extent practicable, distribute TDS Group Subsidiary shares corresponding to Series A Common Shares B-4 to the holders of Series A Common Shares, distribute TDS Group Subsidiary shares corresponding to Common Shares to the holders of Common Shares, and distribute TDS Group Subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares, if any are then outstanding; PROVIDED, HOWEVER, that the same number of shares of common stock of the TDS Group Subsidiary must be distributed with respect to each Series A Common Share, Common Share and any issued Special Common Share. If practicable, the Board shall recapitalize such TDS Group Subsidiary through an amendment to its charter or otherwise, such that the relative rights, limitations and preferences of the shares of capital stock of such TDS Group Subsidiary substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Corporation and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner; PROVIDED, HOWEVER, that if Special Common Shares are then outstanding and the TDS Group Subsidiary has or will have shares corresponding to Series A Common Shares and Common Shares but does not and will not have shares corresponding to Special Common Shares and the Board determines that it is impracticable to recapitalize the subsidiary as provided in this sentence to create shares corresponding to Special Common Shares, the Board shall distribute TDS Group Subsidiary shares corresponding to Common Shares of such TDS Group Subsidiary to the holders of Special Common Shares. 5. DISTRIBUTION OF TRACKING GROUP SUBSIDIARY IN DIVIDEND. Subject to paragraph 2(b) of Section B of Article IV, if at any time a distribution is to be made of shares of capital stock of a subsidiary (for this purpose, a Non- Qualifying Subsidiary") included in a Tracking Group (for this purpose, the "Distributing Group"), other than a Qualifying Subsidiary or Qualifying Subsidiaries holding all of the assets and liabilities of a Tracking Group, and if there is a Retained Interest in such Distributing Group, the Board shall, to the extent practicable, distribute Non-Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such Distributing Group equal to the product of the Outstanding Interest Fraction multiplied by the number of all of the outstanding shares of the Non-Qualifying Subsidiary owned directly or indirectly by the Corporation, on a pro rata basis. The Board, in its sole discretion, may cause the Corporation to retain the balance of the outstanding shares of the common stock of the Non-Qualifying Subsidiaries in respect of the Retained Interest and any Inter-Group Interest in the Distributing Group or, in the sole discretion of the Board, Non-Qualifying Subsidiary shares may be distributed to the holders of TDS Group Shares or shares of any other Tracking Stock as follows: (a) if the Board determines to distribute Non-Qualifying Subsidiary shares to the holders of TDS Group Shares with respect to the Retained Interest, it shall, to the extent practicable, distribute Non-Qualifying Subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, subsidiary shares corresponding to Common Shares to the holders of Common Shares, and subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group, PROVIDED, that the same number of shares of Non-Qualifying Subsidiary common stock must be distributed with respect to each Series A Common Share, Common Share and any issued Special Common Share and (b) if the Board determines to distribute Non-Qualifying Subsidiary shares to the holders of any class or series of Tracking Stock of a Tracking Group other than the Distributing Group with respect to any Inter-Group Interest by such Tracking Group in the Distributing Group, it must, to the extent practicable, distribute Non-Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such other Tracking Group with respect to any such Inter-Group Interest in the Distributing Group. If practicable, the Board shall recapitalize such Non-Qualifying Subsidiary through an amendment to its charter or otherwise, such that the relative rights, limitations and preferences of the shares of capital stock of the Non-Qualifying Subsidiary substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Corporation and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner; PROVIDED, that if the Non-Qualifying Subsidiary has or will have shares corresponding to Series A Common Shares and Common Shares but does not have and will not have shares corresponding to Special Common Shares and the Board determines that it is impracticable to recapitalize such subsidiary as provided in this sentence to create shares corresponding to Special Common Shares, the Board shall distribute Non-Qualifying Subsidiary shares corresponding to Common Shares to the holders of Special Common Shares and to holders of any class of Tracking Stock who would otherwise be entitled to receive subsidiary shares corresponding to Special Common Shares. 6. CERTAIN PROVISIONS RELATING TO LIQUIDATION. (a) Subject to paragraph 6(b) of this Section B, in the event of a liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, after payment or provision for payment of the debts and other liabilities of the Corporation and subject to the prior payment in full of the preferential amounts to which any class or series of Preferred Shares or Undesignated Shares is entitled, the holders of the outstanding B-5 shares of Common Stock shall be entitled to receive the remaining assets of the Corporation, regardless of the Group to which such assets are attributed in accordance with this Article IV, divided among the holders of Common Stock in accordance with the per share "Liquidation Units" attributable to each class of Common Stock. Each Series A Common Share, Common Share and Special Common Share is hereby attributed one Liquidation Unit, each Cellular Group Common Share is hereby attributed 2.5 Liquidation Units, each Telecom Group Common Share is hereby attributed .9 of a Liquidation Unit and each Aerial Group Common Share is hereby attributed 1.1 Liquidation Units. The Liquidation Unit of each class or series of Common Stock shall be adjusted by the Board as appropriate to reflect equitably any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of such class of Common Stock or any dividend or other distribution of shares or similar transaction with respect to such class of Common Stock. Whenever a change in the Liquidation Units with respect to any class or series of Common Stock occurs, the Corporation shall prepare and file a statement of such change with the Secretary of the Corporation and distribute a notice of such change to all holders of shares of such class or series of Common Stock, together with a notice of such stock split, reverse split, distribution or other transaction requiring such change. (b) Prior to the distribution of the remaining assets of the Corporation as set forth in paragraph 6(a) of this Section B, the Board may redeem all shares of Tracking Stock of all Tracking Groups in exchange for shares of a Qualifying Subsidiary or Qualifying Subsidiaries holding all of the assets and liabilities of the related Tracking Group pursuant to paragraph 13 of this Section B. (c) A consolidation, merger, or reorganization of the Corporation with any other corporation or corporations, or a sale of all or substantially all of the assets of the Corporation, shall not be considered a dissolution, liquidation, or winding up of the Corporation within the meaning of these provisions. 7. PREEMPTIVE RIGHTS. No holder of shares of any class or series of the Corporation shall have any preemptive right pursuant to this Restated Certificate of Incorporation to subscribe for or acquire any unissued or treasury shares or other securities of the Corporation of the same or any other class or series, whether such shares or securities be hereby or hereafter authorized, except that holders of Series A Common Shares shall have a preemptive right to acquire unissued or treasury Series A Common Shares or securities convertible into or exchangeable for Series A Common Shares or carrying a right to subscribe to or acquire Series A Common Shares; PROVIDED, HOWEVER, that no preemptive right shall exist to acquire any Series A Common Shares sold otherwise than for cash. 8. VOTING. (a) With respect to the election of directors, the holders of (i) Pre-81 Preferred Shares, (ii) Common Shares, (iii) Special Common Shares, (iv) shares of all classes or series of Tracking Stock and (v) any series of Undesignated Shares which, at the time such series of Undesignated Shares was originally established, provided that the holders of such series shall vote in the election of directors together with the holders of Pre-81 Preferred Shares, Common Shares, Special Common Shares and shares of Tracking Stock (for this purpose, the "Public Holders"), voting together as one group, shall be entitled to elect at each annual meeting that number of directors which (together with all directors whose terms do not expire at the time of such meeting and who were previously elected by such holders) constitutes 25% of the total number of directors of the Corporation (rounded up to the nearest whole number), plus one director, and for this purpose the total number of directors of the Corporation shall be determined without regard to any director(s) whom the holders of one or more classes or series of Undesignated Shares have elected or have the right to elect (without regard to this Section B.8), and in such election each holder of Common Shares and Special Common Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation, the holders of Tracking Stock shall have the votes set forth in paragraph 8(d) of this Section B, the holders of series of Pre-81 Preferred Shares shall have the voting rights set forth on Attachment I hereto and the holders of any class or series of Undesignated Shares shall have the voting rights fixed and determined by the Board at the time such series of Undesignated Shares was originally established. (b) The holders of (i) Post-81 Preferred Shares, (ii) Series A Common Shares and (iii) any class or series of Undesignated Shares which, at the time such class or series of Undesignated Shares was originally established, provided that the holders of such class or series shall vote in the election of directors together with the holders of Post-81 Preferred Shares and Series A Common Shares (for this purpose, the "Series A Holders"), voting together as one group, shall be entitled to elect at each annual meeting that number of directors which (together with all directors whose terms do not expire at the time of such meeting and who were previously elected by such holders) are not elected by the Public Holders, as provided in paragraph 8(a) of this B-6 Section B, subject to the rights, if any, of the holders of any class or series of Undesignated Shares to elect one or more directors (without regard to this Section B.8), and in such election each holder of Series A Common Shares shall be entitled to ten votes for each share of such stock standing in the name of the holder on the books of the Corporation, the holders of series of Post-81 Preferred Shares shall have the voting rights set forth on Attachment I hereto and the holders of any class or series of Undesignated Shares shall have the voting rights fixed and determined by the Board at the time such class or series of Undesignated Shares was originally established. (c) With respect to all matters other than the election of directors, each holder of a series of Pre-81 Preferred Shares or Post-81 Preferred Shares shall have the voting rights set forth on Attachment I hereto, each holder of Common Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation, each holder of Series A Common Shares shall be entitled to ten votes for each share of such stock standing in the name of the holder on the books of the Corporation and the holders of any class or series of Undesignated Shares shall have the voting rights fixed and determined by the Board at the time such class or series of Undesignated Shares was originally established. Neither the holders of Special Common Shares nor the holders of shares of any class of Tracking Stock shall be entitled to vote with respect to any matter other than the election of directors as set forth in subparagraph (a) of this paragraph 8, unless such holders must vote as required by the DGCL or other applicable law or regulation. (d) Upon the first issuance of shares of any class or series of Tracking Stock, each of such shares shall be entitled to one vote per share in the election of directors elected by the Public Holders; PROVIDED, HOWEVER, if shares of a class of Tracking Stock have been traded on a national securities exchange or the Nasdaq Stock Market, or traded in the over-the-counter market, for at least 25 Trading Days immediately prior to any Adjustment Date (as hereinafter defined), the votes per share which each share of a class of Tracking Stock shall have in the election of directors at each annual meeting of shareholders pursuant to paragraph 8(a) of this Section B shall be equal to the quotient (calculated to three decimal places) determined by dividing the Aggregate Votes (as hereinafter defined) of such class of Tracking Stock on the Adjustment Date for such annual meeting, by the average daily number of outstanding shares of such class of Tracking Stock during the Calculation Period (as hereinafter defined) for such Adjustment Date. The Aggregate Votes of a class of Tracking Stock on an Adjustment Date shall be equal to the product of the Market Capitalization Percentage (as hereinafter defined) of such class of Tracking Stock multiplied by the Aggregate Public Holder Votes (as hereinafter defined) on the Adjustment Date for such annual meeting. The Aggregate Public Holder Votes shall be equal to the quotient (calculated to the nearest whole number) determined by dividing the sum of the average daily number of outstanding Pre-81 Preferred Shares, Common Shares and Special Common Shares (the "One-Vote Shares") during the Calculation Period, by the Market Capitalization Percentage of the One-Vote Shares. The Market Capitalization Percentage of any class of Tracking Stock and of the One-Vote Shares shall be equal to the average daily ratio (represented as a percentage calculated to three decimal places) of the Market Capitalization of such class of Tracking Stock or the aggregate Market Capitalization of the One-Vote Shares, as the case may be, to the aggregate Market Capitalization of all shares held by the Public Holders, calculated for the twenty-Trading Day period (the "Calculation Period") ending ten Trading Days prior to the record date for each annual meeting of shareholders (the "Adjustment Date"). The number of votes per share to which shares of classes of Tracking Stock shall be entitled at any time in connection with the election or removal of directors by the Public Holders shall be such number of votes per share that were determined on the last preceding Adjustment Date relating to an annual meeting of shareholders of the Corporation, and such number of votes per share to which shares of Tracking Stock shall be entitled shall not be changed until the next succeeding Adjustment Date for the next succeeding annual meeting of shareholders of the Corporation. (e) In the event the number of issued and outstanding Series A Common Shares at any time falls below 500,000, then with respect to the election of directors at the next annual meeting and at each annual meeting thereafter, the holders of all outstanding Preferred Shares, Common Shares, Series A Common Shares, Special Common Shares, Cellular Group Common Shares, Telecom Group Common Shares and Aerial Group Common Shares, and any class or series of Undesignated Shares which, at the time such class or series of Undesignated Shares was originally established, provided that the holders of such class or series shall vote in the election of directors with the Public Holders or the Series A Holders, shall be entitled to elect all of the directors of the Corporation standing for election at any meeting of shareholders, subject to the rights, if any, of the holders of one or more classes or series of Undesignated Shares to elect one or more directors (without regard to this Section B.8), and in each such election of directors each holder of Pre-81 Preferred Shares or Post-81 Preferred Shares shall have the voting rights set forth on Attachment I hereto, each holder of Common Shares and each holder of Special Common Shares shall be entitled to one vote for each share of such stock B-7 standing in the name of the holder on the books of the Corporation, each holder of Series A Common Shares shall be entitled to ten votes for each share of such stock standing in the name of the holder on the books of the Corporation, the holders of Tracking Stock shall have the votes set forth in paragraph 8(f) of this Section B and the holders of any class or series of Undesignated Shares shall have the voting rights fixed and determined by the Board at the time such class or series of Undesignated Shares was originally established. (f) In the event the number of issued and outstanding Series A Common Shares at any time falls below 500,000, the votes per share which each share of a class of Tracking Stock shall have in the election of directors at each annual meeting of shareholders shall be equal to the quotient (calculated to three decimal places) determined by dividing the Adjusted Aggregate Votes (as hereinafter defined) of such class of Tracking Stock on the Adjustment Date for such annual meeting by the average daily number of outstanding shares of such class of Tracking Stock during the Calculation Period for such Adjustment Date. The Adjusted Aggregate Votes of a class of Tracking Stock on an Adjustment Date shall be equal to the product of the Adjusted Market Capitalization Percentage (as hereinafter defined) of such class of Tracking Stock multiplied by the Aggregate Director Votes (as hereinafter defined) on the Adjustment Date for such annual meeting. The Aggregate Director Votes shall be equal to the quotient (calculated to the nearest whole number) determined by dividing (i) the sum of (A) the average daily number of One-Vote Shares and (B) the product of 10 and the average daily number of Series A Common Shares, in each case during the Calculation Period, by (ii) the Aggregate Market Capitalization Percentage of the One-Vote Shares and the Series A Common Shares. The Aggregate Market Capitalization Percentage of the One-Vote Shares and the Series A Common Shares shall be equal to the average daily ratio (expressed as a percentage calculated to three decimal places) of the aggregate Market Capitalization of the One-Vote Shares and the Series A Common Shares to the aggregate Market Capitalization of all shares of capital stock which are entitled to vote in the election of directors pursuant to paragraph 8(e) of this Section B, calculated during the Calculation Period ending on the Adjustment Date for an annual meeting. The Adjusted Market Capitalization Percentage of any class of Tracking Stock shall be equal to the average daily ratio (expressed as a percentage calculated to three decimal places) of the Market Capitalization of such class of Tracking Stock to the aggregate Market Capitalization of all shares of capital stock which are entitled to vote in the election of directors pursuant to paragraph 8(e) of this Section B, calculated during the Calculation Period ending on the Adjustment Date for an annual meeting. The number of votes per share to which shares of classes of Tracking Stock shall be entitled at any time in connection with the election or removal of directors shall be such number of votes per share that were determined on the last preceding Adjustment Date relating to an annual meeting of shareholders of the Corporation, and such number of votes per share to which shares of Tracking Stock shall be entitled shall not be changed until the next succeeding Adjustment Date for the next succeeding annual meeting of shareholders of the Corporation. 9. CONVERSION AT THE OPTION OF THE HOLDER. Each outstanding Series A Common Share shall be convertible into one Common Share or one Special Common Share at any time at the holder's choice. Any such conversion shall be effected by the presentation and surrender of the certificates representing the Series A Common Shares to be converted at the office of the Corporation or at such other place as may from time to time be designated by the Corporation, in such form and accompanied by all transfer taxes (or proof of payment thereof), if any, as shall be required for such transfer, and upon such surrender, the holder of such stock shall be entitled to receive in exchange therefor certificates for fully paid and non-assessable Common Shares or Special Common Shares, as the case may be, of the Corporation at the rate aforesaid, and such holder shall be registered as the holder of such Common Shares or Special Common Shares, as the case may be. 10. DISPOSITION OF ASSETS OF A TRACKING GROUP. (a) If the Corporation disposes of all or substantially all of the properties and assets of a Tracking Group (defined as 80% or more of the then current market-value (as determined by the Board) of the properties and assets of such Tracking Group as of such date), whether by sale, transfer, assignment, merger, consolidation, contribution of assets or stock or otherwise (a "Disposition"), in one transaction or a series of related transactions with any one or more persons, entities or groups, other than in a transaction referred to in the following sentence, the Corporation shall take one of the actions listed in paragraph 10(b) of this Section B on or prior to the 90th Trading Day following the consummation of a Disposition. This requirement shall not apply to a Disposition (i) in connection with the disposition by the Corporation of all of the Corporation's properties and assets in one transaction or a series of related transactions or in connection with the liquidation, dissolution or winding up of the Corporation, (ii) by dividend, other distribution or redemption in accordance with any provision described under paragraphs 2, 3, 4, 5, 6 or 13 of this Section B, (iii) to any person, entity or group which the Corporation, directly or indirectly, after giving effect to the Disposition, controls (as determined by the B-8 Board) or (iv) in connection with a Related Business Transaction. For purposes of this paragraph 10, the Tracking Group affected by the Disposition of its assets is referred to as the "Affected Tracking Group" and the Tracking Stock of such Affected Tracking Group is referred to as the "Affected Tracking Stock." (b) Other than as described in paragraph (a), the Corporation shall take one of the following actions in the event of a Disposition: (i) subject to paragraph 2(b) of this Section B, declare and distribute a special dividend in cash, securities or other property (other than a dividend or distribution of Common Stock of the Corporation) or any combination thereof to the holders of the outstanding shares of the Affected Tracking Stock, in an aggregate amount equal to the product of the Outstanding Interest Fraction of the Affected Tracking Group as of the record date for determining the holders entitled to receive such dividend and the Fair Value of the Net Proceeds of such Disposition, such dividend to be distributed equally on a share-for-share basis to all outstanding shares of the Affected Tracking Stock, except as provided in paragraph 2(d) of this Section B; (ii) provided that there are assets of the Corporation legally available therefor and the Available Dividend Amount for the Affected Tracking Stock would have been sufficient to pay a dividend in lieu thereof as described in subparagraph (i) of this paragraph, then: (A) if such Disposition involves all (not merely substantially all) of the properties and assets of the Affected Tracking Group, redeem all outstanding shares of the Affected Tracking Stock in exchange for cash, securities or other property (other than Common Stock of the Corporation) or any combination thereof on a pro rata basis in an aggregate amount equal to the product of the Adjusted Outstanding Interest Fraction for the Affected Tracking Group as of the date of such complete redemption and the Fair Value of the Net Proceeds of such Disposition, such aggregate amount to be allocated on a pro rata basis to all outstanding shares of the Affected Tracking Stock, except as provided in paragraph 2(d) of this Section B; or (B) if such Disposition involves substantially all (but not all) of the properties and assets of the Affected Tracking Group, apply an aggregate amount of cash, securities or other property (other than Common Stock of the Corporation) or any combination thereof equal to the product of the Affected Tracking Group's Outstanding Interest Fraction as of the date shares are selected for redemption and the Fair Value of the Net Proceeds of such Disposition to the redemption of outstanding shares of the Affected Tracking Stock, such aggregate amount to be allocated on a pro rata basis or by lot (except as provided in paragraph 2(d) of this Section B) to the shares of the Affected Tracking Stock to be redeemed in a manner such that there shall be redeemed the number of whole shares of Affected Tracking Stock which have in the aggregate an average Market Value during the forty-Trading Day period beginning on the 11th Trading Day following the consummation of the Disposition closest to the product of the Outstanding Interest Fraction as of the date such shares are selected for redemption multiplied by the Fair Value of the Net Proceeds of such Disposition (but in no event more than all of the shares of Affected Tracking Stock then outstanding); or (iii) convert each outstanding share of the Affected Tracking Stock of the Affected Tracking Group into a number (or fraction) of fully paid and non-assessable Special Common Shares or shares of any other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) equal to 110% (the "Disposition Conversion Percentage") of the average daily ratio (calculated to the nearest five decimal places) of the Market Value of (y) one share of Affected Tracking Stock to (z) the Market Value of one Special Common Share or share of such other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) during a forty-Trading Day period beginning on the 11th Trading Day after consummation of the Disposition. In the event of the conversion of the Affected Tracking Stock into Special Common Shares or shares of another class or classes of Tracking Stock, the Fair Value of the Net Proceeds of such Disposition shall be attributed to the Group related to the shares which are issued upon such conversion (on a pro rata basis if a combination of such shares are issued). (c) The Corporation may elect to pay the dividend or redemption price referred to in subparagraph (i) or (ii) of paragraph 10(b) of this Section B either in the same form as the proceeds of the Disposition were received or in any other combination of cash or securities or property (other than Common Stock of the Corporation) B-9 that the Board determines will have an aggregate market value on a fully distributed basis of not less than the amount equal to: (i) in the case of subparagraph (i) or clause (B) of subparagraph (ii) of this paragraph 10(b), the product of the applicable Outstanding Interest Fraction and the Fair Value of the Net Proceeds of such Disposition; or (ii) in the case of clause (A) of subparagraph (ii) of this paragraph 10(b), the product of the applicable Adjusted Outstanding Interest Fraction and the Fair Value of the Net Proceeds of such Disposition. (d) If the dividend or redemption referred to in paragraph 10(b) of Section B is paid in securities of an issuer other than the Corporation (the "Successor"), and if there is a Retained Interest in the Affected Tracking Group at such time, the Board shall, to the extent practicable, distribute Successor shares corresponding to Special Common Shares to the holders of shares of the Affected Tracking Stock. In the event of a Disposition, the Corporation shall not be required to make any payment or other distributions to the holders of TDS Group Shares or shares of any class of Tracking Stock other than the Affected Tracking Stock. The Successor shares relating to any Retained Interest or Inter-Group Interest at the time of the Disposition may be retained by the Corporation and attributed to the TDS Group or the other Tracking Group, respectively, or some or all of such shares may be distributed pro rata to the holders of the TDS Group Shares or the applicable Tracking Stock, respectively, in the sole discretion of the Board. If the Board determines to distribute Successor shares with respect to such a Retained Interest or Inter-Group Interest, it shall, to the extent practicable, distribute Successor shares corresponding to Special Common Shares to the holders of Tracking Stock of another Tracking Group with respect to any such Inter-Group Interest, and distribute Successor shares corresponding to Series A Common Shares to the holders of Series A Common Shares, Successor shares corresponding to Common Shares to the holders of Common Shares, and Successor shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group; PROVIDED that the same number of shares of Successor common stock on a combined basis must be distributed for each Series A Common Share, Common Share and any issued Special Common Share. If practicable, the Board shall cause such Successor to be recapitalized through an amendment to its charter or otherwise, such that the shares of capital stock of such Successor and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Corporation and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner. (e) Subject to the terms of paragraph 10(b) of this Section B, the Board shall have complete discretion as to which option in paragraph 10(b) to select; PROVIDED, HOWEVER, that once the disposition option selected by the Board is publicly announced pursuant to paragraph 11 of this Section B, the selection shall be irrevocable. The Board shall not be required to select the option which results in the distribution with the highest value to the holders of the shares of the Affected Tracking Stock or with the smallest effect on the remaining classes and series of the Corporation's Common Stock. In the event of a Disposition, the Corporation shall not be required to make any payment or other distributions to the holders of Common Shares, Series A Common Shares, Special Common Shares or shares of any class of Tracking Stock other than the Affected Tracking Stock; PROVIDED, HOWEVER, the Corporation may, in the sole discretion of the Board, make a distribution to such other shareholders in respect of any Retained Interest or any Inter-Group Interest in the Affected Tracking Group existing at the time of a Disposition; PROVIDED FURTHER, that if the dividend or redemption referred to in paragraph 10(b) of this Section B is paid in securities of a Successor, and if there is a Retained Interest in the Affected Tracking Group at such time, the Board shall make any such distribution in the manner provided pursuant to paragraph 10(d) of this Section B. (f) The Corporation may, in the sole discretion of the Board, at any time prior to the first anniversary of a dividend on, or partial redemption of, shares of Affected Tracking Stock following a Disposition, convert each remaining outstanding share of Affected Tracking Stock into a number (or fraction) of Special Common Shares or shares of any other class or classes of Tracking Stock (or combination thereof on a pro rata basis) equal to the product of the Disposition Conversion Percentage and the average daily ratio (calculated to the nearest five decimal places) of the Market Value of one Special Common Share or share of such other class or classes of Tracking Stock (or any combination thereof on a pro rata basis) during a twenty-Trading Day period ending on the fifth Trading Day prior to the date of notice of such conversion. B-10 (g) To the extent that any Shares Issuable to Third Parties are included in the determination of the Adjusted Outstanding Interest Fraction, the Corporation's obligations in respect of such securities shall not be a reduction in the calculation of the Fair Value of the Net Proceeds. In the event any redemption of Tracking Stock is made in circumstances in which cash, securities or property are allocated to the TDS Group in respect of Shares Issuable to Third Parties (such cash, securities or other property being referred to herein as the "Reserved Property"), the Corporation shall be permitted to segregate and hold such property separate (in the case of any Reserved Property other than Special Common Shares or shares of another class of Tracking Stock). In the event the Reserved Property is, for any reason, not delivered with respect to the obligations relating to such Shares Issuable to Third Parties, such Reserved Property shall revert to the TDS Group, subject to escheat laws, and the former holders of the Affected Tracking Stock shall have no interest in such Reserved Property. In the event of any conversion of Tracking Stock into Special Common Shares or shares of any other class or classes of Tracking Stock, the Corporation shall duly reserve Special Common Shares or shares of such other class or classes of Tracking Stock or combination thereof issuable with respect to Shares Issuable to Third Parties of the Affected Tracking Stock. (h) At the time of any dividend made as a result of a Disposition, the TDS Group shall be credited, and the Affected Tracking Group shall be charged (in addition to the charge for the dividend paid in respect of outstanding shares of Affected Tracking Stock), with an amount equal to the product of (i) the aggregate amount paid in respect of such dividend times (ii) a fraction the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction of such Tracking Group. (i) If any Inter-Group Interests in a Tracking Group exist at the time of any dividend made as a result of a Disposition, each Tracking Group holding such an Inter-Group Interest in the Affected Tracking Group shall be credited, and the Affected Tracking Group shall be charged (in addition to the charge for the dividend paid in respect of outstanding shares of Affected Tracking Stock) with an amount equal to the product of (i) the aggregate amount paid in respect of such dividend times (ii) a fraction the numerator of which is the Inter-Group Interest Fraction and the denominator of which is the Outstanding Interest Fraction of the Affected Tracking Group. (j) In the case of a Disposition in a series of related transactions, the Disposition shall be deemed to have been consummated upon the consummation of the last of the series of related transactions. (k) The Board shall determine the redemption date or conversion date pursuant to Section B.11 hereof. 11. PROCEDURES RELATING TO DISPOSITION RIGHTS. (a) Not later than the fifth Trading Day following the consummation of a Disposition referred to above, the Corporation shall announce publicly by press release (i) the Fair Value of the Net Proceeds of such Disposition, (ii) the number of outstanding shares of Affected Tracking Stock, (iii) information describing and indicating the number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of such shares into or for which Convertible Securities are then convertible, exercisable or exchangeable, and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iv) the Disposition Conversion Percentage, (v) the Outstanding Interest Fraction for the Affected Tracking Stock as of a recent date preceding the date of such notice and (vi) the Adjusted Outstanding Interest Fraction for the Affected Tracking Stock as of a recent date preceding the date of such notice. Not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such Disposition, the Corporation shall announce publicly by press release which of the redemption options thereof described in paragraph 10(b) of this Section B it has irrevocably determined to take and the kind of capital stock or cash, securities or other property or combination thereof to be delivered pursuant to the option selected. (b) If the Corporation determines to pay a dividend of cash, securities or other property or combination thereof following a Disposition, as described in subparagraph (i) of paragraph 10(b) of Section B, the Corporation shall, not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such Disposition, cause to be sent to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) the record date for determining holders entitled to receive such dividend, which shall be not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition, (ii) the anticipated payment date of such dividend (which shall not be more than 90 Trading Days following the consummation of such Disposition), (iii) the kind and amount of cash, other securities or property or combination thereof to be distributed in respect of each share of the Affected Tracking B-11 Stock, (iv) the amount of the Fair Value of the Net Proceeds of such Disposition, (v) the Outstanding Interest Fraction as of a recent date preceding the date of such notice, and (vi) the number of outstanding shares of the Affected Tracking Stock subject to the Disposition and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). (c) If the Corporation determines to undertake a redemption of a class of Tracking Stock following a Disposition of all (not merely substantially all) of the properties and assets of the Affected Tracking Group with respect to the Fair Value of the Net Proceeds, as described in clause (A) of subparagraph (ii) of paragraph 10(b) of this Section B, the Corporation shall cause to be given to each holder of outstanding shares of Tracking Stock of the Affected Tracking Group a notice setting forth (i) a statement that all of the shares of the Affected Tracking Stock outstanding on the redemption date shall be redeemed, (ii) the anticipated redemption date (which shall not be more than 90 Trading Days following the consummation of such Disposition), (iii) the kind and amount of cash, securities or property or combination thereof to be paid as a redemption price in respect of shares of the Affected Tracking Stock outstanding on the redemption date, (iv) the amount of the Fair Value of the Net Proceeds of such Disposition, (v) the Adjusted Outstanding Interest Fraction as of a recent date preceding the date of such notice, (vi) the place or places where certificates for shares of Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered for delivery of cash, securities or property, and (vii) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice shall be sent not less than 51 Trading Days nor more than 55 Trading Days following the consummation of such Disposition and not less than 25 Trading Days prior to the redemption date. (d) If the Corporation determines to undertake a partial redemption of Tracking Stock following a Disposition of substantially all (but not all) of the properties and assets of the Affected Tracking Group as described in clause (B) of subparagraph (ii) of paragraph 10(b)of this Section B, such partial redemption shall be done on a pro rata basis or by lot. The Corporation shall, not earlier than the 51st Trading Day and not later than the 55th Trading Day following the consummation of such a Disposition, cause to be given to each holder of record of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that some of the shares of the Affected Tracking Stock outstanding on the redemption date shall be redeemed, specifying the number of such shares or how such number shall be determined, (ii) a date not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition which shall be the date on which shares of the Affected Tracking Stock then outstanding shall be selected for redemption, (iii) the anticipated redemption date (which shall not be more than 90 Trading Days following the consummation of such Disposition), (iv) the kind and amount of cash, securities or property or combination thereof to be paid as a redemption price in respect of the shares of the Affected Tracking Stock, (v) the amount of the Fair Value of the Net Proceeds of such Disposition, (vi) the Outstanding Interest Fraction as of a recent date preceding the date of such notice, (vii) the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), and (viii) a statement that the Corporation shall not be required to register a transfer of any shares of the Affected Tracking Stock for a period of up to 15 Trading Days next preceding the date referred to in clause (ii) of this sentence. Promptly following the date referred to in clause (ii) of the preceding sentence, but not earlier than the 61st Trading Day and not later than the 65th Trading Day following the consummation of such Disposition, the Corporation shall cause to be given to each holder of shares of the Affected Tracking Stock, a notice setting forth (i) the number of shares of Affected Tracking Stock held by such holder to be redeemed, (ii) a statement that such shares of Affected Tracking Stock shall be redeemed, (iii) the anticipated redemption date (which shall not be more than 90 Trading Days following the consummation of such Disposition), (iv) the kind and amount of cash, other securities or property to be received by such holder with respect to each share of Affected Tracking Stock to be redeemed, including details as to the calculation thereof, and (v) the place or places where certificates for such B-12 shares of Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered for delivery of such cash, other securities or property or combination thereof. (e) In the event of any conversion following a Disposition, as described in subparagraph (iii) of paragraph 10(b) of this Section B, the Corporation shall cause to be given to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that all of the outstanding shares of the Affected Tracking Stock shall be converted into a number or fraction of Special Common Shares or shares of any other class of Tracking Stock or combination thereof on a pro rata basis, and the calculation pursuant to which such number or fraction was determined or will be determined, (ii) the anticipated conversion date (which shall not be more than 90 Trading Days following the consummation of such Disposition), (iii) the per share number (or fraction) of Special Common Shares or shares of another class of Tracking Stock or combination thereof, as applicable, to be received with respect to each share of Affected Tracking Stock, specifying such number or fraction of shares or combination thereof, the Disposition Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of the Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered, and (v) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). Such notice shall be sent not less than 51 Trading Days nor more than 55 Trading Days following the consummation of the Disposition and not less than 25 days prior to the conversion date. (f) Upon the Corporation's decision to convert all of the remaining outstanding shares of the Affected Tracking Stock as described in paragraph 10(f), the Corporation shall announce publicly by press release (i) the number of outstanding shares of Affected Tracking Stock to be converted, (ii) the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and into or for which Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iii) the Disposition Conversion Percentage and (iv) the Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice. The Corporation shall subsequently announce publicly by press release whether the shares of such Tracking Stock are being converted in exchange for Special Common Shares, shares of another Tracking Stock or a combination thereof on a pro rata basis. (g) In the event of any conversion as described paragraph 10(f) of this Section B, the Corporation shall cause to be given to each holder of outstanding shares of the Affected Tracking Stock a notice setting forth (i) a statement that all of the outstanding shares of the Affected Tracking Stock shall be converted into a number or fraction of Special Common Shares or shares of any other class of Tracking Stock or combination thereof on a pro rata basis, specifying the shares or combination thereof, (ii) the anticipated conversion date (which shall not be more than 90 Trading Days following the press release that publicly announces such conversion), (iii) the per share number (or fraction) of Special Common Shares or shares of another class of Tracking Stock or combination thereof, as applicable, to be received with respect to each share of Affected Tracking Stock, specifying such number or fraction of shares or combination thereof, the Disposition Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of the Affected Tracking Stock, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered, and (v) the number of outstanding shares of the Affected Tracking Stock and the Number of Shares Issuable to Third Parties of the Affected Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of the Affected Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, are Pre-Distribution Convertible Securities). Such notice shall be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the conversion date. 12. CONVERSION AT OPTION OF THE CORPORATION. The Corporation may, in the sole discretion of the Board, at any time convert each outstanding share of any class of Tracking Stock (the "Converted Tracking Stock") of any Tracking Group (the "Converted Tracking Group") into a number (or fraction) of fully paid and non-assessable Special Common Shares or shares of another class or classes of Tracking Stock or any combination thereof on a B-13 pro rata basis, equal to the product of the applicable percentage set forth below (the "Optional Conversion Percentage") on a conversion date selected by the Board pursuant to Section B.14 hereof, and the average daily ratio (calculated to the nearest five decimal places) of the Market Value of one share of Converted Tracking Stock to the Market Value of one Special Common Share or share of such other class of Tracking Stock or any combination thereof on a pro rata basis, during a twenty-Trading Day period ending on the fifth Trading Day prior to the date of notice of such conversion, on a pro rata basis:
12-MONTH PERIOD PRIOR TO OPTIONAL CONVERSION ANNIVERSARY OF INITIAL ISSUANCE DATE PERCENTAGE - ------------------------------------------------------------------------------------- ------------------- First through Fifth.................................................................. 115% Sixth................................................................................ 114% Seventh.............................................................................. 113% Eighth............................................................................... 112% Ninth................................................................................ 111% Thereafter........................................................................... 110%
In the event of the conversion of any class of Tracking Stock into Special Common Shares or shares of another class or classes of Tracking Stock, the assets and liabilities of the Converted Tracking Group shall be attributed to the Group related to the shares which are issued upon such conversion (on a pro rata basis if a combination of such shares are issued). 13. REDEMPTION IN EXCHANGE FOR STOCK OF SUBSIDIARY. (a) Subject to paragraph 2(b) of this Section B, the Corporation, in the sole discretion of the Board, may at any time redeem (at no premium) all of the outstanding shares of any class of Tracking Stock (the "Redeemed Tracking Stock") of a Tracking Group (the "Redeemed Tracking Group"), for a number of outstanding shares of common stock of a Qualifying Subsidiary or Qualifying Subsidiaries holding all of the assets and liabilities attributed to the Redeemed Tracking Group equal to the product of the Adjusted Outstanding Interest Fraction of the Redeemed Tracking Group multiplied by the number of all of the outstanding shares of the Qualifying Subsidiaries owned directly or indirectly by the Corporation, on a pro rata basis. The Corporation shall retain the balance of the outstanding shares of the common stock of the Qualifying Subsidiaries as (i) Reserved Property with respect to the obligations related to the Number of Shares Issuable to Third Parties used in calculating such Adjusted Outstanding Interest Fraction, or (ii) in respect of the Retained Interest and any Inter-Group Interest in the Converted Tracking Group; PROVIDED, HOWEVER, in the sole discretion of the Board, shares of common stock of the Qualifying Subsidiaries retained in respect of the Retained Interest and any Inter-Group Interest in such Tracking Group may be distributed as provided in paragraph 13(b) of this Section B. (b) In the event the Board determines to redeem the shares of any class of Tracking Stock for shares of a Qualifying Subsidiary, and if there is a Retained Interest in such Tracking Group, the Board shall, to the extent practicable, distribute Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Tracking Stock of such Tracking Group with respect to the Adjusted Outstanding Interest Fraction in such Tracking Group and, if the Board determines to distribute shares of such Qualifying Subsidiary to other shareholders with respect to any Retained Interest or Inter-Group Interest shall, to the extent practicable, distribute Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of any other Tracking Stock with respect to any such Inter-Group Interest in such Tracking Group, and distribute Qualifying Subsidiary shares corresponding to Series A Common Shares to the holders of Series A Common Shares, Qualifying Subsidiary shares corresponding to Common Shares to the holders of Common Shares, and Qualifying Subsidiary shares corresponding to Special Common Shares to the holders of Special Common Shares with respect to any Retained Interest in such Tracking Group, provided that the same number of shares of Qualifying Subsidiary common stock on a combined basis shall be distributed for each Series A Common Share, Common Share and any issued Special Common Share. If practicable, the Board shall recapitalize such Qualifying Subsidiary or Qualifying Subsidiaries through an amendment to its charter or otherwise, such that the shares of capital stock of such subsidiary and the relative rights, limitations and preferences thereof substantially correspond to the Series A Common Shares, Common Shares and Special Common Shares of the Corporation and their relative rights, limitations and preferences, as may be determined to be necessary or appropriate in the sole discretion of the Board, in order to permit the distribution to be effected in the foregoing manner; PROVIDED that, if the Qualifying Subsidiary has or will have shares corresponding to Series A Common Shares and Common Shares but does not and will not have shares corresponding to Special Common Shares B-14 and it is impracticable to recapitalize the subsidiary as provided in this sentence to create shares corresponding to Special Common Shares, the Board shall distribute Qualifying Subsidiary shares corresponding to Common Shares to the holders of Tracking Stock which would otherwise be entitled to receive Qualifying Subsidiary shares corresponding to Special Common Shares, and shall distribute Qualifying Subsidiary shares corresponding to Common Shares to the holders of Special Common Shares in respect of the Retained Interest. 14. PROCEDURES RELATING TO CONVERSION OR REDEMPTION OF TRACKING STOCK. (a) Upon the Corporation's decision to convert or redeem all of the outstanding shares of any class of Tracking Stock as described in paragraphs 12 or 13 of this Section B, the Corporation shall announce publicly by press release (i) the number of outstanding shares of the class of Tracking Stock which will be converted or redeemed, (ii) the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and into or for which Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities), (iii) the Optional Conversion Percentage and other details as to the calculation thereof, and (iv) the Outstanding Interest Fraction and the Adjusted Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice. The Corporation shall subsequently announce publicly by press release whether the shares of such Tracking Stock are being converted in exchange for Special Common Shares, shares of another Tracking Stock or a combination thereof on a pro rata basis, or are being redeemed for shares of a Qualifying Subsidiary. A notice by the Corporation that the Corporation is considering a conversion or redemption or is seeking a ruling from the Internal Revenue Service relating to a possible conversion or redemption shall not constitute an announcement of a decision with respect to a redemption or conversion pursuant to this paragraph 14. (b) The Corporation's decision to convert or redeem all of the outstanding shares of Tracking Stock as described in paragraphs 12 or 13 of this Section B shall be revocable, and the determination of the Board with respect to which securities the Corporation shall use to convert or redeem such Tracking Stock shall be revocable, and any such conversion or redemption may be abandoned or modified by the Corporation, in the sole discretion of the Board, at any time prior to the Corporation's delivery of the replacement securities in exchange for the converted or redeemed shares of Tracking Stock. (c) If the Corporation determines to convert the shares of any class of Tracking Stock into Special Common Shares or shares of any other class or classes of Tracking Stock or any combination thereof, as described in paragraph 12 of this Section B, the Corporation shall promptly cause to be given to each holder of shares of Tracking Stock to be converted a notice setting forth (i) a statement that all outstanding shares of such class of Tracking Stock shall be converted in exchange for Special Common Shares or shares of any other class of Tracking Stock or any combination thereof on a pro rata basis, specifying the shares or combination thereof, (ii) the anticipated conversion date (which shall not be more than 90 Trading Days following the press release that publicly announces such a conversion), (iii) the per share number (or fraction) of Special Common Shares or shares of another class of Tracking Stock or combination thereof, as applicable, to be received with respect to each share of the Converted Tracking Stock, specifying such number or fraction of shares or combination thereof, the Optional Conversion Percentage and other details as to the calculation thereof, (iv) the place or places where certificates for shares of such Tracking Stock to be redeemed, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered for delivery of certificates for Special Common Shares, shares of another class of Tracking Stock or both, and (v) the number of outstanding shares of such Tracking Stock to be redeemed and the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of such Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice shall be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the conversion date. (d) If the Corporation determines to redeem the shares of any class of Tracking Stock Shares into shares of a Qualifying Subsidiary as described in paragraph 13 of this Section B, the Corporation shall promptly cause to be given to each holder of shares of Tracking Stock to be redeemed a notice setting forth (i) a statement that all outstanding shares of such class of Tracking Stock shall be redeemed in exchange for shares of a Qualifying Subsidiary, (ii) the anticipated redemption date (which shall not be more than 90 Trading Days following the B-15 press release that publicly announces such a redemption), (iii) the Adjusted Outstanding Interest Fraction for such Tracking Stock as of a recent date preceding the date of such notice, (iv) the place or places where certificates for shares of such Tracking Stock are to be redeemed, properly endorsed or assigned for transfer (unless the Corporation waives such requirement), are to be surrendered for delivery of certificates for shares of common stock of the Qualifying Subsidiary, and (v) the number of outstanding shares of such Tracking Stock and the Number of Shares Issuable to Third Parties of such Tracking Stock, including the number of such shares which are issuable as Committed Acquisition Shares and the number of shares of such Tracking Stock into or for which outstanding Convertible Securities are then convertible, exercisable or exchangeable and the conversion, exercise or exchange prices thereof (and stating which, if any, of such Convertible Securities are Pre-Distribution Convertible Securities). Such notice shall be sent not less than 25 Trading Days nor more than 35 Trading Days prior to the redemption date. 15. GENERAL PROVISIONS RELATING TO CONVERSIONS AND REDEMPTIONS. (a) In each case in which a notice is required to be given to holders of outstanding shares of any class of Tracking Stock in accordance with paragraphs 11 or 14 (other than a notice to holders of shares selected for a partial redemption), notice shall also be given, within the required time period, to each holder of Convertible Securities that are convertible into or exercisable or exchangeable for shares of such Tracking Stock (unless provision for such notice is otherwise made pursuant to the terms of such Convertible Securities), which notice shall include, in addition to all of the information set forth in the corresponding notice to holders of shares of such Tracking Stock, a statement to the effect that the holders of such Convertible Securities shall be entitled to receive the dividend, participate in the redemption of shares following a Disposition with respect to such Tracking Stock or in the selection of shares for conversion or redemption, participate in the conversion of shares or participate in the redemption of shares in exchange for stock of the Qualifying Subsidiaries only if such holder appropriately converts, exercises or exchanges such Convertible Securities on or prior to the record date for the dividend, redemption date, date fixed for selection of shares to be redeemed or conversion date, as applicable, set forth in such notice. In the case of a conversion or redemption of shares of any class of Tracking Stock, the notice to holders of Convertible Securities shall also state what, if anything, such holders shall be entitled to receive pursuant to the terms of such Convertible Securities if such holders convert, exercise or exchange such Convertible Securities following the conversion date or redemption date, as applicable. (b) All notices required to be given in accordance with this paragraph 15 or paragraphs 11 or 14 shall be sent to a holder by first class mail, postage prepaid, at the holder's address as the same appears on the transfer books of the Corporation. Neither the failure to mail any notice to any particular holder of shares of Tracking Stock or of Convertible Securities nor any defect therein shall affect the sufficiency thereof with respect to any other holder of outstanding shares of Tracking Stock or of Convertible Securities, or the validity of any conversion or redemption. (c) The Corporation shall not be required to issue or deliver fractional shares of any class of capital stock or any fractional securities to any holder of shares of Tracking Stock upon any conversion or redemption, dividend or other distribution described in paragraphs 10, 12 or 13 of this Section B. In connection with the determination of the number of shares of any class of capital stock that is issuable or the amount of securities that is deliverable to any holder of record upon any conversion or redemption, dividend or other distribution (including any fractions of shares or securities), the Corporation may aggregate the number of shares of Tracking Stock held at the relevant time by such holder of record. If the number of shares of any class of capital stock or the amount of securities remaining to be issued or delivered to any holder of shares of Tracking Stock is a fraction, the Corporation shall, if such fraction is not issued or delivered to such holder, pay a cash adjustment in respect of such fraction in an amount equal to the fair market value of such fraction on the fifth Trading Day prior to the date such payment is to be made (without interest). For purposes of the preceding sentence, "fair market value" of any fraction shall be (i) in the case of any fraction of a share of capital stock of the Corporation, the product of such fraction and the Market Value of one share of such capital stock and (ii) in the case of any other fractional security, such value as is determined by the Board. (d) No adjustments in respect of dividends shall be made upon the conversion or redemption of any shares of Tracking Stock; PROVIDED, HOWEVER, that if the conversion or redemption date with respect to a class of Tracking Stock is subsequent to the record date for the payment of a dividend or other distribution thereon or with respect thereto, the holders of shares of such class of Tracking Stock at the close of business on such record date shall be entitled to receive the dividend or other distribution payable on or with respect to such shares on the date set for payment of such dividend or other distribution, notwithstanding a conversion or B-16 redemption by the Corporation of such shares or the Corporation's default in payment of the dividend or distribution due on such date. (e) Before any holder of shares of any class of Tracking Stock shall be entitled to receive certificates representing shares of any kind of capital stock or cash, securities or other property or combination thereof to be received by such holder with respect to any conversion or redemption of such Tracking Stock, such holder shall be required to surrender at such place as the Corporation shall specify certificates for such shares, properly endorsed or assigned for transfer (unless the Corporation waives such requirement). The Corporation shall as soon as practicable after surrender of certificates representing shares of such Tracking Stock deliver to the person for whose account such shares were so surrendered, or to the nominee or nominees of such person, certificates representing the number of whole shares of the kind of capital stock or cash, securities or other property or combination thereof to which such person is entitled, together with any payment for fractional securities referred to above. The Corporation shall not be required to register (i) a transfer of any shares of Tracking Stock for a period of up to 15 Trading Days preceding the conversion date or redemption date or (ii) any shares of Tracking Stock selected for redemption. (f) From and after any applicable conversion or redemption date, all rights of a holder of shares of any class of Tracking Stock that were converted or redeemed shall cease except for the right, upon surrender of the certificates representing such Tracking Stock, to receive certificates representing shares of the kind and amount of capital stock or cash, securities or other property or combination thereof for which such shares of Tracking Stock were converted or redeemed, together with any payment for fractional securities, and such holder shall have no other or further rights in respect of the Tracking Stock so converted or redeemed, including, but not limited to, any rights with respect to any shares of capital stock or cash, securities or other property or combination thereof which are reserved or otherwise designated by the Corporation as being held for the satisfaction of the Corporation's obligations to pay or deliver any shares of capital stock, cash, securities or other property or combination thereof upon the conversion, exercise or exchange of any outstanding Convertible Securities or with respect to any other Shares Issuable to Third Parties related to the conversion or redemption of such Tracking Stock as of the date of such conversion or redemption. No holder of a certificate that, immediately prior to the applicable conversion or redemption date for any class of Tracking Stock, represented shares of Tracking Stock which were converted or redeemed shall be entitled to receive any dividend or other distribution with respect to shares of any kind of capital stock or other securities into or in exchange for which the shares of such Tracking Stock were converted or redeemed until surrender of such holder's certificate for a certificate or certificates representing shares of such kind of capital stock or other securities. Upon such surrender, there shall be paid to the holder the amount of any dividends or other distributions (without interest) which theretofore became payable with respect to a record date after the conversion date or redemption date, as the case may be, but that were not paid by reason of the foregoing, with respect to the number of whole shares of the kind of capital stock or other securities represented by the certificate or certificates issued upon such surrender. (g) The Corporation shall pay any and all documentary, stamp or similar issue or transfer taxes that may be payable in respect of the issue or delivery of any shares of capital stock or other securities on the conversion or redemption of any class of Tracking Stock. The Corporation shall not be required to pay any tax that may be payable in respect of any transfer involved in the issue and delivery of any shares of capital stock or other securities in a name other than that in which the shares of Tracking Stock so converted or redeemed were registered and no such issue or delivery shall be made unless and until the person requesting such issue has paid to the Corporation the amount of any such tax, or has established to the satisfaction of the Corporation that such tax has been paid. 16. EFFECTS ON CONVERTIBLE SECURITIES. (a) The following provisions with respect to Convertible Securities shall apply only to the extent that the terms of such Convertible Securities do not provide for adjustments in the event of a conversion or redemption described in paragraphs 10, 12 or 13 of this Section B. (b) After any conversion date or redemption date on which all outstanding shares of any class of Tracking Stock were converted or redeemed, any share of such class of Tracking Stock that is to be issued on conversion, exchange or exercise of any Convertible Security shall, immediately upon such conversion, exchange or exercise and without any notice or any other action on the part of, the Corporation or its Board or the holder of such Convertible Security: B-17 (i) in the event the shares of such class of Tracking Stock outstanding on such conversion date were converted into Special Common Shares or shares of another class or classes of Tracking Stock or combination thereof pursuant to the provisions described in subparagraph (iii) of paragraph 10(b), paragraph 10(f) or paragraph 12 of this Section B, be converted into the number of Special Common Shares or shares of another class or classes of Tracking Stock or combination thereof that the number of shares of such class of Tracking Stock, that were to be issued upon such conversion, exchange or exercise, would have received had such shares been outstanding on such conversion date; or (ii) in the event the shares of such class of Tracking Stock outstanding on such redemption date were redeemed pursuant to the provisions described in subparagraph (ii)(A) of paragraph 10(b) of this Section B or redeemed for shares of capital stock of a Qualifying Subsidiary or Qualifying Subsidiaries pursuant to paragraph 13 of this Section B, be redeemed, to the extent of funds of the Corporation legally available therefor, for the kind and amount of cash, securities or property or any combination thereof, or shares of capital stock of a Qualifying Subsidiary or Qualifying Subsidiaries, that the number of shares of such class of Tracking Stock, that were to be issued upon such conversion, exchange or exercise, would have received had such shares been outstanding on such redemption date. (c) If determined to be appropriate in the sole discretion of the Board, any such capital stock or cash, securities or property or any combination thereof to be delivered upon such conversion or redemption may be irrevocably transferred in trust for the benefit of holders of such Convertible Securities. 17. OTHER PROVISIONS. (a) The Board shall have the power to issue or sell any class or series of stock herein or hereafter authorized, for such consideration as the Board shall from time to time, in its discretion, determine, whether or not greater consideration could be received upon the issue or sale of shares of another class or series, and as otherwise permitted by law. (b) The Board shall have the power to purchase any class or series of stock herein or hereafter authorized for such consideration as the Board shall from time to time, in its discretion, determine, whether or not lesser consideration could be paid upon the purchase of shares of another class or series, and as otherwise permitted by law. (c) If the Corporation shall in any manner split, subdivide or combine the outstanding Common Shares, Series A Common Shares or Special Common Shares, all outstanding Common Shares, Series A Common Shares and Special Common Shares shall be proportionally split, subdivided or combined in the same manner and on the same basis. (d) In the event of a merger or consolidation of the Corporation with or into another entity (whether or not the Corporation is the surviving entity), the holders of Special Common Shares and Common Shares shall be entitled to receive the same consideration per share as a result of such merger or consolidation; provided, that this requirement shall be deemed to be satisfied if the consideration received by the holders of Special Common Shares consists of securities which have relative rights, preferences and limitations vis-a-vis the securities received by the holders of Common Shares that, in the judgment of the Board, are substantially similar in all material respects to the relative rights, preferences and limitations of the Special Common Shares vis-a-vis the Common Shares, respectively. (e) Every reference in this Restated Certificate of Incorporation or under Delaware law to a majority or other proportion of shares of capital stock shall, to the extent permitted under Delaware law, refer to a majority or such other proportion of the votes entitled to be cast by such shares of capital stock. (f) In accordance with Section 203(b)(3) of the DGCL, the Corporation expressly elects not be governed by Section 203 of the DGCL. (g) Advance notice of shareholder nominations for election of directors and other business to be brought by shareholders before a meeting of shareholders shall be given in the manner provided in the Bylaws of the Corporation. 18. REDEMPTION TO PROTECT LICENSES. (a) Notwithstanding any other provision of this Restated Certificate of Incorporation, as amended, to the contrary, any outstanding shares of stock of the Corporation (other than Series A Common Shares) shall be subject to redemption by the Corporation, by action of the Board, if in the judgment of the Board such action B-18 should be taken, pursuant to Section 151(b)(2) of the Delaware General Corporation Law or any other applicable provision of law, to the extent necessary to prevent the loss or secure the reinstatement of, or to prevent the denial of applications for or the renewal of, any license or franchise from any governmental agency held by the Corporation or any of its Subsidiaries, or of any person in which the Corporation has any ownership or voting interest, direct or indirect, to conduct any portion of the business of the Corporation or any of its Subsidiaries, or any person in which the Corporation has any ownership or voting interest, direct or indirect, which license or franchise is conditioned upon some or all of the holders of the Corporation's stock, or any other person with the right to vote such stock or on whose behalf such stock is owned or voted, possessing prescribed qualifications or any other condition. The terms and conditions of such redemption shall be as follows: (i) The redemption price of the shares to be redeemed pursuant to this paragraph 18 shall be equal to the lesser of (A) the Fair Market Value of such shares or (B) if such shares were purchased by such Disqualified Holder within one year of the Redemption Date, such Disqualified Holder's purchase price for such shares; (ii) The redemption price of such shares may be paid in cash, Redemption Securities or any combination thereof; (iii) If less than all the shares held by Disqualified Holders are to be redeemed, the shares to be redeemed shall be selected in such manner as shall be determined by the Board, which may include selection first of the most recently purchased shares thereof, selection by lot or selection in any other manner determined by the Board; (iv) At least 30 days' written notice of the Redemption Date shall be given to the record holders of the shares selected to be redeemed (unless waived in writing by any such holder); PROVIDED that the Redemption Date may be the date on which written notice shall be given to record holders if the cash or Redemption Securities necessary to effect the redemption shall have been deposited in trust for the benefit of such record holders and subject to immediate withdrawal by them upon surrender of the stock certificates for their shares to be redeemed; (v) From and after the Redemption Date, any and all rights of whatever nature, which may be held by the owners of shares selected for redemption (including without limitation any rights to vote or participate in dividends declared on stock of the same class or series as such shares), shall cease and terminate and they shall thenceforth be entitled only to receive the cash or Redemption Securities payable upon redemption; and (vi) Such other terms and conditions as the Board shall determine. (b) For purposes of this paragraph 18: "DISQUALIFIED HOLDER" shall mean any holder of shares of stock of the Corporation whose holding of such stock on behalf of such holder or on behalf of any other person involving any beneficial or other indirect ownership interest or voting power with respect to such stock, either individually or when taken together with the holding or voting of shares of stock of the Corporation by any other holders or persons entitled to vote such stock, may result, in the good faith judgment of the Board, in the loss of, or the failure to secure the reinstatement of, or the denial of applications for or the renewal of, any license or franchise from any governmental agency held by the Corporation or any of its Subsidiaries or of any person in which the Corporation has any ownership or voting interest to conduct any portion of the business of the Corporation or any of its Subsidiaries or of any person in which the Corporation has any ownership or voting interest, direct or indirect. "FAIR MARKET VALUE" of a share of the Corporation's stock of any class or series shall mean the average Closing Price for such a share for each of the 20 most recent days on which shares of stock of such class or series shall have been traded preceding the day on which notice of redemption shall be given pursuant to this paragraph 18; PROVIDED, HOWEVER, that if shares of stock of such class or series are not traded on any securities exchange or in the over-the-counter market, "Fair Market Value" shall be determined by the Board in good faith. "Closing Price" on any day means the reported closing sales price or, in case no such sale takes place, the average of the reported closing bid and asked prices on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which such stock is listed, or, if such stock is not listed on any such exchange, the highest closing sales price or bid quotation for such stock on the Nasdaq Stock Market or any system then in use, or if no such prices or quotations are available, the fair market value on the day in question as determined by the Board in good faith. B-19 A "PERSON" shall mean an individual, a corporation, a partnership, a joint venture, a trust or unincorporated organization, a joint stock company or similar organization, a government or any political subdivision thereof, or any other legal entity. "REDEMPTION DATE" shall mean the date fixed by the Board for the redemption of shares of stock of the Corporation pursuant to this paragraph 18. "REDEMPTION SECURITIES" shall mean any debt or equity securities (other than Series A Common Shares or securities convertible into or exchangeable for, or carrying a right to subscribe to or acquire, Series A Common Shares) of the Corporation, any of its Subsidiaries or any other corporation, or any combination thereof, having such terms and conditions as shall be approved by the Board and which, together with any cash to be paid as part of the redemption price, in the opinion of any nationally recognized investment banking firm selected by the Board (which may be a firm which provides other investment banking, brokerage or other services to the Corporation), has a value, at the time notice of redemption is given pursuant to subparagraph (a)(iv) of this paragraph 18, at least equal to the price required to be paid pursuant to subparagraph (a)(i) of this paragraph 18 (assuming, in the case of Redemption Securities to be publicly traded, such Redemption Securities were fully distributed and subject only to normal trading activity). 19. DEFINITIONS. In addition to the definitions set forth above in this Restated Certificate of Incorporation, unless the context requires otherwise, the following terms shall have the meanings specified below: "ADJUSTED OUTSTANDING INTEREST FRACTION," as of any date, shall mean, with respect to a particular class of Tracking Stock, a fraction the numerator of which is the aggregate number of shares of such class of Tracking Stock outstanding on such date and the denominator of which is the sum of (a) such aggregate number of outstanding shares, (b) the Number of Shares Issuable with Respect to Retained Interest for such class of Tracking Stock as of such date, (c) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any, as of such date and (d) the Number of Shares Issuable to Third Parties with respect to such Tracking Stock as of such date. "AERIAL" shall mean Aerial Communications, Inc., a Delaware corporation. "AERIAL GROUP" shall mean, as of any date that any Aerial Group Common Shares have been issued and continue to be outstanding: (a) the interest of the Corporation or any of its subsidiaries in Aerial and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and liabilities, except any of such businesses, assets or liabilities which have been attributed by the Board to another Group; (b) all businesses, assets and liabilities of the Corporation or any of its subsidiaries to the extent attributed to the Aerial Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of Aerial or any of its subsidiaries (or a successor as described in clause (a) of this sentence); (c) all businesses, assets and liabilities contributed or otherwise transferred to the Aerial Group from the TDS Group or any of the other Tracking Groups; (d) the interest of the Corporation or any of its subsidiaries in the businesses, assets and liabilities acquired by the Corporation or any of its subsidiaries for the Aerial Group, as determined by the Board; (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Aerial Group in such other Tracking Group; and (f) such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be determined in good faith by the Board. If a Retained Interest in the Aerial Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Aerial Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Aerial Group, other than Aerial Group Common Shares, the TDS Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Aerial Group's Retained Interest Fraction and the denominator of which is the Aerial Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Aerial Group B-20 Common Shares so distributed to the holders of Aerial Group Common Shares, the Aerial Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the TDS Group. If an Inter-Group Interest in the Aerial Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Aerial Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Aerial Group other than Aerial Group Common Shares, the Tracking Group(s) holding the Inter-Group Interest(s) in the Aerial Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Inter-Group Interest Fraction in the Aerial Group in effect immediately prior to the record date for such dividend or other distribution and the denominator of which is equal to the Aerial Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Aerial Group Common Shares so distributed to the holders of Aerial Group Common Shares, the Aerial Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the Tracking Group holding the Inter-Group Interest in the Aerial Group. From and after any transfer of cash, securities or other property from the Aerial Group to the TDS Group or to another Tracking Group, the Aerial Group shall no longer include the cash, securities or other property so transferred and the TDS Group or such other Tracking Group, as the case may be, shall include such cash, securities or other property, and from and after any transfer of cash, securities or other property from the TDS Group or another Tracking Group to the Aerial Group, the TDS Group or such other Tracking Group, as the case may be, shall no longer include the cash, securities or other property so transferred and the Aerial Group shall include such cash, securities or other property. "AERIAL GROUP COMMON SHARES," shall mean the Aerial Communications Group Common Shares, par value $0.01 per share. "AVAILABLE DIVIDEND AMOUNT," as of any date, shall mean, with respect to any Tracking Group, the product of the Outstanding Interest Fraction of such Tracking Group and either (a) the excess of (i) an amount equal to the total assets of such Tracking Group less the total liabilities (not including preferred stock) of such Tracking Group as of such date over (ii) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding shares of such class of Tracking Stock of such Tracking Group and each class or series of Preferred Shares or Undesignated Shares attributed to such Tracking Group or (b) in case there is no such excess, an amount equal to Corporation Earnings (Losses) attributable to such Tracking Group (if positive) for the fiscal year in which such date occurs and/or the preceding fiscal year. The Available Dividend Amount for a Tracking Group is intended to be similar to an amount equal to the product of the Outstanding Interest Fraction and the amount that would be legally available for the payment of dividends on shares of Tracking Stock under Delaware law if the related Tracking Group were a separate Delaware corporation. The "Available Dividend Amount" as of any date, shall mean, with respect to the TDS Group, the greater of (x) the amount of all surplus (as defined in the DGCL) of the Corporation or, if there is no surplus, the net profits (as contemplated by the DGCL) of the Corporation for the fiscal year in which such date occurs and/or the preceding fiscal year (if positive), less the sum of the Available Dividend Amounts of all of the Tracking Groups, or (y) an amount equal to the sum of the Retained Interest Available Dividend Amounts (if positive) with respect to all of the Tracking Groups, plus, without duplication, either (a) the excess of (i) an amount equal to the total assets of the TDS Group less the total liabilities (not including preferred stock) of the TDS Group as of such date over (ii) the aggregate par value of, or any greater amount determined to be capital in respect of, all outstanding Series A Common Shares, Common Shares and any issued Special Common Shares, and each class or series of Preferred Shares or Undesignated Shares attributed to the TDS Group or (b) in case there is no such excess, an amount equal to Corporation Earnings (Losses) attributable to the TDS Group (if positive) for the fiscal year in which such date occurs and/or the preceding fiscal year. "BOARD" shall mean the Board of Directors of the Corporation. "CELLULAR GROUP" shall mean, as of any date that any shares of Cellular Group Stock have been issued and continue to be outstanding: (a) the interest of the Corporation or any of its subsidiaries in U.S. Cellular and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and liabilities, except any of such businesses, assets or liabilities which have been attributed by the Board to another Group; B-21 (b) all businesses, assets and liabilities of the Corporation or any of its subsidiaries to the extent attributed to the Cellular Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of U.S. Cellular or any of its subsidiaries (or a successor as described in clause (a) of this sentence); (c) all businesses, assets and liabilities contributed or otherwise transferred to the Cellular Group from the TDS Group or any of the other Tracking Groups; (d) the interest of the Corporation or any of its subsidiaries in the businesses, assets and liabilities acquired by the Corporation or any of its subsidiaries for the Cellular Group, as determined by the Board; (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Cellular Group in such other Tracking Group; and (f) such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be determined in good faith by the Board. If a Retained Interest in the Cellular Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Cellular Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Cellular Group, other than Cellular Group Common Shares, the TDS Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Cellular Group's Retained Interest Fraction and the denominator of which is the Cellular Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Cellular Group Common Shares so distributed to the holders of Cellular Group Common Shares, the Cellular Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the TDS Group. If an Inter-Group Interest in the Cellular Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Cellular Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Cellular Group other than Cellular Group Common Shares, the Tracking Group holding the Inter-Group Interest in the Cellular Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Inter-Group Interest Fraction in the Cellular Group in effect immediately prior to the record date for such dividend or other distribution and the denominator of which is equal to the Cellular Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Cellular Group Common Shares so distributed to the holders of Cellular Group Common Shares, the Cellular Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the Tracking Group holding the Inter-Group Interest in the Cellular Group. From and after any transfer of cash, securities or other property from the Cellular Group to the TDS Group or to another Tracking Group, the Cellular Group shall no longer include the cash, securities or other property so transferred and the TDS Group or such other Tracking Group, as the case may be, shall include such cash, securities or other property, and from and after any transfer of cash, securities or other property from the TDS Group or another Tracking Group to the Cellular Group, the TDS Group or such other Tracking Group, as the case may be, shall no longer include the cash, securities or other property so transferred and the Cellular Group shall include such cash, securities or other property. "CELLULAR GROUP COMMON SHARES" means the United States Cellular Group Common Shares, par value $0.01 per share. "COMMITTED ACQUISITION SHARES" as of any date, shall mean (a) Common Shares that the Corporation had, prior to such date, agreed to issue in connection with acquisitions, but as of such date had not been issued, and (b) Common Shares that are issuable upon conversion, exercise or exchange of Convertible Securities that the Corporation had, prior to such date, agreed to issue in connection with acquisitions, but as of such date had not been issued, in each case including obligations of the Corporation to issue Cellular Group Common Shares, Telecom Group Common Shares and Aerial Group Common Shares as a result of the Distribution pursuant to anti-dilution provisions in the acquisition agreements providing for the issuance of Common Shares or Convertible Securities which are convertible into or exercisable or exchangeable for Common Shares, without duplication of any Common Shares issuable upon conversion, exercise or exchange of Convertible Securities. B-22 "COMMON STOCK" shall mean shares of capital stock of the Corporation designated as common stock, including Series A Common Shares, Common Shares, Special Common Shares, Cellular Group Common Shares, Telecom Group Common Shares and Aerial Group Common Shares. "CORPORATION EARNINGS (LOSS)" for any period, with respect to any class of Common Stock, shall mean the net earnings or loss of the related Group for such period determined on a basis consistent with the determination of the net earnings or loss of such Group for such period as presented in the combined financial statements of such Group for such period, including income and expenses of the Corporation attributed to the operations of such Group on a substantially consistent basis, including without limitation, corporate, general and administrative costs, net interest and income taxes. "CONVERTIBLE SECURITIES" shall mean any securities of the Corporation, including preferred stock, options and other rights (other than Common Stock), that are convertible into, exchangeable for or evidence the right to purchase any shares of any class or series of Common Stock, whether upon conversion, exercise or exchange, pursuant to anti-dilution provisions of such securities or otherwise. "DGCL" shall mean the Delaware General Corporation Law. "DISTRIBUTION" shall mean the contemplated initial distribution of Cellular Group Shares, Telecom Group Shares and/or Aerial Group Shares or any part thereof to be made to the holders of Common Shares and Series A Common Shares. "FAIR VALUE OF NET PROCEEDS" shall mean, as of any date, with respect to any Disposition of any of the businesses, assets and liabilities of a Tracking Group, an amount, if any, equal to the fair value of the gross proceeds of such Disposition less any payment of, or reasonable provision for, (a) any taxes related to such Disposition or in respect of any resulting dividend or redemption, including deferred taxes, but not including any deductions or other offsets which may be available to the Corporation which are not attributed to such Tracking Group, (b) any transaction costs, including, without limitation, any legal, investment banking and accounting fees and expenses and (c) any liabilities and other obligations (contingent or otherwise) of, or attributed to, that Tracking Group, including, without limitation, obligations with respect to committed acquisitions and Convertible Securities attributed to the Tracking Group, any indemnity or guarantee obligations incurred in connection with the Disposition or any liabilities for future purchase price adjustments, and any preferential amounts plus any accumulated and unpaid dividends and other obligations in respect of any class or series of Preferred Shares or Undesignated Shares attributed to such Tracking Group (without duplication). For purposes of this definition, any businesses, assets and liabilities of the affected Tracking Group which the Board determines to retain after such Disposition shall be deemed to constitute "reasonable provision" for such amount of taxes, costs and liabilities (contingent or otherwise). To the extent the proceeds of any Disposition include any securities or other property other than cash, the Board shall determine the fair value of such securities or property, including for the purpose of determining the comparable value thereof if the Board determines to pay a dividend or redemption price in cash or securities or other property as provided in this Restated Certificate of Incorporation. "GROUP" shall mean the Aerial Group, the Cellular Group, the Telecom Group and the TDS Group and any other Group so designated by the Board. "INITIAL ISSUANCE DATE" shall mean, with respect to a class of stock, the initial date of issuance of shares of such class of stock. "INTER-GROUP INTEREST," as of any date, shall mean that part of the Corporation's equity interest in a Tracking Group which is deemed to be held (or subsequently acquired) by the Corporation and attributed to a Group other than the TDS Group. A Tracking Group may not hold an Inter-Group interest in the TDS Group. "INTER-GROUP INTEREST FRACTION," as of any date, with respect to any Investor Group, shall mean a fraction the numerator of which is the Number of Shares issuable with Respect to Inter-Group Interest in an Issuer Group by such Investor Group as of such date and the denominator of which is the sum of (a) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest in such Issuer Group by all Investor Groups as of such date, (b) the aggregate number of shares of Tracking Stock of such Issuer Group outstanding as of such date and (c) the Number of Shares Issuable with Respect to Retained Interest in such Issuer Group as of such date. "ISSUER GROUP" shall mean a Tracking Group in which there is an Inter-Group Interest by an Investor Group. "INVESTOR GROUP" means a Tracking Group which holds an Inter-Group Interest in an Issuer Group. B-23 "MARKET CAPITALIZATION" of any class or series of capital stock of the Corporation on any Trading Day shall mean the product of (a) the Market Value of one share of such class or series on such Trading Day and (b) the number of shares of such class or series outstanding at the close of business on such Trading Day. "MARKET VALUE" of a share of any class or series of capital stock of the Corporation on any day shall mean the average of the high and low reported sale prices regular way of a share of such class or series on such day (if such day is a Trading Day, and if such day is not a Trading Day, on the Trading Day immediately preceding such day) or in case no such reported sale takes place on such Trading Day the average of the reported closing bid and asked prices regular way of a share of such class or series on such Trading Day, in either case on the American Stock Exchange or such other national securities exchange or the Nasdaq National Market on which such class or series is listed, or if the shares of such class or series are not quoted on the American Stock Exchange or any other national securities exchange or the Nasdaq National Market on such Trading Day, the average of the closing bid and asked prices of a share of such class or series in the over-the-counter market on such Trading Day as furnished by any New York Stock Exchange member firm selected from time to time by the Corporation, or if such closing bid and asked prices are not made available by any such New York Stock Exchange member firm on such Trading Day, the market value of a share of such class or series as determined by the Board; PROVIDED, that if the Special Common Shares or Series A Common Shares are not trading on a national securities exchange or the Nasdaq National Market, and if bid and asked prices are not available for the Special Common Shares or the Series A Common Shares, the Market Value of a Special Common Share or a Series A Common Share, as applicable, shall be deemed to be the same as a Common Share for purposes of determining Market Value under Sections 8, 10 and 12 hereof; and PROVIDED FURTHER, that for purposes of determining Market Values under Sections 8, 10 and 12 hereof (a) the "Market Value" of a share of any series of Common Stock on any day prior to the "ex" date or any similar date for any dividend or distribution paid or to be paid with respect to such series of Common Stock shall be reduced by the fair market value of the per share amount of such dividend or distribution as determined by the Board and (b) the "Market Value" of a share of any series of Common Stock on any day prior to (i) the effective date of any subdivision (by stock split or otherwise) or combination (by reverse stock split or otherwise) of outstanding shares of such series of Common Stock or (ii) the "ex" date or any similar date for any dividend or distribution with respect to any such series of Common Stock in shares of such series of Common Stock, shall be appropriately adjusted to reflect such subdivision, combination, dividend or distribution. "MERGER," shall mean the merger of TDS Iowa with and into the Corporation. "NUMBER OF SHARES ISSUABLE WITH RESPECT TO INTER-GROUP INTEREST" shall mean, with respect to any Tracking Group (for purposes of this definition, the ("Issuer Group"), the number of shares of Tracking Stock of the Issuer Group (the ("Issuer Group Shares") which are attributed to, and that could be issued or sold by the Corporation for the benefit of, another Tracking Group (for purposes of this definition, the ("Investor Group"). Initially, the Number of Shares Issuable with Respect to Inter-Group Interest in each Tracking Group shall be zero, and shall from time to time thereafter, as applicable, be: (a) adjusted as appropriate to reflect subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of the Issuer Group Shares and dividends or distributions of Issuer Group Shares to the holders thereof and other reclassifications of the Issuer Group Shares or similar transactions; (b) decreased (but not to less than zero) by (i) the aggregate number of Issuer Group Shares issued or sold by the Corporation, for cash, securities or other property, the proceeds of which are attributed to the Investor Group, (ii) the aggregate number of Issuer Group Shares issued or delivered upon conversion, exercise or exchange of Convertible Securities, the proceeds of which are attributed to the Investor Group, (iii) the aggregate number of Issuer Group Shares issued or delivered by the Corporation as a dividend or distribution to holders of shares of the Investor Group, (iv) the aggregate number of Issuer Group Shares issued or delivered upon the conversion, exercise or exchange of any Convertible Securities issued or delivered by the Corporation as a dividend or distribution or by reclassification or exchange to holders of shares of the Investor Group, and (v) the aggregate number of Issuer Group Shares (rounded, if necessary, to the nearest whole number), equal to the aggregate fair value (as determined by the Board) of assets or properties attributed to the Issuer Group that are transferred from the Issuer Group to the Investor Group in consideration of a reduction in the Number of Shares Issuable with Respect to Inter-Group Interest by the Investor Group in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such transfer; (c) increased by (i) the aggregate number of any Issuer Group Shares which are retired or otherwise cease to be outstanding following their purchase with funds attributed to the Investor Group and (ii) a number B-24 (rounded, if necessary, to the nearest whole number), equal to the fair value (as determined by the Board) of assets or properties theretofore attributed to the Investor Group that are contributed to the Issuer Group in consideration of an increase in the Number of Shares Issuable with Respect to Inter-Group Interest in the Issuer Group by the Investor Group, divided by the Market Value of one Issuer Group Share as of the date of such contribution; and (d) adjusted as may be appropriate to reflect other transactions between the Issuer Group and the Investor Group, as determined in good faith by the Board. Whenever a change in the Number of Shares Issuable with Respect to Inter-Group Interest with respect to any Group occurs, the Corporation shall prepare and file a statement of such change with the Secretary of the Corporation. "NUMBER OF SHARES ISSUABLE WITH RESPECT TO RETAINED INTEREST" shall mean the number of shares of a class of Tracking Stock of a Tracking Group (for purposes of this definition, the "Issuer Group") that are attributed to, and could be issued or sold by the Corporation for the account of, the TDS Group in respect of a Retained Interest by the TDS Group in such Issuer Group. The Number of Shares Issuable with Respect to Retained Interest shall initially be determined by the Board, and shall from time to time thereafter, as applicable, be: (a) adjusted as appropriate to reflect subdivisions (by stock split or otherwise) and combinations (by reverse stock split or otherwise) of the Issuer Group Shares, and dividends or distributions of Issuer Group Shares to the holders thereof and other reclassifications of Issuer Group Shares or similar transactions; (b) decreased (but not to less than zero) by (i) the aggregate number of Issuer Group Shares issued or sold by the Corporation, for cash, securities or other property, the proceeds of which are attributed to the TDS Group, (ii) the aggregate number of Issuer Group Shares issued or delivered upon conversion, exercise or exchange of Convertible Securities (including Pre-Distribution Convertible Securities), the proceeds of which are attributed to the TDS Group, (iii) the aggregate number of Issuer Group Shares issued or delivered by the Corporation as a dividend or distribution to holders of Common Shares, Series A Common Shares or Special Common Shares, (iv) the aggregate number of Issuer Group Shares issued or delivered upon the conversion, exercise or exchange of any Convertible Securities issued or delivered by the Corporation as a dividend or distribution or by reclassification or exchange to holders of shares of Common Shares, Series A Common Shares or Special Common Shares, and (v) the aggregate number of Issuer Group Shares (rounded, if necessary, to the nearest whole number), equal to the aggregate fair value (as determined by the Board) of assets or properties attributed to the Issuer Group that are transferred from the Issuer Group to the TDS Group in consideration of a reduction in the Number of Shares Issuable with Respect to Retained Interest in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such transfer; (c) increased by (i) the aggregate number of any Issuer Group Shares which are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group and (ii) a number (rounded, if necessary, to the nearest whole number), equal to the fair value (as determined by the Board) of assets or properties theretofore attributed to the TDS Group that are contributed to the Issuer Group in consideration of an increase in the Number of Shares Issuable with Respect to Retained Interest in the Issuer Group, divided by the Market Value of one Issuer Group Share as of the date of such contribution; and (d) adjusted as may be appropriate to reflect other transactions between the Issuer Group and the TDS Group, as determined in good faith by the Board. Whenever a change in the Number of Shares Issuable with Respect to Retained Interest in any Tracking Group occurs, the Corporation shall prepare and file a statement of such change with the Secretary of the Corporation. "NUMBER OF SHARES ISSUABLE TO THIRD PARTIES" shall mean, as of any date, the number of shares of any class or series of Common Stock (such shares are herein referred to as "Shares Issuable to Third Parties") which are issuable (a) as Committed Acquisition Shares, (b) pursuant to the conversion, exercise or exchange of Convertible Securities or (c) otherwise, other than shares which are deemed to be issuable with respect to a Retained Interest or with respect to an Inter-Group Interest, as may be determined in good faith by the Board considering any relevant factors, including whether the holders of Convertible Securities would derive an economic benefit from the conversion, exercise or exchange of such Convertible Securities which exceeds the economic cost thereof or the economic benefit of not converting, exercising or exchanging such Convertible Securities. B-25 "OUTSTANDING INTEREST FRACTION," as of any date, shall mean, with respect to any class of Tracking Stock, a fraction the numerator of which is the aggregate number of shares of such class of Tracking Stock outstanding on such date and the denominator of which is the sum of (a) such aggregate number of shares, (b) the Number of Shares Issuable with Respect to Retained Interest of such class of Tracking Stock as of such date and (c) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any, as of such date. "PRE-81 PREFERRED SHARES," as of any date shall mean the series of Preferred Shares of the Corporation which are issued in the Merger in exchange for series of Preferred Shares of TDS Iowa that were originally issued before October 31, 1981, as identified in Section A of Article IV. "PRE-DISTRIBUTION CONVERTIBLE SECURITIES" shall mean Convertible Securities that are outstanding on the record date for the Distribution and are, prior to such date, convertible into or exercisable or exchangeable for either Common Shares or Series A Common Shares; PROVIDED, if the record date for the Distribution of any of the Cellular Group Shares, Telecom Group Shares or Aerial Group Shares is not the same date, the Board shall determine which, if any, Convertible Securities (or proportion thereof) that are issued after the first record date for any part of the Distribution, shall represent Pre-Distribution Convertible Securities. "POST-81 PREFERRED SHARES," as of any date shall mean the series of Preferred Shares of the Corporation which are issued in the Merger in exchange for series of Preferred Shares of TDS Iowa that were originally issued after October 31, 1981, as identified in Section A of Article IV. "QUALIFYING SUBSIDIARY" or "QUALIFYING SUBSIDIARIES" as of any date shall mean a Subsidiary or Subsidiaries of the Corporation (a) in which (i) the Corporation's ownership and voting interest is sufficient to satisfy the requirements of the Internal Revenue Service for a distribution of the Corporation's interest in such Subsidiary to the holders of Common Stock of the Corporation that is tax-free to such holders or (ii) the Corporation owns, directly or indirectly, all of the issued and outstanding capital stock and (b) which hold(s) all of the assets and liabilities attributed to a Tracking Group. "RELATED BUSINESS TRANSACTION" shall mean any Disposition of all or substantially all of the properties and assets of a Tracking Group in which the Corporation receives as proceeds of such Disposition primarily equity securities (including, without limitation, capital stock, convertible securities, partnership or limited partnership interests and other types of equity securities, without regard to the voting power or contractual or other management or governance rights related to such equity securities) of the purchaser or acquiror of such assets and properties of such Tracking Group, any entity which succeeds (by merger, formation of a joint venture enterprise or otherwise) to such assets and properties of such Tracking Group or a third party issuer, which purchaser, acquiror or other issuer is engaged or proposes to engage primarily in one or more businesses similar or complementary to the businesses conducted by such Tracking Group prior to such Disposition, as determined in good faith by the Board. "RETAINED INTEREST AVAILABLE DIVIDEND AMOUNT," as of any date, shall mean, with respect to a Tracking Group, an amount (not less than zero) equal to the product of (a) a fraction, the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction with respect to such Tracking Group multiplied by (b) the Available Dividend Amount of such Tracking Group. "RETAINED INTEREST FRACTION," as of any date, shall mean, with respect to any class of Tracking Stock, a fraction the numerator of which is the Number of Shares Issuable with Respect to Retained Interest of such class of Tracking Stock as of such date and the denominator of which is the sum of (a) such Number of Shares Issuable with Respect to Retained Interest as of such date, (b) the aggregate Number of Shares Issuable with Respect to Inter-Group Interest by all other Tracking Groups in such Tracking Stock, if any, as of such date, and (c) the aggregate number of shares of such class of Tracking Stock outstanding as of such date. "SHARES ISSUABLE TO THIRD PARTIES" shall have the meaning set forth in the definition of "Number of Shares Issuable to Third Parties." "SUBSIDIARY" shall mean, with respect to any person or entity, any corporation or partnership 50% or more of whose outstanding voting securities or partnership interests, as the case may be, are directly or indirectly owned by such person or entity. "TDS GROUP" shall mean, as of any date that any shares of any class or series of Tracking Stock have been issued and continue to be outstanding: B-26 (a) the interest of the Corporation and all of its subsidiaries, (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets) and their respective properties and assets, other than (except as provided in paragraph (e) of this definition) the interest of the Corporation and its subsidiaries in Aerial and its subsidiaries, TDS Telecom and its subsidiaries, U.S. Cellular and its subsidiaries, and any other subsidiaries attributed by the Board to a Group other than the TDS Group (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with Related Business Transactions) and their respective businesses, assets and liabilities; (b) all businesses, assets and liabilities of the Corporation or any of its subsidiaries to the extent attributed to the TDS Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of the TDS Group or any of its subsidiaries (or a successor as described in clause (a) of this sentence); (c) all businesses, assets and liabilities contributed or otherwise transferred to the TDS Group from any of the Tracking Groups; (d) the interest of the Corporation or any of its subsidiaries in the businesses, assets and liabilities acquired by the Corporation or any of its subsidiaries for the TDS Group, as determined by the Board; (e) a proportionate undivided interest in each and every business, asset and liability attributed to a Tracking Group equal to the Retained Interest Fraction of the TDS Group in such other Tracking Group; and (f) such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be determined in good faith by the Board. If a Retained Interest in any Tracking Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to holders of Tracking Stock of such Tracking Group payable in cash, securities or other property of the Corporation attributed to such Tracking Group, other than shares of Tracking Stock, the TDS Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is such Tracking Group's Retained Interest Fraction and the denominator of which is such Tracking Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than shares of Tracking Stock so distributed to the holders of such shares of Tracking Stock, such Tracking Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the TDS Group. From and after any transfer of cash, securities or other property from a Tracking Group to the TDS Group, such Tracking Group shall no longer include the cash, securities or other property so transferred and the TDS Group shall include such cash, securities or other property and from and after any transfer of cash, securities or other property from the TDS Group to a Tracking Group, the TDS Group shall no longer include the cash, securities or other property so transferred and such Tracking Group shall include such cash, securities or other property. "TDS GROUP SHARES" shall mean the Series A Common Shares, Common Shares and any issued Special Common Shares of the Corporation and any other shares of capital stock designated by the Board as TDS Group Shares. "TDS IOWA" shall mean Telephone and Data Systems, Inc., an Iowa corporation. "TDS TELECOM" shall mean TDS Telecommunications Corporation, a Delaware corporation. "TELECOM GROUP" shall mean, as of any date that any shares of Telecom Group Stock have been issued and continue to be outstanding: (a) the interest of the Corporation or any of its subsidiaries in TDS Telecom and its subsidiaries (including any successor thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with a Related Business Transaction) and their respective businesses, assets and liabilities, except any of such businesses, assets or liabilities which have been attributed by the Board to another Group; (b) all businesses, assets and liabilities of the Corporation or any of its subsidiaries to the extent attributed to the Telecom Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of TDS Telecom or any of its subsidiaries (or a successor as described in clause (a) of this sentence); B-27 (c) all businesses, assets and liabilities contributed or otherwise transferred to the Telecom Group from the TDS Group or any of the other Tracking Groups; (d) the interest of the Corporation or any of its subsidiaries in the businesses, assets and liabilities acquired by the Corporation or any of its subsidiaries for the Telecom Group, as determined by the Board; (e) a proportionate undivided interest in each and every business, asset and liability attributed to another Tracking Group equal to the Inter-Group Interest Fraction, if any, of the Telecom Group in such other Tracking Group; and (f) such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be determined in good faith by the Board. If a Retained Interest in the Telecom Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Telecom Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Telecom Group, other than Telecom Group Common Shares, the TDS Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Telecom Group's Retained Interest Fraction and the denominator of which is the Telecom Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Telecom Group Common Shares so distributed to the holders of Telecom Group Common Shares, the Telecom Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the TDS Group. If an Inter-Group Interest in the Telecom Group is then existing and if the Corporation shall pay a dividend or make any other distribution with respect to Telecom Group Common Shares payable in cash, securities or other property of the Corporation attributed to the Telecom Group other than Telecom Group Common Shares, the Tracking Group holding the Inter-Group Interest in the Telecom Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is the Inter-Group Interest Fraction in the Telecom Group in effect immediately prior to the record date for such dividend or other distribution and the denominator of which is equal to the Telecom Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than Telecom Group Common Shares so distributed to the holders of Telecom Group Common Shares, the Telecom Group shall no longer include a corresponding ratable amount or fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the Tracking Group holding the Inter-Group Interest in the Telecom Group. From and after any transfer of cash, securities or other property from the Telecom Group to the TDS Group or to another Tracking Group, the Telecom Group shall no longer include the cash, securities or other property so transferred and the TDS Group or such other Tracking Group, as the case may be, shall include such cash, securities or other property, and from and after any transfer of cash, securities or other property from the TDS Group or another Tracking Group to the Telecom Group, the TDS Group or such other Tracking Group, as the case may be, shall no longer include the cash, securities or other property so transferred and the Telecom Group shall include such cash, securities or other property. "TELECOM GROUP COMMON SHARES" shall mean the TDS Telecommunications Group Common Shares, par value $0.01 per share. "TRACKING GROUP" shall mean the Aerial Group, the Cellular Group and the Telecom Group, and any other business group designated as a Tracking Group by the Board. "TRACKING STOCK" shall mean the Aerial Group Common Shares, the Cellular Group Common Shares and the Telecom Group Common Shares, and any other shares of capital stock of the Corporation which the Board designates as Tracking Stock. "TRADING DAY" shall mean each weekday other than a day on which the relevant class of Common Stock of the Corporation is not traded on any national securities exchange or quoted on the Nasdaq Stock Market or on the over-the-counter market. "U.S. CELLULAR" shall mean United States Cellular Corporation, a Delaware corporation. B-28 20. DETERMINATIONS BY BOARD. The Board of Directors shall make such determinations with respect to the businesses, assets and liabilities to be attributed to the Groups, the items of income and expenses for purposes of determining the Corporation Earnings (Loss) attributable to the Groups, the application of the provisions of this Article IV to transactions to be engaged in by the Corporation and the powers, preferences and relative, participating, optional and other special rights of the holders of the classes of Common Stock, and the qualifications and restrictions thereon, provided by the Restated Certificate of Incorporation of the Corporation, as may be or become necessary or appropriate to the exercise of such powers, preferences and relative, participating, optional and other special rights, including, without limiting the foregoing, the determinations referred to in the following paragraphs of this paragraph 20. A record of any such determination shall be filed with the records of the actions of the Board of Directors. (a) Upon any acquisition by the Corporation or its subsidiaries of any assets or business, or any assumption of liabilities, outside of the ordinary course of business of any then existing Group, the Board of Directors shall determine whether such assets, business and liabilities (or an interest therein) shall be for the benefit of one Group or that an interest therein shall be partly for the benefit of one or more Groups. (b) Upon any issuance of any shares of Tracking Stock at a time when the Number of Shares Issuable with Respect to Retained Interest or the Number of Shares Issuable with Respect to Inter-Group Interest is more than zero, the Board of Directors shall determine, based on the use of the proceeds of such issuance and any other relevant factors, whether all or any part of the shares of such Tracking Stock so issued should reduce the Number of Shares Issuable with Respect to Retained Interest or the Number of Shares Issuable with Respect to Inter-Group Interest, as the case may be. (c) Upon any issuance by the Corporation or any subsidiary thereof of any Convertible Securities that are convertible into or exchangeable or exercisable for shares of a class of Tracking Stock, if at the time such Convertible Securities are issued the Number of Shares Issuable with Respect to Retained Interest or the Number of Shares Issuable with Respect to Inter-Group Interest is greater than zero, the Board of Directors shall determine whether, upon conversion, exchange or exercise of such Convertible Securities, the issuance of shares of such Tracking Stock pursuant thereto shall, in whole or in part, reduce the Number of Shares Issuable with Respect to Retained Interest or the Number of Shares Issuable with Respect to Inter-Group Interest, taking into consideration the use of the proceeds of such issuance of Convertible Securities and any other relevant factors. (d) Upon any repurchase by the Corporation or any subsidiary thereof of shares of any class of Tracking Stock, the Board of Directors shall determine, based on the source of funds used and any other relevant factors, whether all or any part of the shares of such Tracking Stock so purchased shall increase the Number of Shares Issuable with Respect to Retained Interest or the Number of Shares Issuable with Respect to Inter-Group Interest, as the case may be. If the Board designates any new class or series of capital stock, the Board shall make such determinations under this Restated Certificate of Incorporation as the Board determines may be necessary or appropriate in connection therewith. Subject to applicable law, any determinations made in good faith by the Board under any provision of this Article IV or any certificate of designation filed pursuant hereto, and any determinations with respect to any Group or the rights of holders of any class or series of capital stock made pursuant to or in furtherance of this Article IV, shall be final and binding on all shareholders. ARTICLE V The address of the registered office of the Corporation is Corporation Trust Company, in the County of New Castle, and the name of its registered agent at such address is Corporation Trust Center, 1209 Orange Street, Wilmington, Delaware 19801. ARTICLE VI A. NUMBER AND CLASSES OF DIRECTORS. The number of directors of the Corporation shall be fixed by or pursuant to the Bylaws of the Corporation, but shall not be less than three. The directors shall be divided into three classes and each class shall be as nearly equal in number as possible. The term of office of directors of the second class shall expire at the annual meeting of shareholders in 1998; that of the third class shall expire at the annual meeting of shareholders in 1999; and that of the first class shall expire at the annual meeting of shareholders in B-29 2000. At each annual meeting after such classification, the number of directors equal to the number of the class, the term of which expired at the time of such meeting, shall be elected to hold office until the third succeeding annual meeting of shareholders. If the number of directors fixed by or pursuant to the Bylaws of the Corporation is changed at any time, any newly created directorships or any decrease in directorships shall be so apportioned among the classes by the Board so as to make all classes as nearly equal in number as possible; PROVIDED, HOWEVER, that no decrease in the number of directors shall shorten the term of any incumbent director. B. REMOVAL. Any one or more of or all of the directors may be removed with cause only by a vote of the holders of at least a majority of the voting power of shares then entitled to vote in the election of such directors, and any one or more or all of the directors may be removed without cause only by a vote of the holders of at least 80% of the voting power of the shares then entitled to vote in the election of such directors. C. BALLOTS. The election of directors need not be by written ballot unless the Bylaws of the Corporation so provide. ARTICLE VII To the extent permitted by the DGCL or any other applicable law presently or hereafter in effect, no director of the Corporation shall be personally liable to the Corporation or its shareholders for monetary damages for breach of any fiduciary duty owed to the Corporation or its shareholders; PROVIDED that this provision shall not relieve a director from liability (a) for any breach of the director's duty of loyalty to the Corporation or its shareholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (c) for transactions from which the director derives an improper personal benefit or (d) under Section 174 of the DGCL. This Article shall not apply to acts or omissions occurring prior to its effectiveness. No amendment to, expiration of or repeal of this Article shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment, expiration or repeal. ARTICLE VIII The Board of the Corporation, when evaluating any proposal or offer of another party to (a) make a tender or exchange offer for any equity security of the Corporation; (b) merge or consolidate the Corporation with another corporation; or (c) purchase or otherwise acquire all or substantially all of the properties and assets of the Corporation may, in connection with the exercise of its judgment in determining what is in the best interests of the Corporation and its shareholders, give due consideration to all factors the directors deem relevant, including without limitation (i) the effects on the customers of the Corporation or any of its subsidiaries or on such other constituencies of the Corporation as the Board considers relevant under the circumstances; (ii) not only the consideration being offered (after taking into account corporate and shareholder taxes) in relation to the then current market price for the Corporation's outstanding shares of capital stock, but also the Board's estimate of the future value of the Corporation (including the unrealized value of its properties and assets) as an independent going concern; (iii) the purpose of the Corporation, and any of its subsidiaries, to provide quality products and services on a long-term basis; and (iv) the long-term as well as short-term interests of the Corporation and its shareholders, including the possibility that such interests may be best served by the continued independence of the Corporation. If, on the basis of such factors, the Board so determines that a proposal or offer to acquire or merge the Corporation, or to sell its assets, is not in the best interests of the Corporation, it may reject the proposal or offer. If the Board determines to reject any such proposal or offer, the Board shall have no obligation to facilitate, to remove any barriers to, or to refrain from impeding the proposal or offer except as may be required by applicable law. Except to the extent required by applicable law, the consideration of any or all of such factors shall not be a violation of the business judgment rule or of any duty of the directors to the shareholders or a group of shareholders, even if the directors reasonably determine that any such factor or factors outweigh the financial or other benefits to the Corporation or a shareholder or group of shareholders. ARTICLE IX In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to adopt, amend or repeal the Bylaws of the Corporation. B-30 ARTICLE X Subject to the last sentence of this paragraph, each person who is or was a director or officer of the Corporation, and each person who serves or served at the request of the Corporation as a director or officer of another enterprise, shall be indemnified by the Corporation in accordance with, and to the fullest extent authorized by, the DGCL as it may be in effect from time to time. The right of indemnity provided herein shall not be deemed exclusive of any other rights to which any person may be entitled under any Bylaw, agreement, vote of shareholders or directors, or otherwise. The Corporation may provide indemnification to any such person, by agreement or otherwise, on such terms and conditions as the Board of Directors may approve. Any agreement for indemnification of any director, officer, employee or other person may provide indemnification rights which are broader or otherwise differ from those set forth herein. In furtherance and not in limitation of the powers conferred by statute, the Board is expressly authorized to adopt, amend or repeal the Bylaws of the Corporation regarding the manner and conditions under which indemnification shall be provided hereunder by the Corporation and the extent thereof from time to time as deemed appropriate by the Board in the best interests of the Corporation. SECOND: The Board of Directors of the Corporation, at a meeting duly called at which a quorum existed, duly adopted resolutions proposing and approving and declaring advisable this Restated Certificate of Incorporation of the Corporation. THIRD: Pursuant to Section 228 of the DGCL, the adoption of this Restated Certificate of Incorporation was consented to in writing by the sole shareholder of the Corporation. FOURTH: This Restated Certificate of Incorporation was duly adopted in accordance with the provisions of sections 242 and 245 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Telephone and Data Systems, Inc. has caused this Restated Certificate to be signed by its President this day of , 1998. TELEPHONE AND DATA SYSTEMS, INC. By: -------------------------------------- LeRoy T. Carlson, Jr. PRESIDENT
B-31 ATTACHMENT I TO RESTATED CERTIFICATE OF INCORPORATION OF TELEPHONE AND DATA SYSTEMS, INC. INTRODUCTORY NOTE: This Attachment I to the Restated Certificate of Incorporation of Telephone and Data Systems, Inc., a Delaware corporation ("TDS Delaware"), describes the designations, rights, privileges and limitations of the series of Preferred Shares of TDS Delaware which will be issued in the Merger (as defined in the Restated Certificate of Incorporation) in exchange for Preferred Shares of Telephone and Data Systems, Inc., an Iowa corporation ("TDS Iowa"). Unless otherwise required by the context, for purposes of this Attachment I, (i) references to dates of issuance of any series of Preferred Shares shall mean the original dates of issuance of the related series of Preferred Shares of TDS Iowa, (ii) references to conversion rates of any series of Preferred Shares shall mean the conversion rates included in the original certificate of designation of such series by TDS Iowa, without giving effect to stock splits or other events after the original dates of issuance requiring adjustment to such conversion rates, and (iii) references to all conversion or redemption dates and periods shall be based on the original issuance date of each series of Preferred Shares by TDS Iowa. 1. $6.00 CUMULATIVE VOTING SERIES A PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this preferred stock shall be "$6.00 Cumulative Voting Series A Preferred Stock" (hereinafter referred to as "Series A Preferred Stock"). (b) DIVIDENDS--The holders of the Series A Preferred Stock shall be entitled to receive, when and as declared by the board of directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of six dollars ($6.00) per annum per share and no more. The dividends, when payable, shall be paid quarterly on the first days of January, April, July, and October in each year, before any dividends shall be declared or paid upon or set apart for the common stock of the Company for that year. Such dividends upon the preferred stock shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of six dollars ($6.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart but without interest, before any dividend shall be paid upon or set apart for the common stock. Whenever the full dividend upon the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the common stock may be declared by the board of directors out of the remainder of the assets available therefor. (c) REDEMPTION--The Corporation may, at the option of the board of directors, redeem the whole or any part of the outstanding Series A Preferred Stock at any time after January 3, 1974. If such redemption is made, the holders of any shares of Series A Preferred Stock redeemed shall be entitled to receive: $105.00 per share if redeemed on or before January 3, 1975; $104.50 if redeemed after January 3, 1975 but on or before January 3, 1976; $104.00 if redeemed after January 3, 1976 but on or before January 3, 1977; $103.50 if redeemed after January 3, 1977 but on or before January 3, 1978; $103.00 if redeemed after January 3, 1978 but on or before January 3, 1979; $102.50 if redeemed after January 3, 1979 but on or before January 3, 1980; $102.00 if redeemed after January 3, 1980 but on or before January 3, 1981; $101.50 if redeemed after January 3, 1981 but on or before January 3, 1982; $101.00 if redeemed after January 3, 1982 but on or before January 3, 1983; $100.50 if redeemed after January 3, 1983 but on or before January 3, 1984; $100.00 if redeemed after January 3, 1984; plus an amount equal to all dividends accrued and unpaid to the redemption date. BI-1 Notice of election to redeem shall be mailed to each holder of stock to be redeemed not less than thirty (30) days prior to the date upon which the stock is to be redeemed. In case less than all of the outstanding Series A Preferred Stock is to be redeemed, the amount to be redeemed and the method of effecting such redemption, whether by lot or pro rata or otherwise, may be determined by the board of directors. If on or before the redemption date named in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the preferred stock so called for redemption, then, notwithstanding that any certificate of the preferred stock so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of redemption so designated, and all rights with respect to such preferred stock so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and determine, except only the right of the holder to receive the redemption price therefor, but without interest. Stock redeemed pursuant to the provisions hereof or any Series A Preferred Stock purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the shares accordingly. (d) VOTING RIGHTS--The holders of the shares of Series A Preferred Stock shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any shares of Series A Preferred Stock shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class, whether such shares be hereby or hereafter authorized; and no holder of Series A Preferred Stock shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the board of directors may from time to time determine. (f) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series A Preferred Stock shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of the common stock, to receive out of the assets of the Company $100.00 per share of Series A Preferred Stock. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series A Preferred Stock, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of the Preferred Stock ratably in accordance with the respective distributive amount to which such holders shall be entitled. 2. $7.00 CUMULATIVE CONVERTIBLE VOTING SERIES B PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this preferred stock shall be "$7.00 Cumulative Convertible Voting Series B Preferred Stock" (hereinafter referred to as "Series B Preferred Stock"). (b) DIVIDENDS--The holders of the Series B Preferred Stock shall be entitled to receive, when and as declared by the board of directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of seven dollars ($7.00) per annum per share and no more. The dividends, when payable, shall be paid quarterly on the first days of March, June, September and December in each year, before any dividends shall be declared or paid upon or set apart for the common stock of the Company for that year. Such dividends upon the Series B Preferred Stock shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of seven dollars ($7.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart but without interest, before any dividend shall be paid upon or set apart for the common stock. Provided, however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during such prior dividend periods, and further provided, that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the common stock may be declared by the board of directors out of the remainder of the assets available therefor. BI-2 (c) REDEMPTION--The Corporation may, at the option of the board of directors, redeem the whole or any part of the outstanding Series B Preferred Stock at any time commencing five years after the date of issuance. If such redemption is made, the holders of any shares of Series B Preferred Stock redeemed shall be entitled to receive $100 per share plus an amount equal to all dividends accrued and unpaid to the redemption date. Notice of election to redeem shall be mailed to each holder of Series B Preferred Stock to be redeemed not less than thirty (30) days prior to the date upon which such stock is to be redeemed. In case less than all of the outstanding Series B Preferred Stock is to be redeemed, the amount to be redeemed and the method of effecting such redemption, whether by lot or pro rata or otherwise, may be determined by the board of directors. If on or before the redemption date named in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the Series B Preferred Stock so called for redemption, then, notwithstanding that any certificate of the Series B Preferred Stock so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of redemption so designated, and all rights with respect to such Series B Preferred Stock so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and terminate, except only the right of the holder to receive the redemption price therefor, but without interest. Stock redeemed pursuant to the provisions hereof or any Series B Preferred Stock purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the shares accordingly. (d) VOTING RIGHTS--The holders of the shares of Series B Preferred Stock shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock and the holders of other series of the preferred stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any shares of Series B Preferred Stock shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series B Preferred Stock shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the board of directors may from time to time determine. (f) CONVERSION-- (1) The Series B Preferred Stock shall be convertible into Common Stock as hereinafter provided, and, when and as so converted, such Series B Preferred Stock shall be canceled and retired and shall not be reissued as such. Any holder of the Series B Preferred Stock may at any time prior to five years from the date of issuance convert such stock into full shares of the Common Stock of the Corporation at the rate of ten (10) shares of Common Stock for each share of Series B Preferred Stock. On presentation and surrender to the Corporation at its Offices of the certificates for shares of the Series B Preferred Stock to be converted, the holder of such stock shall be entitled to receive in exchange therefor certificates for shares of the fully paid and non-assessable Common Stock of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series B Preferred Stock in the manner aforesaid shall not affect the right of the holder of such stock to receive dividends accrued but unpaid on such shares as of the dividend payment date immediately prior to conversion. (2) The number of shares of Common Stock into which each share of Series B Preferred Stock is convertible, shall be subject to adjustment from time to time as in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Stock in shares of the Corporation, (ii) subdivide its outstanding Common Stock, (iii) combine the outstanding Common Stock into a smaller number of shares, or (iv) issue by reclassification of its Common Stock (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each share of Series B Preferred Stock shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth of a common share; provided, however, that any BI-3 adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Stock, solely for the purpose of issue upon conversion of shares of Series B Preferred Stock as herein provided, such number of shares of Common Stock as shall then be issuable upon the conversion of all outstanding shares of Series B Preferred Stock. (4) Fractional shares of Common Stock shall not be issued upon conversion of Series B Preferred Stock nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (f), the term "Common Stock" shall mean (A) the class of stock designated as the Common Stock of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of change in par value, or from par value to no par value, or from no par value to par value. (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series B Preferred Stock shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of the common stock, to receive out of the assets of the Company $100.00 per share of Series B Preferred Stock. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series B Preferred Stock, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of the Preferred Stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 3. 6.00 CUMULATIVE CONVERTIBLE VOTING SERIES D PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this preferred stock shall be $6.00 Cumulative Convertible Voting Series D Preferred Stock (hereinafter referred to as "Series D Preferred Stock"). (b) DIVIDENDS--The holders of the Series D Preferred Stock shall be entitled to receive, when and as declared by the board of directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of six dollars ($6.00) per annum per share and no more. The dividends, when payable, shall be paid quarterly on the first days of March, June, September, and December in each year, before any dividends shall be declared or paid upon or set apart for the common stock of the Company for that year. Such dividends upon the Series D Preferred Stock shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of six dollars ($6.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart but without interest, before any dividend shall be paid upon or set apart for the common stock. Provided, however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during said prior dividend periods, and further provided, that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the common stock may be declared by the board of directors out of the remainder of the assets available therefor. (c) REDEMPTION--The Corporation may, at the option of the board of directors, redeem the whole or any part of the outstanding Series D Preferred Stock at any time commencing ten years after the date of issuance. If such redemption is made, the holders of any shares of Series D Preferred Stock redeemed shall be entitled to receive $100 per share plus an amount equal to all dividends accrued and unpaid to the redemption date. Notice of election to redeem shall be mailed to each holder of Series D Preferred Stock to be redeemed not less than thirty (30) days prior to the date upon which such stock is to be redeemed. In case less than all of the outstanding Series D Preferred Stock is to be redeemed, the amount to be redeemed and the method of effecting such redemption, whether by lot or pro rata or otherwise, may be determined by the board of directors. If on or before the redemption date named in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the Series D Preferred BI-4 Stock so called for redemption then, notwithstanding that any certificate of the Series D Preferred Stock so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of redemption so designated, and all rights with respect to such Series D Preferred Stock so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and terminate, except only the right of the holder to receive the redemption price therefor, but without interest. Stock redeemed pursuant to the provisions hereof or any Series D Preferred Stock purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the shares accordingly. (d) VOTING RIGHTS--The holders of the shares of Series D Preferred Stock shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock and the holders of other series of the preferred stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any shares of Series D Preferred Stock shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series D Preferred Stock shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the board of directors may from time to time determine. (f) CONVERSION-- (1) The Series D Preferred Stock shall be convertible into Common Stock as hereinafter provided and, when and as so converted, such Series D Preferred Stock shall be canceled and retired and shall not be reissued as such. Any holder of the Series D Preferred Stock may at any time commencing two (2) years and terminating upon the expiration of ten (10) years from the date of issuance convert such stock into full shares of the Common Stock of the Corporation at the rate of ten (10) shares of Common Stock for each share of Series D Preferred Stock. On presentation and surrender to the Corporation at its offices of the certificates for shares of the Series D Preferred Stock to be converted, the holder of such stock shall be entitled to receive in exchange therefor certificates for shares of the fully paid and non-assessable Common Stock of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series D Preferred Stock in the manner aforesaid shall not affect the right of the holder of such stock to receive dividends accrued but unpaid on such shares as of the dividend payment date immediately prior to conversion. (2) The number of shares of Common Stock into which each share of Series D Preferred Stock is convertible, shall be subject to adjustment from time to time as in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Stock in shares of the Corporation, (ii) subdivide its outstanding Common Stock, (iii) combine the outstanding Common Stock into a smaller number of shares, or (iv) issue by reclassification of its Common Stock (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each share of Series D Preferred Stock shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth of a share of Common Stock; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Stock, solely for the purpose of issue upon conversion of shares of Series D Preferred Stock as herein provided, such number of shares of Common Stock as shall then be issuable upon the conversion of all outstanding shares of Series D Preferred Stock. (4) Fractional shares of Common Stock shall not be issued upon conversion of Series D Preferred Stock nor shall cash adjustments be made for fractional shares upon such conversion. BI-5 (5) For the purposes of this paragraph (f), the term "Common Stock" shall mean (A) the class of stock designated as the Common Stock of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of change in par value, or from par value to no par value, or from no par value to par value. (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series D Preferred Stock shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of the common stock, to receive out of the assets of the Company $100.00 per share of Series D Preferred Stock. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series D Preferred Stock, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of the Preferred Stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 4. $7.00 CUMULATIVE CONVERTIBLE VOTING SERIES G PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this preferred stock shall be $7.00 Cumulative Convertible Voting Series G Preferred Stock (hereinafter referred to as "Series G Preferred Stock"). (b) DIVIDENDS--The holders of the Series G Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of seven dollars ($7.00) per annum per share. The dividends, when payable, shall be paid quarterly on the first days of March, June, September and December in each year, before any dividends shall be declared or paid upon or set apart for the common stock of the Company for that year. Such dividends upon the Series G Preferred Stock shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of seven dollars ($7.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart before any dividend shall be paid upon or set apart for the common stock. Provided however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during said prior dividend periods, and further provided, that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the common stock may be declared by the Board of Directors out of the remainder of the assets available therefor. (c) REDEMPTION--Commencing ten years after the date of issuance, the Corporation may, at the option of the Board of Directors, redeem in any one year all or any part of the outstanding shares of Series G Preferred Stock at a price of $100.00 per share. Notice of redemption shall be mailed to each holder of Series G Preferred Stock to be redeemed not less than thirty (30) days prior to the date upon which the stock is to be redeemed. In case less than all of the outstanding Series G Preferred Stock is to be redeemed, the amount to be redeemed and the method of effecting such redemption, whether by lot or pro rata or otherwise, may be determined by the Board of Directors. If on or before the redemption date named in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the Series G Preferred Stock so called for redemption then, notwithstanding that any certificate of the Series G Preferred Stock so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of redemption so designated and all rights with respect to such Series G Preferred Stock so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and determine, except only the right of the holder to receive the redemption price therefor, but with interest on the unpaid dividends calculated only until the date of redemption and without any further interest whatsoever. Stock redeemed pursuant to the provisions hereof or any Series G Preferred Stock purchased or otherwise acquired by the Corporation shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the shares accordingly. BI-6 (d) VOTING RIGHTS--The holders of the shares of Series G Preferred Stock shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock and the holders of other series of the preferred stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any shares of Series G Preferred Stock shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series G Preferred Stock shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the Board of Directors may from time to time determine, unless otherwise restricted by the terms of this statement of designations, powers and preferences. (f) CONVERSION-- (1) The Series G Preferred Stock shall be convertible into Common Stock as hereinafter provided and, when and as so converted, such Series G Preferred Stock shall be canceled and retired and shall not be reissued as such. (2) Any holder of the Series G Preferred Stock, at any time commencing immediately upon the issuance of the Series G Preferred Stock and terminating upon the expiration of ten years from the date of issuance, may convert such stock into full shares of the Common Stock of the Corporation at the rate of nine (9) shares of Common Stock for each share of Series G Preferred Stock upon 90 days written notice. (3) On presentation and surrender to the Corporation at its offices of the certificates for shares of the Series G Preferred Stock to be converted, the holder of such stock shall be entitled to receive in exchange therefor certificates for shares of the fully paid and non-assessable Common Stock of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the Board of Directors of the Corporation. Conversion of Series G Preferred Stock in the manner aforesaid shall not affect the right of the holder of such stock to receive dividends accrued but unpaid on such shares as of the dividend payment date immediately prior to conversion. (4) The number of shares of Common Stock into which each share of Series G Preferred Stock is convertible shall be subject to adjustment from time to time as in clauses (A) and (B) of this subparagraph (4): (A) In case the Corporation shall (i) pay a dividend on its Common Stock in shares of the Corporation, (ii) subdivide its outstanding Common Stock, (iii) combine the outstanding Common Stock into a smaller number of shares, or (iv) issue by reclassification of its Common Stock (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each share of Series G Preferred Stock shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth of a common share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account by any subsequent adjustment. (5) The Corporation shall at all times reserve and keep available out of its authorized Common Stock solely for the purpose of issue upon conversion of shares of Series G Preferred Stock as herein provided, such number of shares of Common Stock as shall then be issuable upon the conversion of all outstanding shares of Series G Preferred Stock. (6) Fractional shares of Common Stock shall not be issued upon conversion of Series G Preferred Stock nor shall cash adjustments be made for fractional shares upon such conversion. (7) For the purpose of this paragraph (f), the term "Common Stock" shall mean (A) the class of stock designated as the Common Stock of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of change in par value, or from par value to no par value, or from no par value to par value. (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series G Preferred Stock shall be entitled, before any BI-7 assets of the Corporation shall be distributed among or paid over to the holders of the common stock, to receive out of the assets of the Company $100.00 per share of Series G Preferred Stock. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series G Preferred Stock, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of the Preferred Stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 5. $7.00 CUMULATIVE CONVERTIBLE VOTING SERIES H PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this preferred stock shall be $7.00 Cumulative Convertible Voting Series H Preferred Stock (hereinafter referred to as "Series H Preferred Stock"). (b) DIVIDENDS--The holders of the Series H Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of seven dollars ($7.00) per annum per share. The dividends, when payable, shall be paid quarterly on the first days of March, June, September and December in each year, before any dividends shall be declared or paid upon or set apart for the common stock of the Company for that year. Such dividends upon the Series H Preferred Stock shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of seven dollars ($7.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart before any dividend shall be paid upon or set apart for the common stock. Provided, however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during said prior dividend periods, and further provided, that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the common stock may be declared by the Board of Directors out of the remainder of the assets available therefor. (c) REDEMPTION-- (1) Unless the holder of Series H Preferred Stock elects not to have his shares redeemed in any one or more years in accordance with this subparagraph (c)(1) by so informing the Corporation at any time or times in writing (which election, if made, shall be irrevocable and shall forever bar redemption of the Series H Preferred Stock except in accordance with the provisions of subparagraph (c)(2)), the Corporation will redeem more than twenty percent of the shares of Series H Preferred Stock then held by each holder of Series H Preferred Stock at an aggregate price of $119.06 per share on the anniversary of the date of issuance of the Series H Preferred Stock in the following years: 1981, 1984, 1987 and 1989 through and including 1995. (2) Beginning on the twenty-first anniversary of the date of issuance of the Series H Preferred Stock, the holders of Series H Preferred Stock shall have the right, at their option, to have the Corporation redeem any or all of the outstanding shares of Series H Preferred Stock at a price of $100.00 per share. (3) If, on or before the applicable redemption date named above, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the Series H Preferred Stock so called for redemption, then, notwithstanding that any certificate of the Series H Preferred Stock so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of redemption so designated and all rights with respect to such Series H Preferred Stock so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and determine, except only the right of the holder to receive the redemption price therefor, but with interest on the unpaid dividends calculated only until the date of redemption and without any further interest whatsoever. (4) Stock redeemed pursuant to any of the provisions of paragraph (c) or any Series H Preferred Stock purchased or otherwise acquired by the Corporation shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the shares accordingly. BI-8 (d) VOTING RIGHTS--The holders of the shares of Series H Preferred Stock shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock and the holders of other series of the preferred stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any shares of Series H Preferred Stock shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series H Preferred Stock shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the Board of Directors may from time to time determine, unless otherwise restricted by the terms of this statement of designations, powers and preferences. (f) CONVERSION-- (1) The Series H Preferred Stock shall be convertible into Common Stock as hereinafter provided and, when and as so converted, such Series H Preferred Stock shall be canceled and retired and shall not be reissued as such. (2) Any holder of the Series H Preferred Stock, at any time commencing immediately upon the issuance of the Series H Preferred Stock and terminating upon the expiration of ten years from the date of issuance, may convert such stock into full shares of the Common Stock of the Corporation at the rate of nine (9) shares of Common Stock for each share of Series H Preferred Stock upon 90 days written notice to the Corporation by the holder of the Series H Preferred Stock. The Corporation, at its option, may consent to shorter notice. (3) On presentation and surrender to the Corporation at its offices of the certificates for shares of the Series H Preferred Stock to be converted, the holder of such stock shall be entitled to receive in exchange therefor certificates for shares of the fully paid and non-assessable Common Stock of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the Board of Directors of the Corporation. Conversion of Series H Preferred Stock in the manner aforesaid shall not affect the right of the holder of such stock to receive dividends accrued but unpaid on such shares as of the dividend payment date immediately prior to conversion. (4) The number of shares of Common Stock into which each share of Series H Preferred Stock is convertible shall be subject to adjustment from time to time as in clauses (A) and (B) of this subparagraph (4): (A) In case the Corporation shall (i) pay a dividend on its Common Stock in shares of the Corporation, (ii) subdivide its outstanding Common Stock, (iii) combine the outstanding Common Stock into a smaller number of shares, or (iv) issue by reclassification of its Common Stock (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each share of Series H Preferred Stock shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth of a common share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account by any subsequent adjustment. (5) The Corporation shall at all times reserve and keep available out of its authorized Common Stock solely for the purpose of issue upon conversion of shares of Series H Preferred Stock as herein provided, such number of shares of Common Stock as shall then be issuable upon the conversion of all outstanding shares of Series H Preferred Stock. (6) Fractional shares of Common Stock shall not be issued upon conversion of Series H Preferred Stock nor shall cash adjustments be made for fractional shares upon such conversion. (7) For the purposes of this paragraph (f), the term "Common Stock" shall mean (A) the class of stock designated as the Common Stock of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of change in par value, or from par value to no par value, or from no par value to par value. BI-9 (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series H Preferred Stock shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of the Common Stock, to receive out of the assets of the Company $100.00 per share of Series H Preferred Stock. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series H Preferred Stock, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of the Preferred Stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 6. $8.00 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES N PREFERRED STOCK, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be "$8.00 Cumulative Convertible and Redeemable Voting Series N Preferred Shares" (hereinafter referred to as the "Series N Preferred Shares"). (b) DIVIDENDS--The holders of the Series N Preferred Shares shall be entitled to receive, when and as declared by the board of directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of eight dollars ($8.00) per annum per share and no more. The dividends, when payable, shall be paid quarterly on the first days of March, June, September and December in each year, before any dividends shall be declared or paid upon or set apart for the Common Shares or Series A Common Shares of the Corporation for that quarter. Such dividends upon the Series N Preferred Shares shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of eight dollars ($8.00) per annum shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart but without interest, before any dividend shall be paid upon or set apart for the Common Shares or Series A Common Shares; provided, however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during such prior dividend periods, and further provided that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all the series of the preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the Common Shares or Series A Common Shares may be declared by the board of directors out of the remainder of the assets available therefor. (c) REDEMPTION-- (1) Unless such shares have been converted pursuant to paragraph (f) hereof prior to the sixth anniversary of the date of issue thereof, the Corporation shall, beginning with the seventh anniversary of the date of issue thereof, and annually thereafter on each subsequent anniversary of the date of issue thereof, redeem one-fourteenth of the number of Series N Preferred Shares outstanding on the sixth anniversary of the date of issue thereof, until all such shares have been redeemed, and the holders thereof shall be entitled to receive $100.00 per share plus an amount equal to all dividends accrued and unpaid thereon to the redemption date. (2) Notice of any redemption shall be mailed to each holder of Series N Preferred Shares to be redeemed not less than thirty (30) days prior to the date upon which such stock is to be redeemed. If on or before the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of Series N Preferred Shares so called for redemption then, notwithstanding that any certificate representing Series N Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series N Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and terminate, except only the right of the holder to receive the redemption price therefor, but without interest. Series N Preferred Shares redeemed pursuant to the provisions hereof or any such shares purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the number of outstanding Series N Preferred Shares accordingly. BI-10 (d) VOTING RIGHTS--The holders of Series N Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation and shall vote together with the holders of the common stock and the holders of other series of the preferred stock of the Corporation as one class. (e) PREEMPTIVE RIGHTS--No holder of any Series N Preferred Shares shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series N Preferred Shares shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the board of directors may from time to time determine. (f) CONVERSION-- (1) The Series N Preferred Shares shall be convertible into the Corporation's Common Shares as hereinafter provided, and when and as so converted, such Series N Preferred Shares shall be canceled and retired and shall not be reissued as such. Commencing upon the issuance and terminating at the close of business on the third anniversary thereof, the Series N Preferred Shares may be converted, upon thirty (30) days' written notice to the Corporation into Common Shares of the Corporation at the rate of ten (10) Common Shares for each Series N Preferred Share. Thereafter, until the close of business on the sixth anniversary of the date of issue, the Series N Preferred Shares may be converted, upon thirty (30) days' written notice to the Corporation, into Common Shares of the Corporation at the rate of nine (9) Common Shares for each Series N Preferred Share. On presentation and surrender to the Corporation at its offices of the certificates representing Series N Preferred Shares to be converted, the holder thereof shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series N Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to conversion. (2) The number of Common Shares into which each Series N Preferred Shares is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series N Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Shares; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account by any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series N Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series N Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series N Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (f), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series N Preferred Shares shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of Common Shares or Series A BI-11 Common Shares, to receive out of the assets of the Corporation $100.00 per Series N Preferred Share. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to stockholders are not sufficient to make payment in full to the holders of the Series N Preferred Shares, payment shall be made to such holders ratably in accordance with the number of shares held by them, and in case there shall then be more than one series of the preferred stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 7. $9.00 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES O PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be "$9.00 Cumulative Convertible and Redeemable Voting Series O Preferred Shares" (hereinafter referred to as the "Series O Preferred Shares"). (b) DIVIDENDS--The holders of the Series O Preferred Shares shall be entitled to receive, when and as declared by the board of directors of the Corporation, out of any assets of the Corporation available for dividends pursuant to the laws of the State of Delaware, preferential dividends at the rate of nine dollars ($9.00) per annum per share and no more. The dividends, when payable, shall be paid quarterly on the first days of March, June, September and December in each year (prorated if the period such stock is outstanding prior to the first quarterly dividend date is less than a calendar quarter), before any dividends shall be declared or paid upon or set apart for the Common Shares or Series A Common Shares of the Corporation for that quarter. Such dividends upon the Series O Preferred Shares shall be cumulative from the date of issue thereof so that if dividends for any past dividend period at the rate of nine dollars ($9.00) per annum per share shall not have been paid thereon or declared and a sum sufficient for payment thereof set apart, the deficiency shall be fully paid or set apart but without interest, before any dividend shall be paid upon or set apart for the Common Shares or Series A Common Shares; provided, however, that no dividends shall be declared on the shares of any series of preferred stock for any dividend period unless the full dividend for all prior dividend periods shall have been declared or shall be declared at the same time upon all preferred stock outstanding during such prior dividend periods, and further provided that no dividends shall be declared on the shares of any series of preferred stock unless a dividend for the same period shall be declared at the same time upon all preferred stock outstanding during said period in like proportion to the dividend rate upon such shares. Whenever the full dividend upon all series of preferred stock for all past dividend periods shall have been paid and the full dividend thereon for the then current dividend period shall have been paid or declared and a sum sufficient for the payment thereof set apart, dividends upon the Common Shares or Series A Common Shares may be declared by the board of directors out of the remainder of the assets available therefor. (c) REDEMPTION-- (1) Unless such shares have been converted pursuant to paragraph (f) hereof prior to January 1, 1990, the Corporation may, at its option from time to time and in such amounts as it may determine, redeem the Series O Preferred Shares for $100.00 per share plus an amount equal to all dividends accrued and unpaid thereon to the redemption date. (2) Unless such shares have been converted pursuant to paragraph (f) hereof prior to January 1, 1990, the holder of Series O Preferred Shares may, at the holder's option, during the period commencing January 1, 1990 and ending December 31, 1999, elect to have redeemed in any one year as much as one-third (1/3) of the number of Series O Preferred Shares held by such person on January 1, 1990. (3) Notice of an election under either of the redemption provisions in subparagraphs (c)(1) and (c)(2) above shall be mailed (A) in case of a redemption at the election of the Corporation to each holder of Series O Preferred Shares to be redeemed or (B) in the case of a redemption at the election of the holder of Series O Preferred Shares to the Corporation not less than thirty (30) days prior to the date upon which such stock is to be redeemed. In case less than all of the outstanding Series O Preferred Shares are to be redeemed by the Corporation, the amount to be redeemed and the method of effecting such redemption, whether by lot or pro rata or otherwise, may be determined by the Board of Directors. If on or before the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of the Series O Preferred Shares so called for or requesting redemption, then, notwithstanding that any certificate representing Series O Preferred Shares so called for or requesting redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series O Preferred Shares so called for or requesting redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and terminate, except only the right of the holder to receive the redemption price therefor, but without BI-12 interest. Series O Preferred Shares redeemed pursuant to the provisions hereof or any such shares purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the number of outstanding Series O Preferred Shares accordingly. (d) VOTING RIGHTS-- (1) For all purposes, the holders of Series O Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) Subject to the rights, if any, of the holders of one or more series of Preferred Shares, voting as a class, to elect one or more directors, in the election of directors, the holders of Series O Preferred Shares shall vote together as one class with the Series A Common Shares. The total number of directors of the Corporation shall be determined without regard to any director(s) whom the holders of one or more series of Preferred Shares, voting as a class, have elected or have the right to elect. In the event the number of issued and outstanding Series A Common Shares at any time falls below 500,000, then with respect to the election of directors at the next annual meeting thereafter the holders of Common Shares, Series A Common Shares and Preferred Shares shall be entitled to elect all of the directors of the Corporation. (e) PREEMPTIVE RIGHTS--No holder of any Series O Preferred Shares shall have any preemptive right to subscribe for or acquire additional shares of the Corporation of the same or any other class or series, whether such shares be hereby or hereafter authorized; and no holder of Series O Preferred Shares shall have any preemptive right to acquire any shares which may be held in the treasury of the Corporation; all such additional or treasury shares may be sold for such consideration at such time and to such person or persons as the board of directors may from time to time determine. (f) CONVERSION-- (1) (A) The Series O Preferred Shares shall be convertible into the Corporation's Common Shares as hereinafter provided, and when and as so converted, such Series O Preferred Shares shall be canceled and retired and shall not be reissued as such. Commencing upon issuance and terminating at the close of business on December 31, 1988, the Series O Preferred Shares may be converted, upon sixty (60) days' written notice to the Corporation, into Common Shares of the Corporation at the rate of nine (9) Common Shares for each Series O Preferred Share. Thereafter, until the close of business on December 31, 1989, the Series O Preferred Shares may be converted, upon sixty (60) days' written notice to the Corporation, into Common Shares of the Corporation at the rate of eight (8) Common Shares for each Series O Preferred Share. On presentation and surrender to the Corporation at its offices of the certificates representing the Series O Preferred Shares to be converted, the holder thereof shall be entitled to receive in exchange therefor certificates for fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series O Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to conversion. (B) Notwithstanding the provisions of clause (A) above, if the Market Value (as defined below) of a Common Share does not exceed $12.875 per share on each of five consecutive trading days for at least two periods of five days each from the date of issuance to December 31, 1987, then the Corporation will deliver additional Common Shares to qualified shareholders, in an amount equal to the Price Differential (as defined below). The payment of additional Common Shares is limited to those shareholders electing to receive stock in connection with the acquisition of Chatham Telephone Company and others who receive such stock from such shareholders through inheritance or gift, and who complete the conversion of their Series O Preferred Shares, as provided herein, prior to August 1, 1988, and is further limited to those Common Shares owned by the shareholder on August 1, 1988 which were (i) issued in the original distribution of Series O Preferred Shares, or (ii) acquired pursuant to a conversion of Series O Preferred Shares (the "Qualified Shares"). For purposes of calculating the number of additional Common Shares to be issued, the value of each additional Common Share being issued shall be the highest average Market Value for two periods of five consecutive trading days from the date of issuance through December 31, 1987. This value is referred to hereinafter as the "Additional Share Value." The number of additional Common Shares to be issued shall be determined by dividing the Price Differential by the Additional Share Value. No fractional shares will be issued in connection with the payment of additional shares. An equivalent amount of cash for such fractional shares shall be distributed based upon the Additional Share Value. For purposes hereof: BI-13 1. "Market Value" means the high sales price of a Common Share, as reported in the Wall Street Journal. 2. "Price Differential" means the difference between the highest average Market Value for five (5) consecutive trading days during the period from the date of issuance through December 31, 1987, and $12.875, multiplied by the number of Qualified Shares. (2) The number of Common Shares into which each Series O Preferred Share is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series O Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which the holder would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account by any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series O Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series O Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series O Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (f), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (g) LIQUIDATION RIGHTS--In the event of any liquidation, dissolution or winding up of the affairs of the Corporation, whether voluntary or involuntary, the holders of the Series O Preferred Shares shall be entitled, before any assets of the Corporation shall be distributed among or paid over to the holders of Common Shares or Series A Common Shares, to receive out of the assets of the Corporation $100.00 per Series O Preferred Share. If upon any such dissolution, liquidation or winding up, the assets of the Corporation available for payment to shareholders are not sufficient to make payment in full to the holders of the Series O Preferred Shares, payment shall be made to such holders ratably in accordance with the number of shares held by them and, in case there shall then be more than one series of preferred stock outstanding at that time, ratably in accordance with the respective distributive amount to which such holders shall be entitled. 8. $10.50/$7.00 CUMULATIVE AND CONVERTIBLE VOTING SERIES S PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be "$10.50/$7.00 Cumulative and Convertible Voting Series S Preferred Shares" (hereinafter referred to as the "Series S Preferred Shares"). (b) DIVIDENDS--The rate of dividend payable upon Series S Preferred Shares shall be ten and 50/100 dollars ($10.50) per share per annum during the first year after issuance and seven and no/100 dollars ($7.00) per share per annum thereafter. (c) VOTING RIGHTS-- (1) With respect to all matters, each holder of Series S Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series S Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and BI-14 that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (d) CONVERSION-- (1) The Series S Preferred Shares shall be convertible into the Corporation's Common Shares as hereinafter provided, and when and as so converted, such Series S Preferred Shares shall be canceled and retired and shall not be reissued as such. Commencing upon issuance and terminating four (4) years thereafter, the Series S Preferred Shares may be converted, upon written notice to the Corporation, into Common Shares of the Corporation at the rate of four (4) Common Shares for each Series S Preferred Share. On presentation and surrender to the Corporation at its offices of the certificate representing the Series S Preferred Shares to be converted, the holder thereof shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series S Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to conversion. (2) The number of Common Shares into which each Series S Preferred Share is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series S Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequently to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account by any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series S Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series S Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series S Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (d), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (e) LIQUIDATION--The amount payable upon each Series S Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all accumulated and unpaid dividends thereon. 9. $8.50 CUMULATIVE, NON-CONVERTIBLE, REDEEMABLE AND VOTING SERIES U PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be "$8.50 Cumulative, Non-Convertible, Redeemable and Voting Series U Preferred Shares" (hereinafter referred to as "Series U Preferred Shares"). BI-15 (b) DIVIDENDS--The rate of dividend payable upon Series U Preferred Shares shall be eight and 50/100 dollars ($8.50) per share per annum. Such dividends shall be cumulative from and commence to accrue on the date of issuance. (c) REDEMPTION-- (1) After the fifth anniversary of the date of issuance, the Corporation may, at its option, redeem annually up to twenty percent (20%) of the Series U Preferred Shares outstanding on such fifth anniversary for $100.00 per share. After the tenth anniversary of their issuance, the Corporation may at any time redeem, in whole or in part, the then outstanding Series U Preferred Shares for $100.00 per share. In addition to the redemption price, the following shall be paid: (A) any accrued and unpaid dividends with respect to each Series U Preferred Share redeemed, and (B) an amount equal to $2.125 for each Series U Preferred Share redeemed MULTIPLIED BY the number of days between the date fixed for redemption and the March 1, June 1, September 1, or December 1 immediately preceding the date fixed for redemption and DIVIDED BY 90. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be delivered to each holder of Series U Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than thirty (30) days prior to the date upon which such stock is to be redeemed. If on or before the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holder of the Series U Preferred Shares so called for redemption, then, notwithstanding that any certificate representing Series U Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series U Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such redemption date, except only the right of the holder to receive the redemption price therefor, but without interest. The Series U Preferred Shares purchased or otherwise acquired shall not be reissued but shall be canceled and proceedings shall be taken in the manner prescribed by statute to reduce the number of Preferred Shares which the Corporation is authorized to issue by the number of shares canceled. (d) VOTING RIGHTS-- (1) With respect to all matters, each holder of Series U Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series U Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION--The Series U Preferred Shares shall not be convertible. (f) LIQUIDATION--The amount payable upon each Series U Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all accumulated and unpaid dividends thereon. 10. $9.00 CUMULATIVE AND CONVERTIBLE VOTING SERIES BB PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be $9.00 Cumulative, Convertible and Redeemable Voting Series BB Preferred Shares" (hereinafter referred to as the "Series BB Preferred Shares"). (b) DIVIDENDS--The rate of dividend payable upon Series BB Preferred Shares shall be nine and no/100 dollars ($9.00) per share per annum. (c) REDEMPTION-- (1) Unless the Series BB Preferred Shares have been converted, or written notice to convert has been received prior to the expiration of the conversion period set forth in paragraph (e) hereof, then commencing with the tenth anniversary of the issuance of the Series BB Preferred Shares and ending ten years thereafter, the Corporation may, at its sole option, at any time thereafter, redeem up to two thousand (2,000) shares per BI-16 annum of the then outstanding Series BB Preferred Shares for $100.00 per share, plus an amount equal to all dividends accrued and unpaid thereon on the redemption date. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be delivered to the Corporation not less than thirty (30) days prior to the date upon which such stock is to be redeemed. If on or before the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holder of Series BB Preferred Shares so offered for redemption, then, notwithstanding that any certificate representing Series BB Preferred Shares so offered for redemption shall have not been so surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series BB Preferred Shares so offered for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date shall cease and terminate, except only the right of the holder to receive the redemption price therefor, but without interest. (d) VOTING RIGHTS-- (1) With respect to all matters, each holder of Series BB Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series BB Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION-- (1) The Series BB Preferred Shares shall be convertible into the Corporation's Common Shares as hereinafter provided. Commencing upon issuance and terminating ten (10) years thereafter, the Series BB Preferred Shares may be converted, upon written notice to the Corporation, into Common Shares of the Corporation at the rate of six (6) Common Shares for each Series BB Preferred Share. On presentation and surrender to the Corporation at its offices of the certificate representing the Series BB Preferred Shares to be converted, the holder thereof shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series BB Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to conversion. (2) The number of Common Shares into which each Series BB Preferred Share is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In case the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares, or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series BB Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series BB Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series BB Preferred Shares. BI-17 (4) Fractional Common Shares shall not be issued upon conversion of Series BB Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation at the date of this Restated Certificate of Incorporation, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (f) LIQUIDATION--The amount payable upon each Series BB Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all accumulated and unpaid dividends thereon. 11. $7.00 CUMULATIVE, CONVERTIBLE AND REDEEMABLE VOTING SERIES DD PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION.--The designation of this series of Preferred Shares shall be $7.00 Cumulative, Convertible and Redeemable Voting Series DD Preferred Shares (hereinafter referred to as the "Series DD Preferred Shares"). (b) DIVIDENDS.--The rate of dividend payable upon Series DD Preferred Shares shall be seven and no/100 dollars ($7.00) per share per annum. (c) CONVERTIBILITY.--Commencing upon issuance and terminating on the day before the fifteenth anniversary thereof, the Series DD Preferred Shares shall be convertible, at the election of the holder of Series DD Preferred Shares and upon surrender to the Corporation of the certificate or certificates representing the shares to be converted, into fully paid and non-assessable TDS Common Shares, $1.00 par value (hereinafter referred to as the "Common Shares"), at the rate of five and one-quarter (5.25) Common Shares for each Series DD Preferred Share. Certificates representing any Series DD Preferred Shares surrendered for conversion shall be delivered to the Corporation duly endorsed, or accompanied by proper instruments of transfer, to the Corporation or in blank, together with a written notice to the Corporation of the holder's election to make the conversion and of the name or names in which the certificate or certificates for Common Shares shall be issued. The Corporation shall pay all documentary, stamp, and similar taxes that may be payable in respect of the issue or delivery of Common Shares upon conversion of any Series DD Preferred Shares. The Corporation shall at all times reserve and keep available, free from preemptive rights, out of its authorized but unissued Common Shares the full number of Common Shares that would be deliverable upon the conversion of Series DD Preferred Shares then outstanding. If at any time the Corporation elects to redeem part or all of the outstanding Series DD Preferred Shares (pursuant to paragraph (e) of this Statement of Designation, Preferences and Rights), the holders of the Series DD Preferred Shares that the Corporation elects to redeem shall be entitled to convert those shares to Common Shares by delivering to the Corporation, not less than ten (10) days before the redemption date specified in the Corporation's notice of redemption, a written notice of the holder's election to convert part or all of his Series DD Preferred Shares to Common Shares, together with the certificate or certificates representing the Series DD Preferred Shares to be converted duly endorsed (or accompanied by proper instruments of transfer) to the Corporation or in blank. The number of Common Shares into which each Series DD Preferred Share is convertible shall be subject to adjustment from time to time as set forth below: In case the Corporation shall (1) pay a dividend on its Common Shares (in shares of the Corporation), (2) subdivide its outstanding Common Shares, (3) combine the outstanding Common Shares into a smaller number of shares or (4) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series DD Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he or she would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made subsequent to the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. Fractional Common Shares shall not be issued upon conversion of Series DD Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (d) LIQUIDATION VALUE.--Each Series DD Preferred Share shall have a liquidation value of $100.00. (e) REDEEMABILITY.--The Series DD Preferred Shares shall be redeemable upon the second anniversary of their issuance, and on each anniversary thereafter through the sixth such anniversary, at the election of the holder of BI-18 Series DD Preferred Shares, which election shall be made not less than ten (10) days before each such anniversary. The Corporation shall redeem on a pro-rata basis for each holder, up to twenty percent (20%) of the number of Series DD Preferred Shares issued and outstanding on each anniversary of their issuance without premium, upon payment to the holder of Series DD Preferred Shares to be redeemed of $100.00 per share PLUS (1) any accrued and unpaid dividends with respect to each Series DD Preferred Share redeemed, and (2) an amount equal to $1.75 for each Series DD Preferred Share redeemed MULTIPLIED BY the number of days between the date fixed for redemption and the March 1, June 1, September 1, or December 1 immediately preceding the date fixed for redemption and DIVIDED BY 90. The right of redemption provided in the preceding sentence shall not be cumulative. In the event that a holder of Series DD Preferred Shares fails to exercise its right of redemption during any year, such right of redemption with respect to the Series DD Preferred Shares eligible for redemption during such year shall lapse. A holder of Series DD Preferred Shares shall exercise its right of redemption by mailing to the Corporation written notice of its election to redeem Series DD Preferred Shares, together with a certificate or certificates representing the Series DD Preferred Shares to be redeemed, duly endorsed or accompanied by proper instruments of transfer. The foregoing right of redemption may only be exercised if the price of the Common Shares at the time the holder of Series DD Preferred Shares gives notice of his or her desire to have Series DD Preferred Shares redeemed is below $19.00 per share (or such equivalent price as may exist as a result of any stock split, stock dividend, reclassification or similar event). After the fifteenth anniversary of their issuance, the Series DD Preferred Shares outstanding may be redeemed at the election of the Corporation from time to time in whole or in part, without premium, upon payment to the holder of Series DD Preferred Shares to be redeemed of $100 per share PLUS (1) any accrued and unpaid dividends with respect to each Series DD Preferred Share redeemed, and (2) an amount equal to $1.75 for each Series DD Preferred Share redeemed MULTIPLIED BY the number of days between the date fixed for redemption and the March 1, June 1, September 1, or December 1 immediately preceding the date fixed for redemption and DIVIDED BY 90. Notice of any redemption shall be mailed to each holder of Series DD Preferred Shares to be redeemed not less than thirty (30) days prior to the date upon which such stock is to be redeemed. If on or before the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holders of Series DD Preferred Shares so called for redemption then, notwithstanding that any certificate representing Series DD Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series DD Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall forthwith after such redemption date cease and terminate, except only the right of the holder to receive the redemption price therefor, but without interest. (f) VOTING RIGHTS.--With respect to all matters, each holder of Series DD Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. With respect to the election of directors, the holders of Series DD Preferred Shares shall have class voting rights (voting together with the holders of (1) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (2) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (g) LIQUIDATION PREFERENCE.--For purposes of Article IV of this Restated Certificate of Incorporation, the "fixed amount payable" for the Series DD Preferred Shares shall be $100.00 per share. 12. $6.00 CUMULATIVE, CONVERTIBLE, REDEEMABLE AND VOTING SERIES EE PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION--The designation of this series of Preferred Shares shall be "$6.00 Cumulative, Convertible, Redeemable and Voting Series EE Preferred Shares" (hereinafter referred to as the "Series EE Preferred Shares"). (b) DIVIDENDS--The rate of dividend payable upon Series EE Preferred Shares shall be six and no/100 dollars ($6.00) per share per annum. Such dividends shall be cumulative from and commence to accrue on the date of issuance. BI-19 (c) REDEMPTION-- (1) After the twentieth anniversary of the date of issuance, the Corporation may, at its option, at any time redeem all or a portion of the then outstanding Series EE Preferred Shares for $100.00 per share, plus an amount equal to all accumulated and unpaid dividends thereon. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be delivered to each holder of Series EE Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than thirty (30) days prior to the date upon which such stock is to be redeemed. If, on the redemption date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment on demand to the holder of Series EE Preferred Shares so called for redemption, then notwithstanding that any certificate representing Series EE Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the date of such redemption so specified, and all rights with respect to such Series EE Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such redemption date, except only the right of the holder to receive the redemption price therefor, but without interest. (d) VOTING RIGHTS-- (1) With respect to all matters, each holder of Series EE Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series EE Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION-- (1) Commencing upon issuance and terminating at the close of business on the day before the tenth anniversary of the date of issuance, each outstanding Series EE Preferred Share may be converted, upon fifteen (15) days' written notice into four and one-half (4.5) Common Shares. On presentation and surrender to the Corporation at its offices of the certificate representing the Series EE Preferred Shares to be converted, the holder thereof shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series EE Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to conversion. (2) The number of Common Shares into which each Series EE Preferred Share is convertible shall be subject to adjustment from time to time. In the event the Corporation shall (A) pay a dividend on its Common Shares (in Common Shares of the Corporation) of more than 20% of the number of outstanding Common Shares, (B) subdivide its outstanding Common Shares, (C) combine the outstanding Common Shares into a smaller number of shares or (D) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series EE Preferred Share shall be entitled to receive, upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made after the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series EE Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series EE Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series EE Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For the purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation on the date this Restated Certificate of Incorporation is BI-20 filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value. (f) LIQUIDATION--The amount payable upon each Series EE Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all accumulated and unpaid dividends thereon. 13. $5.00 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES GG PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION.--The designation of this series of Preferred Shares shall be "$5.00 Cumulative Convertible and Redeemable Voting Series GG Preferred Shares" (hereinafter referred to as the "Series GG Preferred Shares'). (b) DIVIDENDS.--Each holder of a share of Series GG Preferred Shares shall be entitled to receive, when, as and if declared by the board of directs of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series GG Preferred Shares is outstanding at a per annum dividend rate of five dollars ($5.00) per share. Such dividends shall be cumulative from and commence to accrue on the date of original issuance of such Series GG Preferred Shares (the "Issue Date"). (c) REDEMPTION.-- (1) Unless the Series GG Preferred Shares have been converted or the Corporation shall have received prior to the tenth anniversary of the Issue Date written notice of election to convert in accordance with paragraph (e) hereof, on or after the tenth anniversary of the Issue Date, the Series GG Preferred Shares shall be redeemable, in whole or in part from time-to-time, at the option of the Corporation, upon giving notice as provided in subparagraph (c)(2) hereof, at a redemption price (the "Redemption Price") equal to the product of the number of Series GG Preferred Shares called for redemption times the sum of (A) $100.00 per Series GG Preferred Share plus (B) all dividends accrued and unpaid thereon through the date set for redemption (the "Redemption Date"); provided, however, that prior to the twelfth anniversary of the Issue Date the Corporation shall have redeemed all the Series GG Preferred Shares outstanding. The Redemption Price payable on any Redemption Date shall be payable, at the option of Corporation, (x) in cash (by certified check) or (y) by the issuance of Common Shares of the Corporation to the record holder of such Series GG Preferred Shares being redeemed. In the event that the Corporation elects to pay the Redemption Price by issuing its Common Shares, the number of Common Shares to be issued shall be calculated based upon the closing price on the American Stock Exchange (or, if the Corporation's Common Shares are not listed on the American Stock Exchange on the first trading day immediately preceding the date notice is given, the closing price of such Common Shares on (in order if more than one applies) any national securities exchange, any regional securities exchange, the highest bid price quoted through the National Association of Securities Dealers Automated Quotation System or the highest bid price reported by dealers in the over-the-counter market) of the Corporation's Common Shares on the first trading day immediately preceding the date that the notice of redemption is mailed to record holders. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be mailed (by first class, postage prepaid) to each holder of Series GG Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than thirty (30) days prior to the Redemption Date. If on or before the Redemption Date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to the holder of Series GG Preferred Shares so called for redemption upon such holder's surrender of such Series GG Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series GG Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series GG Preferred Shares so called for redemption, including any right to vote or otherwise participate, in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (d) Each such notice of redemption shall state: (1) the Redemption Date; BI-21 (2) the number of Series GG Preferred Shares to be redeemed and, if less than all the shares held by such holder are to be redeemed from such holder, the number of shares to be redeemed from such holder; (3) whether the Redemption Price will be paid in cash (by certified check) or by the issuance of Common Shares of the Corporation, and, if payment is to be made by the issuance of Common Shares, the number of Common Shares to be issued to such holder; (4) the place where certificates for such shares are to be surrendered for payment of the Redemption Price; and (5) that dividends on the shares to be redeemed shall cease to accrue on such Redemption Date. On or after the Redemption Date each holder of shares of Series GG Preferred Shares to be redeemed shall present and surrender his certificate or certificates for such shares to the Corporation at the place designated in such notice and thereupon the Redemption Price of such shares shall be paid to or on the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be cancelled. In case fewer than all the shares represented by such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. From and after the Redemption Date (unless the Corporation shall default in payment of the Redemption Price) all dividends on the shares of Series GG Preferred Shares designated for redemption in such notice shall cease to accrue, and all rights of the holders thereof as shareholders of the Corporation, except the right to receive the Redemption Price thereof, without interest, upon the surrender of certificates representing the same, shall cease and terminate and such shares shall not thereafter be transferred (except with the consent of the Corporation) on the books of the Corporation and such shares shall not be deemed to be outstanding for any purpose whatsoever. (e) VOTING RIGHTS. (1) With respect to all matters, each holder of Series GG Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series GG Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (f) CONVERSION. (1) Commencing upon the Issue Date and terminating at the close of business on the day before the tenth anniversary of the Issue Date, the outstanding Series GG Preferred Shares may be converted at any time, upon fifteen (15) days' written notice mailed to the Corporation (by first class, postage prepaid), into 2.3 Common Shares for each Series GG Preferred Share. On presentation and surrender of the certificate(s) representing the Series GG Preferred Shares to be converted to the Corporation at its offices, the holder thereof shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid, all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series GG Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of the dividend payment date immediately prior to the date of conversion (the "Conversion Date"). (2) The number of Common Shares into which each Series GG Preferred Shares is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In the event the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series GG Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which he would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made after the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. BI-22 (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series GG Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series GG Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series GG Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation on the date this Restated Certificate of Incorporation is filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (6) Each such notice of conversion shall state: (A) The Conversion Date (which shall be at least fifteen (15) days subsequent to the date of mailing of such notice); and (B) The number of Series GG Preferred Shares to be converted, if less than all the shares held by such holder. The holder shall deliver his certificate(s) representing such Series GG Preferred Shares to be converted to the Corporation with the notice of conversion. In case fewer than all the shares represented by such certificate are converted, a new certificate shall be issued representing the unconverted shares. From and after the Conversion Date (unless the Corporation shall default in issuing the Common Shares on the Conversion Date) all dividends on such shares of Series GG Preferred Shares shall cease to accrue and such shares shall not be outstanding for any purpose whatsoever. (g) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series GG Preferred Shares in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all dividends accrued and unpaid dividends thereon. 14. REDEEMABLE VOTING SERIES HH PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "Redeemable Voting Series HH Preferred Shares" (hereinafter referred to as the "Series HH Preferred Shares"). (b) DIVIDENDS. Each holder of a Series HH Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series HH Preferred Shares are outstanding at a per annum dividend rate of six dollars ($6.00) per share. Such dividends shall be payable as declared and cumulative from and commence to accrue on the date of original issuance of such Series HH Preferred Shares (the "Issue Date"). (c) REDEMPTION AT ELECTION OF HOLDER. (1) The Series HH Preferred Shares shall be redeemable, in whole or in part, at the option of the holder thereof, on March 1, 1992, upon written notice given by such holder, between September 1, 1991 and December 1, 1991 and on the first day of March in calendar years 1997 through 2012, upon written notice given by such holder between the first day of September and the first day of December of the immediately preceding calendar year, of the holder's election to have the Corporation redeem such shares on March 1st of the next succeeding calendar year (the "Redemption Date"). Notice of an election under the redemption provision above shall be mailed (by first class, postage prepaid) to the office or agency maintained by the Corporation for that purpose and each notice shall state the number of Series HH Preferred Shares to be redeemed, if less than all the shares held by the holder giving such notice. BI-23 (2) Except as provided in the preceding paragraph, the Series HH Preferred Shares shall not be subject to redemption and shall not be subject to the election by the holder thereof to have the Corporation redeem such Series HH Preferred Shares. (3) Upon receipt of written notice from the holder of its election to redeem, the Corporation shall redeem the Series HH Preferred Shares to be redeemed pursuant to such notice of redemption on the Redemption Date. The redemption price (the "Redemption Price") of the Series HH Preferred Shares shall be equal to the product of the number of Series HH Preferred Shares elected to be redeemed multiplied by the sum of (A) $100.00 per share plus (B) all dividends accrued and unpaid, whether declared or undeclared, thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be paid by check mailed to the holder within 30 days of the Redemption Date. (4) If on or before the Redemption Date, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to any holder of the Series HH Preferred Shares to be redeemed pursuant to such notice of redemption upon such holder's surrender of such Series HH Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series HH Preferred Shares to be so redeemed shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series HH Preferred Shares to be so redeemed, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (5) Each holder who has given notice pursuant to subparagraph (c)(1) above shall deliver the certificate representing the Series HH Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by such certificate are to be redeemed, a new certificate shall be issued representing the shares which were not so redeemed. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series HH Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series HH Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series HH Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 15. REDEEMABLE VOTING SERIES II PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "Redeemable Voting Series II Preferred Shares" (hereinafter referred to as the "Series II Preferred Shares"). (b) DIVIDENDS. Each holder of a Series II Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series II Preferred Shares are outstanding at a per annum dividend rate of six dollars ($6.00) per share. Such dividends shall be payable as declared and cumulative from and commence to accrue on the date of original issuance of such Series II Preferred Shares (the "Issue Date"). (c) REDEMPTION AT ELECTION OF HOLDER. (1) The Series II Preferred Shares shall be redeemable, in whole or in part, at the option of the holder thereof, on March 1, 1993, upon written notice given by such holder, between September 1, 1992 and December 1, 1992 and on the first day of March in calendar years 1997 through 2012, upon written notice given by such holder between the first day of September and the first day of December of the immediately preceding calendar year, of the holder's election to have the Corporation redeem such shares on March 1st of the next succeeding calendar year (the "Redemption Date"). Notice of an election under the redemption provision above shall be mailed (by first class, postage prepaid) to the office or agency maintained by the Corporation for that purpose and each notice shall state the number of Series II Preferred Shares to be redeemed, if less than all the shares held by the holder giving such notice. BI-24 (2) Except as provided in the preceding paragraph, the Series II Preferred Shares shall not be subject to redemption and shall not be subject to the election by the holder thereof to have the Corporation redeem such Series II Preferred Shares. (3) Upon receipt of written notice from the holder of its election to redeem, the Corporation shall redeem the Series II Preferred Shares to be redeemed pursuant to such notice of redemption on the Redemption Date. The redemption price (the "Redemption Price") of the Series II Preferred Shares shall be equal to the product of the number of Series II Preferred Shares elected to be redeemed multiplied by the sum of (A) $100.00 per share plus (B) all dividends accrued and unpaid, whether declared or undeclared, thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be paid by check mailed to the holder within 30 days of the Redemption Date. (4) If on or before the Redemption Date, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to any holder of the Series II Preferred Shares to be redeemed pursuant to such notice of redemption upon such holder's surrender of such Series II Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series II Preferred Shares to be so redeemed shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series II Preferred Shares to be so redeemed, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (5) Each holder who has given notice pursuant to subparagraph (c)(1) above shall deliver the certificate representing the Series II Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by such certificate are to be redeemed, a new certificate shall be issued representing the shares which were not so redeemed. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series II Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series II Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series II Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 16. REDEEMABLE VOTING SERIES JJ PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "Redeemable Voting Series JJ Preferred Shares" (hereinafter referred to as the "Series JJ Preferred Shares"). (b) DIVIDENDS. Each holder of a Series JJ Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series JJ Preferred Shares are outstanding at a per annum dividend rate of six dollars ($6.00) per share. Such dividends shall be payable as declared and cumulative from and commence to accrue on the date of original issuance of such Series JJ Preferred Shares (the "Issue Date"). (c) REDEMPTION AT ELECTION OF HOLDER. (1) The Series JJ Preferred Shares shall be redeemable, in whole or in part, at the option of the holder thereof, on March 1, 1994, upon written notice given by such holder, between September 1, 1993 and December 1, 1993 and on the first day of March in calendar years 1997 through 2012, upon written notice given by such holder between the first day of September and the first day of December of the immediately preceding calendar year, of the holder's election to have the Corporation redeem such shares on March 1st of the next succeeding calendar year (the "Redemption Date"). Notice of an election under the redemption provision above shall be mailed (by first class, postage prepaid) to the office or agency maintained by the Corporation for BI-25 that purpose and each notice shall state the number of Series JJ Preferred Shares to be redeemed, if less than all the shares held by the holder giving such notice. (2) Except as provided in the preceding paragraph, the Series JJ Preferred Shares shall not be subject to redemption and shall not be subject to the election by the holder thereof to have the Corporation redeem such Series JJ Preferred Shares. (3) Upon receipt of written notice from the holder of its election to redeem, the Corporation shall redeem the Series JJ Preferred Shares to be redeemed pursuant to such notice of redemption on the Redemption Date. The redemption price (the "Redemption Price") of the Series JJ Preferred Shares shall be equal to the product of the number of Series JJ Preferred Shares elected to be redeemed multiplied by the sum of (A) $100.00 per share plus (B) all dividends accrued and unpaid, whether declared or undeclared, thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be paid by check mailed to the holder within 30 days of the Redemption Date. (4) If on or before the Redemption Date, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to any holder of the Series JJ Preferred Shares to be redeemed pursuant to such notice of redemption upon such holder's surrender of such Series JJ Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series JJ Preferred Shares to be so redeemed shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series JJ Preferred Shares to be so redeemed, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (5) Each holder who has given notice pursuant to subparagraph (c)(1) above shall deliver the certificate representing the Series JJ Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by such certificate are to be redeemed, a new certificate shall be issued representing the shares which were not so redeemed. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series JJ Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series JJ Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series JJ Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 17. REDEEMABLE VOTING SERIES KK PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "Redeemable Voting Series KK Preferred Shares" (hereinafter referred to as the "Series KK Preferred Shares"). (b) DIVIDENDS. Each holder of a Series KK Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series KK Preferred Shares are outstanding at a per annum dividend rate of six dollars ($6.00) per share. Such dividends shall be payable as declared and cumulative from and commence to accrue on the date of original issuance of such Series KK Preferred Shares (the "Issue Date"). (c) REDEMPTION AT ELECTION OF HOLDER. (1) The Series KK Preferred Shares shall be redeemable, in whole or in part, at the option of the holder thereof, on March 1, 1995, upon written notice given by such holder, between September 1, 1994 and December 1, 1994 and on the first day of March in calendar years 1997 through 2012, upon written notice given by such holder between the first day of September and the first day of December of the immediately preceding calendar year, of the holder's election to have the Corporation redeem such shares on March 1st of the next succeeding calendar year (the "Redemption Date"). Notice of an election under the redemption provision BI-26 above shall be mailed (by first class, postage prepaid) to the office or agency maintained by the Corporation for that purpose and each notice shall state the number of Series KK Preferred Shares to be redeemed, if less than all the shares held by the holder giving such notice. (2) Except as provided in the preceding paragraph, the Series KK Preferred Shares shall not be subject to redemption and shall not be subject to the election by the holder thereof to have the Corporation redeem such Series KK Preferred Shares. (3) Upon receipt of written notice from the holder of its election to redeem, the Corporation shall redeem the Series KK Preferred Shares to be redeemed pursuant to such notice of redemption on the Redemption Date. The redemption price (the "Redemption Price") of the Series KK Preferred Shares shall be equal to the product of the number of Series KK Preferred Shares elected to be redeemed multiplied by the sum of (A) $100.00 per share plus (B) all dividends accrued and unpaid, whether declared or undeclared, thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be paid by check mailed to the holder within 30 days of the Redemption Date. (4) If on or before the Redemption Date, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to any holder of the Series KK Preferred Shares to be redeemed pursuant to such notice of redemption upon such holder's surrender of such Series KK Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series KK Preferred Shares to be so redeemed shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series KK Preferred Shares to be so redeemed, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (5) Each holder who has given notice pursuant to subparagraph (c)(1) above shall deliver the certificate representing the Series KK Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by such certificate are to be redeemed, a new certificate shall be issued representing the shares which were not so redeemed. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series KK Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series KK Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series KK Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 18. REDEEMABLE VOTING SERIES LL PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "Redeemable Voting Series LL Preferred Shares" (hereinafter referred to as the "Series LL Preferred Shares"). (b) DIVIDENDS. Each holder of a Series LL Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series LL Preferred Shares are outstanding at a per annum dividend rate of six dollars ($6.00) per share. Such dividends shall be payable as declared and cumulative from and commence to accrue on the date of original issuance of such Series LL Preferred Shares (the "Issue Date"). (c) REDEMPTION AT ELECTION OF HOLDER. (1) The Series LL Preferred Shares shall be redeemable, in whole or in part, at the option of the holder thereof, on March 1, 1996, upon written notice given by such holder, between September 1, 1995 and December 1, 1995 and on the first day of March in calendar years 1997 through 2012, upon written notice given by such holder between the first day of September and the first day of December of the immediately preceding calendar year, of the holder's election to have the Corporation redeem such shares on March 1st of the next BI-27 succeeding calendar year (the "Redemption Date"). Notice of an election under the redemption provision above shall be mailed (by first class, postage prepaid) to the office or agency maintained by the Corporation for that purpose and each notice shall state the number of Series LL Preferred Shares to be redeemed, if less than all the shares held by the holder giving such notice. (2) Except as provided in the preceding paragraph, the Series LL Preferred Shares shall not be subject to redemption and shall not be subject to the election by the holder thereof to have the Corporation redeem such Series LL Preferred Shares. (3) Upon receipt of written notice from the holder of its election to redeem, the Corporation shall redeem the Series LL Preferred Shares to be redeemed pursuant to such notice of redemption on the Redemption Date. The redemption price (the "Redemption Price") of the Series LL Preferred Shares shall be equal to the product of the number of Series LL Preferred Shares elected to be redeemed multiplied by the sum of (A) $100.00 per share plus (B) all dividends accrued and unpaid, whether declared or undeclared, thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be paid by check mailed to the holder within 30 days of the Redemption Date. (4) If on or before the Redemption Date, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to any holder of the Series LL Preferred Shares to be redeemed pursuant to such notice of redemption upon such holder's surrender of such Series LL Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series LL Preferred Shares to be so redeemed shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series LL Preferred Shares to be so redeemed, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (5) Each holder who has given notice pursuant to subparagraph (c)(1) above shall deliver the certificate representing the Series LL Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by such certificate are to be redeemed, a new certificate shall be issued representing the shares which were not so redeemed. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series LL Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series LL Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series LL Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 19. REDEEMABLE VOTING SERIES QQ PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of the series of Preferred Shares created by this resolution shall be "Redeemable Voting Series QQ Preferred Shares" (hereinafter referred to as the "Series QQ Preferred Shares"). (b) DIVIDENDS. Each holder of a Series QQ Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, cumulative dividends during each fiscal quarter to the extent set forth below. Such dividends shall commence to accrue (whether or not declared), without interest, with the fiscal quarter ending December 31, 1991, at a per annum rate of four dollars ($4.00) per share and shall be paid (if and when declared) in cash on the first business day after the end of the quarter for which accrued; provided, however, that any dividends accrued with respect to the first thirteen quarters after September 30, 1991, shall be paid by issuing additional Series QQ Preferred Shares at the annual rate of .04 of a share for each outstanding Series QQ Preferred Share; and such dividends shall accrue thereafter at a per annum rate of six dollars ($6.00) per share. If with respect to any of the first thirteen quarters after September 30, 1991, any of the additional Series QQ Preferred Shares to be paid in satisfaction of the dividend then accrued are not issued, then, for the purpose of determining the cumulative dividends to which each holder of Series QQ Preferred Shares shall thereafter be entitled to receive with respect to subsequent fiscal quarters ended on or before December 31, 1994, the additional Series QQ BI-28 Preferred Shares not so issued shall be deemed to have been issued as of the first business day following the fiscal quarter for which accrued and to accrue dividends commencing with the quarter in which deemed to be issued. (c) REDEMPTION AT ELECTION OF CORPORATION. (1) Unless the holder shall have elected to have the Series QQ Preferred Shares redeemed in accordance with subparagraph (d)(1) hereof, the Series QQ Preferred Shares shall thereafter be redeemable in whole but not in part by the Corporation, upon giving notice as provided in subparagraph (c)(2) hereof, by delivering, at the option of the Corporation, on any date set for redemption (the "Redemption Date"), for each Series QQ Share (A) 4.35003 (the "Redemption Ratio") fully paid and non-assessable Common Shares, par value $1.00 per share ("USCC Common Shares"), of United States Cellular Corporation, a Delaware corporation ("USCC"), or (B) that number of Common Shares, par value $1.00 per share, of the Corporation ("TDS Common Shares") having a Market Value equal to the Market Value of one USCC Common Share multiplied by the Redemption Ratio, or (C) a combination of USCC Common Shares and TDS Common Shares having an aggregate Market Value equal to the Market Value of one USCC Common Share multiplied by the Redemption Ratio, or (D) cash (paid by certified check) equal to the Market Value of one USCC Common Share multiplied by the Redemption Ratio. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be mailed (by first class, postage prepaid) to each holder of Series QQ Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than thirty (30) days prior to the Redemption Date. If the Corporation elects to redeem any of the Series QQ Preferred Shares in cash and, on or before the Redemption Date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to the holders of Series QQ Preferred Shares so called for redemption upon such holders' surrender of such Series QQ Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series QQ Preferred Shares so called for redemption shall not have been surrendered for cancellation, all rights with respect to such Series QQ Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (3) Each notice of redemption shall state: (A) the Redemption Date; (B) the number of Series QQ Preferred Shares to be redeemed; (C) whether the Redemption Price will be paid in cash (by certified check), by the issuance of TDS Common Shares, by the transfer of USCC Common Shares, or by a combination thereof; and (D) the place where certificates for the Series QQ Preferred Shares are to be surrendered for payment of the Redemption Price. (4) Each holder of Series QQ Preferred Shares to be redeemed shall present and surrender his certificate for such shares to the Corporation at the place designated in such notice. Within two business days after the date of such presentation or, if later, upon the Redemption Date, the Redemption Price of such shares shall be paid to or on the order of the person whose name appears on such certificate as the owner thereof and each surrendered certificate shall be canceled. From and after the Redemption Date (unless the Corporation shall default in payment of the Redemption Price), all rights of the holders thereof as shareholders of the Corporation, except the right to receive the Redemption Price thereof, without interest, upon the surrender of certificates representing the same, shall cease and terminate, such shares shall not thereafter be transferred (except with the consent of the Corporation) on the books of the Corporation, and such shares shall not be deemed to be outstanding for any purpose whatsoever. (5) For purposes of this Statement, (A) the "Market Value" per share of TDS Common Shares or USCC Common Shares at any time as of which such value is to be determined shall be deemed to be the average "Closing Price" (as defined below) for TDS or USCC Common Shares, as the case may be, for the five trading days ending on the fifth business day preceding the relevant Redemption Date, Accelerated Redemption Date or effective date of a Going Private Transaction of the type referred to in clause (d)(4)(C) below, (B) a "business day" means a day on which the New York Stock Exchange or other principal stock exchange or over-the-counter market on which the TDS or USCC Common Shares, as the case may be, are traded was open for at BI-29 least one-half of its normal business day, and (C) the "Closing Price" on any day shall be the last sale price of such shares, regular way, as reported in a composite published report of transactions which includes transactions on the exchange or other principal markets in which such shares are traded or, if there is no such composite report as to any such day, the last reported sale price, regular way (or if there is no such reported sale on such day, the average of the closing reported bid and asked prices) on the principal United States securities trading market (whether a stock exchange, National Association of Securities Dealers Automated Quotation System or otherwise) on which such shares are traded. (d) REDEMPTION AT ELECTION OF HOLDER. (1) The Series QQ Preferred Shares outstanding on January 1, 1995, shall be redeemable in whole or in part at the option of the holder thereof on January 31, 1995, upon written notice given by such holder at the office or agency maintained by the Corporation for that purpose. (2) Each Series QQ Preferred Share tendered to the Corporation for redemption pursuant to subparagraph (d)(1) above shall be redeemed by the Corporation on the date specified in the notice (and permitted by this Statement) referred to in subparagraph (d)(1) above (which shall be the "Redemption Date" of such shares), by delivering, at the option of the Corporation, (A) that number of fully paid and non-assessable USCC Common Shares determined by multiplying one (1) by the Redemption Ratio, or (B) that number of TDS Common Shares having a Market Value equal to the Market Value of one USCC Common Share multiplied by the Redemption Ratio, or (C) a combination of USCC Common Shares and TDS Common Shares having an aggregate Market Value equal to the Market Value of one USCC Common Share multiplied by the Redemption Ratio. (3) Upon presentation and surrender of the certificate representing the Series QQ Preferred Shares to be redeemed, the holder thereof shall be entitled to receive in exchange therefor a certificate or certificates representing the fully paid and non-assessable TDS Common Shares, USCC Common Shares, or a combination thereof, determined in the manner set forth in subparagraph (d)(2) above. In addition, if any additional Series QQ Preferred Shares that were to be issued in payment of dividends accrued with respect to the first thirteen quarters after September 30, 1991, were not issued prior to the Redemption Date, then such holder shall also receive, in satisfaction of such dividends, the additional TDS Common Shares, USCC Common Shares, or a combination thereof, determined in the manner set forth in subparagraph (d)(2) above, which such holder would have received if such additional shares had been issued and had been tendered for redemption. (4) The amount and kind of securities or property to be delivered pursuant to subparagraph (c)(1) or (d)(2) above shall be subject to adjustment from time to time as follows: (A) In case USCC shall (i) take a record of the holders of USCC Common Shares for the purpose of entitling them to receive a dividend payable in USCC Common Shares, (ii) subdivide the outstanding USCC Common Shares, or (iii) combine the outstanding USCC Common Shares into a smaller number of shares, the Redemption Ratio shall be adjusted (or further adjusted in the case of successive such events) so that each holder of Series QQ Preferred Shares shall thereafter be entitled upon the redemption of each share thereof held by him to receive for each such share the number of USCC Common Shares which he would have owned or been entitled to receive after the happening of that one of the events described above which shall have happened had such Series QQ Preferred Share been redeemed immediately prior to the happening of such event in exchange for USCC Common Shares, such entitlement to become effective immediately after the opening of business on the day next following (x) the record date for such dividend, or (y) the day upon which such subdivision or combination shall become effective. (B) In case USCC shall take a record of the holders of USCC Common Shares for the purpose of entitling them to receive an Extraordinary Dividend (as hereinafter defined), the holder of each Series QQ Preferred Share shall be entitled in each such case to an additional cash payment upon the redemption of such share in an amount equal to the amount of cash and the fair market value as of such record date of any property other than cash that such holder would have been entitled to receive as a result of such Extraordinary Dividend had such Series QQ Preferred Share been redeemed immediately prior to such record date in exchange for USCC Common Shares. As used herein the term "Extraordinary Dividend" means any dividend upon USCC Common Shares payable in cash and/or in property other than cash if and to the extent that on the record date thereof the amount of such cash and the fair market value of such property per USCC Common Share (when added to all other dividends (other than any dividend referred to in clause (d)(4)(A) above) previously paid on USCC Common Shares during the same Payment Period BI-30 (as hereinafter defined)) exceeds ten percent of the average Closing Price for USCC Common Shares for the five trading days ending on such record date; provided, however, that the term "Extraordinary Dividend" shall not include any dividend referred to in clause (d)(4)(A) above. As used herein the term "Payment Period" means each consecutive 12-month period commencing on October 1, 1991, and each anniversary thereof. (C) In case USCC shall effect a Going Private Transaction (as hereinafter defined) in which the consideration to be received by the holders of USCC Common Shares consists of equity securities of TDS, then, notwithstanding any provision of this Statement to the contrary, upon the subsequent redemption of the Series QQ Preferred Shares, each Series QQ Preferred Share tendered to the Corporation for redemption pursuant to subparagraph (c)(2) or (d)(1) above shall be redeemed by the Corporation on the Redemption Date specified in the redemption notice (and otherwise permitted by this Statement) by delivering that number of TDS Common Shares having a Market Value as of the effective date of such Going Private Transaction equal to the Market Value on such date of that number of USCC Common Shares for which such Series QQ Preferred Share might have been redeemed immediately prior to such Going Private Transaction, plus that number of USCC Common Shares which the holder of such Series QQ Preferred Share would have been entitled to receive if all of the additional Series QQ Preferred Shares to be issued in payments of accrued dividends for the first thirteen quarters after September 30, 1991, pursuant to the proviso in paragraph (b) above, had been issued and immediately redeemed for USCC Common Shares on the last business day immediately preceding the effective date of such Going Private Transaction. The TDS Common Shares to be delivered pursuant to this clause (d)(4)(C) shall be subject to adjustment from time to time after the effective date of a Going Private Transaction of the type referred to in this clause pursuant to clauses (d)(4)(A) and (B) as if such clauses referred to TDS and TDS Common Shares rather than USCC and USCC Common Shares, respectively. (D) No adjustment in the number of TDS or USCC Common Shares, as the case may be, to which any holder is entitled pursuant to the application of clause (d)(4)(A) above shall be required unless such adjustment would require an increase or decrease of at least 1/10th of a TDS or USCC Common Share, as the case may be; provided, however, that any adjustments which by reason of this clause (D) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (5) Each holder who has given notice pursuant to subparagraph (d)(1) above shall deliver the certificate representing the Series QQ Preferred Shares to be redeemed to the Corporation with the notice of the redemption. In case fewer than all the shares represented by any certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. (e) REDEMPTION IN THE EVENT OF ORGANIC CHANGE. In case USCC shall propose to effect any reorganization or reclassification of USCC Common Shares, consolidate or merge with another corporation, or sell to another corporation all or substantially all of its assets in such a way that holders of its outstanding USCC Common Shares shall be entitled to receive (either directly or upon subsequent liquidation) stock, securities, cash or other property with respect to or in exchange for such USCC Common Shares (collectively, any "Organic Change"), and immediately after such Organic Change TDS or USCC would no longer be under common control within the meaning of Rule 405 promulgated by the Securities and Exchange Commission (the "SEC") under the Securities Act of 1933, as amended (a "Disaffiliation Transaction"), or USCC or TDS shall propose to effect any transaction or series of transactions of the type described in paragraph (a)(3)(i) of Rule 13e-3 promulgated by the SEC under the Securities Exchange Act of 1934, as amended, in which USCC is the "issuer", which has one of the effects described in paragraph (a)(3)(ii) of such Rule (a "Going Private Transaction"), and in which the consideration to be received by the holders of USCC Common Shares is something other than equity securities of TDS, then TDS shall deliver a notice of redemption (as described in subparagraph (c)(3) above) to each holder of Series QQ Preferred Shares at least ten business days prior to the earliest date (the "Effective Date") on which holders of USCC Common Shares shall become entitled to receive stock, securities, cash or other property in connection with such Disaffiliation Transaction or such Going Private Transaction. Such notice of redemption shall specify the Effective Date and each Series QQ Preferred Share shall be redeemed on a date (the "Accelerated Redemption Date") which is not later than the last business day preceding such Effective Date by the delivery by the Corporation of that number of USCC Common Shares for which such Series QQ Preferred Share might have been redeemed immediately prior to such Disaffiliation Transaction or such Going Private Transaction, plus that number of USCC Common Shares which the holder of such Series QQ Preferred Share would have been entitled to receive if all of the additional Series QQ Preferred Shares to be issued in payment of accrued dividends for the first thirteen fiscal BI-31 quarters after September 30, 1991, pursuant to the proviso in paragraph (b) above, had been issued and immediately redeemed for USCC Common Shares on the Accelerated Redemption Date. (f) NO FRACTIONAL SHARES. No fractional TDS Common Shares or USCC Common Shares shall be issued upon the redemption of Series QQ Preferred Shares, nor shall cash adjustments be made for fractional shares upon such redemption. (g) TERMINOLOGY. For purposes of this Statement, the term "TDS Common Shares" and the term "USCC Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation and the Common Shares of USCC, respectively, on the date this Statement is filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassifications of such class consisting solely of a change in par value, or a change from no par value to par value. (h) VOTING RIGHTS. (1) With respect to all matters, each holder of Series QQ Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series QQ Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (i) PREFERENCE VALUE IN LIQUIDATION. The amount payable upon each Series QQ Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00. 20. $7.50 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES RR PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of this series of Preferred Shares shall be "$7.50 Cumulative Convertible and Redeemable Voting Series RR Preferred Shares" (hereinafter referred to as the "Series RR Preferred Shares"). (b) DIVIDENDS. Each holder of a Series RR Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter that such Series RR Preferred Share is outstanding at a per annum dividend rate of seven dollars and fifty cents ($7.50) per share. Such dividends shall be cumulative from and shall commence to accrue on the date of original issuance of such Series RR Preferred Shares (the "Issue Date"). (c) REDEMPTION. (1) Unless the Series RR Preferred Shares have been converted or the Corporation shall have received prior to the fifth anniversary of the Issue Date written notice of election to convert in accordance with paragraph (e) hereof, on or after the fifth anniversary of the Issue Date, the Series RR Preferred Shares shall be redeemable, in whole or in part from time to time, at the option of the Corporation, upon giving notice as provided in subparagraph (c)(2) hereof, at a redemption price (the "Redemption Price") equal to the sum of (A) $100.00 for each Series RR Preferred Share called for redemption plus (B) all dividends accrued and unpaid thereon through the date set for redemption (the "Redemption Date"). The Redemption Price payable on any Redemption Date shall be payable, at the option of the Corporation, (x) in cash (by certified check) or (y) by the issuance of Common Shares of the Corporation to the record holder of such Series RR Preferred Shares being redeemed. In the event that the Corporation elects to pay the Redemption Price by issuing its Common Shares, the number of Common Shares to be issued shall be calculated (and rounded to the nearest whole share) based upon the arithmetical average of the closing price on the American Stock Exchange (or, if the Corporation's Common Shares are not listed on the American Stock Exchange (in order if more than one applies), the closing price of such Common Shares on any national securities exchange or on any regional securities exchange, the highest bid price quoted through the National Association of Securities Dealers Automated Quotation System, or the highest bid price reported by dealers in the over-the-counter market) of the Corporation's Common Shares for the thirty (30) trading days ending on the third trading day prior to the Redemption Date. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be mailed (by first class, postage prepaid) to each holder of Series RR Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than thirty (30) days prior to the Redemption Date. If on or BI-32 before the Redemption Date specified in such notice, the funds necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to the holder of Series RR Preferred Shares so called for redemption upon such holder's surrender of such Series RR Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series RR Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series RR Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (3) Each such notice of redemption shall state: (A) the Redemption Date; (B) the number of Series RR Preferred Shares to be redeemed and, if less than all the shares held by such holder are to be redeemed from such holder, the number of shares to be redeemed from such holder; (C) whether the Redemption Price will be paid in cash (by certified check) or by the issuance of Common Shares of the Corporation; (D) the place where certificates for such shares are to be surrendered for payment of the Redemption Price; and (E) that dividends on the shares to be redeemed shall cease to accrue on such Redemption Date. (5) On or after the Redemption Date each holder of shares of Series RR Preferred Shares to be redeemed shall present and surrender the certificate or certificates for such shares to the Corporation at the place designated in such notice and thereupon the Redemption Price of such shares shall be paid to or on the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be cancelled. In case fewer than all the shares represented by such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. From and after the Redemption Date (unless the Corporation shall default in payment of the Redemption Price) all dividends on the Series RR Preferred Shares designated for redemption in such notice shall cease to accrue, and all rights of the holders thereof as shareholders of the Corporation, except the right to receive the Redemption Price thereof, without interest, upon the surrender of certificates representing the same, shall cease and terminate and such shares shall not thereafter be transferred (except with the consent of the Corporation) on the books of the Corporation and such shares shall not be deemed to be outstanding for any purpose whatsoever. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series RR Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series RR Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION. (1) Commencing upon the Issue Date and terminating at the close of business on the day before the fifth anniversary of the Issue Date, each outstanding Series RR Preferred Share may be converted at any time, upon written notice mailed to the Corporation (by first class, postage prepaid), into 2.06 Common Shares. A holder of Series RR Preferred Shares shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid (rounded to the nearest whole share) within fifteen (15) days following the later of (A) receipt by the Corporation of written notice of intent to convert, and (B) presentation and surrender to the Corporation at its offices of the certificates representing the Series RR Preferred Shares to be converted (the "Conversion Date"), all under suitable regulations to be prescribed by the board of directors of the Corporation. Conversion of Series RR Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive dividends accrued but unpaid thereon as of any dividend payment date prior to the Conversion Date. BI-33 (2) The number of Common Shares into which each Series RR Preferred Share is convertible shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In the event the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series RR Preferred Share shall be entitled to receive upon the conversion of such share, the number of shares of the Corporation which such holder would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. An adjustment made pursuant to this provision shall become effective retroactively with respect to conversions made after the record date in the case of a dividend, and shall become effective on the effective date in the case of a subdivision, combination or reclassification. (B) No adjustment in the conversion rate shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series RR Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series RR Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series RR Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation on the date this Statement is filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassification of such class consisting solely of a change in par value, or a change from no par value to par value. (6) Each notice of conversion shall state the number of Series RR Preferred Shares to be converted, if less than all the shares held by such holder. In case fewer than all the shares represented by such certificate are converted, a new certificate shall be issued representing the unconverted shares. From and after the Conversion Date (unless the Corporation shall default in issuing the Common Shares on the Conversion Date), all dividends on such converted shares of Series RR Preferred Shares shall cease to accrue and such shares shall not be outstanding for any purpose whatsoever. (f) PREFERENCE VALUE IN LIQUIDATION. The amount payable with respect to each Series RR Preferred Share in the event of either voluntary or involuntary liquidation shall be $100.00, plus a sum equal to the amount of all dividends accrued and unpaid thereon. 21. $5.50 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES SS PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of the series of Preferred Shares created by this resolution shall be "$5.50 Cumulative Convertible and Redeemable Voting Series SS Preferred Shares" (hereinafter referred to as the "Series SS Preferred Shares"). (b) DIVIDENDS. Each holder of a Series SS Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter to the extent set forth below. Such dividends shall be cumulative from and shall commence to accrue (whether or not declared) on the date of original issuance of such Series SS Preferred Shares (the "Issue Date"), at a per annum dividend rate of five dollars and fifty cents ($5.50) per share. (c) REDEMPTION. (1) On or after the fifth anniversary of the Issue Date, the Series SS Preferred Shares shall be redeemable, in whole or in part from time to time, at the option of the Corporation, on a date (the "Optional Redemption Date") which is the first business day after a dividend payment date, pursuant to a notice as provided in subparagraph (c)(3) hereof, at a redemption price (the "Optional Redemption Price") equal to the sum of BI-34 (A) $100.00 for each Series SS Preferred Share called for redemption plus (B) all dividends accrued and unpaid thereon through the Optional Redemption Date. The Optional Redemption Price payable on any Optional Redemption Date shall be payable (i) in cash (by certified check), or (ii) in the event that the Average Closing Price (as defined below) for the Common Shares of the Corporation exceeds $44.44, then, at the option of the Corporation (to be exercised, if at all, in its notice of redemption) by (I) the issuance to the record holder of the Series SS Preferred Shares being redeemed of 2.25 Common Shares (subject to adjustment as set forth in paragraph (e)(2) hereof) for each Series SS Preferred Share so redeemed plus (II) the payment in cash of all dividends accrued and unpaid thereon through the Optional Redemption Date. If a holder, subsequent to receiving a notice of redemption of less than all of such holder's Series SS Preferred Shares and at least fifteen (15) days prior to the Redemption Date, elects to convert any Series SS Preferred Shares, then the number of shares to be redeemed from such holder on such Redemption Date shall be reduced by the lesser of (x) the number of Series SS Preferred Shares called for redemption from such holder and (y) the number of such shares converted by such holder. For purposes hereof, the term "Average Closing Price" shall mean the arithmetical average of the closing price on the American Stock Exchange of the Common Shares of the Corporation for the five trading days ending on the fifth business day preceding the relevant Redemption Date and, if the Common Shares of the Corporation are not listed on the American Stock Exchange then, in order, if more than one applies, the arithmetical average of the closing price of such Common Shares on any national securities exchange or on any regional securities exchange, the highest bid price quoted through the National Association of Securities Dealers Automated Quotation System, or the highest bid price reported by dealers in the over-the-counter market. (2) If an Optional Redemption Date has not occurred by the tenth anniversary of the Issue Date (the "Mandatory Redemption Date" and, together with the Optional Redemption Date, the "Redemption Date"), the Corporation shall, on the Mandatory Redemption Date, redeem all Series SS Preferred Shares then outstanding at a redemption price (the "Mandatory Redemption Price" and, together with the Optional Redemption Price, the "Redemption Price") equal to the sum of (A) $100.00 for each Series SS Preferred Share outstanding on the Mandatory Redemption Date plus (B) all dividends accrued and unpaid thereon through the Mandatory Redemption Date. The Mandatory Redemption Price shall be payable in cash by certified check. (3) Notice of (A) an election under the redemption provision in subparagraph (c)(1) above, or (B) the Mandatory Redemption Date, shall be mailed (by registered mail, return receipt requested) to each holder of Series SS Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than sixty (60) days prior to the Redemption Date. If, on or before the Redemption Date specified in such notice, the funds or Common Shares necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to the holder of Series SS Preferred Shares so called for redemption upon such holder's surrender of such Series SS Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series SS Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series SS Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (4) Each such notice of redemption shall state: (A) the Redemption Date; (B) the number of Series SS Preferred Shares to be redeemed and, if less than all the shares held by such holder are to be redeemed from such holder, the number of shares to be redeemed from such holder (subject in each case to the right of the holder to convert such shares prior to the Redemption Date); (C) in the case of an Optional Redemption Date, whether the Optional Redemption Price will be paid in cash (by certified check) or, in the event the Average Closing Price exceeds $44.44, by the issuance of Common Shares of the Corporation; (D) the place where certificates for such shares are to be surrendered for payment of the Redemption Price; and (E) that dividends on the shares to be redeemed shall cease to accrue on such Redemption Date. (5) On or after a Redemption Date, each holder of shares of Series SS Preferred Shares to be redeemed shall present and surrender the certificate or certificates for such shares to the Corporation at the place BI-35 designated in such notice and thereupon the Redemption Price of such shares shall be paid to or on the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be cancelled. In case fewer than all the shares represented by such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. From and after a Redemption Date (unless the Corporation shall default in payment of the Redemption Price) all dividends on the Series SS Preferred Shares designated for redemption in such notice shall cease to accrue, and all rights of the holders thereof as shareholders of the Corporation, except the right to receive the Redemption Price thereof, without interest, upon the surrender of certificates representing the same, shall cease and terminate and such shares shall not thereafter be transferred (except with the consent of the Corporation) on the books of the Corporation and such shares shall not be deemed to be outstanding for any purpose whatsoever. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series SS Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series SS Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION. (1) At any time and from time to time after the Issue Date, any holder of Series SS Preferred Shares may convert all or any portion of the Series SS Preferred Shares held by such holder into Common Shares at a conversion ratio (subject to adjustment as set forth below) of 2.25 Common Shares for each Series SS Preferred Share so converted; provided, however, that, in the case of Series SS Preferred Shares called for redemption or shares to be redeemed on the Mandatory Redemption Date, the right of the holder thereof to convert such shares shall expire fifteen (15) days prior to the Redemption Date. A holder of Series SS Preferred Shares shall be entitled to receive in exchange therefor certificates for the fully paid and non-assessable Common Shares of the Corporation at the rate aforesaid (with the aggregate number of such Common Shares rounded to the nearest whole share) within fifteen (15) days following presentation and surrender by such holder to the Corporation at its offices of the certificates representing the Series SS Preferred Shares to be converted (the "Conversion Date"), all under suitable regulations (which shall not be inconsistent with the provisions hereof, which shall not materially impair the rights of the holder, and of which the holder shall receive advance notice) to be prescribed by the board of directors of the Corporation. Conversion of Series SS Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive (on the Conversion Date if such dividends shall be legally payable by the Corporation on such date, or as promptly after the Conversion Date as such dividends shall be legally payable) dividends accrued but unpaid thereon as of any dividend payment date prior to the Conversion Date. (2) The number of Common Shares to be exchanged for each Series SS Preferred Share that is converted pursuant to subparagraph (e)(1) or redeemed in accordance with subparagraph (c)(1) shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In the event the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series SS Preferred Share shall be entitled to receive in exchange for such share upon the conversion or redemption thereof the number of shares of the Corporation which such holder would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. The adjustments provided for in this clause (A) shall be cumulative if more than one event requiring an adjustment shall occur between the Issue Date and the Conversion Date or Redemption Date, as the case may be. (B) No adjustment pursuant to this paragraph (e) shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. BI-36 (C) Promptly after any adjustment pursuant to this paragraph (e), the Corporation shall give written notice thereof to all holders of Series SS Preferred Shares, setting forth in reasonable detail and certifying the calculation of such adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series SS Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series SS Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series SS Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation on the date this Statement is filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassification of such class consisting solely of a change in par value, or a change from no par value to par value. (6) Each notice of conversion shall state the number of Series SS Preferred Shares to be converted, if less than all the shares held by such holder. In case fewer than all the shares represented by such certificate are converted, a new certificate shall be issued representing the unconverted shares. From and after the Conversion Date (unless the Corporation shall default in issuing the Common Shares on the Conversion Date), all dividends on such converted shares of Series SS Preferred Shares shall cease to accrue and such shares shall not be outstanding for any purpose whatsoever. (f) PREFERENCE VALUE IN LIQUIDATION. The amount payable with respect to each Series SS Preferred Share in the event of either voluntary or involuntary liquidation of the Corporation shall be $100.00, plus a sum equal to the amount of all dividends accrued and unpaid thereon. 22. $5.00 CUMULATIVE CONVERTIBLE AND REDEEMABLE VOTING SERIES TT PREFERRED SHARES, $.01 PAR VALUE, LIQUIDATION VALUE $100.00 PER SHARE (a) DESIGNATION. The designation of the series of Preferred Shares created by this resolution shall be "$5.00 Cumulative Convertible and Redeemable Voting Series TT Preferred Shares" (hereinafter referred to as the "Series TT Preferred Shares"). (b) DIVIDENDS. Each holder of a Series TT Preferred Share shall be entitled to receive, when, as and if declared by the board of directors of the Corporation, out of funds of the Corporation legally available therefor, cumulative dividends during each fiscal quarter to the extent set forth below. Such dividends shall be cumulative from and shall commence to accrue (whether or not declared) on the date of original issuance of such Series TT Preferred Shares (the "Issue Date"), at a per annum dividend rate of five dollars ($5.00) per share. (c) REDEMPTION. (1) On or after the tenth anniversary of the Issue Date, the Series TT Preferred Shares shall be redeemable, in whole or in part from time to time, at the option of the Corporation, on a date (the "Redemption Date") which is the first business day after a dividend payment date, pursuant to a notice as provided in subparagraph (c)(2) hereof, at a redemption price (the "Redemption Price") equal to the sum of (A) $100.00 for each Series TT Preferred Share called for redemption plus (B) all dividends accrued and unpaid thereon through the Redemption Date. The Redemption Price payable on any Redemption Date shall be payable (i) in cash (by certified check), or (ii) by the issuance of Common Shares of the Corporation to the record holder of such Series TT Preferred Shares being redeemed. In the event that the Corporation elects to pay the Redemption Price by issuing its Common Shares, the number of Common Shares to be issued shall be calculated (and rounded to the nearest whole share) based upon the arithmetical average of the closing price on the American Stock Exchange (or, if the Corporation's Common Shares are not listed on the American Stock Exchange (in order if more than one applies), the closing price of such Common Shares on any national securities exchange or on any regional securities exchange, the highest bid price quoted through the National Association of Securities Dealers Automated Quotation System, or the highest bid price reported by dealers in the over-the-counter market) of the Corporation's Common Shares for the thirty (30) trading days ending on the third trading day prior to the Redemption Date. If a holder, subsequent to receiving a notice of redemption of such holder's Series TT Preferred Shares and at least fifteen (15) days prior to the Redemption Date, properly elects to convert any Series TT Preferred Shares, then the number of shares to be redeemed from such holder on BI-37 such Redemption Date shall be reduced by the lesser of (x) the number of Series TT Preferred Shares called for redemption from such holder and (y) the number of such shares converted by such holder. (2) Notice of an election under the redemption provision in subparagraph (c)(1) above shall be mailed (by registered mail, return receipt requested) to each holder of Series TT Preferred Shares to be redeemed at the address appearing on the records of the Corporation not less than sixty (60) days prior to the Redemption Date. If, on or before the Redemption Date specified in such notice, the funds or Common Shares necessary for such redemption shall have been set aside by the Corporation so as to be available for payment to the holder of Series TT Preferred Shares so called for redemption upon such holder's surrender of such Series TT Preferred Shares to the Corporation, then, notwithstanding that any certificate representing Series TT Preferred Shares so called for redemption shall not have been surrendered for cancellation, the dividends thereon shall cease to accrue from and after the Redemption Date, and all rights with respect to such Series TT Preferred Shares so called for redemption, including any right to vote or otherwise participate in the determination of any proposed corporate action, shall terminate at the close of business on such Redemption Date, except only the right of the holder to receive the Redemption Price therefor, but without interest. (3) Each such notice of redemption shall state: (A) the Redemption Date; (B) the number of Series TT Preferred Shares to be redeemed and, if less than all the shares held by such holder are to be redeemed from such holder, the number of shares to be redeemed from such holder (subject, if applicable, to the right of the holder to convert such shares prior to the Redemption Date); (C) whether the Redemption Price will be paid in cash (by certified check) or by the issuance of Common Shares of the Corporation; (D) the place where certificates for such shares are to be surrendered for payment of the Redemption Price; and (E) that dividends on the shares to be redeemed shall cease to accrue on such Redemption Date. (4) On or after a Redemption Date, each holder of shares of Series TT Preferred Shares to be redeemed shall present and surrender the certificate or certificates for such shares to the Corporation at the place designated in such notice and thereupon the Redemption Price of such shares shall be paid to or on the order of the person whose name appears on such certificate or certificates as the owner thereof and each surrendered certificate shall be canceled. In case fewer than all the shares represented by such certificate are redeemed, a new certificate shall be issued representing the unredeemed shares. From and after a Redemption Date (unless the Corporation shall default in payment of the Redemption Price) all dividends on the Series TT Preferred Shares designated for redemption in such notice shall cease to accrue, and all rights of the holders thereof as shareholders of the Corporation, except the right to receive the Redemption Price thereof, without interest, upon the surrender of certificates representing the same, shall cease and terminate and such shares shall not thereafter be transferred (except with the consent of the Corporation) on the books of the Corporation and such shares shall not be deemed to be outstanding for any purpose whatsoever. (d) VOTING RIGHTS. (1) With respect to all matters, each holder of Series TT Preferred Shares shall be entitled to one vote for each share of such stock standing in the name of the holder on the books of the Corporation. (2) With respect to the election of directors, the holders of Series TT Preferred Shares shall have class voting rights (voting together with the holders of (A) other Preferred Shares that are entitled to vote thereon and that were issued after October 31, 1981, and (B) Series A Common Shares) to the extent provided in Article IV of the Restated Certificate of Incorporation of the Corporation. (e) CONVERSION. (1) At any time and from time to time for the period commencing on the Issue Date and terminating on the tenth anniversary of the Issue Date, any holder of Series TT Preferred Shares may convert all or any portion of the Series TT Preferred Shares held by such holder into Common Shares at a conversion ratio (subject to adjustment as set forth below) of 1.818 Common Shares for each Series TT Preferred Share so converted; provided, however, that, in the case of Series TT Preferred Shares called for redemption, the right of the holder thereof to convert such shares shall expire fifteen (15) days prior to the Redemption Date. A holder of Series TT Preferred Shares shall be entitled to receive in exchange therefor certificates for the fully paid and non- BI-38 assessable Common Shares of the Corporation at the rate aforesaid (with the aggregate number of such Common Shares rounded to the nearest whole share) within fifteen (15) days following presentation and surrender by such holder to the Corporation at its offices of the certificates representing the Series TT Preferred Shares to be converted (the "Conversion Date"), all under suitable regulations (which shall not be inconsistent with the provisions hereof, which shall not materially impair the rights of the holder, and of which the holder shall receive advance notice) to be prescribed by the board of directors of the Corporation. Conversion of Series TT Preferred Shares in the manner aforesaid shall not affect the right of the converting holder thereof to receive (on the Conversion Date if such dividends shall be legally payable by the Corporation on such date, or as promptly after the Conversion Date as such dividends shall be legally payable) dividends accrued but unpaid thereon as of any dividend payment date prior to the Conversion Date. (2) The number of Common Shares to be exchanged for each Series TT Preferred Share that is converted pursuant to subparagraph (e)(1) or redeemed in accordance with subparagraph (c)(1) shall be subject to adjustment from time to time as set forth in clauses (A) and (B) of this subparagraph (2): (A) In the event the Corporation shall (i) pay a dividend on its Common Shares in shares of the Corporation, (ii) subdivide its outstanding Common Shares, (iii) combine the outstanding Common Shares into a smaller number of shares or (iv) issue by reclassification of its Common Shares (whether pursuant to a merger or consolidation or otherwise) any shares of the Corporation, then the holder of each Series TT Preferred Share shall be entitled to receive in exchange for such share upon the conversion or redemption thereof the number of shares of the Corporation which such holder would have owned or would have been entitled to receive after the happening of any of the events described above had such share been converted immediately prior to the happening of such event. The adjustments provided for in this clause (A) shall be cumulative if more than one event requiring an adjustment shall occur between the Issue Date and the Conversion Date or Redemption Date, as the case may be. (B) No adjustment pursuant to this paragraph (e) shall be required unless such adjustment would require an increase or decrease in such rate of at least one-tenth (1/10) of a Common Share; provided, however, that any adjustments which by reason of this clause (B) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. (C) Promptly after any adjustment pursuant to this paragraph (e), the Corporation shall give written notice thereof to all holders of Series TT Preferred Shares, setting forth in reasonable detail and certifying the calculation of such adjustment. (3) The Corporation shall at all times reserve and keep available out of its authorized Common Shares, solely for the purpose of issuance upon conversion of Series TT Preferred Shares as herein provided, such number of Common Shares as shall then be issuable upon the conversion of all outstanding Series TT Preferred Shares. (4) Fractional Common Shares shall not be issued upon conversion of Series TT Preferred Shares, nor shall cash adjustments be made for fractional shares upon such conversion. (5) For purposes of this paragraph (e), the term "Common Shares" shall mean (A) the class of stock designated as the Common Shares of the Corporation on the date this Statement is filed with the Delaware Secretary of State, or (B) any other class of stock resulting from successive changes or reclassification of such class consisting solely of a change in par value, or a change from no par value to par value. (6) Each notice of conversion shall state the number of Series TT Preferred Shares to be converted, if less than all the shares held by such holder. In case fewer than all the shares represented by such certificate are converted, a new certificate shall be issued representing the unconverted shares. From and after the Conversion Date (unless the Corporation shall default in issuing the Common Shares on the Conversion Date), all dividends on such converted shares of Series TT Preferred Shares shall cease to accrue and such shares shall not be outstanding for any purpose whatsoever. (f) PREFERENCE VALUE IN LIQUIDATION. The amount payable with respect to each Series TT Preferred Share in the event of either voluntary or involuntary liquidation of the Corporation shall be $100.00, plus a sum equal to the amount of all dividends accrued and unpaid thereon. * * * * * * * * BI-39 EXHIBIT C-1 OPINION OF CREDIT SUISSE FIRST BOSTON CORPORATION December 17, 1997 Board of Directors Telephone and Data Systems, Inc. 30 North LaSalle Street Chicago, Illinois 60602 Dear Sirs: We have reviewed a proposal (the "Proposal") by Telephone and Data Systems, Inc. (the "Company") as set forth in the preliminary Proxy Statement/Prospectus (the "Proxy Statement/Prospectus"), a form of which was presented to the Company's Board of Directors on December 15, 1997, to: (i) create three new classes of common stock, which are intended to reflect separately the performance of the Company's cellular telephone, landline telephone and personal communications service businesses (the "Tracking Stocks"), and (ii) change the state of incorporation of the Company from Iowa to Delaware (the "Reincorporation"). The Proposal would, among other things, authorize three new classes of common stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Common Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Common Shares") and Aerial Communications Group Common Shares (the "Aerial Group Common Shares"). The Cellular Group Common Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which primarily includes the Company's interest in United States Cellular Corporation, currently an approximately 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties ("U.S. Cellular"). The Telecom Group Common Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily includes the Company's interest in TDS Telecommunications Corporation, a wholly-owned subsidiary of the Company which operates landline telephone companies ("TDS Telecom"). The Aerial Group Common Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group" and together with the Cellular Group and the Telecom Group, the "Tracking Group"), which primarily includes the Company's interest in Aerial Communications, Inc., currently an approximately 83%-owned subsidiary of the Company which is developing broadband personal communications services ("Aerial"). According to the Proposal, the Company intends to: (i) offer and sell Telecom Group Common Shares in a public offering for cash, (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group; (ii) issue Cellular Group Common Shares in exchange for all of the shares of common stock of U.S. Cellular which are not owned by the Company pursuant to a merger between a subsidiary of the Company and U.S. Cellular (the "U.S. Cellular Merger"); (iii) issue Aerial Group Common Shares in exchange for all of the shares of common stock of Aerial which are not owned by the Company pursuant to a merger between a subsidiary of the Company and Aerial (the "Aerial Merger"); and (iv) distribute Cellular Group Common Shares, Telecom Group Common Shares and Aerial Group Common Shares (the "Distributed Group Shares") in the form of a stock dividend on a pro rata basis to holders of Series A Common Shares and Common Shares of the Company such that, after the events described in (i), (ii) and (iii) have occurred, approximately 20% of the common shareholders' value of each Tracking Group stock would initially be retained in a residual group (the "Distribution"; the Common Shares of the Company and the Distributed Group Shares distributed to the holders of Common Shares of the Company referred to together as the "Proposed Common Equity"). You have informed us that it is currently anticipated that the Distribution would take place in June 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. The U.S. Cellular Merger, the Aerial Merger and the Distribution are intended to be tax-free to shareholders (except with respect to any cash received in lieu of fractional shares). The Telecom Public Offering, U.S. Cellular Merger, Aerial Merger, Distribution, and Reincorporation are herein collectively referred to as the Recapitalization (the "Recapitalization"). C1-1 You have asked us to advise you with respect to the effect of the implementation of the Recapitalization on (i) the market value of the Proposed Common Equity and (ii) the ability of the Company to raise equity capital through an offering or offerings of shares of common equity or securities convertible into common equity ("Equity Market Access"), assuming that such proposed Recapitalization was effective as of the date hereof. The terms of the Tracking Stocks and the proposed Recapitalization are set forth in the Proxy Statement/Prospectus, and all capitalized terms not specifically defined herein shall have the meanings ascribed to them in the Proxy Statement/ Prospectus. We have assumed with your consent that, immediately prior to the proposed Recapitalization, the Company Common Shares, the Series A Common Shares, the Preferred Shares, the U.S. Cellular Common and Series A Common Shares and the Aerial Common and Series A Common Shares (the "Initial Shares") will continue to be the only classes of capital stock of the Company, U.S. Cellular, and Aerial, respectively, which are outstanding; that, other than in connection with the proposed Recapitalization, there will be no material change in the number of Initial Shares outstanding prior to the implementation of the proposed Recapitalization; and that, immediately after the proposed Recapitalization, the Company Common Shares, the Series A Common Shares, the Preferred Shares and the Tracking Stocks will be the only classes of capital stock then outstanding. We have also assumed that the U.S. Cellular Merger and the Aerial Merger are consummated on the terms set forth in the Proxy Statement/ Prospectus. We have further assumed that, prior to the proposed Recapitalization, the Initial Shares which are currently listed will continue to be listed on their respective exchanges or trading markets, and that, following the proposed Recapitalization, the Company's Common Shares and the Tracking Stocks will be eligible for, and will be the only capital stock of the Company listed on, the American Stock Exchange. In arriving at our opinion, we have reviewed certain publicly available business and financial information relating to the Company, as well as the Proxy Statement/Prospectus. We have also reviewed certain other information, including financial forecasts, provided to us by the Company, and have met with the Company's management to discuss the business and prospects of the Company and the Tracking Group and the potential impact of changes in the competitive environment and in the Company's and the Tracking Group's business plans and strategies on those forecasts, business and prospects. We have also considered certain financial and stock market data of the Company, and we have compared those data with similar data for other publicly held companies which have multiple classes of stock outstanding which reflect the performance of specific lines of business, and we have considered the financial terms of the different classes of stock of such companies. We also considered such other information, financial studies, analyses and investigations and financial, economic and market criteria which we deemed relevant. In connection with our review, we have not assumed any responsibility for independent verification of any of the foregoing information (including the information contained in the Proxy Statement/Prospectus) and have relied on its being complete and accurate in all material respects. With respect to the financial forecasts, we have assumed that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the Company's management as to the future financial performance of the Company and the Tracking Group. In addition, we have not been requested to make, and have not made, an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of the Company or the Tracking Group, nor have we been furnished with any such evaluations or appraisals. We are not expressing any opinion as to what the actual value of the Tracking Stocks will be when issued to the Company's stockholders pursuant to the Recapitalization or the prices at which such Tracking Stocks will trade subsequent to the Recapitalization. In addition, we are not expressing any opinion whatsoever as to the individual merits of the U.S. Cellular Merger, the Aerial Merger, or the Telecom Public Offering, or any opinion whatsoever with respect to the Reincorporation. Our opinion does not address the Company's underlying business decision to effect the Recapitalization and does not constitute a recommendation to any shareholder of the Company as to how such shareholder should vote with respect to the Recapitalization. Our analysis is necessarily based on financial, economic, market, and other conditions as they exist and can be evaluated on the date of this letter and assumes the Recapitalization was effective as of the date hereof, and we note that such conditions may change prior to the expected date of consummation of the Recapitalization. The Recapitalization may cause a change in perception by some investors of the future plans of the Company or the holders of Series A Common Shares. Consequently, our opinion assumes that the market has had a reasonable opportunity to understand and evaluate the Recapitalization. In addition, the Tracking Stocks which would be issued to the public shareholders of the Company in the proposed Distribution might trade initially at market prices below those at which they would trade on a fully distributed basis. C1-2 It is understood that this letter is for the information of the Board of Directors of the Company in connection with its consideration of the proposed Recapitalization and is not to be quoted or referred to, in whole or in part, in any registration statement, prospectus or in any other document used in connection with the offering or sale of securities, nor shall this letter be used for any other purposes, without our prior written consent; provided, that this opinion may be included in its entirety, or appropriately described or referred to, in any communication by the Company or the Board of Directors to the stockholders of the Company or the Securities and Exchange Commission, including the preliminary and definitive proxy statement/prospectus of the Company relating to the Recapitalization; provided, that we have had the opportunity to review and comment on such communication prior to the filing with the Securities and Exchange Commission and prior to its dissemination to stockholders. We have acted as financial advisor to the Company in connection with the Recapitalization and will receive a fee for our services, a portion of which is contingent upon the consummation of the Recapitalization. In the ordinary course of our business, we and our affiliates may actively trade the debt and equity securities of the Company, US Cellular and Aerial for our and such affiliates' own accounts and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities. In the past, we have performed certain investment banking services for the Company, US Cellular and Aerial and their affiliates and have received customary fees for such services. Based upon and subject to the foregoing, it is our opinion that, assuming that the proposed Recapitalization had been effective as of the date hereof, the Recapitalization would not have a material adverse effect from a financial point of view on (i) the aggregate market value on a fully-distributed basis of the Proposed Common Equity outstanding after such Recapitalization as compared with the aggregate market value of the Company Common Shares outstanding immediately prior to the announcement of such Recapitalization or (ii) the Company's Equity Market Access after such Recapitalization as compared to the Company's Equity Market Access prior to the announcement of such Recapitalization. Sincerely, CREDIT SUISSE FIRST BOSTON CORPORATION C1-3 EXHIBIT C-2 OPINION OF SALOMON SMITH BARNEY December 17, 1997 Board of Directors Telephone and Data Systems, Inc. 30 North LaSalle Street Chicago, Illinois 60602 Dear Sirs: We have reviewed a proposal (the "Proposal") by Telephone and Data Systems, Inc. (the "Company") as set forth in the preliminary Proxy Statement/Prospectus (the "Proxy Statement/Prospectus"), a form of which was presented to the Company's Board of Directors on December 15, 1997, to: (i) create three new classes of common stock, which are intended to reflect separately the performance of the Company's cellular telephone, landline telephone and personal communications service businesses (the "Tracking Stocks"), and (ii) change the state of incorporation of the Company from Iowa to Delaware (the "Reincorporation"). The Proposal would, among other things, authorize three new classes of common stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Common Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Common Shares") and Aerial Communications Group Common Shares (the "Aerial Group Common Shares"). The Cellular Group Common Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which primarily includes the Company's interest in United States Cellular Corporation, currently an approximately 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties ("U.S. Cellular"). The Telecom Group Common Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily includes the Company's interest in TDS Telecommunications Corporation, a wholly-owned subsidiary of the Company which operates landline telephone companies ("TDS Telecom"). The Aerial Group Common Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group" and together with the Cellular Group and the Telecom Group, the "Tracking Group"), which primarily includes the Company's interest in Aerial Communications, Inc., currently an approximately 83%-owned subsidiary of the Company which is developing broadband personal communications services ("Aerial"). According to the Proposal, the Company intends to: (i) offer and sell Telecom Group Common Shares in a public offering for cash, (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group; (ii) issue Cellular Group Common Shares in exchange for all of the shares of common stock of U.S. Cellular which are not owned by the Company pursuant to a merger between a subsidiary of the Company and U.S. Cellular (the "U.S. Cellular Merger"); (iii) issue Aerial Group Common Shares in exchange for all of the shares of common stock of Aerial which are not owned by the Company pursuant to a merger between a subsidiary of the Company and Aerial (the "Aerial Merger"); and (iv) distribute Cellular Group Common Shares, Telecom Group Common Shares and Aerial Group Common Shares (the "Distributed Group Shares") in the form of a stock dividend on a pro rata basis to holders of Series A Common Shares and Common Shares of the Company such that, after the events described in (i), (ii) and (iii) have occurred, approximately 20% of the common shareholders' value of each Tracking Group stock would initially be retained in a residual group (the "Distribution"; the Common Shares of the Company and the Distributed Group Shares distributed to the holders of Common Shares of the Company referred to together as the "Proposed Common Equity"). You have informed us that it is currently anticipated that the Distribution would take place in June 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. The U.S. Cellular Merger, the Aerial Merger and the Distribution are intended to be tax-free to shareholders (except with respect to any cash received in lieu of fractional shares). The Telecom Public Offering, U.S. Cellular Merger, Aerial Merger, Distribution, and Reincorporation are herein collectively referred to as the Recapitalization (the "Recapitalization"). C2-1 You have asked us to advise you with respect to the effect of the implementation of the Recapitalization on (i) the market value of the Proposed Common Equity and (ii) the ability of the Company to raise equity capital through an offering or offerings of shares of common equity or securities convertible into common equity ("Equity Market Access"), assuming that such proposed Recapitalization was effective as of the date hereof. The terms of the Tracking Stocks and the proposed Recapitalization are set forth in the Proxy Statement/Prospectus, and all capitalized terms not specifically defined herein shall have the meanings ascribed to them in the Proxy Statement/ Prospectus. We have assumed with your consent that, immediately prior to the proposed Recapitalization, the Company Common Shares, the Series A Common Shares, the Preferred Shares, the U.S. Cellular Common and Series A Common Shares and the Aerial Common and Series A Common Shares (the "Initial Shares") will continue to be the only classes of capital stock of the Company, U.S. Cellular, and Aerial, respectively, which are outstanding; that, other than in connection with the proposed Recapitalization, there will be no material change in the number of Initial Shares outstanding prior to the implementation of the proposed Recapitalization; and that, immediately after the proposed Recapitalization, the Company Common Shares, the Series A Common Shares, the Preferred Shares and the Tracking Stocks will be the only classes of capital stock then outstanding. We have also assumed that the U.S. Cellular Merger and the Aerial Merger are consummated on the terms set forth in the Proxy Statement/ Prospectus. We have further assumed that, prior to the proposed Recapitalization, the Initial Shares which are currently listed will continue to be listed on their respective exchanges or trading markets, and that, following the proposed Recapitalization, the Company's Common Shares and the Tracking Stocks will be eligible for, and will be the only capital stock of the Company listed on, the American Stock Exchange. In arriving at our opinion, we have reviewed certain publicly available business and financial information relating to the Company, as well as the Proxy Statement/Prospectus. We have also reviewed certain other information, including financial forecasts, provided to us by the Company, and have met with the Company's management to discuss the business and prospects of the Company and the Tracking Group and the potential impact of changes in the competitive environment and in the Company's and the Tracking Group's business plans and strategies on those forecasts, business and prospects. We have also considered certain financial and stock market data of the Company, and we have compared those data with similar data for other publicly held companies which have multiple classes of stock outstanding which reflect the performance of specific lines of business, and we have considered the financial terms of the different classes of stock of such companies. We also considered such other information, financial studies, analyses and investigations and financial, economic and market criteria which we deemed relevant. In connection with our review, we have not assumed any responsibility for independent verification of any of the foregoing information (including the information contained in the Proxy Statement/Prospectus) and have relied on its being complete and accurate in all material respects. With respect to the financial forecasts, we have assumed that they have been reasonably prepared on bases reflecting the best currently available estimates and judgments of the Company's management as to the future financial performance of the Company and the Tracking Group. In addition, we have not been requested to make, and have not made, an independent evaluation or appraisal of the assets or liabilities (contingent or otherwise) of the Company or the Tracking Group, nor have we been furnished with any such evaluations or appraisals. We are not expressing any opinion as to what the actual value of the Tracking Stocks will be when issued to the Company's stockholders pursuant to the Recapitalization or the prices at which such Tracking Stocks will trade subsequent to the Recapitalization. In addition, we are not expressing any opinion whatsoever as to the individual merits of the U.S. Cellular Merger, the Aerial Merger, or the Telecom Public Offering, or any opinion whatsoever with respect to the Reincorporation. Our opinion does not address the Company's underlying business decision to effect the Recapitalization and does not constitute a recommendation to any shareholder of the Company as to how such shareholder should vote with respect to the Recapitalization. Our analysis is necessarily based on financial, economic, market, and other conditions as they exist and can be evaluated on the date of this letter and assumes the Recapitalization was effective as of the date hereof, and we note that such conditions may change prior to the expected date of consummation of the Recapitalization. The Recapitalization may cause a change in perception by some investors of the future plans of the Company or the holders of Series A Common Shares. Consequently, our opinion assumes that the market has had a reasonable opportunity to understand and evaluate the Recapitalization. In addition, the Tracking Stocks which would be issued to the public shareholders of the Company in the proposed Distribution might trade initially at market prices below those at which they would trade on a fully distributed basis. C2-2 It is understood that this letter is for the information of the Board of Directors of the Company in connection with its consideration of the proposed Recapitalization and is not to be quoted or referred to, in whole or in part, in any registration statement, prospectus or in any other document used in connection with the offering or sale of securities, nor shall this letter be used for any other purposes, without our prior written consent; provided, that this opinion may be included in its entirety, or appropriately described or referred to, in any communication by the Company or the Board of Directors to the stockholders of the Company or the Securities and Exchange Commission, including the preliminary and definitive Proxy Statement/Prospectus of the Company relating to the Recapitalization; provided, that we have had the opportunity to review and comment on such communication prior to the filing with the Securities and Exchange Commission and prior to its dissemination to stockholders. We have acted as financial advisor to the Company in connection with the Recapitalization and will receive a fee for our services, a portion of which is contingent upon the consummation of the Recapitalization. In the ordinary course of our business, we and our affiliates may actively trade the debt and equity securities of the Company, US Cellular and Aerial for our and such affiliates' own accounts and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities. In the past, we have performed certain investment banking services for the Company, US Cellular and Aerial and their affiliates and have received customary fees for such services. Based upon and subject to the foregoing, it is our opinion that, assuming that the proposed Recapitalization had been effective as of the date hereof, the Recapitalization would not have a material adverse effect from a financial point of view on (i) the aggregate market value on a fully-distributed basis of the Proposed Common Equity outstanding after such Recapitalization as compared with the aggregate market value of the Company Common Shares outstanding immediately prior to the announcement of such Recapitalization or (ii) the Company's Equity Market Access after such Recapitalization as compared to the Company's Equity Market Access prior to the announcement of such Recapitalization. Sincerely, SALOMON SMITH BARNEY C2-3 EXHIBIT D TELEPHONE AND DATA SYSTEMS, INC. 1998 LONG-TERM INCENTIVE PLAN ARTICLE I PURPOSE The purposes of the Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan (the "Plan") are (i) to align the interests of the stockholders of Telephone and Data Systems, Inc., a Delaware Corporation (the "Company"), and selected employees of the Company and certain of its Affiliates who receive awards under the Plan by increasing the interest of such employees in the Company's growth and success, (ii) to advance the interests of the Company by attracting and retaining key executive and management employees of the Company and certain of its Affiliates, and (iii) to motivate such employees to act in the long-term best interests of the Company's stockholders. ARTICLE II DEFINITIONS For purposes of the Plan, the following capitalized terms shall have the meanings set forth in this Article. 2.1 "Aerial Group Stock" shall mean the class of shares of the Company designated "Aerial Communications Group Common Shares" in its Restated Certificate of Incorporation that is intended to reflect the separate performance of the Aerial Communications Group (as defined in the Restated Certificate of Incorporation), which primarily includes Aerial Communications, Inc., an Affiliate of the Company. 2.2 "Affiliate" shall mean a corporation which owns directly or indirectly at least 50% of the outstanding stock of the Company or the combined voting power of such outstanding stock or a corporation at least 50% of whose outstanding stock or the combined voting power of such outstanding stock is owned directly or indirectly by the Company. 2.3 "Agreement" shall mean a written agreement between the Company and an award recipient evidencing an award granted hereunder. 2.4 "Board" shall mean the Board of Directors of the Company. 2.5 "Bonus Stock" shall mean shares of Stock awarded hereunder that are not subject to a Restriction Period or Performance Measures. 2.6 "Bonus Stock Award" shall mean an award of Bonus Stock that may be awarded at the Committee's discretion. 2.7 "Bonus Year" shall mean the calendar year for which an annual bonus is payable. 2.8 "Cellular Group Stock" shall mean the class of fshares of the Company designated "United States Cellular Group Common Shares" in its Restated Certificate of Incorporation that is intended to reflect the separate performance of the United States Cellular Group (as defined in the Restated Certificate of Incorporation), which primarily includes United States Cellular Corporation, an Affiliate of the Company. 2.9 "Change of Control" shall have the meaning set forth in Section 8.9. 2.10 "Code" shall mean the Internal Revenue Code of 1986, as amended. 2.11 "Committee" shall mean a Committee designated by the Board, consisting of two or more members of the Board. 2.12 "Common Stock" shall mean the class of shares of the Company designated as "Common Shares" in its Restated Certificate of Incorporation. 2.13 "Deferred Compensation Account" shall mean a book reserve maintained by the Company for the purpose of measuring the amount of deferred compensation payable to an employee. D-1 2.14 "Disability" shall mean a total physical disability which, in the Committee's judgment, prevents an award recipient from performing substantially such award recipient's employment duties and responsibilities for a continuous period of at least six months. 2.15 "Distributable Balance" shall mean the balance in an employee's Deferred Compensation Account that is distributable upon the earlier of (i) the employee's termination of employment, and (ii) the distribution date specified by the employee. 2.16 "Employer" shall mean the Company or any Affiliate of the Company designated by the Committee and approved by the Board. 2.17 "Employer Match Award" shall mean an amount credited to an employee's Deferred Compensation Account pursuant to Section 7.2 hereof that is based upon the amount deferred by the employee pursuant to Section 7.1. 2.18 "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. 2.19 "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. 2.20 "Fair Market Value" of a share of Stock shall mean its closing sale price on the principal national stock exchange on which the Stock is traded on the date as of which such value is being determined, or, if there shall be no reported sale for such date, on the next preceding date for which a sale was reported; PROVIDED, HOWEVER if Fair Market Value for any date cannot be so determined, Fair Market Value shall be determined by the Committee by whatever means or method as the Committee, in the good faith exercise of its discretion, shall at such time deem appropriate. 2.21 "Incentive Stock Option" shall mean an option to purchase shares of Stock that meets the requirements of section 422 of the Code (or any successor provision) and that is intended by the Committee to constitute an Incentive Stock Option. 2.22 "Legal Representative" shall mean a guardian, legal representative or other person acting in a similar capacity with respect to an optionee. 2.23 "Mature Shares" shall mean shares of Stock (i) for which the holder thereof has good title, free and clear of all liens and encumbrances, and (ii) which such holder has held for at least six months or has purchased on the open market. 2.24 "Non-Qualified Stock Option" shall mean an option to purchase shares of Stock that is not an Incentive Stock Option. 2.25 "Performance Measures" shall mean criteria and objectives established by the Committee that must be attained (i) during a Performance Period in order for an employee eligible to participate in the Plan to be granted a Performance Stock Option, (ii) during the applicable Restriction Period or Performance Period as a condition to the award recipient's receipt of shares of Stock subject to the award in the case of a Restricted Stock Award or receipt of shares of Stock or cash in the case of Performance Share Award, or (iii) as a condition to exercisability of all or a portion of an option or SAR. Such criteria and objectives may be any one or more of the following: the attainment by a share of Stock of a specified Fair Market Value for a specified period of time, earnings per share, return on equity, return on capital, earnings on investments, cash flows, revenues, sales, costs, market share, attainment of cost reduction goals, customer count, attainment of business efficiency measures (I.E., cost per gross or net customer addition, revenue per customer, customer turnover rate, ratios of employees to volume of business measures and population in licensed or operating markets), financing costs, ratios of capital spending and investment to volume of business measures and customer satisfaction survey results. In the case of an option or SAR granted at Fair Market Value as of the date of grant, such criteria may also include the attainment of individual performance objectives, or any other criteria and objectives established by the Committee or any combination thereof. 2.26 "Performance Period" shall mean a period designated by the Committee during which Performance Measures shall be measured. 2.27 "Performance Share" shall mean a right, contingent upon the attainment of specified Performance Measures within a specified Performance Period, to receive one share of Stock, which may be Restricted Stock, or, in lieu of all or a portion thereof, the Fair Market Value of such Performance Share in cash. 2.28 "Performance Share Award" shall mean an award of Performance Shares. D-2 2.29 "Performance Stock Option" shall mean an option to purchase shares that is granted in the event specified Performance Measures during a specified Performance Period are attained. 2.30 "Permanent and Total Disability" shall have the meaning set forth in section 22(e)(3) of the Code (or any successor thereto). 2.31 "Permitted Transferee" shall mean (i) the award recipient's spouse, (ii) any of the award recipient's lineal descendants, lineal ancestors or siblings, (iii) the award recipient's mother-in-law or father-in-law, or any son-in-law, daughter-in-law, brother-in-law or sister-in-law, (iv) a trust of which one or more of the persons described in clauses (i), (ii) or (iii) are the only beneficiaries during the term the award is held by a Permitted Transferee, (v) a partnership in which no other person is a partner other than the award recipient or one or more of the persons described in clauses (i)-(vii) hereof, (vi) a limited liability company in which no person is a member other than the award recipient or one or more of the persons described in clauses (i)-(vii) hereof, or (vii) any other person approved in writing by the Committee prior to any transfer of an award, PROVIDED THAT any person described in clauses (i) - (vii) hereof has entered into a written agreement with the Company to withhold shares of Stock which would otherwise be delivered to such person to pay any federal, state, local or other taxes that may be required to be withheld of paid in connection with such exercise in the event that the award recipient does not provide for an arrangement satisfactory to the Company to assure that such taxes will be paid. 2.32 "Restricted Stock" shall mean shares of Stock that are subject to a Restriction Period. 2.33 "Restricted Stock Award" shall mean an award of Restricted Stock. 2.34 "Restriction Period" shall mean any period designated by the Committee during which the Stock subject to a Restricted Stock Award may not be sold, transferred, assigned, pledged, hypothecated or otherwise encumbered or disposed of, except as provided in the Plan or the Agreement relating to such award. 2.35 "SAR" shall mean a stock appreciation right that entitles the holder thereof to receive upon exercise of the SAR shares of Stock (which may be Restricted Stock), cash or a combination thereof with an aggregate value equal to the excess of the Fair Market Value of one share of Stock on the date of exercise over the base price of a share of Stock subject to such SAR, multiplied by the number of shares of Stock with respect to which such SAR is exercised. 2.36 "Stock" shall mean Common Stock, Aerial Group Stock, Cellular Group Stock, TDS Telecom Group Stock and any other equity security that (i) is designated by the Board to be available for stock option grants under the Plan or (ii) becomes available for grants under the Plan by reason of a conversion, stock split, stock dividend, recapitalization, reorganization, merger, consolidation, combination, exchange of shares, spin-off or other similar change in capitalization or event or any distribution to holders of shares of Common Stock, Aerial Group Stock, Cellular Group Stock or TDS Telecom Group Stock. 2.37 "Stock Award" shall mean a Restricted Stock Award or a Bonus Stock Award. 2.38 "TDS Telecom Group Stock" shall mean the class of shares of the Company designated "TDS Telecommunications Group Common Shares" in its Restated Certificate of Incorporation that is intended to reflect the separate performance of the TDS Telecommunications Group (as defined in the Restated Certificate of Incorporation), which primarily includes TDS Telecommunications Corporation, an Affiliate of the Company. ARTICLE III ELIGIBILITY AND ADMINISTRATION 3.1 ELIGIBILITY. Participants in the Plan shall consist of such employees of the Employers as the Committee in its sole discretion may select from time to time. The Committee's selection of an employee to participate in the Plan at any time shall not require the Committee to select such employee to participate in the Plan at any other time. 3.2 COMMITTEE ADMINISTRATION. (a) IN GENERAL. The Plan shall be administered by the Committee in accordance with the terms of the Plan. The Committee, in its discretion, shall select employees for participation in the Plan and shall determine the form, amount and timing of each grant of an award and, if applicable, the number of shares of Stock subject to each award, the purchase price or base price per share of Stock purchasable upon exercise of the award, the time and conditions of exercise or settlement of the award and all other terms and conditions of the award, including, without limitation, the form and terms of the Agreement evidencing the award. Any one or a combination of the following awards may be made under the Plan to eligible persons: (i) options to purchase shares in the form of Incentive Stock Options or Non-Qualified Stock Options, (ii) SARs, (iii) Stock Awards D-3 in the form of Restricted Stock or Bonus Stock, (iv) Performance Share Awards and (v) Employer Match Awards. The Committee may, in its sole discretion and for any reason at any time, take action such that (A) any or all outstanding options and SARs shall become exercisable in part or in full, (B) the Restriction Period applicable to any outstanding Restricted Stock Award shall terminate or shall be of a shorter duration, (C) the Performance Period applicable to any outstanding Performance Share Award shall terminate or be of a shorter duration, (D) the Performance Measures applicable to any outstanding Performance Share Award or to any outstanding Restricted Stock Award shall be deemed to be attained at the maximum or any other level, and (E) all or a portion of the amount in a Deferred Compensation Account attributable to an Employer Match Award shall become nonforfeitable. The Committee shall interpret the Plan and establish any rules and procedures the Committee deems necessary or desirable for the administration of the Plan and may impose, incidental to the grant of an award, conditions with respect to the award, such as restricting or limiting competitive employment or other activities. All such interpretations, rules, procedures and conditions shall be conclusive and binding on the parties. A majority of the members of the Committee shall constitute a quorum. The acts of the Committee shall be either (i) acts of a majority of the members of the Committee present at any meeting at which a quorum is present or (ii) acts approved in writing by all of the members of the Committee without a meeting. (b) DELEGATION. The Committee may delegate some or all of its power and authority hereunder to the President and Chief Executive Officer or other executive officer of the Company as the Committee deems appropriate; PROVIDED, HOWEVER, that the Committee may not delegate its power and authority with regard to (A) the selection for participation in the Plan of (i) the Chief Executive Officer of the Company (or any employee who is acting in such capacity), one of the four highest compensated officers of the Company (other than the Chief Executive Officer), or any other individual deemed to be a 'covered employee' within the meaning of section 162(m) of the Code or who, in the Committee's judgment, is likely to be a covered employee at any time during the exercise period of the option to be granted to such employee, or (ii) an officer or other person subject to section 16 of the Exchange Act, or (B) decisions concerning the timing, pricing or number of shares subject to an award granted to such an employee, officer or other person who is, or who in the Committee's judgment is likely to be, a covered employee. (c) INDEMNIFICATION. No member of the Board or Committee, and neither the President and Chief Executive Officer nor any other executive officer to whom the Committee delegates any of its power and authority hereunder, shall be liable for any act, omission, interpretation, construction or determination made in good faith in connection with the Plan and each member of the Board and the Committee and the President and Chief Executive Officer and each such other executive officer who is designated by the Committee to exercise any power or authority hereunder shall be entitled to indemnification and reimbursement by the Company in respect of any claim, loss, damage or expense (including attorneys' fees) arising therefrom to the full extent permitted by law, except as otherwise may be provided in the Company's articles of incorporation or by-laws, and under any directors' and officers' liability insurance which may be in effect from time to time. 3.3 SHARES AVAILABLE. Subject to adjustment as provided in Section 6.7, (i) 2,000,000 shares of Common Stock, (ii) 3,200,000 shares of Aerial Tracking Stock, (iii) 3,600,000 shares of Cellular Tracking Stock and (iv) 2,500,000 shares of TDS Telecom Tracking Stock shall be available under the Plan. Such shares of Common Stock, Aerial Tracking Stock, Cellular Tracking Stock, TDS Telecom Tracking Stock and shares of each other class of Stock that become available under the Plan shall be reduced by the sum of the aggregate number of shares of such class of Stock then subject to outstanding award under the Plan. The maximum number of shares with respect to which awards of Bonus Stock, Performance Shares, Stock Options, SARs, Restricted Stock, or any combination thereof may be granted to any individual employee during any three-calendar year period shall be 500,000, subject to any adjustments provided hereunder. To the extent that an outstanding award expires or terminates unexercised or is canceled or forfeited, the shares of Stock subject to such expired, unexercised, canceled or forfeited portion of such award shall again be available under the Plan. Shares of Stock to be delivered under the Plan shall be made available from authorized and unissued shares of Stock, or authorized and issued shares of Stock reacquired and held as treasury shares or otherwise or a combination thereof. ARTICLE IV STOCK OPTIONS AND STOCK APPRECIATION RIGHTS 4.1 STOCK OPTIONS. (a) IN GENERAL. The Committee may, in its discretion, grant options to purchase shares of Stock to such employees as may be selected by the Committee. Each option, or portion thereof, that is not an Incentive Stock Option, shall be a Non-Qualified Stock Option. Each Incentive Stock Option shall be granted within ten years of the effective date of the Plan. To the extent that the aggregate Fair Market Value (determined as of the D-4 date of grant) of shares of Stock with respect to which Incentive Stock Options are exercisable for the first time by an option holder during any calendar year (under the Plan or any other plan of the Company or any of its subsidiaries) exceeds $100,000, such options shall constitute Non-Qualified Stock Options. Options shall be subject to the terms and conditions set forth in this Section 4.1 and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem advisable. (b) NUMBER OF SHARES AND PURCHASE PRICE. The number of shares of Stock subject to an option and the purchase price per share of Stock purchasable upon exercise of the option shall be determined by the Committee; PROVIDED, HOWEVER, that the purchase price per share of Stock purchasable upon exercise of an Incentive Stock Option shall not be less than 100% of the Fair Market Value of a share of Stock on the date such option is granted; PROVIDED FURTHER, that if an Incentive Stock Option shall be granted to an employee who owns capital stock possessing more than ten percent of the total combined voting power of all classes of capital stock of the Company or any of its subsidiaries ('Ten Percent Holder'), the purchase price per share of Stock shall be at least 110% of its Fair Market Value on the date such option is granted. (c) OPTION PERIOD AND EXERCISABILITY. The period during which an option may be exercised shall be determined by the Committee; PROVIDED, HOWEVER, that no Incentive Stock Option shall be exercised later than ten years after its date of grant; PROVIDED FURTHER, that if an Incentive Stock Option shall be granted to a Ten Percent Holder, such option shall be exercised within five years of its date of grant. The Committee may, in its discretion, establish Performance Measures which must be satisfied during a Performance Period as a condition either to a grant of an option or to the exercisability of all or a portion of an option. The Committee shall determine whether an option shall become exercisable in cumulative or non-cumulative installments or in part or in full at any time. An option may be exercised only with respect to whole shares of Stock. (d) METHOD OF EXERCISE. An option may be exercised (i) by giving written notice to the Vice President-Human Resources of the Company specifying the number of whole shares of Stock to be purchased and by accompanying such notice with payment therefor (in full, unless another arrangement for such payment which is satisfactory to the Company has been made) either (A) in cash, (B) in Mature Shares having a Fair Market Value, determined as of the date of exercise, equal to the aggregate purchase price payable by reason of such exercise, (C) by authorizing the Company to withhold whole shares of Stock which would otherwise be delivered upon exercise of the option having a Fair Market Value, determined as of the date of exercise, equal to the aggregate purchase price payable by reason of such exercise, (D) in cash by a broker-dealer acceptable to the Company to whom the optionee has submitted an irrevocable notice of exercise or (E) a combination of (A), (B) and (C), in each case to the extent set forth in the Agreement relating to the option, and (ii) by executing such documents and taking any other actions as the Company may reasonably request. The Committee shall have sole discretion to disapprove of an election pursuant to any of clauses (B)-(E) in the preceding sentence. If payment of the purchase price is to be made pursuant to clause (B) or (C) (or a combination thereof) of the first sentence of this Section 4.1(d), then any fraction of a share of Stock which would be required to pay such purchase price shall be disregarded and the remaining amount due shall be paid in cash by the optionee. No share of Stock shall be delivered until the full purchase price therefor has been paid. 4.2 STOCK APPRECIATION RIGHTS. (a) IN GENERAL. The Committee may, in its discretion, grant SARs to such employees as may be selected by the Committee. SARs shall be subject to the terms and conditions set forth in this Section 4.2 and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem advisable. (b) NUMBER OF SHARES AND BASE PRICE. The number of shares of Stock subject to an SAR award shall be determined by the Committee. The base price of an SAR shall be determined by the Committee; PROVIDED, HOWEVER, that such base price per share of Stock subject to such SAR shall not be less than 100% of the Fair Market Value of a share of Stock on the date of grant of such SAR. (c) EXERCISE PERIOD AND EXERCISABILITY. The Agreement relating to an award of an SAR shall specify whether such award may be settled in shares of Stock (including shares of Restricted Stock) or cash or a combination thereof. The period for the exercise of an SAR shall be determined by the Committee. The Committee may, in its discretion, establish Performance Measures that must be attained as a condition to the grant of an SAR or to the exercisability of all or a portion of an SAR. The Committee shall determine whether an SAR may be exercised in installments and in part or in full at any time. An SAR may be exercised only with respect to whole shares of Stock. If an SAR is exercised with respect to shares of Restricted Stock, a certificate or certificates representing such shares of Restricted Stock shall be issued in accordance with Section 5.4 and the holder of such shares of Restricted Stock shall have rights of a stockholder of the Company as determined pursuant to Section 5.2(b). Prior to the exercise of D-5 an SAR for shares of Stock, including Restricted Stock, the holder of such SAR shall have no rights as a stockholder of the Company with respect to the shares of Stock subject to such SAR. (d) METHOD OF EXERCISE. An SAR may be exercised (i) by giving written notice to the Vice President-Human Resources of the Company specifying the whole number of shares of Stock with respect to which the SAR is being exercised and (ii) by executing such documents and taking any such other actions as the Company may reasonably request. 4.3 TERMINATION OF EMPLOYMENT. (a) DISABILITY. Unless otherwise specified in the Agreement evidencing the grant of an option or SAR and, in the case of an Incentive Stock Option, subject to Section 4.3(f), if an award recipient ceases to be employed by any Employer by reason of Disability, then the option or SAR held by such award recipient shall be exercisable only to the extent that such option or SAR is exercisable on the effective date of such award recipient's termination of employment and after such date may be exercised by such award recipient (or such award recipient's Legal Representative) for a period of 12 months after the effective date of such award recipient's termination of employment or until the expiration of the term of such option or SAR, whichever period is shorter. If the award recipient shall die within such period (or other period specified in the Agreement), then the option or SAR shall be exercisable by the beneficiary or beneficiaries duly designated by the award recipient or, if none, the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option or SAR shall pass by will or by applicable laws of descent and distribution, to the same extent such option or SAR was exercisable by the award recipient on the date of the award recipient's death, for a period ending on the later of (i) the last day of such period and (ii) 90 days after the date of the award recipient's death. (b) RETIREMENT OR RESIGNATION WITH PRIOR CONSENT OF THE BOARD. Unless otherwise specified in the Agreement evidencing the grant of an option or SAR and, in the case of an Incentive Stock Option, subject to Section 4.3(f), if any award recipient ceases to be employed by any Employer by reason of the award recipient's retirement after attainment of age 65 or by reason of the award recipient's resignation of employment at any age with the prior consent of the board of directors of such award recipient's Employer, then the option or SAR held by such award recipient shall be exercisable only to the extent that such option or SAR is exercisable on the effective date of such award recipient's retirement or resignation, as the case may be, and after such date may be exercised by such award recipient (or such award recipient's Legal Representative) for a period of 90 days after such effective date or until the expiration of the term of such option or SAR, whichever period is shorter. If the award recipient who has so retired or resigned shall die within such period (or other period specified in the Agreement), then the option or SAR shall be exercisable by the beneficiary or beneficiaries duly designated by the award recipient or, if none, the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option or SAR shall pass by will or by the applicable laws of descent and distribution, to the same extent such option or SAR was exercisable by the award recipient on the date of the award recipient's death, for a period ending 180 days after the effective date of such award recipient's retirement or resignation. (c) TRANSFER OF EMPLOYMENT. Unless otherwise specified in the Agreement evidencing the grant of an option or SAR, and in the case of an Incentive Stock Option, subject to Section 4.3(f), if an award recipient ceases to be employed by any Employer by reason of the award recipient's transfer of employment to an Affiliate that is not an Employer, then any option or SAR held by the award recipient shall be exercisable during the award recipient's continuous period of employment with one or more Affiliates, but only to the extent that such option or SAR is exercisable on the date of the award recipient's transfer of employment from an Employer to an Affiliate. (d) DEATH. Unless otherwise specified in the Agreement evidencing the grant of an option or SAR and, in the case of an Incentive Stock Option, subject to Section 4.3(f), if an award recipient ceases to be employed by any Employer by reason of death, then the option or SAR held by such award recipient shall be exercisable only to the extent that such option or SAR is exercisable on the date of such award recipient's death, and after such date may be exercised by the beneficiary or beneficiaries duly designated by the award recipient or, if none the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option or SAR shall pass by will or by the applicable laws of descent or distribution for a period of 180 days after the date of death or until the expiration of the term of such option or SAR, whichever period is shorter. (e) OTHER TERMINATION OF EMPLOYMENT. Unless otherwise specified in the Agreement evidencing the grant of an option or SAR and, in the case of an Incentive Stock Option, subject to Section 4.3(f), if an award recipient ceases to be employed by any Employer for any reason other than Disability, retirement after attainment of age 65, resignation of employment with the prior consent of the board of directors of such award recipient's Employer, a transfer to an Affiliate that is not an Employer or death, the option or SAR held by such award recipient shall be D-6 exercisable only to the extent that such option or SAR is exercisable on the effective date of such award recipient's termination of employment and after such date may be exercised by such award recipient (or such award recipient's Legal Representative) for a period of 30 days after such effective date or until the expiration of the term of such option or SAR, whichever period is shorter. If the award recipient shall die within such period (or other period specified in the Agreement), then the option or SAR held by such award recipient shall be exercisable only to the extent that such option or SAR is exercisable on the date of such award recipient's death, and after such date may be exercised by the beneficiary or beneficiaries duly designated by the award recipient or, if none, the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option or SAR shall pass by will or by the applicable laws of descent or distribution for a period of 120 days after the date of death or until the expiration of the term of such option or SAR, whichever period is shorter. Notwithstanding anything in this Section 4.3 to the contrary, if an award recipient ceases to be employed by an Employer on account of such award recipient's negligence, willful misconduct, competition with the Company or an Affiliate or misappropriation of confidential information of the Company or an Affiliate, then the option or SAR shall terminate on the date the award recipient's employment with such Employer terminates, unless such option or SAR terminates earlier pursuant to Section 8.10. (f) TERMINATION OF EMPLOYMENT--INCENTIVE STOCK OPTIONS. Each Incentive Stock Option held by an award recipient who ceases to be employed by any Employer by reason of death or Permanent and Total Disability shall be exercisable only to the extent that such option is exercisable on the date of such award recipient's death or on the effective date of such award recipient's termination of employment by reason of Permanent and Total Disability, as the case may be. In the case of the award recipient's Permanent and Total Disability, the option may thereafter be exercised by such award recipient (or such award recipient's Legal Representative) for a period of one year (or such shorter period as the Committee may specify in the Agreement) after the effective date of such award recipient's termination of employment by reason of Permanent and Total Disability or until the expiration of the term of such Incentive Stock Option, whichever period is shorter. In the case of the award recipient's death, the option may thereafter be exercised by the beneficiary or beneficiaries duly designated by the award recipient or, if none, the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option shall pass by will or by the applicable laws of descent and distribution for a period of one year (or such other period as the Committee may specify in the Agreement) after the date of such award recipient's death or until the expiration of the term of such Incentive Stock Option, whichever period is shorter. Each Incentive Stock Option held by an award recipient who ceases to be employed by any Employer for any reason other than death or Permanent and Total Disability shall be exercisable only to the extent such option is exercisable on the effective date of such award recipient's termination of employment, and may thereafter be exercised by such award recipient (or such award recipient's Legal Representative) for a period of three months after the effective date of such award recipient's termination of employment or until the expiration of the term of the Incentive Stock Option, whichever period is shorter. Notwithstanding anything in this Section 4.3 to the contrary, if an award recipient ceases to be employed by an Employer on account of such award recipient's negligence, willful misconduct, competition with the Company or an Affiliate or misappropriation of confidential information of the Company or an Affiliate, then the Incentive Stock Option shall terminate on the date the award recipient's employment with such Employer terminates, unless such Incentive Stock Option terminates earlier pursuant to Section 8.10. If an award recipient dies during the exercise period specified in the Agreement evidencing the grant of such option following termination of employment by reason of Permanent and Total Disability, or if the award recipient dies during the three-month period following termination of employment for any reason other than death or Permanent and Total Disability, then each Incentive Stock Option held by such award recipient shall be exercisable only to the extent such option is exercisable on the date of the award recipient's death and may thereafter be exercised by the beneficiary or beneficiaries duly designated by the award recipient or, if none, the executor or administrator of the award recipient's estate or, if none, the person to whom the award recipient's rights under such option shall pass by will or by the applicable laws of descent and distribution for a period of one year (or such shorter period as the Committee may specify in the Agreement) after the date of death or until the expiration of the term of such Incentive Stock Option, whichever period is shorter. D-7 ARTICLE V STOCK AWARDS 5.1 STOCK AWARDS. The Committee may, in its discretion, grant Stock Awards to such employees as may be selected by the Committee. The Agreement relating to a Stock Award shall specify the number of shares of Stock subject to the award, the purchase price (if any) and whether the Stock Award is a Restricted Stock Award or Bonus Stock Award. Stock Awards shall be subject to the terms and conditions set forth in this Article V and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem advisable. 5.2 RESTRICTED STOCK AWARDS. (a) VESTING AND FORFEITURE. The Agreement relating to a Restricted Stock Award shall provide, in the manner determined by the Committee, in its discretion, and subject to the provisions of the Plan, (i) for the vesting of the shares of Stock subject to such award in accordance with a schedule based upon either (y) the attainment of specified Performance Measures during the specified Restriction Period or (z) the award recipient's periods of employment with any Employer or Affiliate during the specified Restriction Period, and for (ii) the forfeiture of the shares of Stock subject to such award (w) if such specified Performance Measures are not attained during the specified Restriction Period or (x) if the holder of such award terminates such employment during the specified Restriction Period. (b) RIGHTS WITH RESPECT TO RESTRICTED STOCK AWARDS. Unless otherwise set forth in the Agreement relating to a Restricted Stock Award, and subject to the terms and conditions of a Restricted Stock Award, the holder of such award shall have all rights as a stockholder of the Company, including, but not limited to, voting rights, the right to receive dividends and the right to participate in any capital adjustment applicable to all holders of Stock; PROVIDED, HOWEVER, that a distribution with respect to shares of Stock, other than a distribution in cash, shall be deposited with the Company and shall be subject to the same restrictions as the shares of Stock with respect to which such distribution was made. (c) DISABILITY, RETIREMENT, RESIGNATION WITH PRIOR CONSENT OF THE BOARD AND DEATH. Unless otherwise specified in the Agreement evidencing the grant of a Restricted Stock Award, if an award recipient ceases to be employed by any Employer by reason of Disability, retirement after attainment of age 65, resignation of employment of any age with prior consent of the board of directors of such award recipient's Employer or death, then the Restriction Period applicable to such Restricted Stock Award shall terminate as of the effective date of the award recipient's termination of employment and any applicable Performance Measures shall be deemed attained of the target level. Notwithstanding the first sentence of this subsection (c), if an award recipient ceases to be employed by an Employer on account of such award recipient's negligence, willful misconduct, competition with the Company or an Affiliate or misappropriation of confidential information of the Company or an Affiliate, then the Restricted Stock Award shall terminate on the date the award recipient's employment with such Employer terminates, unless such Restricted Stock Award terminates earlier pursuant to Section 8.10. (d) TRANSFER OF EMPLOYMENT. Unless otherwise specified in the Agreement evidencing the grant of a Restricted Stock Award, if an award recipient ceases to be employed by any Employer by reason of the award recipient's transfer of employment to an Affiliate that is not an Employer, then the award recipient's employment with such Affiliate shall be deemed to be employment with an Employer solely for the purpose of determining whether any applicable service requirement is satisfied during the Restriction Period. (e) OTHER TERMINATION OF EMPLOYMENT. Unless otherwise specified in the Agreement evidencing the grant of a Restricted Stock Award, if an award recipient ceases to be employed by any Employer for any reason other than Disability, retirement after attainment of age 65, resignation of employment with the prior consent of the board of directors of such award recipient's Employer, a transfer to an Affiliate that is not an Employer or death, then the Company shall cancel such award to the extent it is subject to a Restriction Period on the effective date of such award recipient's termination of employment, unless such Restricted Stock Award terminates earlier pursuant to Section 8.10. 5.3 SHARE CERTIFICATES. During the Restriction Period, a certificate or certificates representing a Restricted Stock Award may be registered in the holder's name and may bear a legend, in addition to any legend which may be required pursuant to Section 8.7, indicating that the ownership of the shares of Stock represented by such certificate is subject to the restrictions, terms and conditions of the Plan and the Agreement relating to the Restricted Stock Award. All such certificates shall be deposited with the Company, together with stock powers or other instruments of assignment (including a power of attorney), each endorsed in blank with a guarantee of signature if deemed necessary or appropriate by the Company, that would permit transfer to the Company of all or a D-8 portion of the shares of Stock subject to the Restricted Stock Award in the event such award is forfeited in whole or in part. Upon termination of any applicable Restriction Period, or upon the grant of a Bonus Stock Award, in each case subject to the Company's right to require payment of any taxes in accordance with Section 8.6, a certificate or certificates evidencing ownership of the requisite number of shares of Stock shall be delivered to the holder of such award. ARTICLE VI PERFORMANCE SHARE AWARDS 6.1 PERFORMANCE SHARE AWARDS. The Committee may, in its discretion, grant Performance Share Awards to such employees as may be selected by the Committee. Performance Share Awards shall be subject to the terms and conditions set forth in this Section 6.1 and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem advisable. (a) NUMBER OF PERFORMANCE SHARES AND PERFORMANCE MEASURES. The number of Performance Shares subject to any award and the Performance Measures and Performance Period applicable to such award shall be determined by the Committee. (b) VESTING AND FORFEITURE. The Agreement relating to a Performance Share Award shall provide, in the manner determined by the Committee, in its discretion, and subject to the provisions of the Plan, for the vesting of such award upon the attainment of specified Performance Measures during the specified Performance Period, and for the forfeiture of such award if the Performance Measures are not attained during the Performance Period. (c) SETTLEMENT OF VESTED PERFORMANCE SHARE AWARDS. The Agreement relating to a Performance Share Award (i) shall specify whether such award may be settled in shares of Stock (including shares of Restricted Stock) or cash or a combination thereof and (ii) may specify whether the holder thereof shall be entitled to receive, on a current or deferred basis, dividend equivalents, and, if determined by the Committee, interest on or the deemed reinvestment of any deferred dividend equivalents, with respect to the number of shares of Stock subject to such award. If a Performance Share Award is settled in shares of Restricted Stock, a certificate or certificates representing such Restricted Stock shall be issued in accordance with Section 5.4 and the holder of such Restricted Stock shall have such rights of a stockholder of the Company as determined pursuant to Section 5.2(b). Prior to the settlement of a Performance Share Award in shares of Stock, including Restricted Stock, the holder of such award shall have no rights as a stockholder of the Company with respect to the shares of Stock subject to such award. 6.2 TERMINATION OF EMPLOYMENT. (a) DISABILITY, RETIREMENT, RESIGNATION WITH PRIOR CONSENT OF THE BOARD AND DEATH. Unless otherwise specified in the Agreement evidencing the grant of a Performance Share Award, if an award recipient ceases to be employed by any Employer by reason of Disability, retirement after attainment of age 65, resignation of employment at any age with prior consent of the board of directors of such award recipient's Employer or death, then any current Performance Period applicable to such award shall thereupon terminate as of the effective date of the award recipient's termination of employment and Performance Measures shall be deemed satisfied at the target level. Notwithstanding the immediately preceding sentence, if an award recipient ceases to be employed by an Employer on account of such award recipient's negligence, willful misconduct, competition with the Company or an Affiliate or misappropriation of confidential information of the Company or an Affiliate, then the Performance Share Award shall terminate on the date the award recipient's employment with such Employer terminates, unless such Performance Share Award terminates earlier pursuant to Section 8.10. (b) TRANSFER OF EMPLOYMENT. Unless otherwise specified in the Agreement evidencing the grant of a Performance Share Award, if an award recipient ceases to be employed by any Employer by reason of the award recipient's transfer of employment to an Affiliate that is not an Employer, then the award recipient's employment with such Affiliate shall be deemed to be employment with an Employer solely for the purpose of determining whether any applicable service requirement is satisfied during the Performance Period. (c) OTHER TERMINATION. Unless otherwise specified in the Agreement evidencing the grant of a Performance Share Award, if an award recipient ceases to be employed by any Employer for any reason other than Disability, retirement after attainment of age 65, resignation of employment at any age with prior consent of the board of directors of such award recipient's Employer or death, then the portion of such award which is subject to a Performance Period on the effective date of such holder's termination of employment shall be forfeited and such portion shall be canceled by the Company, unless such Performance Share Award terminates earlier pursuant to Section 8.10. D-9 ARTICLE VII DEFERRED COMPENSATION ACCOUNTS AND EMPLOYER MATCH AWARDS 7.1 DEFERRED COMPENSATION AWARDS. The Committee may, in its discretion, permit an employee selected by the Committee to make an irrevocable election (i) not to receive currently any whole percentage of his gross annual bonus payment and (ii) to have an amount equal to such percentage credited to the employee's Deferred Compensation Account (such election, a "deferral election"); PROVIDED, HOWEVER, that the amount subject to such deferral election with respect to any Bonus Year shall not exceed $250,000. Any deferral election shall be made prior to the last day of the calendar year preceding the Bonus Year with respect to which such bonus is earned. Notwithstanding the preceding sentence, (i) in the year in which the Plan becomes effective, an employee selected by the Committee may make such a deferral election within 30 days after the Plan's effective date (as defined in Section 8.1) and (ii) in the first year in which an employee is selected for participation in the Plan pursuant to this Section 7.1, the employee may make a deferral election within 30 days after the date of his selection. Amounts so credited to the employee's Deferred Compensation Account (as adjusted for deemed investment returns) shall be 100% vested at all times. 7.2 EMPLOYER MATCH AWARDS. At the time the Committee selects an employee for participation in the Plan pursuant to Section 7.1, the Committee may also grant such an employee an Employer Match Award to be made in accordance with the Agreement evidencing such award. Employer Match Awards shall be subject to the terms and conditions set forth in this Section 7.2 and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem advisable. As of the date on which an amount (the "deferred amount") is credited to an employee's Deferred Compensation Account pursuant to Section 7.1, there also shall be credited to the employee's Deferred Compensation Account an Employer Match Award equal to a percentage of such deferred amount specified by the Committee not in excess of 33 1/3%. One-third of the Employer Match Award so credited to the employee's Deferred Compensation Account (as adjusted for deemed investment returns pursuant to Section 7.3) shall become nonforfeitable on each of the first three anniversaries of the last day of the Bonus Year, if such employee is an employee of an Employer or an Affiliate on such a date and the amount credited to his Deferred Compensation Account has not been distributed before such date; PROVIDED, HOWEVER if the employee's employment terminates by reason of retirement after attainment of age 65, resignation at any age with prior consent of the board of directors of the employee's Employer, Disability or death, all Employer Match Awards (as adjusted for deemed investment returns pursuant to Section 7.3) credited to the employee's Deferred Compensation Account shall become nonforfeitable upon such termination of employment. Notwithstanding the previous sentence, if an employee ceases to be employed by an Employer on account of such employee's negligence, willful misconduct, competition with the Company or an Affiliate or misappropriation of confidential information of the Company or an Affiliate, then any Employer Match Award shall terminate on the date the employee's employment with such Employer terminates, unless such Employer Match Award terminates earlier pursuant to Section 8.10. Any Employer Match Awards and any deemed investment returns credited to an employee's Deferred Compensation Account shall be an expense allocated to the employee's Employer for the related Bonus Year. 7.3 DEEMED INVESTMENT OF DEFERRED COMPENSATION ACCOUNT. Amounts credited to an employee's Deferred Compensation Account pursuant to Sections 7.1 and 7.2 above shall be deemed to be invested in whole and fractional phantom shares of Stock as specified below at the Fair Market Value thereof on the date as of which the amount is credited to the Deferred Compensation Account. If the employee's Employer for the Bonus Year with respect to which an amount is credited to his Deferred Compensation Account is the Company, then such credited amount shall be deemed to be invested in whole and fractional phantom shares of Common Stock. If the employee's Employer for the Bonus Year with respect to which an amount is credited to his Deferred Compensation Account is a member of the Aerial Communications Group, then such credited amount shall be deemed to be invested in whole and fractional phantom shares of Aerial Group Stock. If the employee's Employer for the Bonus Year with respect to which an amount is credited to his Deferred Compensation Account is a member of the United States Cellular Group, then such credited amount shall be deemed to be invested in whole and fractional phantom shares of Cellular Group Stock. If the employee's Employer for the Bonus Year with respect to which an amount is credited to his Deferred Compensation Account is a member of the TDS Telecommunications Group, then such credited amount shall be deemed to be invested in whole and fractional phantom shares of TDS Telecom Group Stock. In the event the employment of an employee with a Deferred Compensation Account balance is transferred to another Employer, the amounts credited to his Deferred Compensation Account on the date of such employment transfer shall continue to be invested in the same class of phantom shares of Stock as on such date, and any amount credited to his Deferred Compensation Account for service after such transfer shall be credited in the class of phantom shares determined in reference to the identity of his new Employer. D-10 7.4 PAYMENT OF DEFERRED COMPENSATION ACCOUNT. An employee shall receive a distribution of the Distributable Balance (as determined below) of his Deferred Compensation Account after such employee terminates employment with the Employers and Affiliates, PROVIDED, HOWEVER that an employee may irrevocably elect, at the time he makes a deferral election pursuant to Section 7.1, to receive a distribution of the amount so deferred, the related vested Employer Match Awards and any deemed investment earnings thereon (or any portion thereof) at any earlier date that is at least two years after the date such election is made. As of the earlier of the distribution date elected by the employee and the date the employee terminates his employment (the "determination date"), the Company shall compute the Distributable Balance in the Deferred Compensation Account. This Distributable Balance shall include (i) all bonus deferrals made through the current month reduced by any distributions of such bonus deferrals made prior to the determination date, (ii) all nonforfeitable Employer Match Awards reduced by any distributions of Employer Match Awards made prior to the determination date and (iii) any deemed investment earnings and losses attributable to the amounts included under (i) and (ii) as determined pursuant to Section 7.3. In the event that an employee becomes disabled, his employment shall for these purposes be deemed to terminate on the first day of the month following the month in which the employee became disabled (thus, the Distributable Balance shall be computed as of the preceding month). Payment of deferred compensation under these events will be in accordance with the employee's payment method election, provided such election is made prior to the calendar year in which the distribution is made. If no such timely election is made, then payment will be made in the form of a single sum payment. All payments of deferred compensation hereunder will be made in (i) whole shares of Stock and in the class or classes of Stock in which the Deferred Compensation Account is deemed invested under Section 7.3 above, and (ii) cash equal to the Fair Market Value of any fractional share. If an employee dies before the entire Distributable Balance has been paid, then the Company shall pay the Distributable Balance to the employee's designated beneficiary. 7.5 HARDSHIP WITHDRAWALS. In the event of an unforeseeable emergency causing a severe financial hardship, an employee may request a payment of all or a portion of his nonforfeitable Deferred Compensation Account in an amount equal to that which is reasonably necessary to satisfy the emergency by submitting a written request to the Committee accompanied with documentation evidencing the employee's financial hardship. The Committee shall review the request and shall determine, in its sole discretion, whether a severe financial hardship exists. A severe financial hardship means a hardship to the employee resulting from a sudden and unexpected illness or accident of the employee or of a dependent (as defined in section 152(a) of the Code) of the employee, loss of the employee's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the employee. The circumstances that will constitute an emergency will depend upon the facts of each case, but, in any event, payment may not be made to the extent that such hardship is or may be relieved (i) through reimbursement or compensation by insurance or otherwise, (ii) by liquidation of the employee's assets, to the extent the liquidation of such assets would not itself cause severe financial hardship or (iii) by cessation of deferrals under the Plan. Examples of what are not considered to be unforeseeable emergencies include the need to send the employee's child to college or the desire to purchase a home. ARTICLE VIII GENERAL 8.1 EFFECTIVE DATE AND TERM OF PLAN. The Plan shall become effective as of the effective date of the merger of Telephone and Data Systems, Inc., an Iowa corporation, into the Company and shall terminate ten years thereafter unless terminated earlier by the Board. Termination of the Plan shall not affect the terms or conditions of any award granted prior to termination. Grants of awards hereunder may be made at any time on or after the effective date and prior to the termination of the Plan. 8.2 AMENDMENTS AND ADJUSTMENTS TO PERFORMANCE MEASURES. The Board may amend the Plan as it shall deem advisable, subject to any requirement of stockholder approval under applicable law; PROVIDED, HOWEVER, that, except as provided in Section 8.8, no amendment shall be made without stockholder approval if such amendment (a) would increase the maximum number of shares of any class of Stock available for issuance under the Plan or (b) would reduce the minimum purchase price in the case of an option or SAR. No amendment may impair the rights of a holder of an outstanding award without the consent of such holder. At any time prior to the issuance or delivery of any shares of Stock or the payment of any cash in connection with an award subject to Performance Measures, the Committee may revise the Performance Measures applicable to an award and any related computation of payment if unforeseen events occur during the applicable Performance Period or Restriction Period that have a substantial effect on the Performance Measures and which, in the judgment D-11 of the Committee, make the application of the Performance Measures unfair unless such revision is made; PROVIDED, HOWEVER, that no such revision shall be made with respect to an award to the extent that the Committee determines that such revision would cause payment under the award to fail to be deductible in full by the Company under section 162(m) of the Code. 8.3 AGREEMENT. Each award granted under the Plan shall be evidenced by an Agreement setting forth the terms and conditions applicable to such award. No award shall be valid until an Agreement is executed by the Company and the recipient of the award and, upon execution by each party and delivery of the Agreement to the Vice President-Human Resources of the Company, such award shall be effective as of the effective date set forth in the Agreement. 8.4 DESIGNATION OF BENEFICIARIES. Each employee may designate a beneficiary with respect to each of his awards and his Deferred Compensation Account by executing and filing with the Company during his lifetime a beneficiary designation. The employee may change or revoke any such designation by executing and filing with the Company during his lifetime a new beneficiary designation. If any designated beneficiary predeceases the employee, or if any corporation, partnership, trust or other entity which is a designated beneficiary is terminated, dissolved, becomes insolvent, or is adjudicated bankrupt prior to the date of the employee's death, or if the employee fails to designate a beneficiary, then the following persons in the order set forth below shall receive the entire amount which the previous designated beneficiary would have been entitled to receive: i) the employee's spouse, if living; otherwise ii) the employee's then living descendants, per stirpes; and otherwise iii) the employee's estate. 8.5 TRANSFERABILITY. No Incentive Stock Option shall be transferable other than to a beneficiary determined pursuant to Section 8.4. An employee's Deferred Compensation Account shall not be transferable other than (a) to beneficiary pursuant to Section 8.4 or (b) pursuant to a court order entered in connection with a dissolution of marriage or child support. No other award shall be transferable other than (a) to a beneficiary determined pursuant to Section 8.4, (b) pursuant to a court order entered in connection with a dissolution of marriage or child support, (c) to the extent permitted by (i) securities laws relating to the registration of securities subject to employee benefit plans and (ii) the Agreement evidencing the grant of such award, by transfer to a Permitted Transferee. No award or Deferred Compensation Account balance may otherwise be sold, transferred, assigned, pledged, hypothecated, encumbered or otherwise disposed of (whether by operation of law or otherwise) or be subject to execution, attachment or similar process. Upon any such attempt to so sell, transfer, assign, pledge, hypothecate, encumber or otherwise dispose of any award or Deferred Compensation Account balance, such award and all rights thereunder shall immediately become null and void and any Employer Match Awards credited to such Deferred Compensation Account shall be forfeited. 8.6 TAX WITHHOLDING. Prior to (i) the issuance or delivery of any shares of Stock, (ii) the payment of any cash pursuant to an award made hereunder or (iii) any distribution from an employee's Deferred Compensation Account, the Company shall have the right to require payment by the recipient thereof of any federal, state, local or any other taxes which may be required to be withheld or paid in connection with such award or distribution. As determined by the Committee at the time of the grant of an award or a deferral to an employee's Deferred Compensation Account, an Agreement may provide that (i) the Company shall withhold whole shares of Stock which would otherwise be delivered to the recipient, having an aggregate Fair Market Value determined as of the date the obligation to withhold or pay taxes arises in connection with an award (the "Tax Date") in the amount necessary to satisfy any such obligation or (ii) the holder may satisfy any such obligation by any of the following means: (A) a cash payment to the Company, (B) delivery to the Company of Mature Shares the aggregate Fair Market Value of which shall be determined as of the Tax Date, (C) authorizing the Company to withhold whole shares of Stock which would otherwise be delivered the aggregate Fair Market Value of which shall be determined as of the Tax Date, (D) in the case of the exercise of an option, a cash payment by a broker-dealer acceptable to the Company to whom the holder has submitted an irrevocable notice of exercise or (E) any combination of (A), (B) and (C) in each case to the extent set for in the Agreement relating to the award; PROVIDED, HOWEVER, that the Committee shall have sole discretion to disapprove of an election pursuant to any of clauses (B)-(E). An Agreement may provide for shares of Stock to be delivered or withheld having an aggregate Fair Market Value in excess of the minimum amount required to be withheld. Any fraction of a share of Stock which would be required to satisfy such an obligation shall be disregarded and the remaining amount due shall be paid in cash by the holder. D-12 8.7 RESTRICTIONS ON SHARES. Each award granted hereunder shall be subject to the requirement that if at any time the Company determines that the listing, registration or qualification of the shares of Stock subject to such award upon any securities exchange or under any law, or the consent or approval of any governmental body, or the taking of any other action is necessary or desirable as a condition of, or in connection with, the delivery of shares thereunder, such shares shall not be delivered unless such listing, registration, qualification, consent, approval or other action shall have been effected or obtained, free of any conditions not acceptable to the Company. The Company may require that certificates evidencing shares of Stock delivered pursuant to any award made hereunder bear a legend indicating that the sale, transfer or other disposition thereof by the holder is prohibited except in compliance with the Securities Act of 1933, as amended, and the rules and regulations thereunder. 8.8 ADJUSTMENT. In the event of any conversion, stock split, stock dividend, recapitalization, reclassification, reorganization, merger, consolidation, spin-off, combination of shares in a reverse stock split or other similar event, (a) the number and class of securities deemed to be held in each Deferred Compensation Account shall be adjusted by the Committee, (b) the number and class of securities subject to each outstanding Stock Award and each outstanding Performance Share Award shall be adjusted by the Committee and (c) each holder of an option or SAR shall be entitled to receive upon the exercise of an option or SAR, at a price determined by the Committee in its sole discretion, such shares of Stock or other securities, the value of which shall be determined by the Committee to be equivalent to the value of shares of Stock to which the holder would be entitled had the holder exercised such option or SAR prior to the occurrence of such event. If any other event shall occur which in the judgment of the Board would warrant an adjustment to (i) the number and class of securities deemed to be held in each Deferred Compensation Account, (ii) the number and class of securities subject to each outstanding Stock Award and each outstanding Performance Share Award, (iii) the number or designation of the class or classes of securities available under the Plan or (iv) the number or designation of the class or classes of securities subject to each outstanding option or SAR or the purchase price of a share of Stock subject to the option or SAR, or any combination of adjustments provided for in clauses (i), (ii), (iii) and (iv), then such adjustments shall be authorized by the Board and made by the Committee upon such terms and conditions as it may deem equitable and appropriate. To the extent that any such event or any action taken under this Section 8.8 shall increase the number of shares of Stock or other security subject to an outstanding Stock Award or Performance Share Award or held in Deferred Compensation Accounts, or entitle a holder of an option or SAR to purchase additional shares of Stock or other security, the shares of Stock available under the Plan shall be deemed to include such additional shares of Stock or other security. If any such adjustment would result in a fractional security being generally available under the Plan, then such fractional security shall be disregarded. If any such adjustment would result in a fractional security being subject to an award under the Plan, then the Company shall pay the holder of such an award, in connection with the first vesting or exercise of such award occurring after such adjustment, an amount in cash determined by multiplying (i) the fraction of such security (rounded to the nearest hundredth) by (ii) the excess, if any, of (A) the Fair Market Value on the vesting or exercise date over (B) the purchase price of such security. Any determination made by the Committee under this Section 8.8 shall be final, binding and conclusive on all holders of awards granted under the Plan. 8.9 CHANGE IN CONTROL. (a) Notwithstanding any other provision of the Plan or any provision of any agreement, in the event of a Change in Control, (i) any Restriction Periods applicable to outstanding Restricted Stock Awards shall lapse, (ii) any Performance Periods applicable to outstanding Performance Share Awards shall lapse; (iii) any Performance Measures applicable to outstanding Performance Share Awards and to outstanding Restricted Stock Awards (if any) shall be deemed to be satisfied at the target level, (iv) all outstanding options or SARs shall become immediately exercisable in full and (v) all amounts deemed to be held in Deferred Compensation Accounts shall become nonforfeitable. In the event of a Change in Control pursuant to Section (b)(3) below, there may be substituted for each share of Stock available under the Plan, whether or not then subject to an outstanding award, the number and class of shares into which each outstanding share of such Stock shall be converted pursuant to such Change in Control. In the event of such a substitution, the purchase price per share of stock then subject to an outstanding award under the Plan shall be appropriately adjusted by the Committee, but in no event shall the aggregate purchase price for such shares be greater than the aggregate purchase price for the shares of Stock subject to such award prior to the Change in Control. (b) For purposes of the Plan, "Change in Control" shall mean: (1) the acquisition by any individual, entity or group (a "Person"), including any "person" within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act, of beneficial ownership within the meaning of Rule 13d-3 promulgated under the Exchange Act, of 25% or more of the combined voting power of the then outstanding securities of the Company entitled to vote generally on matters (without regard to the election of directors) (the "Outstanding Voting Securities"), excluding, however, the following: (i) any acquisition directly D-13 from the Company or an Affiliate (excluding any acquisition resulting from the exercise of an exercise, conversion or exchange privilege, unless the security being so exercised, converted or exchanged was acquired directly from the Company or an Affiliate), (ii) any acquisition by the Company or an Affiliate, (iii) any acquisition by an employee benefit plan (or related trust) sponsored or maintained by the Company or an Affiliate, (iv) any acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (3) of this Section 8.9(b), or (v) any acquisition by the following persons: (A) LeRoy T. Carlson or his spouse, (B) any child of LeRoy T. Carlson or the spouse of any such child, (C) any grandchild of LeRoy T. Carlson, including any child adopted by any child of LeRoy T. Carlson, or the spouse of any such grandchild, (D) the estate of any of the persons described in clauses (A)-(C), (E) any trust or similar arrangement (including any acquisition on behalf of such trust or similar arrangement by the trustees or similar persons) PROVIDED THAT all of the current beneficiaries of such trust or similar arrangement are persons described in clauses (A)-(C) or their lineal descendants, or (F) the voting trust which expires on June 30, 2009, or any successor to such voting trust, including the trustees of such voting trust on behalf of such voting trust (all such persons, collectively, the "Exempted Persons"); (2) individuals who, as of the effective date of the merger of Telephone and Data Systems, Inc., an Iowa corporation, into the Company, constitute the Board of Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of such Board; PROVIDED THAT any individual who becomes a director of the Company subsequent to the effective date of the merger of Telephone and Data Systems, Inc., an Iowa corporation, into the Company, whose election, or nomination for election by the Company's stockholders, was approved by the vote of at least a majority of the directors then comprising the Incumbent Board shall be deemed a member of the Incumbent Board; and PROVIDED FURTHER, that any individual who was initially elected as a director of the Company as a result of an actual or threatened election contest, as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act, or any other actual or threatened solicitation of proxies or consents by or on behalf of any Person other than the Board shall not be deemed a member of the Incumbent Board; (3) approval by the stockholders of the Company of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Corporate Transaction"), excluding, however, a Corporate Transaction pursuant to which (i) all or substantially all of the individuals or entities who are the beneficial owners of the Outstanding Voting Securities immediately prior to such Corporate Transaction will beneficially own, directly or indirectly, more than 51% of the combined voting power of the outstanding securities of the corporation resulting from such Corporate Transaction (including, without limitation, a corporation which as a result of such transaction owns, either directly or indirectly, the Company or all or substantially all of the Company's assets) which are entitled to vote generally on matters (without regard to the election of directors), in substantially the same proportions relative to each other as the shares of Outstanding Voting Securities are owned immediately prior to such Corporate Transaction, (ii) no Person (other than the following Persons: (V) the Company or an Affiliate, (W) any employee benefit plan (or related trust) sponsored or maintained by the Company or an Affiliate, (X) the corporation resulting from such Corporate Transaction, (Y) the Exempted Persons, (Z) and any Person which beneficially owned, immediately prior to such Corporate Transaction, directly or indirectly, 25% or more of the Outstanding Voting Securities) will beneficially own, directly or indirectly, 25% or more of the combined voting power of the outstanding securities of such corporation entitled to vote generally on matters (without regard to the election of directors) and (iii) individuals who were members of the Incumbent Board will constitute at least a majority of the members of the board of directors of the corporation resulting from such Corporate Transaction; or (4) approval by the stockholders of the Company of a plan of complete liquidation or dissolution of the Company. 8.10 FORFEITURE OF AWARD UPON COMPETITION WITH COMPANY OR ANY AFFILIATE OR MISAPPROPRIATION OF CONFIDENTIAL INFORMATION. Notwithstanding any other provision herein, on or after any date on which an award recipient (a) enters into competition with the Company or an Affiliate, or (b) misappropriates confidential information of the Company or an Affiliate, as determined by the Company in its sole discretion, any option, SAR, Restricted Stock Award or Performance Share Award then held by the award recipient shall be forfeited and any balance credited to the award recipient's Deferred Compensation Account attributable to Employer Match Awards shall be forfeited, in each case regardless of whether such award or account balance would otherwise be nonforfeitable. For purposes of the preceding sentence, an award recipient shall be treated as entering into competition with the Company or an Affiliate if such award recipient (i) directly or indirectly, individually or in conjunction with any person, firm or corporation, has contact with any customer of the Company or an Affiliate or with any prospective D-14 customer which has been contacted or solicited by or on behalf of the Company or an Affiliate for the purpose of soliciting or selling to such customer or prospective customer any product or service, except to the extent such contact is made on behalf of the Company or an Affiliate, or (ii) otherwise competes with the Company or an Affiliate in any manner or otherwise engages in the business of the Company or an Affiliate. An award recipient shall be treated as misappropriating confidential information of the Company or an Affiliate if such award recipient (i) uses confidential information (as described below) for the benefit of anyone other than the Company or such Affiliate, as the case may be, or discloses the confidential information to anyone not authorized by the Company or such Affiliate, as the case may be, to receive such information, (ii) upon termination of employment, makes any summaries of, takes any notes with respect to, or memorizes any information or takes any confidential information or reproductions thereof from the facilities of the Company or an Affiliate, or (iii) upon termination of employment or upon the request of the Company or an Affiliate, fails to return all confidential information then in the award recipient's possession. "Confidential information" shall mean any confidential and proprietary drawings, reports, sales and training manuals, customer lists, computer programs, and other material embodying trade secrets or confidential technical, business, or financial information of the Company or an Affiliate. 8.11 NO RIGHT OF PARTICIPATION OR EMPLOYMENT. No person shall have any right to participate in the Plan. Neither the Plan nor any award granted hereunder shall confer upon any person any right to continued employment by the Company or any of its subsidiaries or affiliates or affect in any manner the right of the Company or any of its subsidiaries or affiliates to terminate the employment of any person at any time without liability hereunder. 8.12 RIGHTS AS STOCKHOLDER. No person shall have any right as a stockholder of the Company with respect to any shares of Stock of the Company that are subject to an award granted hereunder unless and until such person becomes a stockholder of record with respect to such shares of Stock. 8.13 GOVERNING LAW. The Plan, each award granted hereunder and the related Agreement, and all determinations made and actions taken pursuant thereto, to the extent not otherwise governed by the Code or the laws of the United States, shall be governed by the laws of the State of [Delaware] and construed in accordance therewith without giving effect to principles of conflicts of laws. 8.14 SEVERABILITY. If a provision of the Plan shall be held illegal or invalid, the illegality or invalidity shall not affect the remaining parts of the Plan and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included in the Plan. D-15 EXHIBIT E SECTIONS 490.1301 ET SEQ., OF THE IOWA BUSINESS CORPORATION ACT (DISSENTERS' RIGHTS) DIVISION XIII DISSENTERS' RIGHTS (AS OF THE DATE OF THIS PROXY STATEMENT) PART A 490.1301 DEFINITIONS FOR DIVISION XIII IN THIS DIVISION: 1. "Beneficial shareholder" means the person who is a beneficial owner of shares held by a nominee as the record shareholder. 2. "Corporation" means the issuer of the shares held by a dissenter before the corporate action, or the surviving or acquiring corporation by merger or share exchange of that issuer. 3. "Dissenter" means a shareholder who is entitled to dissent from corporate action under section 490.1302 and who exercises that right when and in the manner required by sections 490.1320 through 490.1328. 4. "Fair value," with respect to a dissenter's shares, means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. 5. "Interest" means interest from the effective date of the corporate action until the date of payment, at the average rate currently paid by the corporation on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances. 6. "Record shareholder" means the person in whose name shares are registered in the records of a corporation or the beneficial owner of shares to the extent of the rights granted by a nominee certificate on file with a corporation. 7. "Shareholder" means the record shareholder or the beneficial shareholder. 490.1302 SHAREHOLDERS' RIGHT TO DISSENT 1. A shareholder is entitled to dissent from, and obtain payment of the fair value of the shareholder's shares in the event of, any of the following corporate actions: a. Consummation of a plan of merger to which the corporation is a party if either of the following apply: (1) Shareholder approval is required for the merger by section 490.1103 or the articles of incorporation and the shareholder is entitled to vote on the merger. (2) The corporation is a subsidiary that is merged with its parent under section 490.1104. b. Consummation of a plan of share exchange to which the corporation is a party as the corporation whose shares will be acquired, if the shareholder is entitled to vote on the plan. c. Consummation of a sale or exchange of all, or substantially all, of the property of the corporation other than in the usual and regular course of business, if the shareholder is entitled to vote on the sale or exchange, including a sale in dissolution, but not including a sale pursuant to court order or a sale for cash pursuant to a plan by which all or substantially all of the net proceeds of the sale will be distributed to the shareholders within one year after the date of sale. d. An amendment of the articles of incorporation that materially and adversely affects rights in respect of a dissenter's shares because it does any or all of the following: (1) Alters or abolishes a preferential right of the shares. (2) Creates, alters, or abolishes a right in respect of redemption, including a provision respecting a sinking fund for the redemption or repurchase, of the shares. E-1 (3) Alters or abolishes a preemptive right of the holder of the shares to acquire shares or other securities. (4) Excludes or limits the right of the shares to vote on any matter, or to cumulate votes, other than a limitation by dilution through issuance of shares or other securities with similar voting rights. (5) Reduces the number of shares owned by the shareholder to a fraction of a share if the fractional share so created is to be acquired for cash under section 490.604. (6) Extends, for the first time after being governed by this chapter, the period of duration of a corporation organized under chapter 491 or 496A and existing for a period of years on the day preceding the date the corporation is first governed by this chapter. e. Any corporate action taken pursuant to a shareholder vote to the extent the articles of incorporation, bylaws, or a resolution of the board of directors provides that voting or nonvoting shareholders are entitled to dissent and obtain payment for their shares. 2. A shareholder entitled to dissent and obtain payment for the shareholder's shares under this chapter is not entitled to challenge the corporate action creating the shareholder's entitlement unless the action is unlawful or fraudulent with respect to the shareholder or the corporation. 490.1303 DISSENT BY NOMINEES AND BENEFICIAL OWNERS 1. A record shareholder may assert dissenters' rights as to fewer than all the shares registered in that shareholder's name only if the shareholder dissents with respect to all shares beneficially owned by any one person and notifies the corporation in writing of the name and address of each person on whose behalf the shareholder asserts dissenters' rights. The rights of a partial dissenter under this subsection are determined as if the shares as to which the shareholder dissents and the shareholder's other shares were registered in the names of different shareholders. 2. A beneficial shareholder may assert dissenters' rights as to shares held on the shareholder's behalf only if the shareholder does both of the following: a. Submits to the corporation the record shareholder's written consent to the dissent not later than the time the beneficial shareholder asserts dissenters' rights. b. Does so with respect to all shares of which the shareholder is the beneficial shareholder or over which that beneficial shareholder has power to direct the vote. PART B 490.1320 NOTICE OF DISSENTERS' RIGHTS 1. If proposed corporate action creating dissenters' rights under section 490.1302 is submitted to a vote at a shareholders' meeting, the meeting notice must state that shareholders are or may be entitled to assert dissenters' rights under this part and be accompanied by a copy of this part. 2. If corporate action creating dissenters' rights under section 490.1302 is taken without a vote of shareholders, the corporation shall notify in writing all shareholders entitled to assert dissenters' rights that the action was taken and send them the dissenters' notice described in section 490.1322. 490.1321 NOTICE OF INTENT TO DEMAND PAYMENT 1. If proposed corporate action creating dissenters' rights under section 490.1302 is submitted to a vote at a shareholders' meeting, a shareholder who wishes to assert dissenters' rights must do all of the following: a. Deliver to the corporation before the vote is taken written notice of the shareholder's intent to demand payment for the shareholder's shares if the proposed action is effectuated. b. Not vote the dissenting shareholder's shares in favor of the proposed action. 2. A shareholder who does not satisfy the requirements of subsection 1, is not entitled to payment for the shareholder's shares under this part. E-2 490.1322 DISSENTERS' NOTICE 1. If proposed corporate action creating dissenters' rights under section 490.1302 is authorized at a shareholders' meeting, the corporation shall deliver a written dissenters' notice to all shareholders who satisfied the requirements of section 490.1321. 2. The dissenters' notice must be sent no later than ten days after the proposed corporate action is authorized at a shareholders' meeting, or, if the corporate action is taken without a vote of the shareholders, no later than ten days after the corporate action is taken, and must do all of the following: a. State where the payment demand must be sent and where and when certificates for certificated shares must be deposited. b. Inform holders of uncertificated shares to what extent transfer of the shares will be restricted after the payment demand is received. c. Supply a form for demanding payment that includes the date of the first announcement to news media or to shareholders of the terms of the proposed corporate action and requires that the person asserting dissenters' rights certify whether or not the person acquired beneficial ownership of the shares before that date. d. Set a date by which the corporation must receive the payment demand, which date shall not be fewer than thirty nor more than sixty days after the date the dissenters' notice is delivered. e. Be accompanied by a copy of this division. 490.1323 DUTY TO DEMAND PAYMENT 1. A shareholder sent a dissenters' notice described in section 490.1322 must demand payment, certify whether the shareholder acquired beneficial ownership of the shares before the date required to be set forth in the dissenters' notice pursuant to section 490.1322, subsection 2, paragraph "c", and deposit the shareholder's certificates in accordance with the terms of the notice. 2. The shareholder who demands payment and deposits the shareholder's shares under subsection 1 retains all other rights of a shareholder until these rights are canceled or modified by the taking of the proposed corporate action. 3. A shareholder who does not demand payment or deposit the shareholder's share certificates where required, each by the date set in the dissenters' notice, is not entitled to payment for the shareholder's shares under this division. 490.1324 SHARE RESTRICTIONS 1. The corporation may restrict the transfer of uncertificated shares from the date the demand for their payment is received until the proposed corporate action is taken or the restrictions released under section 490.1326. 2. The person for whom dissenters' rights are asserted as to uncertificated shares retains all other rights of a shareholder until these rights are canceled or modified by the taking of the proposed corporate action. 490.1325 PAYMENT 1. Except as provided in section 490.1327, at the time the proposed corporate action is taken, or upon receipt of a payment demand, whichever occurs later, the corporation shall pay each dissenter who complied with section 490.1323 the amount the corporation estimates to be the fair value of the dissenter's shares, plus accrued interest. 2. The payment must be accompanied by all of the following: a. The corporation's balance sheet as of the end of a fiscal year ending not more than sixteen months before the date of payment, an income statement for that year, a statement of changes in shareholders' equity for that year, and the latest available interim financial statements, if any. E-3 b. A statement of the corporation's estimate of the fair value of the shares. c. An explanation of how the interest was calculated. d. A statement of the dissenter's right to demand payment under section 490.1328. e. A copy of this division. 490.1326 FAILURE TO TAKE ACTION 1. If the corporation does not take the proposed action within sixty days after the date set for demanding payment and depositing share certificates, the corporation shall return the deposited certificates and release the transfer restrictions imposed on uncertificated shares. 2. If after returning deposited certificates and releasing transfer restrictions, the corporation takes the proposed action, it must send a new dissenters' notice under section 490.1322 as if the corporate action was taken without a vote of the shareholders and repeat the payment demand procedure. 490.1327 AFTER-ACQUIRED SHARES 1. A corporation may elect to withhold payment required by section 490.1325 from a dissenter unless the dissenter was the beneficial owner of the shares before the date set forth in the dissenters' notice as the date of the first announcement to news media or to shareholders of the terms of the proposed corporate action. 2. To the extent the corporation elects to withhold payment under subsection 1, after taking the proposed corporate action, it shall estimate the fair value of the shares, plus accrued interest, and shall pay this amount to each dissenter who agrees to accept it in full satisfaction of the dissenter's demand. The corporation shall send with its offer a statement of its estimate of the fair value of the shares, an explanation of how the interest was calculated, and a statement of the dissenter's right to demand payment under section 490.1328. 490.1328 PROCEDURE IF SHAREHOLDER DISSATISFIED WITH PAYMENT OR OFFER 1. A dissenter may notify the corporation in writing of the dissenter's own estimate of the fair value of the dissenter's shares and amount of interest due, and demand payment of the dissenter's estimate, less any payment under section 490.1325, or reject the corporation's offer under section 490.1327 and demand payment of the fair value of the dissenter's shares and interest due, if any of the following apply: a. The dissenter believes that the amount paid under section 490.1325 or offered under section 490.1327 is less than the fair value of the dissenter's shares or that the interest due is incorrectly calculated. b. The corporation fails to make payment under section 490.1325 within sixty days after the date set for demanding payment. c. The corporation, having failed to take the proposed action, does not return the deposited certificates or release the transfer restrictions imposed on uncertificated shares within sixty days after the date set for demanding payment. 2. A dissenter waives the dissenter's right to demand payment under this section unless the dissenter notifies the corporation of the dissenter's demand in writing under subsection 1 within thirty days after the corporation made or offered payment for the dissenter's shares. PART C 490.1330 COURT ACTION 1. If a demand for payment under section 490.1328 remains unsettled, the corporation shall commence a proceeding within sixty days after receiving the payment demand and petition the court to determine the fair value of the shares and accrued interest. If the corporation does not commence the proceeding within the sixty-day period, it shall pay each dissenter whose demand remains unsettled the amount demanded. 2. The corporation shall commence the proceeding in the district court of the county where a corporation's principal office or, if none in this state, its registered office is located. If the corporation is a foreign corporation without a registered office in this state, it shall commence the proceeding in the county in this state where the E-4 registered office of the domestic corporation merged with or whose shares were acquired by the foreign corporation was located. 3. The corporation shall make all dissenters, whether or not residents of this state, whose demands remain unsettled parties to the proceeding as in an action against their shares and all parties must be served with a copy of the petition. Nonresidents may be served by registered or certified mail or by publication as provided by law. 4. The jurisdiction of the court in which the proceeding is commenced under subsection 2 is plenary and exclusive. The court may appoint one or more persons as appraisers to receive evidence and recommend decision on the question of fair value. The appraisers have the powers described in the order appointing them, or in any amendment to it. The dissenters are entitled to the same discovery rights as parties in other civil proceedings. 5. Each dissenter made a party to the proceeding is entitled to judgment for either of the following: a. The amount, if any, by which the court finds the fair value of the dissenter's shares, plus interest, exceeds the amount paid by the corporation. b. The fair value, plus accrued interest, of the dissenter's after-acquired shares for which the corporation elected to withhold payment under section 490.1327. 490.1331 COURT COSTS AND COUNSEL FEES 1. The court in an appraisal proceeding commenced under section 490.1330 shall determine all costs of the proceeding, including the reasonable compensation and expenses of appraisers appointed by the court. The court shall assess the costs against the corporation, except that the court may assess costs against all or some of the dissenters, in amounts the court finds equitable, to the extent the court finds the dissenters acted arbitrarily, vexatiously, or not in good faith in demanding payment under section 490.1328. 2. The court may also assess the fees and expenses of counsel and experts for the respective parties, in amounts the court finds equitable, for either of the following: a. Against the corporation and in favor of any or all dissenters if the court finds the corporation did not substantially comply with the requirements of sections 490.1320 through 490.1328. b. Against either the corporation or a dissenter, in favor of any other party, if the court finds that the party against whom the fees and expenses are assessed acted arbitrarily, vexatiously, or not in good faith with respect to the rights provided by this chapter. 3. If the court finds that the services of counsel for any dissenter were of substantial benefit to other dissenters similarly situated, and that the fees for those services should not be assessed against the corporation, the court may award to these counsel reasonable fees to be paid out of the amounts awarded the dissenters who were benefited. E-5 EXHIBIT F ILLUSTRATION OF CERTAIN TERMS The following illustrations demonstrate the method of calculation of the Retained Interest and an Inter-Group Interest in any Tracking Group which the Company may create, and the application of certain terms of the Tracking Stock Proposal based on the assumptions set forth herein. For purposes hereof, the Cellular Group is used as an example to illustrate the application of certain terms applicable to all Tracking Stocks and Tracking Groups. Also for purposes of illustration, 140 million shares are used as the number of authorized Cellular Group Shares, 80 million shares are used as the number of Cellular Group Shares issued in the Distribution and the U.S. Cellular Merger, 20 million shares are used as the Number of Shares Issuable with Respect to Retained Interest in the Cellular Group immediately following the Distribution and the U.S. Cellular Merger and 5 million shares are used as the pre-Distribution Number of Shares Issuable to Third Parties. Unless otherwise specified, each illustration below should be read independently as if none of the other transactions illustrated in this Annex had occurred. Actual calculations may be slightly different due to rounding. The following illustrations are not intended to be complete and are qualified in their entirety by the more detailed information contained in the Proxy Statement/Prospectus and the other Exhibits and Appendices thereto. Please note that the following illustrations are purely hypothetical and the numbers used herein (including assumptions of market values) were chosen to simplify the calculations and are not intended to represent estimates of actual numbers or values. Capitalized terms used herein have the respective meanings ascribed to them in the Proxy Statement/Prospectus. See Exhibit G--Index of Certain Defined Terms. At any given time, the Outstanding Interest Fraction, which represents the percentage interest in the equity value of the Company attributable to a Tracking Group that is represented by the outstanding shares of Tracking Stock of that Tracking Group, will be equal to the quotient of: Outstanding Shares of such Tracking Stock ------------------------------------------------------------------------ Outstanding Shares of such Tracking Stock + Number of Shares Issuable with Respect to Retained Interest in such Tracking Group + Number of Shares Issuable with Respect to Inter-Group Interest(s) in such Tracking Group by other Tracking Group(s) The balance of the equity of the Tracking Group is represented by the Retained Interest held by the TDS Group and any other Tracking Group's Inter-Group Interest in such Tracking Group. At any given time, the Retained Interest Fraction, which represents the percentage interest in the equity value of the Company attributable to a Tracking Group that is attributable to the TDS Group, will be equal to the quotient of: Number of Shares Issuable with Respect to Retained Interest in the applicable Tracking Group ------------------------------------------------------------------------ Outstanding Shares of such Tracking Stock + Number of Shares Issuable with Respect to Retained Interest in such Tracking Group + Number of Shares Issuable with Respect to Inter-Group Interest(s) in such Tracking Group by other Tracking Group(s) At any given time, the Inter-Group Interest Fraction, which represents the percentage interest in the equity value of the Company attributable to a Tracking Group that is attributed to other Tracking Groups, will be equal to the quotient of: Number of Shares Issuable with Respect to Inter-Group Interest in the applicable Tracking Group ------------------------------------------------------------------------ Outstanding Shares of such Tracking Stock + Number of Shares Issuable with Respect to Retained Interest in such Tracking Group + Number of Shares Issuable with Respect to Inter-Group Interest(s) in such Tracking Group by other Tracking Group(s) For a particular Tracking Group, the sum of the Outstanding Interest Fraction, the Retained Interest Fraction and the Inter-Group Interest Fraction(s) will always equal 100%. The Adjusted Group Outstanding Interest Fraction is a measure that differs from the Outstanding Interest Fraction in that it takes into account the dilutive effect of certain convertible securities and options, shares F-1 committed for acquisitions or otherwise. It is used instead of the Outstanding Interest Fraction in certain situations and would be equal to the quotient of: Outstanding Shares of Tracking Stock ------------------------------------------------------------------------ Outstanding Shares of such Tracking Stock + Number of Shares Issuable with Respect to Retained Interest in such Tracking Group + Number of Shares Issuable with Respect to Inter-Group Interest(s) in such Tracking Group by other Tracking Group(s) + Number of Shares Issuable to Third Parties of such Tracking Stock PURCHASES OF SHARES OF TRACKING STOCK The following two illustrations reflect the purchase by the Company of 5 million shares of Cellular Group Shares, which are retired or otherwise cease to be outstanding following their purchase. For purposes of these illustrations, it is assumed that no Inter-Group Interest in the Cellular Group exists. A. PURCHASE WITH TRACKING GROUP FUNDS Assume all such shares are identified as having been purchased with funds attributed to the Cellular Group, with the Cellular Group being charged with the consideration paid for such shares. Shares previously issued and outstanding............................. 80 million Shares purchased.......................... (5) million Total shares issued and outstanding after purchase................................ 75 million
- - The Number of Shares Issuable with Respect to Retained Interest in the Cellular Group by the TDS Group would not be changed by the purchase of any shares of Cellular Group Shares which are purchased with funds attributed to the Cellular Group. - - The Cellular Group Outstanding Interest Fraction would be 79%, calculated as follows: 75 million ------------------------ 75 million + 20 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 21% in the Cellular Group. - - In this case, the TDS Group would be credited, and the Cellular Group would be charged, with an amount equal to 27% (representing the ratio of the Retained Interest Fraction (21%) to the Cellular Group Outstanding Interest Fraction (79%)) of the aggregate amount of any dividend or other distribution paid on the outstanding shares of Cellular Group Shares (other than a dividend or other distribution payable in shares of Cellular Group Shares or in certain other securities). If, for example, a dividend of $1 per share were declared and paid on the 75 million shares of Cellular Group Shares outstanding (an aggregate of $75 million), the TDS Group would be credited with $20 million, and the Cellular Group would be charged with that amount in addition to the $75 million dividend on the outstanding Cellular Group Shares (a total of $95 million). - - The Company would have 65 million authorized and unissued shares of Cellular Group Shares (140 million minus 75 million issued and outstanding). B. PURCHASE WITH TDS GROUP FUNDS Assume all such shares are identified as having been purchased with funds attributed to the TDS Group, with the TDS Group being charged with the consideration paid for such shares. Shares previously issued and outstanding............................. 80 million Shares purchased.......................... (5) million Total shares issued and outstanding after purchase................................ 75 million
F-2 - - The Number of Shares Issuable with Respect to Retained Interest would be increased by the number of shares of Cellular Group Shares which are so purchased with funds attributed to the TDS Group. Number of Shares Issuable with Respect to Retained Interest prior to purchase..... 20 million Shares purchased.......................... 5 million Number of Shares Issuable with Respect to Retained Interest after purchase........ 25 million
- - The Cellular Group Outstanding Interest Fraction would be 75%, calculated as follows: 75 million ------------------------ 75 million + 25 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 25% in the Cellular Group. - - In this case, the TDS Group would be credited, and the Cellular Group would be charged, with an amount equal to 33% (representing the ratio of the Retained Interest Fraction (25%) to the Cellular Group Outstanding Interest Fraction (75%)) of the aggregate amount of any dividend or other distribution paid on the outstanding shares of Cellular Group Shares (other than a dividend or other distribution payable in shares of Cellular Group Shares or in certain other securities). If, for example, a dividend of $1 per share were declared and paid on the 75 million shares of Cellular Group Shares outstanding (an aggregate of $75 million), the TDS Group would be credited with $25 million, and the Cellular Group would be charged with that amount in addition to the $75 million dividend on the outstanding Cellular Group Shares (a total of $100 million). - - The Company would have 65 million authorized and unissued Cellular Group Shares (140 million minus 75 million issued and outstanding). TRANSFERS OF ASSETS BETWEEN THE TDS GROUP AND A TRACKING GROUP A. CONTRIBUTION OF ASSETS FROM THE TDS GROUP TO A TRACKING GROUP The following illustration reflects the contribution by the TDS Group to the Cellular Group of $150 million of assets attributed to the TDS Group in return for an increase in the Retained Interest on a date on which the Market Value of the Cellular Group Shares is $50 per share and the Number of Shares Issuable with Respect to Retained Interest is 20 million. Shares previously issued and outstanding............................. 80 million Newly issued shares....................... -- Total shares issued and outstanding after contribution............................ 80 million
- - The Number of Shares Issuable with Respect to Retained Interest would be increased to reflect the contribution to the Cellular Group of assets theretofore attributed to the TDS Group. The increase in the Number of Shares Issuable with Respect to Retained Interest would be calculated by dividing the value of the contribution by the per share Market Value of the Cellular Group Shares. Thus, the $150 million contribution by the TDS Group to the Cellular Group would result in an increase of 3 million shares (an amount equal to $150 million divided by $50). Number of Shares Issuable with Respect to Retained Interest prior to contribution............................ 20 million Adjustment to reflect contribution to the Cellular Group of assets attributed to the TDS Group ($150 divided by $50)..... 3 million Number of Shares Issuable with Respect to Retained Interest after contribution.... 23 million
F-3 - - The Cellular Group Outstanding Interest Fraction would be 78%, calculated as follows: 80 million ------------------------ 80 million + 23 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 22% in the Cellular Group. - - In this case, the TDS Group would be credited, and the Cellular Group would be charged, with an amount equal to 28% (representing the ratio of the Retained Interest Fraction (22%) to the Cellular Group Outstanding Interest Fraction (78%)) of the aggregate amount of any dividend or other distribution paid on the outstanding Cellular Group Shares (other than a dividend or other distribution payable in Cellular Group Shares or in certain other securities). - - The Company would have 60 million authorized and unissued Cellular Group Shares (140 million minus 80 million issued and outstanding). B. TRANSFER OF ASSETS FROM A TRACKING GROUP TO THE TDS GROUP The following illustration reflects the transfer by the Cellular Group to the TDS Group of $150 million of assets attributed to the Cellular Group in return for a reduction in the Retained Interest on a date on which the Market Value of the Cellular Group Shares is $50 per share and the Number of Shares Issuable with Respect to Retained Interest is 20 million. Shares previously issued and outstanding............................. 80 million Shares purchased.......................... -- Total shares issued and outstanding after transfer................................ 80 million
- - The Number of Shares Issuable with Respect to Retained Interest would be decreased to reflect the contribution to the TDS Group of assets theretofore attributed to the Cellular Group. The decrease in the Number of Shares Issuable with Respect to Retained Interest would be calculated by dividing the value of the contribution by the per share Market Value of the Cellular Group Shares. Thus, the $150 million contribution by the Cellular Group to the TDS Group would result in a decrease of 3 million shares (an amount equal to $150 million divided by $50). Number of Shares Issuable with Respect to Retained Interest prior to transfer..... 20 million Adjustment to reflect transfer to the TDS Group of assets attributed to the Cellular Group ($150 divided by $50).... (3) million Number of Shares Issuable with Respect to Retained Interest after transfer........ 17 million
The Cellular Group will not make transfers of assets to the TDS Group in reduction of the Retained Interest if the effect would be to reduce the Number of Shares Issuable with Respect to Retained Interest to less than zero. The Cellular Group cannot have an Inter-Group Interest in the TDS Group. - - The Cellular Group Outstanding Interest Fraction would be 82%, calculated as follows: 80 million ------------------------ 80 million + 17 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 18% in the Cellular Group. - - In this case, the TDS Group would be credited, and the Cellular Group would be charged, with an amount equal to 22% (representing the ratio of the Retained Interest Fraction (18%) to the Cellular Group Outstanding Interest Fraction (82%)) of the aggregate amount of any dividend or other distribution paid on the outstanding Cellular Group Shares (other than a dividend or other distribution payable in Cellular Group Shares or in certain other securities). F-4 - - The Company would have 60 million authorized and unissued Cellular (140 million minus 80 million issued and outstanding). FUTURE OFFERINGS OF TRACKING GROUP STOCK The following illustrations reflect the sale by the Company of 10 million Cellular Group Shares on a date on which the Number of Shares Issuable with Respect to Retained Interest is 20 million shares. A. OFFERING FOR TRACKING GROUP The following example assumes all such Cellular Group Shares issued pursuant to the offering are identified as issued for the account of the Cellular Group, with the net proceeds credited to the Cellular Group: Shares previously issued and outstanding............................. 80 million Newly issued shares....................... 10 million Total shares issued and outstanding after offering................................ 90 million
- - The Number of Shares Issuable with Respect to Retained Interest would not be changed by the issuance of any Cellular Group Shares for the account of the Cellular Group. - - The Outstanding Interest Fraction would be 82%, calculated as follows: 90 million ------------------------ 90 million + 20 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 18% in the Cellular Group. - - The Company would have 50 million authorized and unissued Cellular Group Shares remaining (140 million minus 90 million issued and outstanding). B. OFFERING FOR THE TDS GROUP The following example assumes all such Cellular Group Shares issued pursuant to the offering are identified as issued for the account of the TDS Group with respect to the Retained Interest, with the net proceeds credited to the TDS Group: Shares previously issued and outstanding............................. 80 million Newly issued shares....................... 10 million Total shares issued and outstanding after offering................................ 90 million
- - The Number of Shares Issuable with Respect to Retained Interest would decrease by the number of Cellular Group Shares issued for the account of the TDS Group. Number of Shares Issuable with Respect to Retained Interest prior to offering..... 20 million Shares issued in offering................. (10) million Number of Shares Issuable with Respect to Retained Interest after offering........ 10 million
F-5 - - The Cellular Group Outstanding Interest Fraction would be 90%, calculated as follows: 90 million ------------------------ 90 million + 10 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 10% in the Cellular Group. - - The Company would have 50 million authorized and unissued Cellular Group Shares (140 million minus 90 million issued and outstanding). OFFERINGS OF CONVERTIBLE SECURITIES FOLLOWING THE DISTRIBUTION If the Company were to issue any debt or preferred stock which was convertible into shares of Tracking Stock, the Retained Interest Fraction and the Outstanding Interest Fraction would be unchanged at the time of such issuance. If any shares of Tracking Stock were issued upon the conversion of such Convertible Security, however, then the Retained Interest Fraction and the Outstanding Interest Fraction would be affected in a manner similar to that shown above under "Offering for the Tracking Group", if such Convertible Security were attributed to the Tracking Group, or under "Offering for the TDS Group," if such Convertible Security were attributed to the TDS Group. The conversion, exercise or exchange of Pre-Distribution Convertible Securities will be attributed to the TDS Group. TRACKING GROUP COMMON STOCK DIVIDENDS The following illustrations reflect stock dividends of a Tracking Stock on the outstanding Tracking Stock of the same Tracking Group, and on the outstanding TDS Group Shares, respectively, on a date on which the Number of Shares Issuable with Respect to Retained Interest is 20 million shares. A. TRACKING STOCK DIVIDEND ON TRACKING GROUP SHARES The following example assumes that the Company declares a stock dividend of one-fourth of one Cellular Group Share on each outstanding Cellular Group Share. Shares previously issued and outstanding............................. 80 million Newly issued shares....................... 20 million Total shares issued and outstanding after dividend................................ 100 million
- - The Number of Shares Issuable with Respect to Retained Interest would be increased proportionately to reflect the stock dividend payable in Cellular Group Shares to holders of Cellular Group Shares. Number of Shares Issuable with Respect to Retained Interest prior to dividend..... 20 million Adjustment to reflect dividend of shares on outstanding Cellular Group Shares.... 5 million Number of Shares Issuable with Respect to Retained Interest after dividend........ 25 million
- - The Outstanding Cellular Group Interest Fraction would be 80%, calculated as follows: 100 million ------------------------ 100 million + 25 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 20% in the Cellular Group. The Cellular Group Outstanding Interest Fraction and the Retained Interest Fraction would be unchanged from the corresponding percentages prior to the dividend. - - The Company would have 40 million authorized and unissued Cellular Group Shares remaining (140 million minus 100 million issued and outstanding). F-6 B. TRACKING STOCK DIVIDEND ON TDS GROUP SHARES The following example assumes that an aggregate of 60 million TDS Group Shares are outstanding and the Company declares a stock dividend of one-tenth of one Cellular Group Share on each outstanding TDS Group Share. Cellular Group Shares previously issued and outstanding......................... 80 million Newly issued Cellular Group Shares........ 6 million Total Cellular Group Shares issued and outstanding after dividend.............. 86 million
- - Any dividend of Cellular Group Shares on the outstanding TDS Group Shares will be treated as a dividend payable from the Number of Shares Issuable with Respect to Retained Interest in the Cellular Group. As a result, the Number of Shares Issuable with Respect to Retained Interest would decrease by an amount equal to the number of Cellular Group Shares distributed on the outstanding TDS Group Shares pursuant to the stock dividend. Number of Cellular Group Shares Issuable with Respect to Retained Interest prior to dividend............................. 20 million Cellular Group Shares distributed on outstanding TDS Group Shares............ (6) million Number of Cellular Group Shares Issuable with Respect to Retained Interest after dividend................................ 14 million
- - The Company will not distribute to holders of TDS Group Shares as a dividend a number of Cellular Group Shares exceeding the Number of Shares Issuable with Respect to Retained Interest by the TDS Group in the Cellular Group. - - The Cellular Group Outstanding Interest Fraction would be 86%, calculated as follows: 86 million ------------------------ 86 million + 14 million The Retained Interest Fraction would accordingly represent a TDS Group interest of 14% in the Cellular Group. - - The Company would have 54 million authorized and unissued Cellular Group Shares remaining (140 million minus 86 million issued and outstanding). CERTAIN CONVERSION, REDEMPTION AND SPECIAL DIVIDEND PROVISIONS The following illustrations reflect (a) conversion of the Cellular Group Shares at the option of the Company, (b) mandatory dividend, redemption or conversion of the Cellular Group Shares following the Disposition of all or substantially all of the properties and assets of the Cellular Group and (c) redemption of all the Cellular Group Shares in exchange for stock of a subsidiary holding all the assets and liabilities of the Cellular Group, in each case assuming that (i) the number of outstanding Cellular Group Shares is 80 million shares, (ii) the Number of Shares Issuable with Respect to Retained Interest is 20 million shares and (iii) the pre-Distribution Number of Shares Issuable to Third Parties is 5 million. CONVERSION AT THE OPTION OF THE COMPANY The following example assumes that the Company elects to convert the Cellular Group Shares into TDS Group Special Common Shares at the Optional Conversion Percentage and the post-Distribution Number of Shares Issuable to Third Parties (with respect to the Cellular Group) is 5 million. - - The Adjusted Outstanding Cellular Group Shares would be 110 million (representing the sum of (i) the number of outstanding Cellular Group Shares, (ii) the Number of Shares Issuable with Respect to Retained Interest, (iii) the pre-Distribution Number of Shares Issuable to Third Parties (with respect to the Cellular Group) and F-7 (iv) the post-Distribution Number of Shares Issuable to Third Parties (with respect to the Cellular Group)), calculated as follows: 80 million + 20 million + 5 million + 5 million - - If the Company elected to convert the Cellular Group Shares into Special Common Shares, assuming that the Market Value of one Cellular Group Share on each Trading Day during the twenty-Trading Day period ending on the 5th Trading Day prior to the date of notice of such conversion is $50 and the Market Value of one Special Common Share (or Common Share, if there is no public market value for the Special Common Shares) on each Trading Day during such period is $20, the Cellular Group Shares would be converted into Special Common Shares at a ratio of 2.875 Special Common Shares for each Cellular Group Share (representing 115% of the average daily ratio during such period of the Market Value of one Cellular Group Share to the Market Value of one Special Common Share). The Optional Conversion Percentage is fixed at 115% for the first five years after the initial issuance date of the applicable Tracking Stock, and then declines 1% per year until it is 110% on the ninth anniversary of the initial issuance date and for all periods thereafter. DISPOSITION OF ASSETS OF TRACKING GROUP The following example assumes that a Disposition of all (not merely substantially all) of the properties and assets of the Cellular Group occurs and the Fair Value of the Net Proceeds from such Disposition equal $5 billion. - - If the Company elected to redeem all outstanding Cellular Group Shares, the aggregate redemption price would be $3.64 billion (representing the product of the Adjusted Outstanding Interest Fraction for the Cellular Group and the Fair Value of the Net Proceeds of such Disposition), calculated as follows: 80 million __________________________________________ X $5 billion 80 million + 20 million + 5 million + 5 million In this case each outstanding Cellular Group Share would be redeemed in exchange for $45.50 per share (representing the quotient of the aggregate redemption price ($3.64 billion) and the number of outstanding Cellular Group Shares (80 million)). If any Shares Issuable to Third Parties remain outstanding at the time of any redemption of all outstanding Cellular Group Shares following the disposition of all (not merely substantially all) of the properties and assets of the Cellular Group, the proportionate interest in the Fair Value of the Net Proceeds of the Disposition to be distributed to the holders of Cellular Group Shares will be determined on the basis of the Adjusted Outstanding Interest Fraction, which will result in the allocation to the TDS Group of a portion of such Fair Value of the Net Proceeds, in addition to the portion attributable to any Retained Interest in the Cellular Group, sufficient to provide for the delivery of the portion of the consideration (if any) deliverable by the Company with respect to the Shares Issuable to Third Parties. - - If the Company elected to convert the Cellular Group Shares into Special Common Shares, assuming that the Market Value of one Cellular Group Share on each Trading Day during the forty-Trading Day period beginning on the 11th Trading Day following the consummation of such Disposition is $50 and the Market Value of one Special Common Share (or Common Share, if there is no public market value for the Special Common Shares) on each Trading Day during such period is $20, the Cellular Group Shares would be converted into Special Common Shares at a ratio of 2.75 Special Common Shares for each Cellular Group Share (representing 110% of the average daily ratio during such period of the Market Value of one Cellular Group Share to the Market Value of one Special Common Share). The following example assumes that a Disposition of substantially all (but not all) of the properties and assets of the Cellular Group occurs and the Fair Value of the Net Proceeds from the Disposition equal $4 billion. - - If the Company elected to pay a dividend to the holders of Cellular Group Shares, the aggregate amount of the dividend would be $3.2 billion (representing the product of the Outstanding Interest Fraction and the Fair Value of the Net Proceeds of the Disposition), calculated as follows: 80 million ____________________ X $4 billion 80 million + 20 million F-8 In this case, the TDS Group would be credited, and the Cellular Group would be charged, with $800 million, an amount equal to 25% (representing the ratio of the Retained Interest Fraction (20%) and the Outstanding Interest Fraction (80%)) of the aggregate amount of such dividend. - - If the Company elected to redeem Cellular Group Shares, the aggregate redemption price would be $3.2 billion (representing the product of the Outstanding Interest Fraction and the Fair Value of the Net Proceeds of such Disposition), calculated as follows: 80 million ____________________ X $4 billion 80 million + 20 million In this case, assuming that the average Market Value of one of Cellular Group Share for the forty-Trading Day period beginning on the 11th Trading Day following the consummation of such Disposition is $50, an aggregate of 64 million (equal to the quotient of the aggregate redemption price and such average Market Value) outstanding Cellular Group Shares would be redeemed in exchange for $50 per share. - - If the Company elected to convert Cellular Group Shares into Special Common Shares, assuming that the Market Value of one Cellular Group Share on each Trading Day during the forty-Trading Day period beginning on the 11th Trading Day following the consummation of such Disposition was $50 and the Market Value of one Special Common Share (or Common Share, if there is no public market value for the Special Common Shares) on each Trading Day during such period was $20, the Cellular Group Shares would be converted into Special Common Shares at a ratio of 2.75 (representing 110% of the average daily ratio during such period of the Market Value of one Cellular Group Share to the Market Value of one share of Special Common Share) Special Common Shares for each Cellular Group Share. REDEMPTION IN EXCHANGE FOR STOCK OF SUBSIDIARY The following example assumes that the Company elects to redeem all of the outstanding Cellular Group Shares in exchange for shares of common stock of U.S. Cellular and that U.S. Cellular is a wholly-owned subsidiary of the Company. Prior to the redemption, the Company would recapitalize U.S. Cellular so that its capital structure included shares which were substantially similar to the Series A Common Shares, Common Shares and Special Common Shares and increase the number of authorized shares to permit the redemption to take place. For this purpose, assume that the total number of outstanding shares of common stock of U.S. Cellular is 110 million after such recapitalization, consisting of an appropriate number of shares which correspond to the same number of shares of Series A Common Shares, Common Shares and Special Common Shares which are then issued and outstanding. - - In this case, Cellular Group Shares would be redeemed in exchange for an aggregate number of shares of common stock of U.S. Cellular corresponding to Special Common Shares equal to 80 million (representing the product of the Adjusted Outstanding Interest Fraction and the number of shares of common stock of U.S. Cellular), calculated as follows: 80 million __________________________________________ X 110 million U.S. Cellular Common Shares 80 million + 20 million + 5 million + 5 million In this case each outstanding Cellular Group Share would be redeemed in exchange for one share of common stock of U.S. Cellular corresponding to Special Common Shares, and the Company would retain 30 million shares of common stock of U.S. Cellular corresponding to Series A Common Shares, Common Shares and Special Common Shares. Of such shares, 10 million would correspond to Special Common Shares and would be held by the TDS Group to be used in connection with Shares Issuable to Third Parties. The remaining shares would be held by the TDS Group for the benefit of the holders of TDS Group Shares or, alternatively, the Board could elect to distribute such shares of U.S. Cellular to the holders of TDS Group Shares. In such event, holders of Series A Common Shares would receive U.S. Cellular shares corresponding to Series A Common Shares, holders of Common Shares would receive U.S. Cellular shares corresponding to Common Shares and holders of Special Common Shares, if any, would receive U.S. Cellular shares corresponding to Special Common Shares. F-9 EXHIBIT G INDEX OF CERTAIN DEFINED TERMS
TERM PAGE - ---------------------------------------------------------------------------------------------------------------------- ----------- Adjusted Outstanding Interest Fraction Adjustment Date Aerial Aerial Group Aerial Group Shares Aerial Merger Affected Tracking Group Affected Tracking Stock AMEX Articles Available Dividend Amount Board C.S. First Boston Calculation Period Cellular Business Cellular Group Cellular Group Shares Committed Acquisition Shares Committee Common Share DRIP Common Share Group Common Shares Common Stock Communications Act Company Company Earning (Loss) Converted Tracking Group Converted Tracking Stock Convertible Securities Corporation Delaware Common Shares Delaware Preferred Shares Delaware Series A Common Shares Delaware Shares Derivative Action DGCL Disposition Disposition Conversion Percentage Distribution Distribution Ratio Effective Time Equity Market Access Exchange Act Existing Plans Fair Market Value Fair Value Fair Value of Net Proceeds FCC Financial Advisors Group IBCA Initial Shares
G-1
TERM PAGE - ---------------------------------------------------------------------------------------------------------------------- ----------- Inter-Group Interest Inter-Group Interest Fraction Inter-Group Interest in Issuer Group Investor Group Iowa Common Shares Iowa Preferred Shares Iowa Series A Common Shares Iowa Shares ISO Issuer Group Issuer Group Inter-Group Interest Fraction Issuer Group Outstanding Interest Fraction Issuer Group Shares Liquidation Unit Market Capitalization Market Value Merger Merger Agreement Non-U.S. Shareholder Number of Shares Issuable with Respect to Inter-Group Interest Number of Shares Issuable with Respect to Retained Interest Number of Shares Issuable to Third Parties One-Vote Holders Optional Conversion Percentage Outstanding Interest Outstanding Interest Fraction PCS PCS Business Plan Plan Stock Pre-Distribution Convertible Securities Preferred Shares Proposed Common Equity Proxy Statement/Prospectus Public Holders Qualifying Subsidiary Recapitalization Record Shareholder Redemptions Date Registration Statement Related Business Transaction Required Price Reserved Property Restated Certificate Retained Interest Retained Interest Available Dividend Amount Retained Interest Fraction Salomon Smith Barney SAR SEC Securities Act Series A Common Shares Series A DRIP Series A Holders Service Shares Issuable to Third Parties
G-2
TERM PAGE - ---------------------------------------------------------------------------------------------------------------------- ----------- Special Common Shares Special Meeting Subsidiary Successor TDS TDS Delaware TDS Group TDS Group Dividend Rate TDS Group Shares TDS Iowa TDS Telecom TDS Voting Trust Telecom Business Telecom DRIP Telecom Equivalent Dividend Rate Telecom Group Shares Telecom Public Offering Telecom Group Tracking Group Tracking Stock Tracking Stock Proposal Trading Day Transactions Undesignated Shares U. S. Cellular U. S. Cellular Merger Voting Percentage
G-3 ANNEX I DESCRIPTION OF BUSINESS OF TELEPHONE AND DATA SYSTEMS, INC. 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, 1997, the Company served approximately 3.2 million customer units in 37 states, including 1,710,000 cellular telephones, 515,500 telephone access lines, 125,000 PCS telephones and 811,100 pagers. For the year ended December 31, 1997, cellular operations provided 60% of the Company's consolidated revenues; telephone operations provided 30%; PCS operations provided 4%; and paging operations provided 6%. The Company's long-term business development strategy is to expand its existing operations through internal growth and acquisitions and to explore and develop other telecommunications businesses that management believes will utilize the Company's expertise in customer-based telecommunications. The Company conducts substantially all of its cellular operations through its 81%-owned subsidiary, United States Cellular Corporation [AMEX: USM]. At December 31, 1997, U.S. Cellular provided cellular telephone service to 1,710,000 customers through 134 majority-owned and managed ("consolidated") cellular systems serving approximately 16% of the geography and approximately 9% of the population of the United States. Since 1985, when U.S. Cellular began providing cellular service in Knoxville, Tennessee, U.S. Cellular has expanded its cellular networks and customer service operations to cover 143 managed markets in 26 states as of December 31, 1997. In total, the Company operated eight market clusters, of which four had a total population of more than two million, and each of which had a total population of more than one million. Overall, 86% of the Company's 26.2 million population equivalents were in markets which were consolidated, 2% were in managed but not consolidated markets and 12% were in markets in which the Company holds an investment interest. The Company conducts substantially all of its telephone operations through its wholly owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom"). At December 31, 1997, TDS Telecom operated 106 telephone companies serving 515,500 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 18 telephone companies and divested one telephone company since the beginning of 1993. These net acquisitions added 89,600 access lines during this five-year period, while internal growth added 104,200 lines. The Company conducts substantially all of its broadband personal communications services ("PCS") operations through its 83%-owned subsidiary, Aerial Communications, Inc. [NASDAQ: AERL]. Aerial provides PCS service in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major Trading Areas ("MTAs") (collectively, the "PCS Markets"). The PCS Markets include approximately 27.6 million population equivalents. Aerial has commenced service in all its markets and provided service to 125,000 PCS telephones as of December 31, 1997. The Company conducts substantially all of its radio paging operations through its 82%-owned subsidiary, American Paging, Inc. [AMEX: APP]. American Paging offers radio paging and related services through its subsidiaries. Since the beginning of 1993, the number of pagers in service increased from 322,200 to 811,100 at December 31, 1997, primarily from internal growth. American Paging provides service in 21 states and the District of Columbia through 35 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 I-1 Communications Services ("PCS") markets; (x) references to "population equivalents" mean the population of a market, based on 1997 Claritas Estimates, multiplied by the percentage interests that the Company owns or has the right to acquire in an entity licensed, designated to receive a license or expected to receive a construction permit ("licensee") by the FCC to construct or operate a cellular or a PCS system in such market. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT This business description, 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 and PCS 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 1,710,000 customers through 134 majority-owned and managed cellular systems at December 31, 1997. Overall, U.S. Cellular owned 26.2 million population equivalents in 192 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 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 operators to complete initial deployment of PCS in portions of all of its market clusters by the end of 1998. 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 of 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 may be charged a separate fee for system access, airtime, long-distance calls, and ancillary services. Cellular system operators often provide service to customers of other operators' cellular systems while the customers are temporarily located within the operators' service areas. Customers using service away from their home system are called "roamers." Roaming is available because technical standards require that analog cellular telephones be compatible in all market I-2 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, on certain cellular systems the radio transmission is done on an analog basis. During 1992, a new transmission technique was approved for implementation by the cellular industry. Time Division Multiple Access ("TDMA") technology was selected as one industry standard by the cellular industry and has been deployed in several markets, including U.S. Cellular's operations in portions of several clusters. Another digital technology, Code Division Multiple Access ("CDMA"), is being deployed by U.S. Cellular in portions of certain clusters. 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 is continuing on an industry-wide basis; however this process is expected to take a number of years. PCS operators have deployed TDMA, CDMA and a third digital technology, Global Systems for Mobile Communications ("GSM"), in the markets where they have begun operations. The cellular telephone industry is characterized by high initial fixed costs. Accordingly, if and when revenues less variable costs exceed fixed costs, incremental revenues should yield an operating profit. The amount of profit, if any, under such circumstances is dependent on, among other things, prices and variable marketing costs which in turn are affected by the amount and extent of competition. Until technological limitations on total capacity are approached, additional cellular system capacity can normally be added in increments that closely match demand and at less than the proportionate cost of the initial capacity. CELLULAR OPERATIONS From its inception in 1983 until 1993, U.S. Cellular had principally been in a start-up phase. During 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 four years, U.S. Cellular has generated operations-driven net income and has significantly increased its operating cash flows during that time. Management anticipates further growth in cellular units in service and revenues as U.S. Cellular continues to expand through internal growth. Marketing and system operations expenses associated with this expansion may reduce the rate of growth in operating cash flow and operating income during the period of increased growth. In addition, U.S. Cellular anticipates that the seasonality of revenue streams and operating expenses may cause U.S. Cellular's operating income to vary from quarter to quarter. While U.S. Cellular produced operating income and net income during the last four years, changes in any of several factors may reduce U.S. Cellular's growth in operating income and net income over the next few years. These factors include: (i) the growth rate in U.S. Cellular's customer base; (ii) the usage and pricing of cellular services; (iii) the churn rate; (iv) the cost of providing cellular services, including the cost of attracting new customers; (v) 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: Wisconsin/Illinois/Indiana, Iowa/Missouri, Eastern North Carolina/South Carolina, West Virginia/Maryland/Pennsylvania/Ohio, Virginia, Washington/Oregon/Idaho, Oregon/California, Maine/New Hampshire/Vermont, Florida/Georgia, Oklahoma/Missouri/Kansas, Texas/Oklahoma, Eastern Tennessee/Western North Carolina, and Southwestern Texas. See "U.S. Cellular's Cellular Interests." U.S. Cellular has acquired its cellular interests through the wireline application process (17%), including settlements and exchanges with other applicants, and through acquisitions (83%), 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. Including acquisitions of cellular interests from TDS, U.S. Cellular has increased its population equivalents by 17% from approximately 22.5 million at December 31, 1992, to approximately 26.2 million at December 31, 1997. I-3 Markets managed by U.S. Cellular have increased from 116 markets at December 31, 1992, to 143 markets at December 31, 1997. As of December 31, 1997, 88% of U.S. Cellular's population equivalents represented interests in markets it manages compared to 75% at December 31, 1992. 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 just 3% 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 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 four 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 1997, U.S. Cellular, or TDS for the benefit of U.S. Cellular, purchased majority interests in two markets and several additional minority interests, representing approximately 534,000 population equivalents. The total consideration paid for these purchases, primarily in the form of cash and TDS Common Shares totaled $81.4 million. During 1997, U.S. Cellular completed the divestiture of majority interests in one market plus one market partition and minority interests in two other markets, representing approximately 358,000 population equivalents, for an aggregate consideration of $54.5 million in cash and receivables. The two minority interests involved interests U.S. Cellular had previously acquired from TDS pursuant to an agreement between the two companies signed in June 1996. Also during 1997, U.S. Cellular completed an exchange with BellSouth Corporation ("BellSouth"). Pursuant to the exchange, U.S. Cellular received majority interests representing approximately 4.0 million pops in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests U.S. Cellular received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters. PENDING ACQUISITIONS. At December 31, 1997, U.S. Cellular had entered into agreements to acquire a majority interest in one market and a minority interest in a market in which the U.S. Cellular owns a majority interest, representing 410,000 population equivalents, for $51.3 million in cash. If the majority interest is acquired as expected, U.S. Cellular will subsequently sell that interest to BellSouth for cash. PENDING DIVESTITURES. At December 31, 1997, U.S. Cellular and TDS had entered into agreements with Airtouch Communications, Inc. ("AirTouch") to divest minority interests in 11 markets, representing approximately 900,000 population equivalents. AirTouch will issue approximately 4.0 million shares of its common stock and $54.2 million in cash for minority interests in nine markets held by U.S. Cellular and approximately 1.0 million shares of its common stock for minority interests in two markets held by TDS. I-4 Additionally, U.S. Cellular has entered into an agreement to sell its minority interests in two other markets representing 176,000 population equivalents, for $37.6 million in cash. The sales are expected to be completed during the first half of 1998. Management anticipates that it will record significant book gains on these divestitures when the transactions are completed. 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. U.S. Cellular is a majority-owned subsidiary of TDS. TDS owns 81% of the combined total of the outstanding Common Shares and Series A Common Shares of U.S. Cellular and controls 96% of the combined voting power of both classes of common stock. U.S. Cellular benefits from the extensive telecommunications industry experience of TDS, which also operates telephone and paging businesses and is developing its PCS business. CELLULAR INTERESTS AND CLUSTERS U.S. Cellular operates clusters of adjacent cellular systems in nearly all of its markets, enabling its customers to benefit from larger service areas than otherwise possible. Where U.S. Cellular offers wide-area coverage, its customers enjoy uninterrupted service within the designated area. Customers may also make outgoing calls and receive incoming calls within this area without special roaming arrangements. In addition to benefits to customers, clustering also has provided to U.S. Cellular certain economies in its capital and operating costs. These economies are made possible through increased sharing of facilities, personnel and other costs and have resulted in a reduction of U.S. Cellular's per customer cost of service. The extent to which U.S. Cellular benefits from these revenue enhancements and economies of operation is dependent on market conditions, population size of each cluster and engineering considerations. U.S. Cellular may continue to make opportunistic acquisitions and exchanges which will complement its established market clusters. From time to time, U.S. Cellular may also consider exchanging or selling its interests in markets which do not fit well with its long-term strategies. U.S. Cellular owned interests in cellular telephone systems in 192 markets at December 31, 1997, representing 26.2 million population equivalents. Including the 11 interests to be sold during 1998, U.S. Cellular owned or had the right to acquire 181 markets, representing 25.3 million population equivalents, at December 31, 1997. The following table summarizes the growth in U.S. Cellular's population equivalents in recent years and the development status of these population equivalents.
DECEMBER 31, ----------------------------------------------------- 1997 1996 1995 1994 1993 --------- --------- --------- --------- --------- (THOUSANDS OF POPULATION EQUIVALENTS)(1) Operational Markets: Majority-Owned and Managed.............................................. 22,778 20,389 20,104 18,829 19,086 Minority-Owned and Managed (2).......................................... 401 401 514 1,234 1,263 Markets to be Managed, Net of Markets to be Divested: (3) To Be Majority-Owned ................................................. -- 216 273 2,220 1,035 To Be Minority-Owned (2).............................................. -- -- -- -- 6 --------- --------- --------- --------- --------- Total Markets Managed and to be Managed............................... 23,179 21,006 20,891 22,283 21,390 Minority Interest in Markets Managed by Others.......................... 2,121 4,511 4,026 3,779 3,577 --------- --------- --------- --------- --------- Total................................................................. 25,300 25,517 24,917 26,062 24,967 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
- ------------ (1) Based on 1997 Claritas 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, 1997. 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 I-5 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. U.S. CELLULAR'S CELLULAR INTERESTS The table below sets forth certain information with respect to the interests in cellular markets which U.S. Cellular owned or had the right to acquire pursuant to definitive agreements as of December 31, 1997.
TOTAL CURRENT AND ACQUIRABLE 1997 POPULATION CLUSTER/MAJOR SERVICE AREA POPULATION EQUIVALENTS - ------------------------------------------------------------------------------------------------ ------------- ------------- MIDWEST REGIONAL MARKET CLUSTER: Wisconsin/Illinois/Indiana.................................................................... 6,080,000 5,754,000 Iowa/Missouri................................................................................. 3,424,000 3,207,000 ------------- ------------- Total Midwest Regional Market Cluster....................................................... 9,504,000 8,961,000 ------------- ------------- MID-ATLANTIC REGIONAL MARKET CLUSTER: Eastern North Carolina/South Carolina......................................................... 2,379,000 2,349,000 West Virginia/Maryland/Pennsylvania/Ohio...................................................... 1,387,000 1,260,000 Virginia...................................................................................... 1,152,000 1,144,000 ------------- ------------- Total Mid-Atlantic Regional Market Cluster.................................................. 4,918,000 4,753,000 ------------- ------------- NORTHWEST REGIONAL MARKET CLUSTER: Washington/Oregon/Idaho....................................................................... 1,482,000 1,266,000 Oregon/California............................................................................. 1,038,000 964,000 ------------- ------------- Total Northwest Regional Market Cluster..................................................... 2,520,000 2,230,000 ------------- ------------- MAINE/NEW HAMPSHIRE/VERMONT MARKET CLUSTER:..................................................... 1,688,000 1,631,000 ------------- ------------- FLORIDA/GEORGIA MARKET CLUSTER:................................................................. 1,539,000 1,539,000 ------------- ------------- TEXAS/OKLAHOMA/MISSOURI/KANSAS REGIONAL MARKET CLUSTER: Oklahoma/Missouri/Kansas...................................................................... 1,420,000 879,000 Texas/Oklahoma................................................................................ 695,000 495,000 ------------- ------------- Total Texas/Oklahoma/Missouri/Kansas Regional Market Cluster:............................... 2,115,000 1,374,000 ------------- ------------- EASTERN TENNESSEE/WESTERN NORTH CAROLINA MARKET CLUSTER:........................................ 1,623,000 1,308,000 SOUTHWESTERN TEXAS MARKET CLUSTER:.............................................................. 1,254,000 1,243,000 ------------- ------------- Other Operations:............................................................................... 140,000 140,000 ------------- ------------- Total Managed Markets........................................................................... 25,301,000 23,179,000 Markets Managed by Others....................................................................... 2,121,000 ------------- Total Population Equivalents.................................................................... 25,300,000 ------------- -------------
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 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 I-6 MTSO. Although the installation of microwave network interconnection equipment requires a greater initial capital investment, a microwave network enables a system operator to avoid the current and future charges associated with leasing telephone lines from the landline telephone company, while generally improving system reliability. In addition, microwave facilities can be used to connect separate cellular systems to allow shared switching, which reduces the aggregate cost of the equipment necessary to operate both systems. U.S. Cellular expanded 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, Airtouch/US West, Ameritech, BellSouth, Centennial Cellular Corp., Southwestern Bell, AT&T Wireless Communications, Vanguard Cellular Systems and others. Additionally, U.S. Cellular has implemented certain Signal Transfer Points which have allowed it to interconnect efficiently with network providers such as Illuminet and the North American Cellular Network. U.S. Cellular plans to integrate the systems in the markets acquired in the exchange with BellSouth into its internal network as quickly as possible. This may involve changing out certain system equipment and replacing it with new equipment which will allow for more efficient networking. During 1997, U.S. Cellular has extended the network for its customers through interconnection with additional system operators for call delivery and hand-off. This expanded network increases 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. In recent years, these funding requirements have been met with cash generated from operations, proceeds from debt and equity offerings and proceeds from the sales of cellular interests. MARKETING U.S. Cellular's marketing plan is centered around rapid penetration of its market clusters, increasing customer awareness of cellular service and reducing churn through both the building of brand awareness and the implementation of marketing programs. The marketing plan stresses the value of U.S. Cellular's service offerings and incorporates combinations of rate plans and cellular telephone equipment which are designed to meet the needs of a variety of customer segments and their usage patterns. U.S. Cellular's distribution channels include direct sales personnel, agents and retail service centers in the vast majority of its markets. 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. Customers may now order U.S. Cellular service through this web site. 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, including sales, customer service, engineering and in some cases installation personnel. Direct sales consultants market cellular service to business customers throughout each cluster. Retail associates work out of the retail locations and market cellular service primarily to the consumer and small business segment. U.S. Cellular maintains 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 I-7 obtain a minimum amount of usage at discounted rates per minute, at fixed prices which are charged even if usage falls below a defined monthly minimum amount. U.S. Cellular continues to expand its relationships with agents, dealers and non-U.S. Cellular retailers to obtain customers. Agents and dealers are independent business people who obtain customers for U.S. Cellular on a commission basis. U.S. Cellular's agents are generally in the business of selling cellular telephones, cellular service packages and other related products. U.S. Cellular's dealers include car stereo companies and other companies whose customers are also potential cellular customers. The non-U.S. Cellular retailers include car dealers, major appliance dealers, office supply dealers and mass merchants. U.S. Cellular opened its first retail locations in late 1993, expanding to 260 stand-alone retail stores by December 31, 1997. These U.S. Cellular-owned and operated businesses utilize rental facilities in high-traffic areas. U.S. Cellular has implemented a uniform appearance in these stores, with all having similar displays and layouts. The retail centers' hours of business match those of the retail trade in the local marketplace, often staying open on weekends and later in the evening than a typical business supplier. To fully serve customer needs, these stores sell accessories to complement the phones and services U.S. Cellular has traditionally provided. During 1996, U.S. Cellular further expanded its retail presence by opening smaller retail kiosks within other larger merchandisers and grocery stores. At December 31, 1997, U.S. Cellular had opened over 140 "stores within a store," primarily in Wal-Mart 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 Ford Motor Company, General Motors, Radio Shack, Best Buy, Circuit City, Staples, Office Depot 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. In 1997, U.S. Cellular increased its focus on brand advertising, using the tag line "The Way People Talk Around Here"-SM- to promote the United States Cellular-Registered Trademark- brand. 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 some of U.S. Cellular's customers still use in-vehicle cellular telephones, most new customers are selecting portable cellular telephones. These units have become more compact and fully featured as well as more attractively priced, and they appeal to newer segments of the customer population. U.S. Cellular's cellular systems are used most extensively during normal business hours between 7:00 am and 6:00 pm. On average, the local retail customers in U.S. Cellular's consolidated systems used their cellular systems approximately 103 minutes per unit each month and generated retail revenue of approximately $36 per month during 1997, compared to 107 minutes and $40 per month in 1996. 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 $54 during 1997. Average monthly service revenue per customer unit decreased approximately 15% during 1997 compared to the same period in 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 I-8 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 few years. 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, by operating cluster, the total population, U.S. Cellular's customer units and penetration for U.S. Cellular's majority-owned and managed markets that were operational as of December 31, 1997.
OPERATING CLUSTERS POPULATION CUSTOMERS PENETRATION - ----------------------------------------------------------------------------------- ------------- ----------- ------------- Wisconsin/Illinois/Indiana ........................................................ 5,778,000 452,000 7.82% Iowa/Missouri...................................................................... 3,154,000 257,000 8.15 Eastern North Carolina/South Carolina ............................................. 2,379,000 124,000 5.21 West Virginia/Maryland/Pennsylvania/Ohio .......................................... 1,138,000 69,000 6.06 Virginia .......................................................................... 1,152,000 70,000 6.08 Washington/Oregon/Idaho ........................................................... 1,380,000 102,000 7.39 Oregon/California ................................................................. 1,038,000 71,000 6.84 Maine/New Hampshire/Vermont ....................................................... 1,688,000 103,000 6.10 Florida/Georgia ................................................................... 1,539,000 115,000 7.47 Oklahoma/Missouri/Kansas .......................................................... 1,420,000 111,000 7.82 Texas/Oklahoma .................................................................... 695,000 46,000 6.62 Eastern Tennessee/Western North Carolina .......................................... 1,279,000 117,000 9.15 Southwestern Texas ................................................................ 1,254,000 56,000 4.47 Other Operations .................................................................. 140,000 17,000 12.14 ------------- ----------- ----- 24,034,000 1,710,000 7.11% ------------- ----------- ----- ------------- ----------- -----
The following table summarizes certain information about customers and market penetration in U.S. Cellular's managed operations.
YEAR ENDED OR AT DECEMBER 31, -------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Majority-owned and managed markets: Cellular markets in operation (1)........................ 134 131 137 130 116 Total population of markets in service (000s)............ 24,034 21,712 22,309 21,314 19,383 Customer Units: at beginning of period (2)............................. 1,073,000 710,000 421,000 261,000 150,800 additions during period (2)............................ 941,000 561,000 426,000 250,000 165,300 disconnects during period (2).......................... 304,000 198,000 137,000 90,000 55,100 at end of period (2)................................... 1,710,000 1,073,000 710,000 421,000 261,000 Market penetration at end of period (3).................. 7.11% 4.94% 3.18% 1.98% 1.35% Consolidated revenues (4).................................. $ 876,965 $ 680,068 $ 480,316 $ 327,630 $ 210,344 Depreciation expense....................................... 97,591 74,631 57,302 39,520 25,665 Amortization expense....................................... 34,788 34,208 32,156 25,934 19,362 Operating income (loss).................................... 129,543 87,366 42,755 17,385 (8,656) Capital expenditures....................................... 318,748 248,123 210,878 167,164 92,915 Identifiable assets........................................ $ 2,548,909 $2,116,592 $1,890,621 $1,584,142 $1,275,569
I-9 - ------------ (1) Represents the number of markets in which U.S. Cellular owned at least a 50% interest and which it managed. The revenues and expenses of these cellular markets are included in U.S. Cellular's consolidated revenues and expenses. (2) Represents the approximate number of revenue-generating cellular telephones served by the cellular markets referred to in footnote (1). The revenue generated by such cellular telephones is included in consolidated revenues. (3) Computed by dividing the number of customer units at the end of the period by the total population of markets in service as estimated by Donnelley Marketing Service for the respective years (Claritas in 1997). (4) Consolidated revenues for 1997 reflect U.S. Cellular's change in financial reporting presentation of certain credits given to customers on their monthly bills. 1993-1996 consolidated revenues have been reclassified to conform to 1997 presentation. 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. U.S. Cellular has 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 U.S. Cellular. The construction, operation and transfer of cellular systems in the United States are regulated to varying degrees by the FCC pursuant to the Communications Act of 1934 (the "Communications Act"). In 1996, Congress enacted the Telecommunications Act of 1996 (the "1996 Act"), which amended the Communications Act. The 1996 Act mandates significant changes in existing telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops 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 I-10 non-wireline entity, but no entity which controls a cellular system may own an interest in another cellular system in the same MSA or RSA. The completion of acquisitions involving the transfer of control of a cellular system requires prior FCC approval. Acquisitions of minority interests generally do not require FCC approval. Whenever FCC approval is required, any interested party may file a petition to dismiss or deny the application for approval of the proposed transfer. The FCC must be notified each time an additional cell is constructed which enlarges the service area of a given market. The FCC's rules also generally require persons or entities holding cellular construction permits or licenses to coordinate their proposed frequency usage with neighboring cellular licensees in order to avoid electrical interference between adjacent systems. The height and power of base stations in the cellular system are regulated by FCC rules, as are the types of signals emitted by these stations. In addition to regulation by the FCC, cellular systems are subject to certain Federal Aviation Administration ("FAA") regulations with respect to the siting and construction of cellular transmitter towers and antennas as well as local zoning requirements. Beginning in 1996, the FCC has also imposed a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. 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. Beginning in October 1997, cellular systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements (cellular towers of less than 10 meters in height, building mounted antennas and cellular telephones). After October 1997, all new cellular facilities must be in compliance when they are brought into service. Existing facilities must be brought into compliance with the requirements when their licenses are renewed. U.S. Cellular believes that the great majority of its existing facilities already comply with the requirements, the remainder will be brought into compliance as required and that the cellular telephones it sells comply with the standards. Initial cellular telephone licenses were granted for ten-year periods. The FCC has established standards for conducting comparative renewal proceedings between a cellular licensee seeking renewal of its license and challengers filing competing applications. The FCC has: (i) established criteria for comparing the renewal applicant to challengers, including the standards under which a renewal expectancy will be granted to the applicant seeking license renewal; (ii) established basic qualifications standards for challengers; and (iii) provided procedures for preventing possible abuses in the comparative renewal process. The FCC has concluded that it will award a renewal expectancy if the licensee has (i) provided "substantial" performance, which is defined as "sound, favorable and substantially above a level of mediocre service just minimally justifying renewal," and (ii) complied with FCC rules, policies and the Communications Act. If a renewal expectancy is awarded to an existing licensee, its license is renewed and competing applications are not considered. 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. In September 1997, U.S. Cellular filed license renewal applications for its Davenport, Iowa; Tallahassee, Florida; Asheville, North Carolina; Manchester, New Hampshire; Columbia, Missouri; Wichita Falls, Texas; Gainesville, Florida; Lewiston, Maine; Joplin, Missouri; Cedar Rapids, Iowa; LaCrosse, Wisconsin; Bangor, Maine; Fort Pierce, Florida; Victoria, Texas; Evansville, Indiana and Owensboro, Kentucky licenses. Those applications were unopposed and are now grantable. On October 30, 1997, U.S. Cellular assigned its Evansville and Owensboro licenses to a subsidiary of BellSouth Cellular Corporation as part of the larger U.S. Cellular-BellSouth transaction. As part of the same transaction, BellSouth assigned its Appleton, Wisconsin; Rockford, Illinois; Green Bay, Wisconsin and Janesville, Wisconsin licenses to U.S. Cellular. Unopposed grantable renewal applications are pending for those licenses as well. U.S. Cellular expects all of those license renewal applications to be granted shortly. U.S. Cellular conducts and plans to conduct its operations in accordance with all relevant FCC rules and regulations and anticipates being able to qualify for a renewal expectancy in its upcoming renewal filings. Accordingly, U.S. Cellular believes that current regulations will have no significant effect on its operations and financial condition. However, changes in the regulation of cellular operators or their activities and of other mobile service providers could have a material adverse effect on U.S. Cellular's operations. The FCC has also provided that five years after the initial licenses are granted, unserved areas within markets previously granted to licensees may be applied for by both wireline and non-wireline entities and by third parties. Accordingly, many unserved area applications have been filed by U.S. Cellular and others. U.S. Cellular's strategy I-11 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 will enable cellular systems to determine the precise location of persons making emergency calls. The new rules will require cellular carriers to work with local public safety officials to process 911 calls, including those made from mobile telephones not registered with the cellular system, will require carriers by April 1998 to be able to identify the cell from which the call has been made, 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 roaming subscribers of broadband PCS providers, among others, even though the subscribers involved have no pre-existing service relationship with that carrier. Under these new policies, broadband PCS providers 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 vacated the FCC's rules. However, the FCC's rules requiring reciprocal and symmetrical compensation remain in effect as applied to the cellular industry. 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 other parts of the 1996 Act. The 1996 Act provides that implementing its legislative objectives will be the task of the FCC, the state public utilities commissions and a Federal-state Joint Board. Much of this implementation is proceeding in numerous, concurrent proceedings with aggressive deadlines. The Company cannot predict the full extent, 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 provisions 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. I-12 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 implemented the mandate of the 1996 Act to create a new universal service support mechanism "to ensure that all Americans have access to telecommunications services." The 1996 Act requires all interstate telecommunications providers, including wireless service providers, to "make an equitable and non-discriminatory contribution," to support the cost of providing universal service, unless their contribution would be de minimis. At present, the provision of landline telephone service in high cost areas is subsidized by access charges and other payments by interexchange carriers to LECs. The obligation to make payments to support universal service has been expanded to include other telecommunications service providers, including cellular carriers. Such payments, which are to be based on a percentage of the total "billed revenue" of carriers for a given previous half year, are to begin being made in the first quarter of 1998. Carriers are free to pass such charges on to their customers. Cellular carriers are also eligible to receive universal service support payments in certain circumstances under the new systems if they provide specified services in "high cost" areas. U.S. Cellular has sought designation as an "eligible telecommunications carrier" qualified to receive universal service support in certain states. 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. 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 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. STATE AND LOCAL REGULATION. U.S. Cellular is also subject to state and local regulation in some instances. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure. In 1993, Congress preempted states from regulating the entry of cellular systems into service and the rates charged by cellular systems to customers. The siting and construction of the cellular facilities, including transmitter towers, antennas and equipment shelters are still subject to state or local zoning and land use regulations. However, in 1996, Congress amended the Communications Act to provide that states could not discriminate against wireless carriers in tower zoning proceedings and had to decide on zoning requests with reasonable speed. In addition, states may still regulate other terms and conditions of cellular service. The FCC is 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. The FCC is required to forbear from applying any statutory or regulatory provision that is not necessary to keep telecommunications rates and terms reasonable or to protect consumers. A state may not apply a statutory or regulatory provision that the FCC decides to forbear from applying. In addition, the FCC must review its telecommunications regulations every two years and change any that are no longer necessary. Further, the FCC is empowered under certain circumstances to preempt state regulatory authorities if a state is obstructing the Communications Act's basic purposes. 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. I-13 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 ESMR systems were implemented in 1993 in Los Angeles and are being constructed in several other cities across the United States. In 1995, an ESMR provider initiated service in Tulsa, Oklahoma, where U.S. Cellular operates a cellular system. 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 many markets across the United States, including a number of 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 complete initial deployment of PCS in portions of all of U.S. Cellular clusters by the end of 1998. 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. I-14 TELEPHONE OPERATIONS OVERVIEW The Company's telephone operations are conducted through TDS Telecom. TDS Telecom provides modern, high-quality telecommunications services to rural and suburban communities. Through its network of ILECs, TDS Telecom served approximately 515,500 access lines as of December 31, 1997 and on this basis is the ninth largest non-Bell local exchange telephone company in the United States. TDS Telecom's ILEC markets are located in 28 states throughout the United States. The table below sets forth, as of December 31, 1997, (i) the eight largest states of operations of TDS Telecom based on the number of access lines and (ii) the total number of access lines operated by all of the telephone subsidiaries of TDS Telecom.
NUMBER OF ACCESS LINES STATE AT DECEMBER 31, 1997 % OF TOTAL - ---------------------------------------------------------------------------------------- ------------------------ ----------- Tennessee............................................................................... 87,910 17.1% Wisconsin............................................................................... 86,262 16.7 Georgia................................................................................. 37,729 7.3 Minnesota............................................................................... 30,054 5.8 Indiana................................................................................. 26,977 5.2 Alabama................................................................................. 25,535 5.0 Michigan................................................................................ 23,786 4.6 Maine................................................................................... 23,055 4.5 -------- ----- Total for 8 Largest States.......................................................... 341,308 66.2 -------- ----- Other States............................................................................ 174,170 33.8 -------- ----- Total............................................................................. 515,478 100.0% -------- ----- -------- -----
TDS Telecom recently began providing telecommunications services as a competitive local exchange carrier ("CLEC") in Madison, Wisconsin and is developing CLEC operations in selected additional markets in Wisconsin and Minnesota. TDS Telecom is also pursuing emerging markets such as data and Internet services. TDS Telecom is a wholly owned business unit of TDS, founded in 1968. TDS Telecom's corporate headquarters are located in Madison, Wisconsin. TELECOMMUNICATIONS SERVICES MARKET The market for local telecommunications services has historically consisted of firms offering traditional landline telephone service along with complementary services and equipment in a highly regulated environment. TDS Telecom's ILEC business has traditionally focused primarily on providing service to rural and suburban areas. TDS Telecom's ILEC markets are geographically dispersed throughout the United States with a significant concentration in the Upper Midwest and the Southeast. The ILEC business of TDS Telecom is being changed by telecommunications reform legislation, the growth of the Internet and rapid advances in technology. With the passage of the 1996 Act, competition in the local telecommunications marketplace is increasing because of the removal of certain state and local entry barriers and the introduction of ILEC facility interconnection requirements. These changes will create challenges for TDS Telecom in its existing ILEC business but will also create growth opportunities for TDS Telecom in connection with its entry into CLEC markets. BUSINESS STRATEGY TDS Telecom has historically produced revenue growth in its ILEC markets by providing its customers with state-of-the-art telecommunications solutions, maintaining a high quality of on-going service and selectively acquiring landline telephone companies. Management believes that TDS Telecom has a number of advantages as an ILEC, including (i) a modern network substantially upgraded to provide a variety of Advanced Calling Services, (ii) a strong local presence and established brand name, (iii) economies of scale not available to smaller independent operators, (iv) attractive, growing markets and (v) a favorable regulatory environment which is likely to be less competitive than urban markets. TDS Telecom intends to: (i) grow and protect TDS Telecom's core local exchange business, (ii) provide service to targeted CLEC markets by leveraging its technical and managerial expertise and I-15 telecommunications infrastructure from its ILEC's existing operations, (iii) pursue emerging markets, such as data and Internet services, to become a leading provider of electronically deliverable products and services in all of its markets and (iv) enhance profitability through improved operating efficiencies. GROW CORE ILEC BUSINESS Management of TDS Telecom believes that the key to growing and protecting its existing ILEC markets is to continue to build customer loyalty by providing superior customer service, offering a full range of standardized products and services not typically available in rural markets and rapidly developing new data products and services. Management of TDS Telecom maintains a local presence in each of its ILEC markets in order to provide superior customer service. With respect to products and services, TDS Telecom offered Advanced Calling Services to 78% of its customers at December 31, 1997. TDS Telecom increasingly markets itself to consumers as a single telecommunications provider offering bundled packages of advanced telecommunications services including local, long distance, Internet and data services. These service packages will further build brand equity in the TDS Telecom name. In addition, management of TDS Telecom believes it can achieve cost economies through selective acquisitions designed to increase the geographic clustering of TDS Telecom's ILEC markets. LEVERAGE ILEC STRENGTHS INTO CLEC MARKETS TDS Telecom is providing CLEC services in certain targeted third-tier cities which are geographically proximate to existing TDS Telecom facilities and service areas. Management of TDS Telecom believes that service levels have deteriorated in certain markets due to a lack of focus by the ILECs thereby creating an opportunity for TDS Telecom to compete effectively in those markets. In addition, management of TDS Telecom believes that the smaller size of these markets may discourage competition from additional CLECs. Through February 28, 1998, TDS Telecom had invested $13 million to install a digital switch and to construct 54 miles of fiber optic cable in and around Madison, Wisconsin. TDS Telecom initiated service as a CLEC in Madison in January 1998 and is providing service to approximately 4,000 business access lines. In addition, TDS Telecom commenced operations as a CLEC in secondary markets in Minnesota in January 1998, initially as a reseller, through its regional long-distance reseller, USLink, and is providing service to approximately 3,000 business access lines in those markets. TDS Telecom intends to initiate service in Appleton and Green Bay, Wisconsin in mid-1998. The geographic focus of TDS Telecom's CLEC strategy is designed to leverage TDS Telecom's existing infrastructure to facilitate early entry into new CLEC markets and to complement TDS Telecom's ILEC clustering strategy. TDS Telecom believes that significant synergies exist between its ILEC and CLEC businesses. TDS Telecom is able to utilize existing resources and business processes that currently serve ILEC markets in developing and expanding its CLEC operations, including administrative and financial support, marketing and new product development support, information technology and systems, and shared network systems support. These synergies reduce the overall time to market and cost required for TDS Telecom to expand into its new CLEC markets. PURSUE EMERGING DATA MARKETS Data communications is one of the fastest growing segments of the telecommunications services industry. In light of the growth of the use of the Internet and rapid introduction of new telecommunications technology, TDS Telecom intends to offer a full range of data products to its customers, including Internet access and potentially, ATM, Frame Relay and other products, if appropriate, in all of its markets, thereby positioning itself as a full-service data communications service provider. Most of TDS Telecom's data products are in the early stages of development. TDS Telecom has, however, developed a LAN wiring business and currently provides Internet access service to approximately 40,000 customers. NETWORK INFRASTRUCTURE TDS Telecom plans to provide its operating telephone companies with the most advanced central office switching equipment that is economically feasible in order to offer customers up-to-date services, such as advanced calling services, high-speed data access and Internet access services. TDS Telecom plans to provide its customers bundled service offerings and to become a single source for their telecommunications needs as an Integrated Communications Provider ("ICP"). In furtherance of this objective, in 1997, TDS Telecom continued its program of enhancing and expanding its service providing network. TDS Telecom intends to meet competition by providing its customers with high-quality telecommunications services and building its network to take full advantage of advanced telecommunications technologies such as Signaling System 7, fiber optic fed Digital Serving I-16 Areas, Integrated Services Digital Network and Advanced Calling Services. The following table illustrates that TDS Telecom continues to make these advanced features available to a large majority of its customers:
% EQUIPPED LINES # EQUIPPED LINES 1997 1997 --------------------- ------------------ Signaling System 7................................................ 86% 478,690 Advanced Calling Services......................................... 86% 478,690 Integrated Services Digital Network................................................. 68% 378,570
As TDS Telecom upgrades and expands its network, it is also standardizing equipment and processes to increase efficiency and has centralized the monitoring and management of its network to reduce costs and improve service reliability. Strategic alliances with Lucent Technologies and Siemens Telecom Networks to modernize and standardize TDS Telecom's switching platform with the Lucent 5ESS-2000 and Siemens EWSD switches assisted TDS Telecom in implementing its 24 hour-a-day/7 day-per-week Network Management Center. The Network Management Center continuously monitors the network in an effort to proactively identify and correct network faults prior to any customer impact. By the end of 1998, the Network Management Center is expected to be proactively monitoring 100% of TDS Telecom's network. TDS Telecom's total 1998 capital budget is $140 million compared to actual capital expenditures of $151.5 million in 1997 and $144.4 million in 1996. Financing for the 1998 capital additions will be primarily provided by internally generated funds and supplemented by federal long-term financing. ILEC TELEPHONE MARKETS TDS Telecom's goal is to be a leading provider of electronically deliverable products in its ILEC markets. According to published sources, TDS Telecom is currently the ninth largest non-Bell local exchange telephone company in the United States, based on the number of telephone access lines served. At December 31, 1997, the telephone subsidiaries of TDS Telecom served approximately 515,500 access lines in 28 states. TDS Telecom currently operates over 378 central office and remote switching centers in its telephone operating areas. Substantially all of TDS Telecom's access lines are served by digital switching technology, which, in conjunction with other technologies, allows TDS Telecom to offer additional premium services to its customers, including call forwarding, conference calling, caller identification, selective call ringing and call waiting. As one of the major independent telephone companies in the United States, TDS Telecom's ILECs provide both local telephone service and access to the long distance network for customers in their respective service areas. The ILECs also provide directory advertising through a contract with another company and billing and collection services to inter-exchange carriers ("IXCs"). TDS Telecom provides centralized administrative and support services to field operations from its corporate offices in Madison, Wisconsin. The following table summarizes certain information regarding TDS Telecom's telephone operations:
AT OR FOR THE YEAR ENDED DECEMBER 31, --------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------- ------------- ------------- ----------- ----------- (DOLLARS IN THOUSANDS) Telephone Operations Access lines(1)....................................... 515,500 484,500 425,900 392,500 356,200 % Residential......................................... 78.3% 79.9% 80.6% 81.3% 82.0% % Business (nonresidential)........................... 21.7% 20.1% 19.4% 18.7% 18.0% Total Revenues........................................ $ 444,203 $ 395,602 $ 354,841 $ 306,341 $ 268,122 % Local service....................................... 27.7% 27.9% 26.8% 26.8% 26.9% % Network access and long-distance.................... 53.1% 53.9% 55.1% 56.9% 59.3% % Miscellaneous and other............................. 19.2% 18.2% 18.1% 16.3% 13.8% Depreciation and amortization expense................. $ 98,066 $ 88,459 $ 77,354 $ 68,878 $ 59,562 Operating income...................................... 98,613 102,708 98,240 91,606 78,585 Construction expenditures............................. 151,460 144,440 104,372 115,483 80,818 Total identifiable assets............................. $ 1,221,463 $ 1,181,084 $ 1,058,241 $ 984,563 $ 829,489
- --------- (1) An "access line" is a single or multi-party circuit between the customer's establishment and the central switching office. I-17 RETAIL MARKETS TDS Telecom's existing ILEC business consists of two major customer focused organizations addressing the retail and wholesale marketplace for its services. The Retail Markets Group focuses on TDS Telecom's retail customers and is comprised of TDS Telecom's 106 operating companies. The Retail Markets Group serves a mix of rural and suburban customers, with a significant geographic concentration in the Upper Midwest and Southeast. Approximately 78% of TDS Telecom's retail customers are residential and approximately 22% are businesses, most of which are of the small business or small office/home office segments. The Retail Markets Group has identified three primary goals to grow and protect its existing ILEC business: (i) build customer loyalty, (ii) develop revenue growth, and (iii) implement cost control. Management of TDS Telecom believes it can achieve these goals by offering bundled services to its customers, by building brand equity in the TDS Telecom brand name, and by providing superior customer service to its retail customers. In addition, TDS Telecom will continue to standardize operations, improve cost controls and selectively invest in network facilities in order to enhance efficiency and reduce costs. BUNDLED SERVICE OFFERINGS. Management of TDS Telecom believes that its consumer and business customers have a strong preference to purchase all of their telecommunications services from a single provider. TDS Telecom believes that by offering a full complement of telecommunications services and bundling those services in customer-friendly packages it can build customer loyalty and reduce customer churn. Implementing a full-service strategy requires TDS Telecom to combine the services of its network with the products and services of carefully selected strategic partners. TDS Telecom plans to pursue such relationships to develop the long distance, video, and wireless components of its product mix. BRAND EQUITY. In 1996, TDS Telecom adopted the TDS Telecom name as a unified brand name across its ILEC markets to build its brand image. Prior to 1996, the local identity of each operating company enjoyed a higher profile than TDS Telecom. TDS Telecom has subsequently implemented a customer awareness campaign to build brand awareness of the TDS Telecom name. For example, all bills now contain the TDS Telecom name and all customer checks are made payable to TDS Telecom. The change in branding has been reinforced by a comprehensive media campaign that includes television, radio, newspaper, bill inserts and direct mail advertising. Management of TDS Telecom believes that branding will increase the loyalty of its customers and also reduce expenses through more cost effective marketing. CUSTOMER SERVICE. TDS Telecom maintains a local business office in each of its ILEC markets to ensure high levels of customer service. Management believes that its community-based business offices offering full-service, face-to-face customer service are a fundamental competitive advantage for TDS Telecom. To further TDS Telecom's goal of enhancing service to its customers, TDS Telecom is implementing a VBO initiative. The VBO builds on TDS Telecom's current community oriented customer service by linking business offices through technology, standardizing processes, expanding hours of operations, and providing management information on operations and service quality. VBO technology will be deployed across TDS Telecom's business offices to enable multiple local business offices to perform customer sales and service functions as if they were one "virtual" office in the eyes of the customer. Unlike traditional call centers where service representatives and technology are centrally located, the VBO environment distributes call center technology to the individual business offices enabling customer service representatives to remain in their local communities. WHOLESALE MARKETS The Wholesale Markets Group focuses on TDS Telecom's wholesale customers and has traditionally provided a majority of TDS Telecom's revenues. TDS Telecom receives much of its ILEC revenue from the sale of traditional wholesale services, such as access charges and billing and collections services. As a result, TDS Telecom continues to provide a high level of service to traditional wholesale customers such as AT&T, MCI, Sprint and the RBOCs. TDS Telecom intends to grow its wholesale business by pursuing opportunities created by the 1996 Act. TDS Telecom plans to expand into new wholesale groups by targeting two groups of customers. First, TDS Telecom will provide new entrants to markets, such as CLECs and PCS carriers, with access to the public network, as well as dedicated services. Second, TDS Telecom will supply existing businesses such as cable television providers, electric utilities and long distance resellers with network services needed to complement their existing assets. TDS Telecom also intends to pursue other wholesale opportunities, such as network management and Internet access, as demand for those services increases. I-18 The primary source of TDS Telecom's wholesale business revenues are access revenues. TDS Telecom's operating telephone subsidiaries receive access revenue as compensation for carrying interstate and intrastate long-distance traffic on its network. The interstate and intrastate access rates charged include the cost of providing service plus a fair rate of return on the capital allocated to such services. Access revenues account for approximately 57% of the revenue generated by TDS Telecom's ILEC subsidiaries. TDS Telecom's ILECs participate in the National Exchange Carrier Association ("NECA") interstate common line and traffic sensitive tariffs for all but one portion of one ILEC's interstate access. 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 access rates and other matters relating to interstate telephone service. On May 16, 1997, the FCC released an order on access reform. This order applies primarily to price cap local exchange carriers ("LECs"). However, non-price cap companies, such as TDS Telecom, were also affected in certain areas by this order. The FCC is expected to release an order on access charge reform for non-price cap companies in mid-1998. Depending on the outcome of the order for non-price cap companies, the source and nature of the operating companies' recovery of costs from interstate services will be affected. The 1996 Act provides for reciprocal compensation for parties to 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 pay access charges to wireless carriers to terminate calls from LEC customers. Since this order raises interconnection costs, the operating companies may adjust their charges to recover such increased costs. On October 7, 1997, the FCC released a Notice of Proposed Rulemaking ("NPRM") on jurisdictional separations reform. In the NPRM, the FCC reviews the current procedures for separating LECs' service costs between the state and federal jurisdictions. Many of the proposals in the NPRM seek to limit costs assigned to the interstate jurisdiction and seek to assign greater costs to the intrastate jurisdiction. To the extent that the costs are not made up in the new federal and state universal service mechanisms, the Telecom Group may seek rate increases in local service rates to offset any reductions in interstate revenues. Where applicable and subject to state regulatory approval, TDS Telecom's ILEC subsidiaries utilize intrastate access tariffs and participate in intrastate revenue pools. However, many intrastate toll revenue pooling arrangements, historically 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 has accelerated 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. Some states are utilizing a state high cost fund to offset access charge reductions. Given the many regulatory issues still unresolved, TDS Telecom cannot predict the cumulative nature or extent of impacts from federal and state regulatory reform. TELEPHONE ACQUISITIONS TDS and TDS Telecom continually review attractive opportunities to acquire operating telephone companies. Since January 1, 1993, TDS has acquired 17 telephone companies serving a total of 89,600 access lines for an aggregate consideration totaling $188.0 million, all of which were attributed to TDS Telecom. During the past five years, TDS acquired one telephone company in 1997 serving 3,200 access lines, five telephone companies in 1996 serving an aggregate of 33,100 access lines, four telephone companies in 1995 serving an aggregate of 13,500 access lines, three telephone companies in 1994 serving an aggregate of 19,700 access lines and four telephone companies in 1993 serving an aggregate of 20,100 access lines. Recently, TDS Telecom has modified its acquisition strategy to focus on geographic clustering of telephone companies to achieve cost economies and to complement TDS Telecom's growth strategy. It is TDS Telecom's policy to preserve, in so far as possible, the local management of each telephone company it acquires. TDS Telecom provides the telephone companies with centralized purchasing and general management and other services, at cost plus a reasonable rate of return on invested capital. These services afford the subsidiaries expertise in finance; accounting and treasury services; marketing; customer service; traffic; network management; engineering and construction; customer billing; rate administration; credit and collection; and the development of administrative and procedural practices. I-19 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"), each of which is an agency of the United States of America. The RUS has made primarily 35-year loans to telephone companies since 1949, at interest rates of 2% and 5%, for the purpose of improving telephone service in rural areas. Currently, the RUS is authorized to issue hardship loans at a 5% interest 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 (6.54% for its fiscal year ended September 30, 1997), 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 (6.01% for a 35-year note at December 31, 1997). Substantially all of TDS Telecom's telephone plant is pledged under, or is otherwise subject to, mortgages securing obligations of the operating telephone companies to the RUS, RTB and FFB. The amount of dividends on common stock that may be paid by the operating telephone companies is limited by certain financial requirements set forth in the mortgages. Effective October 6, 1997, the RUS revised its regulations on the amount of allowable distributions a borrower can make in any calendar year. For those companies with greater than 40% net worth to total assets, the entire amount above 40% net worth to total assets can be distributed. The majority of TDS Telecom's telephone subsidiaries exceed this percentage. At December 31, 1997, TDS Telecom's operating telephone companies had unadvanced loan commitments under the RUS, RTB and FFB loan programs aggregating approximately $112.0 million, at a weighted average annual interest rate of 5.71%, to finance specific construction activities in 1998 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 government loan programs will continue to be available or that these applications will be accepted or what the terms or interest rates of any future loan commitments will be. FEDERAL AND STATE SUPPORT MECHANISMS To promote universal service, the FCC developed a number of federal support mechanisms to keep telephone rates affordable for both high-cost rural areas and low-income customers. Many of TDS Telecom's ILEC subsidiaries provide telephone service in rural areas and all of them offer service to low-income customers. The 1996 Act codified universal service goals and support; set forth clear principles for ensuring affordable access to modern telephone service nationwide; established discounts for schools, libraries and rural health care facilities; and established a federal-state joint board to make recommendations to the FCC regarding implementation of the universal service provisions of the 1996 Act. On May 8, 1997, the FCC released an order on universal service, adopting many of the joint board's recommendations. The FCC adopted the use of forward-looking proxy cost models to determine costs rather than relying on actual costs. However, rural ILECs will continue to receive support based on their actual costs through December 31, 2000. After December 31, 2000, rural ILECs will transition to the use of proxy cost models over an additional three-year period. To date, management of TDS Telecom believes that no proxy cost models have proven to provide sufficient and predictable revenue support for the provision of universal service by rural ILECs. The FCC has not adopted any proxy cost model for rural ILECs. Both petitions for review and judicial appeals of portions of the FCC's universal service rules and policies remain pending, and Congress legislated a requirement for the FCC to report on its implementation of universal service in its appropriations legislation. The FCC's order also mandated that all telecommunications providers contribute to the universal service fund beginning January 1, 1998. However, the order allows ILECs to recover these contributions through their interstate access rates. The final rules to implement the universal service provisions of the 1996 Act will involve development of new support mechanisms and changes in the eligibility criteria. In addition, some of TDS Telecom's ILEC subsidiaries operate in states where support and rate structures are either being re-evaluated or have already been changed. Full recovery of universal service costs in the future through interstate and intrastate mechanisms is uncertain. If interstate or intrastate support decreases, TDS Telecom's ILEC subsidiaries may pursue local service rate increases to recover the difference. I-20 Historically, telephone company acquisition and investment decisions assumed the ability to recover the cost and a reasonable rate of return through local service, access and support revenues. Significant changes in the universal service funding system could affect TDS's and TDS Telecom's acquisition and investment strategy. CLEC TELEPHONE MARKETS The 1996 Act facilitates entry of TDS Telecom into new markets by requiring non-exempted ILECs (e.g., RBOCs, GTE and other-ILECs, based on state regulators' determinations) to provide reasonable and non-discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. TDS Telecom, through TDS METROCOM, a wholly-owned subsidiary of TDS Telecom, has targeted certain third-tier cities, geographically proximate to existing TDS Telecom facilities and service areas, for facilities-based entry as a CLEC. Management of TDS Telecom believes that the size of the target markets will sustain one or two facilities-based competitors in addition to the ILEC. While additional competitors may enter such markets as resellers, TDS Telecom believes facility-based CLECs will have a long-run cost advantage, establish a barrier to entry and enable an alternative wholesale strategy for growth. To this end, TDS Telecom plans to build fiber-ring, switching and other network facilities in its targeted CLEC markets. TDS Telecom plans to follow a "clustering" approach to building its CLECs which will allow it to seek regional long distance traffic, share service and repair resources, and realize marketing efficiencies. As in its ILEC markets, TDS Telecom intends to become an ICP in its CLEC markets. TDS Telecom will provide local, long-distance, Internet access and other services through its own facilities and via resale. TDS Telecom also intends to resell mobile services in many markets. TDS Telecom's first CLEC in Madison, Wisconsin became operational in January 1998. The Madison CLEC is a facilities-based, full-service alternative to Madison's existing ILECs, Ameritech and Mid-Plains Telephone Companies, providing both voice and data services to commercial and consumer accounts, as well as wholesale services to IXCs and other carriers. While TDS Telecom is beginning its CLEC venture in its Madison and Minnesota markets, it plans to expand operations to Appleton and Green Bay, Wisconsin. As of December 31, 1997, TDS Telecom has invested $12 million in constructing its facilities in the Madison market and plans to invest $18 million during 1998. The CLEC strategy will place primary emphasis on small and medium-sized commercial and wholesale customers such as IXCs, Internet Service Providers ("ISPs") and cellular, paging and PCS companies. TDS Telecom expects to pursue consumer markets approximately six months after the CLEC enters the commercial market. Wholesale customers purchase transmission capacity and access services from CLECs. These services will be available to wholesale customers shortly after network completion. TDS Telecom believes that these customers are generally more sophisticated and are more likely to switch providers to obtain network reliability, redundancy and more flexible pricing. Medium-sized commercial prospects are characterized by above-average access line-to-employee ratios, heavier utilization of data services, and a focus on using telecommunications for business improvement rather than by concerns for cost reduction. These companies are generally growth-oriented and may be underserved by the ILEC or major IXCs. TDS Telecom will pursue a personal selling approach for its primary target markets. This approach builds on customer preference for integrated communication services and the customer's perception that the quality of the product is in the personalized service. While the CLEC is positioning itself as a high-quality provider, it expects price competition from the ILECs as they attempt to retain and regain their customers. The CLEC will seek to maintain an efficient cost structure to ensure it can match price-based initiatives from competitors. TDS Telecom expects to be more flexible in responding to customer needs than its ILEC competitors. To effectively compete in this new environment, TDS Telecom will enhance its efforts at product development to provide high-quality, cutting-edge services to its customers. DATA INITIATIVES In 1997, TDS Telecom continued to expand its investments into data communications in order to offer a full suite of data products in its CLEC and many of its ILEC markets. TDS Telecom believes the targeted third-tier markets present a significant opportunity to market data services as the major carriers serving these locations have typically underinvested in these markets despite the growing demand. Switched data communications represent one of the fastest growing segments of the telecommunications services market. Computer proliferation, connectivity via local and wide area networks, the Internet and the emergence of multimedia applications are all driving demand. As a result, the domestic network infrastructure is strained at both the local and national levels. TDS Telecom's CLEC initiative will add local capacity in its selected cities designed to capture this growth. I-21 TDS Telecom has developed a LAN wiring business as part of its data services business. The LAN wiring business provides in-building wiring services to its customers. TDS Telecom assists its customers in designing and constructing specialized wiring networks for their business needs. Customers of the LAN wiring business include traditional in-market business customers of TDS Telecom and also non-traditional business customers located in ILEC markets not currently served by TDS Telecom. At December 31, 1997, TDS DATACOM, TDS Telecom's LAN wiring entity, operated in 14 markets and generated approximately $6.6 million in revenue for the year then ended. In furtherance of TDS Telecom's strategy to position itself as a full-service, networking service provider, it plans to make high-speed Digital Subscriber Loop ("xDSL") based services available to customers in many of its ILEC markets. TDS Telecom believes xDSL technology will form the foundation for new, high-speed data services and applications and is currently conducting trials of xDSL modems manufactured by several vendors. This technology will be employed to offer high-speed Internet access as well as high-speed LAN connectivity. In addition, TDS Telecom plans to develop Frame Relay and ATM services in select markets. TDSNET, TDS Telecom's ISP, is expanding its existing business offerings to include web hosting services and customized web content development. TDSNET expanded its operation in 1997 by adding an additional 13 operating markets to bring its total operating markets to 49. It served approximately 30,000 customers and generated approximately $4 million in revenue for the year then ended. SALES AND MARKETING TDS Telecom seeks to leverage its networks through sales and marketing activities targeted at two separate customer groups: retail and wholesale. Retail customers are composed primarily of residential customers, businesses, government and institutional telecommunications users. Wholesale customers consist of IXCs and information service providers such as commercial data processing service providers and ISPs. RETAIL MARKETS COMMERCIAL MARKETS. Businesses account for approximately 22% of TDS Telecom's access lines. TDS Telecom focuses its business customer marketing on information-intensive industries such as financial services, health services, realty, hotels and motels, education and government. TDS Telecom uses its direct sales force, targeted mailings, and telemarketing to sell products and services to the commercial markets, which are segmented into tiers based on size and strategic importance. Different sales and distribution channels are employed for each segment. Specific account executives focus on the most profitable commercial customers by staying in contact with them on a regular basis. In 1996, TDS Telecom adopted a more aggressive compensation plan for its account executives targeted at revenue and customer satisfaction results. CONSUMER MARKETS. TDS Telecom's promotional and sales strategy with respect to its residential customers consists of two major initiatives: building brand equity by creating awareness of the TDS Telecom brand name; and using direct marketing to sell specific products and product groupings. Approximately 78% of TDS Telecom's total access lines are residential. The nature of TDS Telecom's residential markets has historically made direct marketing more effective than mass media such as radio and television. In addressing its consumer markets, TDS Telecom has made extensive and aggressive use of direct mail. TDS Telecom has been more selective in the use of telemarketing as a means of generating awareness, qualified leads, and sales. Increasingly, uniform branding has made the use of mass media more attractive, and TDS Telecom is beginning to increasingly incorporate these elements into its marketing program. In nearly all of its markets, TDS Telecom offers a complete family of custom calling services, including call waiting, call forwarding, three-way calling, and speed dialing. In 1997, TDS Telecom sold 27,700 residential second lines, an increase of 46% over 1996. The Telecom Group recently launched its Advanced Calling Services family, which is centered around Caller ID service. In 1997, the Advanced Calling Services family of services were available to 78% of the lines in service compared to 66% in 1996. In 1997, penetration of Caller ID increased from 13% in 1996 to 16% of lines equipped and aggregate penetration of ACS increased from 25% in 1996 to 30% of lines equipped. WHOLESALE MARKETS Access charges, billing and collection services and other traditional wholesale offerings generated $253 million, or approximately 61 percent, of TDS Telecom's ILEC subsidiaries revenue for the year ended December 31, 1997. TDS Telecom seeks to establish close working relationships with the IXCs. TDS Telecom is working to establish systems to support "electronic bonding" of its operations with those of the IXCs. Electronic bonding provides seamless integration of TDS Telecom's and the IXCs' networks, enabling the IXCs to access service, billing I-22 and other data directly from TDS Telecom's network. It will also permit the IXCs to enter access service requests electronically using the integrated network. The initial phase of establishing these systems has taken place with the establishment of a dedicated customer service team to provide a single point of contact for the IXCs. During 1998 and beyond, automated systems solutions will be implemented to fully support electronic bonding. TDS Telecom sees significant potential in leveraging its infrastructure to provide new wholesale offerings to non-traditional customers. TDS Telecom has targeted high growth industry sectors such as CLECs, independent telephone companies, cable television companies, electric utilities and other telecommunications service providers for purchase of its wholesale offerings. Additionally, existing cellular wireless carriers are expanding their services in and near TDS Telecom's territories and new PCS wireless carriers are, or soon will be, offering service. COMPETITION ILEC MARKETS The 1996 Act was intended to promote competition in the telecommunications industry as a national policy and continue the process of deregulation. The 1996 Act requires ILECs to provide reasonable and non-discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. The 1996 Act also allows CLECs to co-locate network equipment on the ILEC's premises and prevents ILECs and CLECs from unduly restricting each other from use of facilities or information that would allow other organizations to effectively compete with them. All 106 telephone company subsidiaries of TDS Telecom are currently exempt from many of the interconnection provisions of the 1996 Act. According to the 1996 Act, a rural telephone company (which currently includes all 106 TDS Telecom ILECs) is exempt from the ILEC interconnection requirements until (i) such company has received a bona fide request for interconnection, resale of services, or network elements, and (ii) the state commission determines that such request is not unduly economically burdensome, is technically feasible, and is consistent with the universal service provisions of the 1996 Act. The party making a bona fide request must submit a notice of its request to the appropriate state commission which must then conduct an inquiry to determine whether to terminate the exemption. Within 120 days after a state commission receives notice of the request, it must determine if it will terminate the exemption. Upon termination of the exemption, the state commission must establish an implementation schedule for compliance with the request. Accordingly, the length of TDS Telecom's rural exemptions will vary based on the decisions of the various state commissions. Some TDS Telecom ILECs have already had requests filed by potential competitors seeking to terminate their exemptions and TDS Telecom believes there will eventually be open entry into nearly every aspect of the telephone industry, including local service, and, switched and special access services. TDS Telecom expects competition in the local telephone and access services businesses to be increased substantially as a result of the entrance of new competitors and the development of new technologies, products and services. Increased competition is expected from competitive access providers, IXCs, out-of-territory RBOCs and independent telephone companies, niche entrepreneurs, cable and utility companies, and wireless and satellite providers. To meet this increasing competition, TDS Telecom's strategy is to build customer loyalty by providing superior customer service, offering a full range of standardized products and services bundled in response to customer preferences and to rapidly develop new data products and services. TDS Telecom believes that the wireless companies pose the most significant threat in the long run to the local exchange industry. Although traditional analog cellular radio service cannot match the features or the clarity of communications provided via wireline networks, and as a result of high error rates and speed limitations is not currently suitable for data transmission, advances in digital PCS technology may permit wireless companies to eventually match the functionality and clarity of wireline communication and still allow customers the mobility of traditional wireless service. As the emerging PCS companies compete directly with established cellular radio companies, flat rate pricing alternatives may drive wireless rates towards or below wireline rates. In order to minimize the impact of wireless competition, TDS Telecom is pursuing wholesale service agreements with wireless companies to provide services to them and expects to provide wireless services through resale in many of its markets. CLEC MARKETS In Madison and in each city in which TDS Telecom expands as a CLEC, TDS Telecom faces, and expects to continue to face, significant competition from the ILECs which currently dominate their local telecommunications markets. TDS Telecom will compete with the ILECs on the basis of price, reliability, state-of-the-art technology, I-23 product offerings, route diversity, ease of ordering and customer service. However, the ILECs have long-standing relationships with their customers, have the potential to subsidize competitive services from monopoly service revenues, and benefit from favorable state and federal regulations. TDS Telecom expects its CLECs to provide a full range of local telecommunications services in order to compete effectively with the ILECs. Although the ILECs generally are subject to greater pricing and regulatory constraints than CLECs, ILECs are achieving increased pricing flexibility for their services as a result of, among other things, the 1996 Act. Existing competition for private line, special access and local exchange services is based primarily on quality, capacity and reliability of network facilities, customer service, response to customer needs, service features and price, and is not based on any proprietary technology. As a result of the technology used in its networks, TDS Telecom may have cost and service quality advantages over some currently available ILEC networks. In addition, TDS Telecom believes that, in general, it will provide more attention and responsiveness to its customers than its ILEC competitors. TDS Telecom may face competition from other CLECs and other potential competitors in certain of the cities in which TDS Telecom plans to offers its services. Many of TDS Telecom's existing and potential competitors have financial, personnel and other resources significantly greater than those of TDS Telecom. However, TDS Telecom believes that its strategy of targeting third tier cities, its capital, technical and management resources and its orientation toward IXCs and other commercial telecommunications users will enable it to achieve its strategic objectives. CLECs' ability to compete depends in part on federal and state rules covering pricing and terms for ILECs' services provided by unbundled network elements and resale, as well as ILECs' operation support systems. In addition to the ILECs and other CLECs, potential competitors capable of offering private line, special access and local exchange services include long distance carriers, cable television companies, electric utilities, microwave carriers, wireless telephone system operators, and private networks built by large end users. Previous impediments to certain utility companies entering telecommunications markets under the Public Utility Holding Company Act of 1935 were removed by the 1996 Act. REGULATION The intrastate, local and access services of TDS Telecom's ILEC subsidiaries are regulated by state regulatory agencies, and TDS Telecom seeks to maintain positive relationships with these regulators. Rate setting, including local rates, intrastate toll rates and intrastate access charges, are subject to state commission approval. 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, and the FCC must pre-empt challenged state requirements if they impose such barriers to entry, a state retains limited authority to regulate certain competitive practices in rural telephone company service areas. The 1996 Act establishes a general duty for all telecommunications carriers, including wireless providers, to interconnect with other carriers. Congress prescribed a more specific list of interconnection requirements for all LECs including resale, number portability, dialing parity, access to rights-of-way and reciprocal compensation. The FCC has adopted or is considering rules and policies implementing the provisions of the 1996 Act. Unless exempted, or granted suspension or modification, ILECs have additional obligations: (a) to negotiate in good faith terms of interconnection; (b) to comply with more detailed interconnection terms, including non- discrimination and unbundling their network and service components so competitors may use only those elements they choose for providing their services; (c) to offer their retail services at wholesale rates to facilitate resale by their competitors; and (d) to allow other carriers to place equipment necessary for interconnection or access on their premises. Rural telephone companies are exempted from these obligations until they receive a bona fide request for interconnection, resale of services or network elements and the applicable state commission determines that termination of the exemption is not unduly economically burdensome, is technically feasible and is consistent with universal service. I-24 Many of the FCC determinations made to implement the 1996 law and to facilitate competition in local service and other telephone services involve investment and upgrades to TDS Telecom networks. These investments and upgrades include requirements to implement local number portability so subscribers may change to competitors' services without changing their telephone numbers, network signaling information that must be provided to certain other carriers and pay phone providers, and other changes that require additional investments and expenses. TDS Telecom is seeking to comply with these requirements, and is pursuing policies that provide a fair opportunity to recover its costs, but in some cases is asking for waivers or delayed implementation deadlines. A new law also requires LECs to provide certain communications for law enforcement purposes. The full cost and the adequacy of the government compensation are not yet known, but the LEC industry is pursuing regulatory policies that cover any shortfall in available government compensation. As defined in the 1996 Act, all of TDS Telecom's ILEC subsidiaries qualify as rural telephone companies. Therefore, they enjoy an exemption from the ILEC interconnection requirements until they receive a bona fide request for interconnection from, and the state commission lifts the exemption. TDS Telecom has received two requests for interconnection, one of which has been withdrawn, and the other of which is currently pending. 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. A federal appellate decision striking down FCC pricing regulations for interconnection and several rules that limited TDS Telecom telephone companies' ability to obtain regulatory relief from stricter interconnection requirements for incumbent telephone companies has been accepted for review by the U.S. Supreme Court. TDS cannot predict the outcome of this or the numerous other court and FCC proceedings stemming from the 1996 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 resulting from the 1996 Act. TDS Telecom is preparing for competition even though such changes will often require changes in state regulation or state regulatory approvals. For example, TDS Telecom is seeking the necessary pricing flexibility to adjust its rate structures to a more competitive model. TDS Telecom is also participating in state regulatory and legislative processes to urge that any telecommunications reform measures treat rural areas fairly and continue to provide sufficient contributions to high cost rural service areas to keep TDS Telecom ILECs' rates affordable. The ongoing changes in public policy and introduction of competition may negatively affect the earnings of the operating subsidiaries, and TDS Telecom is not able to predict the extent of any such negative impact. While the majority of TDS Telecom's ILEC subsidiaries continue to operate in a rate-of-return environment, a number of state commissions are negotiating, or have agreed to alternative regulation plans with ILECs. Price regulation, the most common form of alternative regulations, focuses on the price of telecommunications services rather than rules based on authorized costs and rates of return. TDS Telecom's ILEC subsidiaries in Alabama, Arkansas, Michigan and Pennsylvania are currently operating in a price-regulated environment, whereby the commissions in those states are no longer reviewing earnings annually. For several years, the RBOCs and some of the nation's larger ILECs have operated under an FCC "price cap" plan, modified in 1997, where earnings can be increased through productivity improvements. For 1998, TDS Telecom's telephone subsidiaries neither elected federal price caps nor an alternative FCC plan, which was designed for smaller LECs. Instead, the operating subsidiaries plan to continue to abide by traditional rate-of-return regulation for interstate purposes, unless those regulatory terms are changed. Since approximately one-third of TDS Telecom's telephone subsidiaries serve high-cost areas, important averaging mechanisms associated with the NECA pooling process would be lost if TDS Telecom elected either of the alternatives to traditional rate-of-return regulation. However, the FCC periodically considers whether to initiate a proceeding to lower the allowed rate-of-return for rate-of-return LECs. The FCC also plans to reform the rules that govern how rate-of-return regulated LECs, on their own or through NECA, charge IXCs for local distribution of their interstate calls. Some of the reforms already adopted for price cap regulated LECs, if expanded to cover the TDS Telecom LECs, could reduce interstate cost recovery, and could prompt the LECs to seek state commission approval of increased local rates. NECA is requesting access charge changes from the FCC which would use a "banded" rate structure to help pool members with lower costs charge more competitive rates. NECA's most recent access charges were approved effective January 1, 1998. I-25 Access to affordable long-distance service in rural areas was achieved because the FCC ordered AT&T to provide nationwide average rates. As a result of increasing competition, the FCC lifted all regulations relating to AT&T's interstate services in 1996. However, the 1996 Act preserves interstate toll rate averaging and endorses a nationwide policy that interstate and intrastate long-distance rates of all long-distance carriers should not be higher in rural areas than in urban areas they serve. The statute is intended to ensure affordable long distance services even in TDS Telecom's most remote exchanges. BROADBAND PCS OPERATIONS The Company's broadband PCS operations are conducted through Aerial Communications, Inc. and subsidiaries. Aerial is a provider of Personal Communications Services in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major Trading Areas (collectively, the "PCS Markets"). The PCS Markets include approximately 27.6 million population equivalents ("POPs"). Aerial has constructed networks for its PCS Markets using Global Systems for Mobile Communications ("GSM") technology. Aerial has commenced service in each of its markets and served 125,000 PCS telephones at December 31, 1997. At December 31, 1997, Aerial had expanded its system coverage to approximately 80% of the six MTAs' total population. THE WIRELESS TELECOMMUNICATIONS INDUSTRY OVERVIEW. Wireless service is currently available using analog or digital technology. Most wireless services currently transmit voice and data signals over analog-based networks by varying the amplitude or frequency of one continuous electronic signal transmitted over a single radio channel. Analog technology currently has several limitations, including inconsistent service quality, lack of privacy, limited capacity and less reliability in transferring data without errors. Aerial has chosen GSM, which utilizes a digital technology, for use in the PCS Markets. Digital systems convert voice or data signals into a stream of digits that is compressed before transmission, enabling a single radio channel to carry multiple simultaneous signal transmissions. This additional capacity, along with improvements in digital protocols, allows digital-based wireless technologies to offer new and enhanced services, such as greater call privacy and more robust data transmission features, such as "mobile office" applications (including facsimile, electronic mail and wireless connections to computer/data networks, including the Internet). While digital technology serves generally to reduce transmission interference relative to analog technology, coding methods in the 8 Kb vocoder cellular digital handsets which have been deployed by several digital wireless operators using TDMA technology cause a perceptible decline in voice quality. This gap in voice quality has proven to be a significant barrier to cellular operators attempting to switch their customers from analog to digital service. Manufacturers have developed enhanced 13 Kb vocoder digital handsets for both PCS and digital cellular networks using GSM or CDMA technology and an 8Kb vocoder using TDMA technology. These new handsets are expected to offer digital voice transmission comparable to wireline quality. PCS spectrum differs from existing cellular and specialized mobile radio ("SMR") spectrum in three basic ways: frequency, spectrum and geographic division. PCS networks will operate in a higher-frequency range (1850-1990 MHz) compared to the cellular and SMR frequency (800-900 MHz). PCS is comprised of 30 or 10 MHz spectrum versus 25 MHz spectrum for cellular networks. As a result of the improved capacity of the infrastructure and large allocation of spectrum in the A, B and C PCS frequency Blocks, PCS will have more capacity for new wireless services such as data and video transmission. Finally, the geographic areas for PCS licenses are divided differently than for cellular licenses. PCS is segmented among 51 MTAs and 493 Basic Trading Areas ("BTAs") as opposed to cellular's 306 Metropolitan Statistical Areas ("MSAs") and 428 Rural Service Areas ("RSAs"). An MTA license generally covers a much larger geographic area than a BTA, MSA or RSA license. OPERATION OF WIRELESS NETWORKS. Wireless service areas are divided into smaller geographic areas called "cells", each of which contains an antenna and a base transceiver station ("BTS") consisting of a low-power transmitter, a receiver and signaling equipment. The cells are typically configured on a grid in a honeycomb-like pattern, although terrain factors (including natural and man-made obstructions) and signal coverage patterns may result in irregularly shaped cells and overlaps or gaps in coverage. The BTS in each cell is connected by microwave, fiber optic cable or telephone wires to a switching office ("mobile switching center" or "MSC"). The MSC controls the operation of the wireless telephone network for its entire service area, performing inter-BTS hand-offs, managing call delivery to handsets, allocating calls among the cells within the network and connecting calls to local landline telephone systems or to long-distance telephone carriers. Wireless service providers have interconnection agreements with various local exchange carriers and interexchange carriers, thereby integrating the wireless telephone network with landline telecommunications systems. Because two-way wireless networks are I-26 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 call may be "handed off" to another BTS that can establish a stronger signal with the handset. If a handset leaves the service area of the wireless service provider, the call is disconnected unless an appropriate technical interface is established to hand off the call to an adjacent service provider's system. Operators of wireless networks frequently agree to provide service to customers from other compatible networks who are temporarily located or traveling through the operator's service area. Such customers are called "roamers." Agreements among network operators allocate revenues received from roamers. With automatic roaming, wireless customers are preregistered in certain networks outside their home service area and receive service automatically while they are roaming. Other roaming features permit calls to a customer to follow the customer into different networks, so that the customer will continue to receive calls in a different network just as if the customer were within his or her service area. Wireless customers generally are charged separately for monthly access, airtime, 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 airtime usage rates, which usually are higher than standard airtime usage rates for their own customers, and additionally may charge daily access fees. Special, discounted rate roaming arrangements, often between neighboring operators who wish to stimulate usage in their respective territories, provide for reduced roaming fees and no daily access fees. TECHNOLOGY With GSM technology, Aerial offers easy-to-use, interactive menu-driven phones, and advanced features such as caller identification and a smart card, as well as more complex features such as text messaging, which allows the GSM handset to function as a two-way messaging device. In the future, Aerial intends to increasingly emphasize services which are expected to increase the size and scope of the wireless market, such as wireless data and information services as well as wireless local loop services. Aerial anticipates that PCS will ultimately offer a competitive alternative to wireline telephone service as PCS networks are constructed and PCS operators form strategic alliances. GSM is not compatible with other PCS or cellular technologies. However, compatibility can be achieved through the use of handsets that support multiple technologies. Aerial expects that compatibility between GSM and the existing analog cellular systems will be achieved with the use of dual-mode handsets. Dual-mode handsets are expected to be available in 1998. Because analog cellular service is available nationwide, Aerial expects that PCS customers will be able to roam into service areas served by analog cellular providers. To date, 17 other North American PCS licensees have implemented or announced their intention to utilize the GSM protocol in the construction of their networks. GSM committed providers in the U.S. have licenses to cover approximately 260 million POPs (representing approximately 98% of the population of the United States) and approximately 25 million POPs in Canada, although their can be no assurance that all the licensees will build-out their licensed territory. GSM systems are currently in commercial operation in over 700 North American cities with more than one million customers. Aerial anticipates that its customers will be able to roam substantially throughout the United States, either on other GSM-based PCS networks or by using dual-mode handsets that can also be used on existing cellular networks. Aerial is a member of the North American GSM Alliance LLC ("GSM Alliance"), an all-digital wireless PCS network of U.S. and Canadian carriers. The GSM Alliance was established to create a national network and develop seamless wireless communications for customers, whether at home, away or abroad. The GSM Alliance's collaborative efforts focus on serving the wireless customer efficiently by addressing the areas of roaming, customer care, national distribution, and data communications. Aerial is also a part of the GSM North America consortium, which is the North American interest group for the GSM MoU Association. Formed in 1995, GSM North America brings together service providers and equipment manufacturers to identify and resolve issues related to making GSM the premier PCS digital technology. I-27 PRODUCTS AND SERVICES Aerial offers coverage in those areas of the PCS Markets where most of the population lives and works. Subsequent construction of its PCS networks will provide urban and suburban coverage which is competitive with that of current cellular operators. Aerial provides roaming capabilities, through agreements with other GSM and cellular operators. Aerial's two primary sources of revenues are similar to those available to other cellular system providers. Service revenue primarily consists of charges for access, airtime and value-added services provided to Aerial's retail customers who use the network operated by Aerial, and charges for long-distance calls made on Aerial's systems. Equipment sales revenue consists of the sale of handsets and related accessories to retailers, independent agents and end user customers. At December 31, 1997, Aerial had 125,000 customers. Service revenues and equipment sales revenues totaled $32.3 million and $23.6 million, respectively, for the year ended December 31, 1997. Aerial provides the following services and features: THE SMART CARD. GSM technology employs a Smart Card which contains a microchip containing detailed information about a customer's service profile. The Smart Card allows Aerial to initiate services or change a customer's service package from a remote location. The Smart Card also allows customers to roam onto other participating GSM-based networks by using their cards in handsets compatible with the local network. FEATURE-RICH HANDSETS. As part of its basic service package, Aerial provides easy-to-use, interactive menu-driven phones that enable customers to utilize the features available in a GSM network. These handsets primarily use words and easy-to-use menus rather than numeric codes to operate handset functions such as call-forwarding, call-waiting and text messaging. SHORT TEXT MESSAGING. GSM technology allows for the capability to send and receive short text messages, similar to two-way radio paging services. This service allows Aerial to offer a quicker and less expensive form of wireless communication when a full conversation is not necessary. ENHANCED SECURITY. Aerial's service provides greater security from eavesdropping and cloning than 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 emphasize the value of Aerial's high-quality, innovative services and are supported by heavily promoting the Aerial brand name. This is supported by a substantial advertising program. Aerial offers its services and products through traditional cellular sales channels as well as through new, lower cost channels. Aerial utilizes traditional sales channels which include mass merchandisers and retail outlets, company retail stores, sales agents and a direct sales force. National distributors include Best Buy, Circuit City, Office Depot, Office Max and Radio Shack in certain markets. Aerial currently also distributes its services and products through over 50 company retail locations (mall stores, strip mall stores and kiosks). Based in part upon the remote activation feature of the GSM Smart Card, Aerial also intends to develop distribution innovations such as simplified retail sales processes and lower-cost channels which include inbound telesales, affinity marketing programs, neighborhood sales and on-line sales. AERIAL'S PCS MARKETS The PCS Markets cover large areas which, in general, have attractive demographic characteristics including growing populations, high population densities, favorable commuting patterns, high median household incomes I-28 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. 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). 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., Southwestern Bell, Bell Atlantic-NYNEX Mobile and Ameritech Cellular. Additionally, Aerial competes with SMR provider Nextel Communications, Inc. in each of its six PCS Markets. Aerial also expects to compete with other communications technologies that now exist, such as paging, enhanced specialized mobile radio ("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 1998, 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 service providers in several markets. Aerial anticipates that market prices for two-way wireless services generally will decline in the future based on increased competition. Aerial will compete to attract and retain customers principally on the basis of services and enhancements, its customer service, the size and location of its service areas and pricing. Aerial's ability to compete successfully will also depend, in part, on its ability to anticipate and respond to various competitive factors affecting the industry, including new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and discount pricing strategies by competitors, which could adversely affect Aerial's operating margins. REGULATION REGULATORY ENVIRONMENT. The FCC regulates the licensing, construction, operation and acquisition of wireless telecommunications systems in the 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. I-29 In addition, the 1996 Act, which amended the Communications Act, mandates significant changes in existing telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops and makes regulation less necessary. The FCC promulgated and continues to promulgate regulations governing construction and operation of wireless 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. On November 9, 1995, in Cincinnati Bell Telephone Co. v. FCC (Case No. 94- 3701/4113), the United States Court of Appeals for the Sixth Circuit granted two petitions for review of an FCC order that had barred certain common ownership of cellular and PCS interests in the same market, and remanded the case to the FCC for further proceedings. Neither of the two petitioners had been barred by cross interests from applying for any of the authorizations the FCC later granted to Aerial. Aerial is watching the FCC proceedings closely. The grants of licenses to Aerial are conditioned upon timely compliance with the FCC's build-out requirements, I.E., coverage of one-third of the population of a PCS market within five years of initial license grant and coverage of two-thirds of that population within ten years. The FCC also imposes a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. Aerial is currently engaged in this registration process. All new towers must be registered at the time of construction. 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. There are certain regulatory proceedings currently pending before the FCC which are of particular importance to the broadband PCS industry. In one proceeding, the FCC has 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. I-30 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. Beginning in October 1997, broadband PCS systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements. After October 1997, all new broadband PCS facilities must be in compliance when they are brought into service. 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 and nature of developments of the 1996 Act, which will depend, in part, upon interrelationships among state and federal regulators. The primary purpose and effect of the 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 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 of state and local regulators. 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 were 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. On July 18, 1997, the Eighth Circuit vacated the FCC's rules prescribing interim rates for reciprocal compensation because it has held that the 1996 Act requires that rate issues are to be decided by the states. It upheld the authority of the FCC to order LECs to interconnect with broadband PCS and other wireless providers and to issue rules relating to certain terms of interconnection between LECs and such providers. The 1996 Act establishes principles and a process for implementing a modified "universal service" policy. This policy seeks nationwide, affordable service and access to advanced telecommunications and information services. It calls for reasonably comparable urban and rural rates and services. The 1996 Act also requires universal service to schools, libraries and rural health facilities at discounted rates. In a series of Orders adopted in 1997, the FCC established universal service support mechanisms which require telecommunications providers, including all wireless carriers, to contribute. Aerial has made the required Universal Service Worksheet filings and expects to make the required periodic payments starting in the first quarter of 1998. 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. I-31 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. COMBINATION OF AMERICAN PAGING AND TSR PAGING American Paging is currently an 82%-owned subsidiary of the Company which offers radio paging and related services. In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. Pursuant to the agreement, TDS made an offer to American Paging to negotiate and enter into a merger agreement pursuant to which TDS would acquire all of the outstanding Common Shares of American Paging held by persons other than TDS (the "Minority Shareholders") for cash in an amount equal to $2.25 per American Paging Common Share. The TDS offer was considered by a special committee of the Board of Directors of American Paging, which consists of two independent directors of American Paging. Following review of the offer by the special committee and negotiations between the special committee and TDS, TDS increased its offer to $2.50 per American Paging Common Share. On February 10, 1998, the special committee approved the revised offer and recommended that the full Board of Directors of American Paging approve the revised offer. As a result, on February 10, 1998, the Board of Directors of each of American Paging and TDS approved a merger agreement providing for the acquisition by TDS (through a wholly-owned subsidiary ("TDS Sub")) of all the issued and outstanding American Paging Common Shares held by the Minority Shareholders for cash in an amount equal to $2.50 per American Paging Common Share. The merger agreement provides that TDS Sub will initially commence a tender offer for each of the American Paging Common Shares held by the Minority Shareholders in exchange for $2.50 in cash. Following the offer, TDS will effect a merger of American Paging and TDS Sub. In such merger, all Minority Shareholders will receive $2.50 in cash for each American Paging Common Share. Following the effectiveness of such merger, American Paging Common Shares will cease to be traded on the American Stock Exchange and American Paging will cease to be a reporting company under the Securities Exchange Act of 1934. Upon consummation of the merger, TDS will cause American Paging to contribute substantially all of its assets and certain, limited liabilities, and TSR would contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company. I-32 WIRELESS MESSAGING INDUSTRY Wireless communications messaging technology uses an assigned radio frequency, licensed by the FCC, to contact a customer within a geographic service area. Subscriber devices 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 subscriber device 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 landline 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 wireless messaging 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 have occurred in the 1990s which has resulted in further consolidation of the paging industry. Manufacturers of subscriber devices and transmission equipment have produced innovative technological advances which are expected to continue to broaden the potential market size for wireless messaging 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 messaging services while reducing equipment and airtime costs and equipment size. Narrowband PCS technology is expected to greatly expand the messaging capacity of the infrastructure and provide advanced two-way messaging and data services. Recent technological innovations in subscriber devices and transmission protocols have resulted in the development of acknowledgment paging and two-way paging. In acknowledgment paging, the subscriber devices can initiate a return message to the original message sender, informing him or her that the message was successfully received. In two-way paging, the subscriber devices enable the user to initiate, receive and/or reply to messages and pages through a built-in keyboard and miniaturized transmitter. In addition, the subscriber devices can communicate with other devices such as pagers, fax machines, and computers through electronic mail addresses. The following table summarizes certain information about American Paging's operations.
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- ----------- ----------- ----------- --------- (DOLLARS IN THOUSANDS) Pagers in service.......................................... 811,100 777,400 784,500 652,800 460,900 Total revenues............................................. $ 94,413 $ 104,187 $ 107,150 $ 92,065 $ 75,363 Depreciation and amortization expense...................... 32,040 33,777 24,692 17,178 13,392 Operating (loss)........................................... (35,307) (36,626) (8,997) (169) (721) Capital expenditures....................................... 18,624 32,517 26,527 28,966 21,454 Identifiable assets........................................ $ 135,840 $ 153,374 $ 159,170 $ 146,107 $ 74,923
DEVELOPMENT American Paging's business strategy is to enhance the customers' business and solve their communications problems by utilizing quality employees and leading-edge wireless messaging technology while creating value for shareholders. American Paging also strives to be a company that people enjoy doing business with through consistent positive customer interactions. American Paging's business strategy is based on the following elements: QUALITY CUSTOMER SERVICE. American Paging's centralized Customer Telecare Center ("CTC") located in Oklahoma City, Oklahoma can provide full customer service to the entire customer base 24-hours-per-day, seven-days-per-week. Customer service representatives at the CTC, which are organized based on geographic regions, have the capability to fulfill sales orders, add additional services and answer technical and billing questions. American Paging experienced difficulties in converting to the CTC in 1996, but has gradually improved customer satisfaction levels throughout 1997 as a result of improvements in customer communication and workflow processes. I-33 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. During 1997, American Paging launched North America's first commercial two-way paging network utilizing the ReFLEX25-Registered Trademark-protocol in Pittsburgh, Pennsylvania. Testing of the network occurred in the second half of 1997 with commercial sales expected during the first half of 1998. The licenses 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. These services will be initially available in the Western Pennsylvania market with potential expansion throughout the rest of the United States as the network is expanded to cover these areas. 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 one-way 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 as 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. TECHNOLOGICAL LEADERSHIP. American Paging invests in state-of-the-art communication network technology which provides high transmission quality, data speed and system capacity, while also providing strong system management tools which allow American Paging to efficiently and effectively operate the systems. American Paging utilizes FLEX-Registered Trademark- protocol technology for all new transmitters installed on its one-way networks which increases system capacity and will allow a more cost effective migration to narrowband PCS technology and other future wireless messaging services. American Paging also utilizes satellite-based digital technology which reduces maintenance and eliminates expensive terrestrial radio links, site costs and repeater equipment. American Paging's satellite-controlled systems cover portions of Arizona, Minnesota, Wisconsin, Illinois, Oklahoma, Florida, Texas and Washington, D.C. American Paging is converting all other wide-area systems to this satellite-based digital technology. In order to reduce the cost of providing service, American Paging implemented a plan in 1997 to migrate the existing customer base from its current 19 frequencies and 43 networks to no more than three frequencies supported by six nationwide networks. During this three to four year migration period, American Paging expects to dismantle and sell some of the older, less efficient systems. In addition, American Paging intends to relocate some existing transmitters to more heavily populated areas in order to expand coverage, improve quality and gain new customers. 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 35 sales and service offices. American Paging 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. American Paging expects to begin commercial sales on its two-way network in the Western Pennsylvania in the first half of 1998. Nationwide one-way and two-way paging services are offered through American Paging's alliances with nonaffiliated service providers. Generally, a one-way wireless messaging 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 subscriber devices 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 subscriber device'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 subscriber device 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 message. I-34 A one-way wireless messaging system can be migrated to a two-way system through modification of the control center and additional receivers. The new network configuration provides continuity between existing one-way transmitters and receivers and the narrowband PCS network. The network configuration also provides the receiver network for return messages generated from two-way subscriber devices. The narrowband PCS network will be capable of services such as guaranteed delivery, short response messaging and gateways to the Internet. A paging operator is generally assigned a block of numbers by the local telephone company in its service area. These numbers are assigned to individual subscriber devices. When the number assigned to the subscriber device is called from the PSTN, messages can be transmitted automatically by terminal equipment in the control center without the intervention of a live operator. American Paging currently provides four types of subscriber devices in all of its markets: alphanumeric text display, numeric, 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. 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) subscriber device rentals, (iii) subscriber device 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 subscriber device 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 indirect agents. American Paging sells subscriber devices to agents at a small mark-up or at cost. Agents then sell the subscriber devices 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 airtime 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 subscriber device for those who lease 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 wireless messaging 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 wireless messaging business or increase competitive pressure in American Paging's markets, American Paging's results of operations could be adversely affected. I-35 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 wireless messaging 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 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 also imposes a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. American Paging is currently engaged in this registration process. All new towers must be registered at the time of construction. 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 I-36 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 1997. In one decision, the FCC amended its environmental protection rules to adopt new guidelines and procedures for evaluating the environmental effects of RF emissions. Beginning in October 1997, paging systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements. After October 1997, all new paging facilities must be in compliance when they are brought into service. In addition, in February of 1997, the FCC adopted market area licensing rules to replace site-by-site licensing of paging base stations and granted nationwide exclusive authority for American Paging to operate on 929.3375 MHz under those new rules. The FCC has also recently announced its intention to hold spectrum auctions for 929/931 MHz paging channels in 1998. 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 1997 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 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 were 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. On July 18, 1997, the Eighth Circuit vacated the FCC's rules prescribing interim rates for reciprocal compensation because it has held that the 1996 Act requires that rate issues are to be decided by the states. It upheld the authority of the FCC to order LECs to interconnect with paging and other wireless providers and to issue rules relating to certain terms of interconnection between LECs and such providers. 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 now concluded proceedings 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. In a series of Orders adopted in 1997, the FCC established universal service support mechanisms which require telecommunications providers, including all wireless carriers, to contribute. American Paging has made the required Universal Service Worksheet filings and expects to make the required periodic payments starting in the first quarter of 1998. I-37 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 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. EMPLOYEES The Company enjoys satisfactory employee relations. As of December 31, 1997, approximately 9,685 persons were employed by the Company, approximately 155 of whom are represented by unions. I-38 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Telephone and Data Systems, Inc. ("TDS" or the "Company") provides high-quality telecommunications services to approximately 3.2 million cellular telephone, telephone, personal communications services ("PCS") telephone and radio paging customer units in 37 states and the District of Columbia. The accompanying financial statements present the results of operations of the Company's primary businesses: United States Cellular Corporation ("U.S. Cellular"), an 81%-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom"), a wholly owned subsidiary, Aerial Communications, Inc. ("Aerial"), an 83%-owned subsidiary, and American Paging, Inc. ("American Paging"), an 82%-owned subsidiary. See "Proposed Corporate Restructuring" and "Combination of American Paging and TSR Paging." TDS's long-term business development strategy is to expand its operations through internal growth and acquisitions, and to explore and develop telecommunications businesses that management believes utilize TDS's expertise in customer-based telecommunications. 1997 OVERVIEW TDS reported a net loss available to common and earnings per share--diluted of $11.4 million, or $.19 per share, in 1997 compared to net income available to common of $126.2 million, or $2.07 per share, in 1996 and $101.5 million, or $1.74 per share, in 1995. Net income available to common from U.S. Cellular and TDS Telecom increased 45% in 1997 and 23% in 1996. The excellent growth at U.S. Cellular and steady growth at TDS Telecom in 1997 was overshadowed by large start-up losses at Aerial due to the costs associated with the launch of service in all six PCS markets. Net income included significant gains on the sale of cellular interests and other investments in 1996 and 1995. The table below summarizes the effects of the business units and gains (along with the related impact of income taxes and minority interest) on net income (loss) available to common and earnings per share--diluted.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) NET INCOME (LOSS) AVAILABLE TO COMMON U.S. Cellular and TDS Telecom........................................... $ 135.1 $ 93.4 $ 75.7 Aerial.................................................................. (129.4) (15.3) (6.7) American Paging......................................................... (33.0) (16.4) (8.1) Gains................................................................... 15.9 64.5 40.6 --------- --------- --------- $ (11.4) $ 126.2 $ 101.5 --------- --------- --------- --------- --------- --------- EARNINGS PER SHARE--DILUTED U.S. Cellular and TDS Telecom........................................... $ 2.25 $ 1.54 $ 1.30 Aerial.................................................................. (2.15) (.25) (.11) American Paging......................................................... (.55) (.27) (.14) Gains................................................................... .26 1.05 .69 --------- --------- --------- $ (.19) $ 2.07 $ 1.74 --------- --------- --------- --------- --------- ---------
U.S. Cellular continued its outstanding growth during 1997. Customer units increased by 637,000 units, or 59% (442,000 units, or 41%, excluding customers added through acquisitions), to 1.7 million customer units, following a 363,000 unit, or 51%, increase in 1996. The increase in customer units drove a 29% increase in revenues, a 33% increase in cash flow and a 48% increase in operating income. Capital expenditures to add cell sites, expand coverage and add capacity totaled $318.7 million and expenditures for acquisitions totaled $128.8 million. TDS Telecom continued to provide steady growth in revenues and cash flow. Telephone access lines increased 6% resulting in a 12% increase in operating revenues and a 3% increase in cash flow. Operating income decreased 4% as TDS Telecom incurred additional expenses related to the development and marketing of its new business ventures, an Internet access provider, a structured wiring business and a competitive local exchange company ("CLEC"). TDS Telecom's investment in outside plant facilities and new digital switches to maintain and enhance the quality of service and offer new revenue opportunities totaled $151.5 million. I-39 Aerial launched service in all of its markets prior to the end of the second quarter. A total of 125,000 net customers were added by the end of 1997. Service was launched across its markets with approximately 600 cell sites in place, which provided wide-area metropolitan coverage in its Major Trading Areas ("MTAs"). By the end of 1997, it had 1,044 cell sites in service and had extended coverage to approximately 80% of the population in its MTAs. Aerial's operating results reflect the high cost of launching service. Revenues totaled $56.0 million, operating cash flow, a negative $157.5 million and operating loss totaled $196.6 million. Aerial's investment in property and equipment, including network design and equipment, site acquisition and information systems totaled $274.7 million in 1997. RESULTS OF OPERATIONS OPERATING REVENUES increased 25% ($291.7 million) during 1997 and 25% ($237.5 million) during 1996 primarily as a result of growth at U.S. Cellular and TDS Telecom in 1997 and 1996 as well as the start-up of PCS operations at Aerial in 1997. U.S. Cellular revenues increased $196.9 million in 1997 and $199.8 million in 1996 on 59% and 51% increases in customer units and 13% and 31% increases in inbound roaming revenues, respectively. TDS Telecom revenues increased $48.6 million in 1997 and $40.8 million in 1996 as a result of recovery of increased costs of providing long-distance services, internal access line growth, acquisitions and increased network usage. Aerial revenues totaled $56.0 million since start-up of operations in mid-1997. American Paging revenues decreased $9.8 million in 1997 and $3.0 million in 1996 reflecting competitive pricing declines. U.S. Cellular contributed 60% of consolidated revenue in 1997, up from 51% in 1995 reflecting revenue growth rates substantially higher than the other business units. TDS Telecom and American Paging contributed 30% and 6% of consolidated revenue in 1997 and 38% and 11% in 1995, respectively. Aerial contributed 4% of consolidated revenue in 1997. OPERATING EXPENSES rose 44% ($448.8 million) in 1997 and 27% ($216.1 million) in 1996. The increase in expenses includes Aerial's expenses subsequent to the launch of service in 1997 as well as added expenses from the growth in operations at U.S. Cellular and TDS Telecom in 1997 and 1996. PCS operating expenses totaled $252.5 million in 1997 reflecting the costs of operating Aerial's network, marketing, selling and advertising and promotion expenses, cost of equipment sold, customer service expenses as well as general and administrative expenses. U.S. Cellular operating expenses increased $154.7 million during 1997 and $155.1 million during 1996 due to the effects of additional marketing and selling expenses to add new customers as well as the costs of providing services to the larger customer base. TDS Telecom operating expenses increased $52.7 million during 1997 and $36.3 million during 1996 due to growth in internal operations, the development and start-up of new business ventures and the effects of acquisitions. American Paging operating expenses decreased $11.1 million in 1997 and increased $24.7 million in 1996. OPERATING INCOME declined to a negative $3.7 million in 1997 from $153.4 million in 1996 reflecting strong growth at U.S. Cellular offset by Aeriel's costs of launching service. Operating income increased to $153.4 million in 1996 from $132.0 million in 1995 reflecting growth in operations at U.S. Cellular, offset somewhat by increased losses at American Paging. U.S. Cellular's operating income increased 48% ($42.2 million) in 1997 and 104% ($44.6 million) in 1996 reflecting the increase in customers and revenues. U.S. Cellular's operating margin has increased steadily to 14.8% in 1997 from 12.8% in 1996 and 8.9% in 1995. TDS Telecom's operating income decreased $4.1 million in 1997 and increased $4.5 million in 1996. The decrease in TDS Telecom's operating income was primarily due to operating losses from new business ventures. TDS Telecom's operating margin continued its decline to 22.2% in 1997 from 26.0% in 1996 and 27.7% in 1995 due primarily to the development of new business ventures which have lower margins than traditional telephone operations as well as earnings pressures on telephone operations from regulatory agencies and long-distance providers. Aerial's operating loss I-40 totaled $196.6 million in 1997, reflecting the costs associated with launching service in all six markets. American Paging's operating loss decreased $1.3 million in 1997 and increased $27.6 million in 1996.
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ----------- ----------- (DOLLARS IN THOUSANDS) Operating Income (Loss) U.S. Cellular................................................... $ 129,543 $ 87,366 $ 42,755 TDS Telecom..................................................... 98,613 102,708 98,240 Aerial.......................................................... (196,551) -- -- American Paging................................................. (35,307) (36,626) (8,997) ------------ ----------- ----------- $ (3,702) $ 153,448 $ 131,998 ------------ ----------- ----------- ------------ ----------- -----------
Management expects Aerial to generate significant losses in 1998 as it continues to build its customer base. Upon completion of a December 1997 agreement between TDS and TSR Paging, Inc. to combine their respective paging businesses, TDS will follow the equity method of accounting for its 30% interest in the new combined company and will report these results as a component of Investment and Other Income. This combination is expected to be completed in the first half of 1998. See "Combination of American Paging and TSR Paging." INVESTMENT AND OTHER INCOME (EXPENSE) totaled $114.0 million in 1997, $141.2 million in 1996 and $103.9 million in 1995. Investment and other income (expense) includes interest and dividend income, cellular investment income, gain on sale of cellular interests and other investments, PCS development costs and minority share of income. CELLULAR INVESTMENT INCOME, the Company's share of income of cellular markets in which the Company has a minority interest and follows the equity method of accounting, increased 42% ($22.8 million) in 1997 and 35% ($14.1 million) in 1996. Cellular investment income is net of amortization of license costs relating to these minority interests. Cellular investment income is expected to decrease in 1998 as a result of the transfer of certain minority interests to BellSouth Corporation ("BellSouth") in the fourth quarter of 1997 and the pending transfer of certain other minority interests to AirTouch Communications, Inc. in 1998. See "Financial Resources--Acquisitions, Trades and Sales." GAIN ON SALE OF CELLULAR INTERESTS AND OTHER INVESTMENTS totaled $41.4 million in 1997, $138.7 million in 1996 and $86.6 million in 1995. TDS and U.S. Cellular continue to assess the makeup of cellular holdings in order to maximize the benefits derived from clustering markets. Certain markets, identified as non-strategic, were sold or traded in the past few years resulting in the recognition of gains. PCS DEVELOPMENT COSTS totaled $21.6 million in 1997, $43.9 million in 1996 and $7.8 million in 1995. Expenses incurred by Aerial prior to the launch of operations in March 1997 to recruit an experienced management team, develop and execute a business plan, raise capital and design and construct its PCS networks were recorded in Other Income (Expense). Revenues and expenses incurred subsequent to the launch of service have been included as a component of operating income. MINORITY SHARE OF INCOME includes the minority shareholders' share of U.S. Cellular's, Aerial's and American Paging's net income or loss, the minority partners' share of U.S. Cellular's operating markets net income or loss and other minority shareholders' and partners' share of subsidiaries' net income or loss. The change in 1997 is primarily I-41 related to the increased losses of Aerial allocated to its minority shareholders. Minority shareholders of American Paging are not allocated losses in 1997 as American Paging's shareholders' equity is negative.
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Minority Share of (Income) Loss U.S. Cellular Minority Shareholders' Share.................................... $ (21,264) $ (25,179) $ (19,046) Minority Partners' Share........................................ (12,298) (13,743) (7,902) ---------- ---------- ---------- (33,562) (38,922) (26,948) Aerial.......................................................... 43,038 4,944 -- American Paging................................................. -- 6,368 2,781 Telephone Subsidiaries and Other................................ (2,663) 920 (1,691) ---------- ---------- ---------- $ 6,813 $ (26,690) $ (25,858) ---------- ---------- ---------- ---------- ---------- ----------
INTEREST EXPENSE increased 113% ($48.4 million) in 1997 and decreased 16% ($8.0 million) in 1996. Interest expense increased in 1997 due to increased interest expense from larger short-term debt balances ($19.6 million), a smaller amount of capitalized interest ($16.6 million), additional interest expense from U.S. Cellular's sale of debt in 1997 and Aerial's zero coupon notes issued in late 1996 ($11.7 million). Interest expense decreased in 1996 because of increased capitalized interest ($14.4 million) which offset additional interest from U.S. Cellular's sale of convertible debt in 1995 ($6.0 million). TDS and Aerial capitalized interest totaling $11.0 million in 1997, $27.6 million in 1996 and $13.2 million in 1995 on expenditures for PCS licenses and construction costs. The Company stops capitalizing interest on qualifying assets when those assets are placed in service. MINORITY INTEREST IN INCOME OF SUBSIDIARY TRUST totaled $1.5 million in 1997. In November 1997, TDS Capital I, a subsidiary trust (the "Trust") of TDS, issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities (the "Preferred Securities") at $25 per Preferred Security. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due December 31, 2037. INCOME TAX EXPENSE decreased $95.1 million in 1997 to $28.6 million and increased $42.6 million to $123.6 million in 1996, reflecting primarily the changes in pretax income. NET INCOME (LOSS) AVAILABLE TO COMMON was ($11.4 million) in 1997, $126.2 million in 1996 and $101.5 million in 1995. EARNINGS PER COMMON SHARE--DILUTED was ($.19) in 1997, $2.07 in 1996 and $1.74 in 1995. I-42 CELLULAR TELEPHONE OPERATIONS TDS provides cellular telephone service through U.S. Cellular. Results of operations include 1,710,000 customer units at the end of 1997 compared to 1,073,000 customer units at the end of 1996 and 710,000 customer units at the end of 1995.
YEAR ENDED OR AT DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER CUSTOMER AMOUNTS) Operating Revenues Local retail................................................... $ 568,578 $ 414,815 $ 277,439 Inbound roaming................................................ 217,499 193,278 148,020 Long-distance and Other........................................ 90,888 71,975 54,857 ----------- ----------- ----------- 876,965 680,068 480,316 ----------- ----------- ----------- Operating Expenses System operations.............................................. 153,137 117,368 70,442 Marketing and selling.......................................... 175,117 127,689 92,180 Cost of equipment sold......................................... 82,302 74,024 54,948 General and administrative..................................... 204,487 164,782 130,533 Depreciation................................................... 97,591 74,631 57,302 Amortization................................................... 34,788 34,208 32,156 ----------- ----------- ----------- 747,422 592,702 437,561 ----------- ----------- ----------- Operating Income................................................. $ 129,543 $ 87,366 $ 42,755 ----------- ----------- ----------- ----------- ----------- ----------- Consolidated Markets: Customers...................................................... 1,710,000 1,073,000 710,000 Markets........................................................ 134 131 137 Market penetration............................................. 7.11% 4.94% 3.18% Cell sites in service.......................................... 1,748 1,328 1,116 Average monthly service revenue per customer................... $ 54.18 $ 63.69 $ 70.64 Churn rate per month........................................... 1.9% 1.9% 2.1% Marketing cost per gross customer addition..................... $ 313 $ 327 $ 335 Employees...................................................... 4,600 3,800 3,175 ----------- ----------- ----------- ----------- ----------- -----------
OPERATING REVENUES increased 29% ($196.9 million) in 1997 and 42% ($199.8 million) in 1996. The revenue increases in 1997 and 1996 were driven by the 59% (41% excluding customers added through acquisitions) and 51% growth in customer units and the 13% and 31% growth in inbound roaming revenues, respectively. Customer units grew by 637,000 units in 1997 as compared to 363,000 units in 1996. The units added in 1997 include 195,000 units from acquisitions, primarily related to the exchange with BellSouth which occurred at the end of October 1997. Average monthly service revenue per customer was $54.18 in 1997, $63.69 in 1996 and $70.64 in 1995. Average monthly service revenue per customer continues to decline due to roaming revenues increasing at a slower rate than the U.S. Cellular customer base, competitive pricing pressures, incentive programs and consumer market penetration. Management anticipates that average monthly service revenue per customer will continue to decrease as local retail and inbound roaming revenue per minute of use decline. LOCAL RETAIL REVENUE (charges to U.S. Cellular's customers for local system usage) increased 37% ($153.8 million) in 1997 and 50% ($137.4 million) in 1996 due primarily to the growth in customers. Average monthly local retail revenue per customer was $36.11 in 1997, $39.87 in 1996 and $42.19 in 1995. Local minutes of use averaged 103 per month in 1997, 107 per month in 1996 and 95 per month in 1995. Average revenue per minute was $.35 in 1997, $.37 in 1996 and $.44 in 1995. U.S. Cellular's use of incentive programs that encourage lower- priced weekend and off-peak usage, in order to stimulate overall usage, and the increased amounts of bill credits given to customers as incentive to become or remain customers resulted in the decrease in average monthly local retail revenue per minute which in turn caused the decrease in average monthly local retail revenue per customer. The industry trend of declining average monthly retail revenue per customer is believed to be related to the continued penetration of the consumer market, which tends to include fewer peak business hour usage customers and the effects of increased competition in the industry. I-43 INBOUND ROAMING REVENUE (charges to customers of other systems who use U.S. Cellular's cellular systems when roaming) increased 13% ($24.2 million) in 1997 and 31% ($45.3 million) in 1996 due to increased minutes of use offset somewhat by negotiated reductions in roaming rates. Minutes of use increased 27% in 1997 and 38% in 1996. Average revenue per minute of use was $.83 in 1997, $.92 in 1996 and $.99 in 1995. Average monthly inbound roaming revenue per U.S. Cellular customer was $13.81, $18.58 and $22.51 in 1997, 1996 and 1995, respectively. The decrease is the result of U.S. Cellular's customer base growing at a faster rate than roaming revenue and negotiated reductions in roaming rates. LONG-DISTANCE AND OTHER REVENUE, including equipment sales, increased 26% ($18.9 million) in 1997 and 31% ($17.1 million) in 1996 primarily due to increased long-distance revenue from the growth in the volume of long-distance calls billed by U.S. Cellular. OPERATING EXPENSES increased 26% ($154.7 million) in 1997 and 35% ($155.1 million) in 1996. The increase in operating expenses is primarily due to the costs to expand the customer base ($55.7 million in 1997 and $54.6 million in 1996); increased administrative expenses ($39.7 million in 1997 and $34.2 million in 1996); the cost of providing service to the expanding customer base ($35.8 million in 1997 and $46.9 million in 1996); and additional depreciation on the increased investment in cell sites and equipment ($23.0 million in 1997 and $17.3 million in 1996). MARKETING AND SELLING EXPENSES (salaries, commissions and expenses of field sales and retail personnel and offices; agent expenses; advertising and public relations expenses) increased 37% ($47.4 million) in 1997 and 39% ($35.5 million) in 1996 due to the increase in customer activations. Gross customer activations (excluding acquisitions) rose 33% in 1997 to 746,000 from 563,000 in 1996. The 1996 gross customer activations increased 44% to 563,000 from 392,000 in 1995. U.S. Cellular incurred significant increases in advertising costs to promote the United States Cellular-Registered Trademark- brand name and to add new customers. Cost of equipment sold increased 11% ($8.3 million) in 1997 and 35% ($19.1 million) in 1996 reflecting the increase in units sold offset somewhat by falling manufacturer equipment prices per unit. Cost per gross customer addition (marketing and selling expenses and cost of equipment sold less equipment revenues, divided by gross customer additions) totaled $313 in 1997, $327 in 1996 and $335 in 1995. GENERAL AND ADMINISTRATIVE EXPENSES (costs of local business offices and corporate expenses) increased 24% ($39.7 million) in 1997 and 26% ($34.2 million) in 1996. The increases include the effects of an increase in expenses required to serve the growing customer base and an expansion of both local administrative office and corporate staff, resulting from growth in U.S. Cellular's business. Employee-related expenses increased $19.4 million in 1997 and $15.6 million in 1996, primarily due to an increase in the number of administrative employees in each year. Also, bad debt expense increased $8.0 million in 1997 and $5.0 million in 1996, primarily due to the increased penetration of the consumer market. SYSTEM OPERATIONS EXPENSES increased 30% ($35.8 million) in 1997 and 67% ($46.9 million) in 1996 as a result of increases in customer usage expenses and costs associated with operating the increased number of cell sites. Customer usage expenses (charges from other service providers for landline connection, toll and roaming costs incurred by customers' use of systems other than their local systems) grew 32% ($24.3 million) in 1997 and 116% ($40.4 million) in 1996. The increase was due primarily to roaming usage and increased minutes of use. Net outbound roaming usage expense is a result of offering U.S. Cellular's customers increasingly larger service footprints in which their calls are billed at local rates. In certain cases these service footprints include other operators' service areas. U.S. Cellular pays roaming rates to the other carriers for calls its customers make in these areas, while charging these customers a local rate which is usually lower than the roaming rate. The increase in 1996 also relates to increases in fraud-related costs. These fraud-related costs totaled $6.5 million in 1997, $18.0 million in 1996 and $4.1 million in 1995. U.S. Cellular continues to implement procedures in its markets to combat this fraud, which is primarily related to roaming usage. Maintenance, utility and cell site expenses grew 27% ($11.5 million) in 1997 and 18% ($6.5 million) in 1996 reflecting the 32% and 19% increase in the number of cell sites, respectively. The number of cell sites operated increased to 1,748 in 1997 from 1,328 in 1996 and 1,116 in 1995. Operating cash flow increased 33% to $261.9 million in 1997 compared to a 48% increase to $196.2 million in 1996. The improvement was primarily due to the growth in customers and revenue. U.S. Cellular continues to provide increasing operating cash flow to support its construction activities. I-44 DEPRECIATION EXPENSE increased 31% ($23.0 million) in 1997 and 30% ($17.3 million) in 1996, reflecting increases in average fixed asset balances of 35% and 34%, respectively. OPERATING INCOME was $129.5 million in 1997 compared to $87.4 million in 1996 and $42.8 million in 1995. Operating margins improved to 14.8% in 1997 from 12.8% in 1996 and 8.9% in 1995. The improvement was primarily due to the substantial growth in customers and revenue. Management believes there exists a seasonality at U.S. Cellular in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth. This seasonality may cause operating income to vary from quarter to quarter. Competitors licensed to provide PCS services have initiated service in certain U.S. Cellular markets in the past eighteen months. U.S. Cellular expects PCS operators to complete initial deployment of PCS in portions of all its market clusters by the end of 1998. U.S. Cellular's management continues to monitor other wireless communications providers' strategies to determine what effect this additional competition will have on U.S. Cellular's future strategies and results. While the effects of additional wireless competition have slowed customer growth in certain of U.S. Cellular's markets, the overall effect on total customer growth to date has not been material. I-45 TELEPHONE OPERATIONS TDS provides landline telephone service through TDS Telecom. TDS Telecom served 515,500 access lines at the end of 1997 compared to 484,500 access lines at the end of 1996 and 425,900 access lines at the end of 1995 ("telephone operations"). TDS Telecom also owns a long-distance provider, an Internet access provider, a structured wiring business and a competitive local exchange company ("other services").
YEAR ENDED OR AT DECEMBER 31, ----------------------------------- 1997 1996 1995 ----------- ----------- --------- (DOLLARS IN THOUSANDS, EXCEPT PER CUSTOMER AMOUNTS) Operating Revenues Telephone Revenues Local Service................................................... $ 122,826 $ 110,501 $ 95,184 Network Access and Long Distance................................ 235,725 213,113 195,575 Miscellaneous................................................... 53,829 48,299 41,528 ----------- ----------- --------- Total Telephone Revenues...................................... 412,380 371,913 332,287 Other Services.................................................... 33,516 24,747 23,764 Intercompany Revenues............................................. (1,693) (1,058) (1,210) ----------- ----------- --------- Total Operating Revenues...................................... 444,203 395,602 354,841 ----------- ----------- --------- Operating Expenses Telephone Expenses Network Operations.............................................. 80,487 67,521 54,964 Depreciation and Amortization................................... 95,278 85,575 74,758 Customer Operations............................................. 65,167 53,764 46,818 Corporate Operations............................................ 68,454 62,276 58,998 ----------- ----------- --------- Total Telephone Expenses...................................... 309,386 269,136 235,538 Other Services.................................................... 37,897 24,816 22,273 Intercompany Expenses............................................. (1,693) (1,058) (1,210) ----------- ----------- --------- Total Operating Expenses...................................... 345,590 292,894 256,601 ----------- ----------- --------- Operating Income.................................................... $ 98,613 $ 102,708 $ 98,240 ----------- ----------- --------- ----------- ----------- --------- Companies........................................................... 106 105 100 Access lines........................................................ 515,500 484,500 425,900 Growth in access lines from prior year-end: Acquisitions...................................................... 3,200 33,100 13,500 Internal growth................................................... 27,800 25,500 19,900 Telephone plant in service per access line.......................... $ 2,488 $ 2,461 $ 2,356 Average monthly revenue per access line............................. $ 68.78 $ 67.10 $ 66.82 Employees........................................................... 2,350 2,160 1,925 ----------- ----------- --------- ----------- ----------- ---------
OPERATING REVENUES totaled $444.2 million in 1997, up 12% ($48.6 million) from 1996 and totaled $395.6 million in 1996, up 11% ($40.8 million) from 1995. The increases were due to the growth in telephone revenues and other services revenues. Operating revenues from telephone operations increased 11% ($40.5 million) in 1997 and 12% ($39.6 million) in 1996. Acquisitions increased telephone revenues $8.1 million in 1997 and $18.8 million in 1996. Recovery of increased costs of providing long-distance services resulted in increases in revenue of $12.1 million in 1997 and $8.1 million in 1996. Internal growth and increases in the sales of custom-calling features increased revenue by $8.7 million in 1997 and $8.0 million in 1996. Increased sales of customer premise equipment, including digital broadcast satellites, increased revenues by $6.1 million in 1997 and $2.2 million in 1996. Increased network usage resulted in revenue increases of $5.7 million in 1997 and $4.5 million in 1996. Average monthly revenue per access line was $68.78 in 1997, $67.10 in 1996 and $66.82 in 1995. Operating revenues from other services increased 35% ($8.8 million) in 1997 and 4% ($1.0 million) in 1996. The increase in 1997 is primarily due to increases in the structured wiring business ($6.0 million) and the Internet business ($2.8 million). I-46 OPERATING EXPENSES totaled $345.6 million in 1997, up 18% ($52.7 million) from 1996 and totaled $292.9 million in 1996, up 14% ($36.3 million) from 1995. The increases were due to the growth in telephone expenses and additional other services expenses. Operating expenses from telephone operations increased 15% ($40.3 million) in 1997 and 14% ($33.6 million) in 1996. The effects of acquisitions increased expenses 2% ($6.2 million) in 1997 and 6% ($14.6 million) in 1996. Depreciation and amortization expenses increased 11% ($9.7 million) in 1997 and 14% ($10.8 million) in 1996 due primarily to increased investment in plant and equipment. Cost of goods sold for customer premise equipment, including digital broadcast satellite, increased operating expenses by $5.2 million in 1997. Increased marketing and advertising campaigns increased expenses by $4.7 million in 1997. Increased investment in systems and systems support in 1997 resulted in an $8.4 million increase in expenses. The development of a centralized network management center to provide more effective network monitoring and maintenance increased expenses by $1.8 million in 1997 and $3.4 million in 1996. The costs to explore new business increased expenses by $3.2 million in 1996. The remaining increase in each year was due primarily to growth in internal operations. Operating expenses from other services increased 53% ($13.1 million) in 1997 and 11% ($2.5 million) in 1996. The increase in 1997 is primarily due to increases in the structured wiring business ($7.6 million) and the Internet business ($3.2 million) as well as costs related to the start-up of the CLEC business. OPERATING CASH FLOW increased 3% to $196.7 million in 1997 compared to an increase of 9% to $191.2 million in 1996 due primarily to the growth in telephone operations. TDS Telecom continues to provide steadily growing operating cash flow to support its construction activities. OPERATING INCOME decreased 4% ($4.1 million) in 1997 and increased 5% ($4.5 million) in 1996. Operating income from telephone operations increased $200,000 to $103.0 million in 1997 from $102.8 million in 1996 and increased $6.0 million in 1996 from $96.7 million in 1995. The effects of acquisitions increased operating income 2% ($1.9 million) in 1997 and 4% ($4.2 million) in 1996. The telephone operating margin was 25.0% in 1997, 27.6% in 1996 and 29.1% in 1995. The reduction in operating margin was caused by earnings pressures from regulatory agencies and long-distance providers and expenses incurred in the development of new business ventures. Operating loss from other services was $4.4 million in 1997 and $100,000 in 1996 as compared to an operating income of $1.5 million in 1995, reflecting the expenses associated with the start-up of the Internet business in late 1995, the structured wiring business in mid-1996 and the CLEC business in 1997. TDS Telecom is subject to the provisions of Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation." The Company periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. The Company believes that such criteria are still being met and therefore has no current plans to change its method of accounting. In analyzing the effects of discontinuing the application of SFAS No. 71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally accepted accounting principles and therefore, any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. BROADBAND PERSONAL COMMUNICATIONS SERVICES TDS manages its broadband personal communications services business through Aerial. Aerial's licenses include the Major Trading Areas ("MTAs") of Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus. The preparation of each of its markets for initial service launch and the development of its PCS business was Aerial's center of attention in 1997. Aerial launched service in the first of its six markets on March 27, 1997 and completed the launch of its last market in June. Across all six markets, Aerial launched service with approximately 600 cell sites in service. At the end of 1997, Aerial served 125,000 customers and had 1,044 cell sites in service. Operating results reflect the revenues and expenses of Aerial since the initiation of service on March 27, 1997, when Aerial ceased to be a development stage enterprise. Expenses for the periods prior to March 27 are reported I-47 as PCS Development Expenses included in the "Investment and Other Income (Expense)" section of the Income Statement.
YEAR ENDED OR AT DECEMBER 31, ------------------------------------ 1997 1996 1995 ------------ ---------- ---------- (DOLLARS IN THOUSANDS, EXCEPT PER CUSTOMER AMOUNTS) Operating Revenues................................................. $ 55,952 $ -- $ -- ------------ ---------- ---------- Operating Expenses Systems Operations............................................... 30,655 -- -- Marketing and selling............................................ 45,974 -- -- Cost of equipment sold........................................... 71,454 -- -- General and administrative....................................... 44,467 -- -- Customer service................................................. 20,882 -- -- Depreciation and amortization.................................... 39,071 -- -- ------------ ---------- ---------- 252,503 -- ------------ ---------- ---------- Operating (loss)................................................... $ (196,551) $ -- $ -- ------------ ---------- ---------- ------------ ---------- ---------- Customers.......................................................... 125,000 -- -- Market penetration................................................. .45% -- -- Cell sites in service.............................................. 1,044 -- -- Average monthly service revenue per customer....................... $ 73.56 -- -- Churn rate per month............................................... 4.5% -- -- Employees.......................................................... 1,414 424 50 ------------ ---------- ---------- ------------ ---------- ----------
OPERATING REVENUES totaled $56.0 million in 1997. Service revenues consisting of charges for access, airtime and value-added services provided to Aerial's customers who use its network and charges for long-distance calls made on its systems totaled $32.3 million. The average monthly service revenue per customer was $73.56 in 1997. Equipment sales revenues consisting of units sold to retailers, independent agents and customers totaled $23.6 million. The average revenue per unit sold was $124. OPERATING EXPENSES totaled $252.5 million in 1997 reflecting the costs of operating Aerial's network, marketing, selling and advertising and promotion expenses, cost of equipment sold, customer service expenses as well as general and administrative expenses. SYSTEMS OPERATIONS expenses totaled $30.7 million reflecting the costs of operating Aerial's network, primarily cell site expenses, landline interconnection and toll charges and employee costs. MARKETING AND SELLING EXPENSES totaled $46.0 million reflecting an aggressive advertising campaign that accompanied the launch of service and continued throughout 1997. Marketing and selling expenses primarily consist of salaries and benefits of sales and marketing personnel, sales commissions, the cost of promotions and the cost of print, radio and television advertising. COST OF EQUIPMENT SOLD totaled $71.5 million reflecting the cost of equipment sold to customers and independent retailers and agents. The average cost per unit sold was $374. GENERAL AND ADMINISTRATIVE EXPENSES totaled $44.5 million reflecting the expenses associated with the management and operating teams as well as overhead expenses. CUSTOMER SERVICE EXPENSES totaled $20.9 million primarily for customer service activity at Aerial's national operations center to support the PCS markets. DEPRECIATION AND AMORTIZATION totaled $39.1 million. OPERATING LOSS totaled $196.6 million in 1997. Management expects Aerial to generate significant losses in 1998 as it continues to build its customer base. RADIO PAGING OPERATIONS TDS manages its radio paging business through American Paging. American Paging provided wireless messaging communications through its digital radio transmission systems to 811,100 pagers at the end of 1997 compared to 777,400 pagers at the end of 1996 and 784,500 pagers at the end of 1995. COMBINATION OF AMERICAN PAGING AND TSR PAGING In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. On February 10, 1998 the board of directors of American Paging approved a merger agreement providing for the acquisition by TDS of all the issued and outstanding shares of American Paging not owned by TDS I-48 for cash in an amount equal to $2.50 per share, approximately $9.1 million in total. Upon consummation of the merger, TDS will contribute substantially all of the assets and certain, limited liabilities of American Paging, and TSR will contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company. TDS will not have any funding requirements once the combination is completed.
YEAR ENDED OR AT DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER UNIT AMOUNTS) Operating revenue............................................. $ 94,413 $ 104,187 $ 107,150 ----------- ----------- ----------- Costs and expenses Cost of services............................................ 27,822 26,712 22,294 Selling, general and administrative......................... 62,089 70,441 55,064 Cost of goods sold.......................................... 7,769 9,883 14,097 Depreciation and amortization............................... 32,040 33,777 24,692 ----------- ----------- ----------- 129,720 140,813 116,147 ----------- ----------- ----------- Operating (Loss).............................................. $ (35,307) $ (36,626) $ (8,997) ----------- ----------- ----------- ----------- ----------- ----------- Pagers in service............................................. 811,100 777,400 784,500 Average monthly revenue per unit.............................. $ 9.17 $ 9.88 $ 10.57 Transmitters in service....................................... 1,049 1,048 1,018 Churn rate per month.......................................... 2.6% 3.1% 2.5% Employees..................................................... 621 837 717 ----------- ----------- ----------- ----------- ----------- -----------
OPERATING REVENUES decreased 9% ($9.8 million) in 1997, primarily due to competitive pricing declines. Operating revenues decreased 3% ($3.0 million) in 1996 primarily as a result of a 27% ($3.8 million) decline in equipment sales. Average monthly revenue per unit declined 7% to $9.17 in 1997 and 7% to $9.88 in 1996. OPERATING EXPENSES decreased 8% ($11.1 million) in 1997 and increased 21% ($24.7 million) in 1996 reflecting the effects of restructuring charges. In 1996, American Paging recorded restructuring expenses of $9.3 million related to subleasing office space, employee severance, outplacement services and consulting services ($4.0 million) and write-offs of certain assets ($5.3 million) compared to $2.9 million of restructuring charges in 1995. American Paging experienced significant employee turnover as a result of the restructuring in 1996 which resulted in increased costs to recruit and train new employees. Also, in 1996, the cost of service increased primarily due to the increase in third-party reseller expense related to the increase in nationwide units in service and the costs to increase system capacity. OPERATING LOSS was $35.3 million in 1997, $36.6 million in 1996 and $9.0 million in 1995. Upon the completion of the merger with TSR, TDS will adopt the equity method of accounting for this investment. INFLATION Management believes that inflation affects TDS's business to no greater extent than the general economy. FINANCIAL RESOURCES TDS and its subsidiaries operate relatively capital-intensive businesses. Rapid growth has caused expenditures for construction, expansion and acquisition programs to exceed internally generated cash flow. Accordingly, in recent years, TDS and its principal subsidiaries have obtained substantial funds from external sources to acquire PCS licenses, to finance PCS construction, start-up and development costs and to fund acquisitions. Although the increasing internal cash flow from U.S. Cellular and the steady internal cash flow from TDS Telecom have reduced the need for external financing, Aerial's development and construction activities have required substantial additional funds from external sources. I-49 CASH FLOWS FROM OPERATING ACTIVITIES. TDS is generating substantial internal funds from the rapid growth in customer units and revenues at U.S. Cellular and steady growth at TDS Telecom. The launch of PCS operations, however, required substantial funds, thereby reducing cash flows from operating activities in 1997. Cash flows from operating activities totaled $206.5 million in 1997, $295.0 million in 1996 and $210.9 million in 1995. Aerial's market launch activities also substantially reduced operating cash flow in 1997. Operating cash flow (operating income plus depreciation and amortization) decreased 23% to $297.9 million in 1997 from $384.5 million in 1996 and $323.5 million in 1995. Aerial's operations reduced operating cash flow by $157.5 million in 1997. U.S. Cellular's operating cash flow increased 33% ($65.7 million) to $261.9 million in 1997, and 48% ($64.0 million) to $196.2 million in 1996 while TDS Telecom's operating cash flow increased 3% ($5.5 million) to $196.7 million in 1997, and 9% ($15.6 million) to $191.2 million in 1996. Cash flows from other operating activities (investment and other income, interest and income tax expense and changes in working capital and other assets and liabilities) required $91.3 million in 1997, $89.5 million in 1996, and $112.6 million in 1995.
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1996 1995 ------------ ----------- ------------ (DOLLARS IN THOUSANDS) Operating cash flow U.S. Cellular.................................................. $ 261,922 $ 196,205 $ 132,213 TDS Telecom.................................................... 196,679 191,167 175,595 Aerial......................................................... (157,480) -- -- American Paging................................................ (3,267) (2,849) 15,695 ------------ ----------- ------------ 297,854 384,523 323,503 Other operating activities..................................... (91,347) (89,529) (112,627) ------------ ----------- ------------ $ 206,507 $ 294,994 $ 210,876 ------------ ----------- ------------ ------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES. TDS's long-term strategy is to maintain a strong yet flexible financial foundation. Consolidated equity capital (common equity, preferred stock, trust originated preferred securities and minority interest) was 59% of total capitalization at December 31, 1997, compared to 68% and 66% at December 31, 1996 and 1995, respectively. The reduced equity capital percentage to total capitalization in 1997 is primarily a result of increases in long-term debt at U.S. Cellular and Aerial and the increase in TDS's short-term debt. TDS targets a ratio of equity to total capital in the range of 55% to 65%. Cash flows from financing activities totaled $547.6 million in 1997, $124.9 million in 1996 and $369.5 million in 1995. TDS has required significant funds from external sources to finance PCS construction, start-up and development activities in 1997 and 1996 and the purchase of the PCS licenses in 1995. TDS has used short-term debt to finance these PCS expenditures, as well as to finance its radio paging operations, for acquisitions and for general corporate purposes. TDS takes advantage of attractive opportunities to retire short-term debt with proceeds from long-term debt and equity financing, including sales of debt and equity securities by subsidiaries. Proceeds from the issuance of long-term debt and equity securities totaled $392.0 million, $195.3 million and $260.7 million in 1997, 1996 and 1995, respectively. Proceeds from the sales of non-strategic cellular and other investments from time to time in 1997, 1996 and 1995 have also been used to retire short-term debt. TDS has cash management arrangements with its subsidiaries under which the subsidiaries may from time to time deposit excess cash with TDS for investment under TDS's cash management program. Deposits made under the arrangements are available to the subsidiaries on demand and bear interest each month at the 30-day Commercial Paper Rate as reported in The Wall Street Journal, plus 1/4%, or such higher rate as TDS may at its discretion offer on such deposits. In 1997, TDS received net proceeds of $144.8 million on the sale of 8.5% Trust Originated Preferred Securities-SM-. U.S. Cellular received $247.0 million on the sale of 10-year 7.25% notes and used the proceeds to repay existing balances on the vendor financing arrangements, to finance the cash requirements for the BellSouth exchange and for general corporate purposes. In 1996, Aerial received $195.3 million in an initial public offering of Common Shares. In 1995, U.S. Cellular received $221.5 million from the sale of 20-year 6% zero coupon convertible debt and TDS sold $39.2 million of Medium-Term Notes. - --------- - -SM-"Trust Originated Preferred Securities" is a service mark of Merrill Lynch & Co. Inc. I-50 Aerial, TDS Telecom and U.S. Cellular have also used long-term debt to finance their construction and development activities. In 1996, Aerial issued 10-year 8.34% zero coupon notes for $100 million of digital radio channel and switching equipment. The $100 million proceeds of the sale of the notes were paid to Nokia Telecommunications, Inc. ("Nokia") in satisfaction of all outstanding obligations and future obligations up to $100 million under a $200 million Credit Agreement between Aerial and Nokia ("Nokia Credit Agreement"). TDS Telecom telephone subsidiaries borrowed $15.0 million in 1997, $12.2 million in 1996 and $12.0 million in 1995 under the Rural Utility Service and the Rural Telephone Bank long-term federal government loan programs to finance their telephone construction programs. U.S. Cellular financed cellular system equipment and construction costs totaling $59.5 million in 1995 under vendor financing arrangements. In 1997, TDS purchased 1.8 million TDS Common Shares for $69.9 million. In December 1996, TDS authorized the repurchase of up to 3.0 million TDS Common Shares over a period of three years. A total of 1.0 million shares were subsequently reissued, primarily for acquisitions. TDS has paid dividends of $.42, $.40 and $.38 per Common and Series A Common Share in 1997, 1996 and 1995, respectively. Aggregate dividends paid on Common and Preferred Shares, excluding dividends reinvested, totaled $27.2 million in 1997, $26.2 million in 1996 and $24.0 million in 1995. CASH FLOWS FROM INVESTING ACTIVITIES. TDS makes substantial investments each year to acquire, construct, operate and maintain modern high-quality communications networks and facilities as a basis for creating long-term value for shareowners. In recent years, rapid changes in technology and new opportunities have required substantial investments in revenue enhancing and cost reducing upgrades of the Company's networks. In addition, the Company has made substantial investments to enter the PCS business. Cash flows from investing activities totaled $760.7 million in 1997, $417.4 million in 1996 and $550.0 million in 1995 primarily for capital expenditures, the purchase of PCS licenses and acquisitions. Cash expenditures for capital additions totaled $786.3 million in 1997, $550.2 million in 1996 and $360.0 million in 1995. The acquisition of broadband and narrowband PCS licenses required $326.0 million in 1995. Cash used for acquisitions, excluding cash acquired, totaled $129.0 million in 1997, $31.0 million in 1996 and $53.8 million in 1995. The sale of non-strategic cellular assets and other investments provided net proceeds of $84.2 million in 1997, $221.5 million in 1996 and $197.6 million in 1995. Distributions from partnerships totaled $56.4 million in 1997, $25.5 million in 1996 and $9.1 million in 1995. I-51 CAPITAL EXPENDITURES The primary purpose of TDS's construction and expansion program is to provide for significant customer growth, to upgrade service, to expand into new communication areas, and to take advantage of service-enhancing and cost-reducing technological developments. The following table summarizes the Company's investments in its communications networks and related facilities during the past three years.
YEAR ENDED OR AT DECEMBER 31, --------------------------------------- 1997 1996 1995 ------------- ----------- ----------- (DOLLARS IN THOUSANDS) U.S. Cellular Cell sites and equipment....................................... $ 238,797 $ 133,832 $ 150,340 Switching equipment............................................ 5,457 5,713 13,002 Systems development............................................ 40,949 28,753 10,148 Other.......................................................... 33,545 79,825 37,388 ------------- ----------- ----------- 318,748 248,123 210,878 ------------- ----------- ----------- TDS Telecom Central office................................................. 52,479 47,208 38,697 Outside plant.................................................. 60,974 53,130 55,569 Systems development............................................ 9,127 20,497 7,137 Other.......................................................... 28,880 23,605 2,969 ------------- ----------- ----------- 151,460 144,440 104,372 ------------- ----------- ----------- Aerial Cell sites and equipment....................................... 291,922 150,386 -- Switching equipment............................................ 38,428 53,170 -- Systems development............................................ 55,553 26,277 -- Other.......................................................... 1,815 12,436 8,521 Prepaid network infrastructure................................. (70,300) 70,300 -- ------------- ----------- ----------- 317,418 312,569 8,521 Less noncash items............................................. (42,709) (199,630) -- ------------- ----------- ----------- 274,709 112,939 8,521 ------------- ----------- ----------- American Paging.................................................. 18,624 32,517 26,527 ------------- ----------- ----------- Other.......................................................... 22,776 12,185 9,698 ------------- ----------- ----------- $ 786,317 $ 550,204 $ 359,996 ------------- ----------- ----------- ------------- ----------- -----------
U.S. Cellular's capital additions include expenditures to add additional cell sites and radio channels to expand coverage and add capacity. U.S. Cellular constructed 331 cell sites in 1997, 242 in 1996 and 292 in 1995. TDS Telecom's capital additions include expenditures for switch modernization and outside plant facilities to maintain and enhance the quality of service and offer new revenue opportunities. TDS Telecom installed 32 digital switches in 1997, 35 in 1996 and 39 in 1995. Aerial has completed the construction of the five planned switching centers, the central Network Operations Center and has over 1,000 cell sites in service. The Company's expected 1998 property, plant and equipment additions reflect the Company's construction and expansion programs and are anticipated to aggregate approximately $545 million. In addition, Aerial's working capital and operating expenses will require an estimated $175 million. - The cellular capital additions budget totals approximately $330 million, including about $240 million for new cell sites and about $90 million for various information systems initiatives. - The telephone capital additions budget totals approximately $140 million, including about $50 million for new digital switches and other switching facilities and $35 million for improvements to outside plant facilities. - The PCS capital additions budget totals approximately $75 million, including $20 million for cell sites, $25 million for switching equipment and $15 million for systems development. In addition, Aerial's working capital and operating expenses will require an estimated $175 million. I-52 ACQUISITIONS, TRADES AND SALES TDS continually reviews attractive opportunities for the acquisition of additional telecommunications companies which add value to the organization. TDS and U.S. Cellular continue to assess the makeup of cellular holdings in order to maximize the benefits derived from clustering U.S. Cellular's markets. As the number of opportunities for outright acquisitions of cellular interests has decreased and as U.S. Cellular's clusters have grown to realize greater economies of scale, U.S. Cellular's focus has shifted toward exchanges and sales of non-strategic interests. Cash expenditures (excluding cash acquired) for acquisitions totaled $129.0 million in 1997, $31.0 million in 1996 and $53.8 million in 1995. TDS completed an exchange with BellSouth in 1997, completed the acquisition of controlling interests in two cellular markets and one telephone company in 1997, two cellular markets and five telephone companies in 1996 and eleven cellular markets and five telephone companies in 1995 and increased its ownership of certain cellular interests during the last three years for an aggregate consideration (consisting of cash, TDS Common Shares, TDS Preferred Shares, and U.S. Cellular Common Shares) totaling $174.7 million, $144.1 million and $194.4 million, respectively. In October 1997, U.S. Cellular completed an exchange with BellSouth. Pursuant to the exchange, U.S. Cellular received majority interests representing approximately 4.0 million pops in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests U.S. Cellular received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/ Indiana clusters. In December 1997, U.S. Cellular announced that AirTouch will acquire noncontrolling interests in 11 markets owned by U.S. Cellular and TDS. AirTouch will issue approximately 5,000,000 shares of its common stock and pay approximately $54.2 million in cash to U.S. Cellular and TDS in exchange for these interests. Management expects that it will record a significant pretax gain upon the completion of the sales transactions. The sales are expected to be completed in the first half of 1998. LIQUIDITY The Company anticipates that the aggregate resources required for 1998 will include approximately $545 million for capital spending, consisting of $330 million for cellular capital additions, $140 million for telephone capital additions and $75 million for PCS capital additions. In addition, Aerial's working capital and operating expenses will require an estimated $175 million. U.S. Cellular plans to finance its construction program primarily with internally generated cash supplemented by short-term financing. U.S. Cellular's operating cash flow totaled $261.9 million in 1997 (approximately 82% of 1997 capital expenditures) up 33% ($65.7 million) from 1996. U.S. Cellular also received $52.4 million in distributions from minority partnership interests and $61.1 million from the proceeds of investment sales to supplement operating cash flow. At December 31, 1997, U.S. Cellular had $500 million of bank lines of credit for general corporate purposes, all of which was available. TDS Telecom plans to finance its construction program using internally generated cash supplemented by long-term financing from federal government programs. Operating cash flow totaled $196.7 million in 1997 (approximately 130% of 1997 capital expenditures) up 3% ($5.5 million) from 1996. At December 31, 1997, TDS Telecom telephone subsidiaries had $112.0 million in unadvanced loan funds from federal government programs to finance the telephone construction program. These loan commitments have a weighted average annual interest rate of 5.71%. Aerial plans to finance its construction expenditures and working capital requirements with borrowings under the TDS lines of credit and vendor financing. Aerial issued 10-year 8.05% zero coupon notes for $100 million in February 1998 to finance digital radio channel and switching infrastructure equipment. The $100 million proceeds from the sale were paid to Nokia in satisfaction of all outstanding obligations and certain future obligations of Aerial under the Nokia Credit Agreement. TDS and its subsidiaries had cash and temporary investments totaling $75.6 million and longer-term investments totaling $32.6 million at December 31, 1997. These investments are primarily the result of telephone operations' internally generated cash. While certain regulated telephone subsidiaries' debt agreements place limits on intercompany dividend payments, these restrictions are not expected to affect the Company's ability to meet its cash obligations. I-53 TDS had $644 million of bank lines of credit for general corporate purposes at December 31, 1997 of which $118 million was unused. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate. In February 1998, TDS received net proceeds of $145 million on the sale of 6.0 million 8.04% Trust Originated Preferred Securities at $25 per Preferred Security. The net proceeds were used to repay certain short-term indebtedness. Subject to the approval of the Tracking Stock Proposal by shareholders, the Company intends to, among other things, offer and sell Telecom Group Shares in a public offering for cash, and allocate the net proceeds to the Telecom Group. The Company intends to file with the SEC a registration statement on Form S-3 relating to the registration of between 10,000,000 and 17,000,000 Telecom Group Shares. This offering is expected to commence promptly after the approval of the Tracking Stock Proposal by shareholders, subject to prevailing market conditions and other factors. Management estimates proceeds of approximately $150 million from the offering which the Telecom Group would use to repay obligations to TDS, and which TDS would use to repay certain short-term indebtedness. Management believes that TDS's internal cash flows and funds available from cash and cash equivalents, lines of credit, and longer-term financing commitments provide sufficient financial flexibility. However, the timing and amounts of capital expenditures and acquisitions as well as working capital requirements and amounts needed for general corporate purposes may vary throughout the year. There can be no assurance that sufficient funds will be available to the Company on terms or at prices acceptable to the Company. If sufficient funding is not made available to the Company on terms and prices acceptable to the Company, the Company would have to reduce its construction, development and acquisition programs. TDS and its subsidiaries anticipate accessing public and private capital markets to issue debt and equity securities only when capital requirements, financial market conditions and other factors warrant. TDS has assessed, and continues to assess, the impact of the Year 2000 Issue on its reporting systems and operations. The Company believes that modifying its reporting systems and operations is not a material event and is taking steps to make its systems Year 2000 compliant. The Year 2000 Issue exists because many computer systems and applications abbreviate dates by eliminating the first two digits of the year, assuming that these two digits would always be "19". Unless corrected, this shortcut is expected to cause problems when the century date occurs. On that date, some computer programs may recognize the date as January 1, 1900 instead of January 1, 2000. This may cause systems to incorrectly process critical financial and operational information, or stop processing altogether. The cost of addressing the Year 2000 Issue to date was not material to the Company's results of operations or financial condition, and management believes that the costs to be incurred in 1998 and 1999 will not be material to future operating results or financial condition. If management's steps are not successful in making the systems Year 2000 compliant, it could have a material adverse effect on results of operations. PROPOSED CORPORATE RESTRUCTURING The Board of Directors of Telephone and Data Systems, Inc. (the "Board") has adopted a proposal which, if approved by shareholders and implemented by the Board, would authorize the Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). The Tracking Stocks are intended to result in greater market recognition of the value (individually and collectively) of TDS and of TDS's three principal business groups ("Tracking Groups"), thereby enhancing shareholder value over the long term, while at the same time enabling TDS's businesses to preserve the benefits of being part of a consolidated enterprise. The Tracking Stock Proposal is expected to: - provide TDS with greater flexibility in raising capital and making acquisitions, using equity securities specifically related to the Tracking Groups; - enable TDS to more effectively tailor employee benefit plans to provide incentives to employees of the Tracking Groups; - provide shareholders with the opportunity to invest in separate securities that specifically reflect the underlying businesses, depending upon their investment objectives; I-54 - permit shareholders to continue to invest in all of the TDS businesses through the Common Shares and the Series A Common Shares. Pursuant to the Tracking Stock Proposal each issued Preferred Share, Common Share and Series A Common Share of TDS would be converted into a new Preferred Share, Common Share and Series A Common Share, respectively, of the new TDS Delaware Corporation. In addition, the Tracking Stock Proposal would authorize three new classes of common stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Shares") and Aerial Communications Group Common Shares (the "Aerial Group Shares"). The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of TDS's interest in United States Cellular Corporation, a subsidiary of TDS operating and investing in cellular telephone companies and properties ("U. S. Cellular"). The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily consists of TDS's interest in TDS Telecommunications Corporation, a subsidiary of TDS operating landline telephone companies ("TDS Telecom"). The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of TDS's interest in Aerial Communications, Inc., a subsidiary of TDS providing broadband personal communications services ("Aerial"). Subject to the approval of the Tracking Stock Proposal by shareholders, TDS intends to: - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group, - issue Cellular Group Shares in exchange for all of the Common Shares of U. S. Cellular which are not owned by TDS, subject to approval by the board of directors and the shareholders of U. S. Cellular, (the "U.S. Cellular Merger"), - issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by TDS, subject to approval by the board of directors and the shareholders of Aerial (the "Aerial Merger"), and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of TDS (the "Distribution"). It is currently expected that the Distribution would take place in July 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, although the Board reserves the right to effect all or any part of the Distribution at any time after the approval of the Tracking Stock Proposal, or not to make the Distribution, regardless of whether or not such other transactions have taken place. The shares of Tracking Stock which would be issued in the Distribution would represent an approximately 75% interest in the common equity value of TDS in each Tracking Group (the "Outstanding Interest"). When considering the shares of Tracking Stock which would also be issued in the Telecom Public Offering, the U. S. Cellular Merger and the Aerial Merger, as well as the Distribution, the Outstanding Interest would initially represent in the aggregate an approximately 80% interest in each Tracking Group. Upon completion of all of the Transactions as contemplated, approximately 20% of the common shareholders' value of each Tracking Group would initially be retained (the "Retained Interest") in a residual group (the "TDS Group"), along with all other interests held by TDS. The TDS Series A Common Shares and Common Shares will continue to be outstanding and are intended to reflect the performance of the Cellular Group, the Telecom Group, and the Aerial Group to the extent of the Retained Interest in the respective groups, and to reflect the performance of the other assets and businesses attributed to the TDS Group. Following the Distribution, subject to the legal and contractual restrictions on the payment of dividends, the Board currently intends to establish an annual dividend on the TDS Common Shares and Series A Common Shares in an amount equal to $.10 per share. The Board also currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $.48 per share. (Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, the dividend on Telecom Group shares would equate to a per share dividend of $.32 per existing Common Share and Series A Common Share. The total of the dividend on TDS Common Shares and Series A Common Shares of $.10 and the equivalent dividend on Telecom Group Shares of $.32 equals the existing current annual dividend on the existing Common Shares and Series A Common Shares of $.42.) With regard to the Cellular Group and the Aerial Group Shares, the Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group I-55 and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group or the Aerial Group Shares in the foreseeable future. Future dividends on the shares of common stock will be payable when, as and if declared by the Board out of the lesser of (1) all funds of TDS legally available therefor and (2) the available dividend amount with respect to the relevant Group. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $1,222 million for the Cellular Group, $287 million for the Telecom Group and $144 million for the Aerial Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group shares. With respect to the TDS Group, the Available Dividend Amount (approximately $602 million as of December 31, 1997) is an amount approximately equal to the greater of a) an amount (approximately $313 million) which is approximately equal to the Surplus of TDS less the sum of all Available Dividend Amounts of all Tracking Groups or b) an amount (approximately $602 million) which is approximately equal to the TDS Group Equity and Preferred Stock less the par or stated value of all Common and Series A Common Shares and Preferred Stock outstanding. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the policies between TDS and such subsidiaries would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group, and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group, and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group, and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. LEGAL PROCEEDINGS. On December 29, 1997, a party, which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, U.S. Cellular, and the directors of U.S. Cellular. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the U.S. Cellular Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. On January 30, 1998, a virtually identical complaint has been filed by an individual. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. On January 5, 1998, an individual who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, Aerial and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more I-56 months. On February 6, 1998, a virtually identical complaint has been filed by a second individual. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AND OTHER SECTIONS OF THIS PROXY STATEMENT/PROSPECTUS 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. I-57 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 ------------- ------------- ------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) OPERATING REVENUES Cellular...................................................................... $ 876,965 $ 680,068 $ 480,316 Telephone..................................................................... 444,203 395,602 354,841 PCS........................................................................... 55,952 -- -- Radio paging.................................................................. 94,413 104,187 107,150 ------------- ------------- ------------- 1,471,533 1,179,857 942,307 ------------- ------------- ------------- OPERATING EXPENSES Cellular...................................................................... 747,422 592,702 437,561 Telephone..................................................................... 345,590 292,894 256,601 PCS........................................................................... 252,503 -- -- Radio paging.................................................................. 129,720 140,813 116,147 ------------- ------------- ------------- 1,475,235 1,026,409 810,309 ------------- ------------- ------------- OPERATING INCOME (LOSS)......................................................... (3,702) 153,448 131,998 ------------- ------------- ------------- INVESTMENT AND OTHER INCOME (EXPENSE) Interest and dividend income.................................................. 13,660 15,569 13,024 Cellular investment income, net of license cost amortization.................. 77,620 54,799 40,666 Gain on sale of cellular interests and other investments...................... 41,438 138,735 86,625 PCS development costs......................................................... (21,614) (43,950) (7,829) Other (expense) income, net................................................... (3,938) 2,727 (2,771) Minority share of loss (income)............................................... 6,813 (26,690) (25,858) ------------- ------------- ------------- 113,979 141,190 103,857 ------------- ------------- ------------- INCOME BEFORE INTEREST AND INCOME TAXES......................................... 110,277 294,638 235,855 Interest expense................................................................ 89,744 42,853 50,848 Minority interest in income of subsidiary trust................................. 1,523 -- -- ------------- ------------- ------------- INCOME BEFORE INCOME TAXES...................................................... 19,010 251,785 185,007 Income tax expense.............................................................. 28,559 123,646 81,029 ------------- ------------- ------------- NET INCOME (LOSS)............................................................... (9,549) 128,139 103,978 Preferred Dividend Requirement.................................................. (1,892) (1,957) (2,509) ------------- ------------- ------------- NET INCOME (LOSS) AVAILABLE TO COMMON........................................... $ (11,441) $ 126,182 $ 101,469 ------------- ------------- ------------- ------------- ------------- ------------- WEIGHTED AVERAGE COMMON SHARES (000S)........................................... 60,211 60,464 57,456 EARNINGS PER COMMON SHARE--BASIC................................................ $ (.19) $ 2.09 $ 1.77 ------------- ------------- ------------- ------------- ------------- ------------- EARNINGS PER COMMON SHARE--DILUTED.............................................. $ (.19) $ 2.07 $ 1.74 ------------- ------------- ------------- ------------- ------------- ------------- DIVIDENDS PER COMMON AND SERIES A COMMON SHARE.................................. $ .42 $ .40 $ .38 ------------- ------------- ------------- ------------- ------------- ------------- Pro forma (unaudited): (Note 1) Net income Attributable to Common Stocks United States Cellular Group Shares........................................... $ 67,706 $ 78,562 $ 60,522 TDS Telecommunications Group Shares........................................... 22,791 26,770 25,616 Aerial Communications Group Shares............................................ (153,014) (24,733) (4,851) TDS Common and Series A Common Shares......................................... $ 51,076 $ 45,583 $ 20,182 Weighted Average Common Shares Outstanding United States Cellular Group Shares........................................... 60,211 60,464 57,456 TDS Telecommunications Group Shares........................................... 40,141 40,309 38,304 Aerial Communications Group Shares............................................ 40,141 40,309 38,304 TDS Common and Series A Common Shares......................................... 60,211 60,464 57,456 Earnings per Common Share United States Cellular Group Shares........................................... $ 1.12 $ 1.30 $ 1.05 TDS Telecommunications Group Shares........................................... 0.57 0.66 0.67 Aerial Communications Group Shares............................................ (3.81) (0.61) (0.13) TDS Common and Series A Common Shares......................................... $ 0.85 $ 0.75 $ 0.35
The accompanying notes to consolidated financial statements are an integral part of these statements. I-58 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss)................................................................. $ (9,549) $ 128,139 $ 103,978 Add (Deduct) adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization................................................... 301,556 231,075 191,504 Deferred taxes.................................................................. 17,236 75,015 19,603 Investment income............................................................... (83,395) (57,947) (43,188) Minority share of income (loss)................................................. (6,813) 26,690 25,858 Gain on sale of cellular interests and other investments........................ (41,438) (138,735) (86,625) Noncash interest expense........................................................ 24,289 17,042 12,761 Other noncash expense........................................................... 16,561 24,022 16,946 Change in accounts receivable................................................... (41,900) (28,687) (33,346) Change in materials and supplies................................................ (25,827) (2,395) (2,999) Change in accounts payable...................................................... 32,498 23,531 (11,630) Change in accrued taxes......................................................... 7,612 (8,249) 6,252 Change in other assets and liabilities.......................................... 15,677 5,493 11,762 ------------ ------------ ------------ 206,507 294,994 210,876 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Long-term debt borrowings....................................................... 260,099 15,846 334,323 Repayment of long-term debt..................................................... (121,958) (34,200) (30,734) Change in notes payable......................................................... 368,858 (27,133) 80,351 Trust preferred securities...................................................... 144,788 -- -- Dividends paid.................................................................. (27,193) (26,231) (23,972) Proceeds from the issuance of subsidiaries' stock............................... -- 195,265 -- Repurchase of Common Shares..................................................... (69,942) -- -- Other financing activities...................................................... (7,064) 1,349 9,506 ------------ ------------ ------------ 547,588 124,896 369,474 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures............................................................ (786,317) (550,204) (359,996) Investments in cellular investment entities and license costs................... (20,084) (23,134) (25,025) Distributions from investments.................................................. 56,413 25,453 9,062 Investments in PCS licenses..................................................... (5,034) (26,548) (326,035) Proceeds from investment sales.................................................. 84,230 221,542 197,558 Acquisitions, net of cash acquired.............................................. (128,979) (31,019) (53,770) Change in temporary investments and marketable securities....................... 36,422 (30,797) 11,871 Other investing activities...................................................... 2,629 (2,666) (3,632) ------------ ------------ ------------ (760,720) (417,373) (549,967) ------------ ------------ ------------ NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS.............................. (6,625) 2,517 30,383 CASH AND CASH EQUIVALENTS Beginning of period............................................................. 57,633 55,116 24,733 ------------ ------------ ------------ End of period................................................................... $ 51,008 $ 57,633 $ 55,116 ------------ ------------ ------------ ------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part of these statements. I-59 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--ASSETS
DECEMBER 31, -------------------------- 1997 1996 ------------ ------------ (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents........................................................................ $ 51,008 $ 57,633 Temporary investments............................................................................ 24,559 61,664 Construction funds............................................................................... 775 1,405 Accounts receivable Due from customers, less allowance of $15,102 and $6,090, respectively......................... 148,811 97,093 Other, principally connecting companies........................................................ 98,487 84,119 Materials and supplies, at average cost.......................................................... 55,127 29,125 Other............................................................................................ 29,517 15,031 ------------ ------------ 408,284 346,070 ------------ ------------ INVESTMENTS Cellular license costs, net of amortization...................................................... 1,190,917 1,088,409 Cellular minority interests...................................................................... 138,367 206,390 Broadband PCS license acquisition costs, net of amortization..................................... 319,918 322,420 Franchise and other costs in excess of the underlying book value of subsidiaries, net of amortization.................................................................................... 180,669 181,845 Other investments................................................................................ 142,713 144,840 ------------ ------------ 1,972,584 1,943,904 ------------ ------------ PROPERTY, PLANT AND EQUIPMENT Cellular In service and under construction................................................................ 1,212,575 846,005 Less accumulated depreciation.................................................................... 272,322 195,251 ------------ ------------ 940,253 650,754 ------------ ------------ Telephone In service and under construction, substantially at original cost................................ 1,420,890 1,293,779 Less accumulated depreciation.................................................................... 590,123 524,418 ------------ ------------ 830,767 769,361 ------------ ------------ PCS In service and under construction................................................................ 642,122 324,703 Less accumulated depreciation.................................................................... 38,018 1,980 ------------ ------------ 604,104 322,723 ------------ ------------ Radio Paging In service and under construction................................................................ 118,275 113,000 Less accumulated depreciation.................................................................... 75,045 61,528 ------------ ------------ 43,230 51,472 ------------ ------------ Other In service and under construction................................................................ 96,809 82,781 Less accumulated depreciation.................................................................... 49,510 48,202 ------------ ------------ 47,299 34,579 ------------ ------------ 2,465,653 1,828,889 ------------ ------------ OTHER ASSETS AND DEFERRED CHARGES................................................................ 125,080 82,106 ------------ ------------ $ 4,971,601 $ 4,200,969 ------------ ------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part of these statements. I-60 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, -------------------------- 1997 1996 ------------ ------------ (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Current portion of long-term debt and preferred shares........................................... $ 16,115 $ 38,197 Notes payable.................................................................................... 527,587 160,537 Accounts payable................................................................................. 239,783 205,427 Advance billings and customer deposits........................................................... 33,640 32,434 Accrued interest................................................................................. 18,284 11,777 Accrued taxes.................................................................................... 6,961 3,194 Accrued compensation............................................................................. 23,386 10,279 PCS microwave relocation costs................................................................... 7,354 17,046 Other............................................................................................ 32,775 30,376 ------------ ------------ 905,885 509,267 ------------ ------------ DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability................................................................ 202,680 183,792 Postretirement benefits obligation other than pensions........................................... 11,364 11,451 Other............................................................................................ 21,602 19,663 ------------ ------------ 235,646 214,906 ------------ ------------ LONG-TERM DEBT, excluding current portion........................................................ 1,264,218 982,232 ------------ ------------ REDEEMABLE PREFERRED SHARES, excluding current portion........................................... 180 280 ------------ ------------ MINORITY INTEREST in subsidiaries................................................................ 416,566 432,343 ------------ ------------ COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (a)............................................................. 150,000 -- ------------ ------------ NONREDEEMABLE PREFERRED SHARES................................................................... 30,987 29,000 ------------ ------------ COMMON STOCKHOLDERS' EQUITY Common Shares, par value $1 per share; authorized 100,000,000 shares; issued and outstanding 54,443,260 and 54,237,180 shares, respectively.................................................. 54,443 54,237 Series A Common Shares, par value $1 per share; authorized 25,000,000 shares; issued and outstanding 6,936,277 and 6,916,546 shares, respectively........................................ 6,936 6,917 Common Shares issuable, 10,480 and 30,977 shares, respectively................................... 499 1,461 Capital in excess of par value................................................................... 1,664,432 1,661,093 Treasury Shares, at cost, 794,576 shares......................................................... (30,682) -- Retained earnings................................................................................ 272,491 309,233 ------------ ------------ 1,968,119 2,032,941 ------------ ------------ $ 4,971,601 $ 4,200,969 ------------ ------------ ------------ ------------
- --------- (a) As described in Note 9, the sole asset of TDS Capital I is $154.6 million principal amount of 8.5% subordinated debentures due 2037 from TDS. The accompanying notes to consolidated financial statements are an integral part of these statements. I-61 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
SERIES A COMMON CAPITAL IN COMMON COMMON SHARES EXCESS OF TREASURY RETAINED SHARES SHARES ISSUABLE PAR VALUE SHARES EARNINGS --------- ----------- --------- ------------ ---------- ----------- (DOLLARS IN THOUSANDS) BALANCE, DECEMBER 31, 1994.......................... $ 47,938 $ 6,887 $ 1,995 $ 1,288,453 $ -- $ 127,765 Net Income.......................................... -- -- -- -- -- 103,978 Dividends Common and Series A Common Shares................. -- -- -- -- -- (21,910) Preferred Shares.................................. -- -- -- -- -- (2,507) Acquisitions........................................ 2,948 -- -- 125,231 -- -- Dividend reinvestment, incentive and benefit plans.............................................. 186 18 -- 6,994 -- -- Conversion of Preferred Shares...................... 43 -- -- (2,962) -- -- Conversion of Series A Common Shares................ 12 (12) -- -- -- -- Shares issued pursuant to acquisition agreements.... 10 -- (499) 489 -- -- Other............................................... -- -- -- (692) -- -- --------- ----------- --------- ------------ ---------- ----------- BALANCE, DECEMBER 31, 1995.......................... 51,137 6,893 1,496 1,417,513 -- 207,326 Net Income.......................................... -- -- -- -- -- 128,139 Dividends Common and Series A Common Shares................. -- -- -- -- -- (24,274) Preferred Shares.................................. -- -- -- -- -- (1,958) Acquisitions........................................ 2,635 -- 464 110,648 -- -- Dividend reinvestment, incentive and benefit plans.............................................. 100 27 -- 4,487 -- -- Conversion of Preferred Shares...................... 352 -- -- 4,422 -- -- Conversion of Series A Common Shares................ 3 (3) -- -- -- -- Shares issued pursuant to acquisition agreements.... 10 -- (499) 489 -- -- Gain on sale of subsidiary stock.................... -- -- -- 114,056 -- -- Other............................................... -- -- -- 9,478 -- -- --------- ----------- --------- ------------ ---------- ----------- BALANCE, DECEMBER 31, 1996.......................... 54,237 6,917 1,461 1,661,093 -- 309,233 Net (Loss).......................................... -- -- -- -- -- (9,549) Dividends Common and Series A Common Shares................. -- -- -- -- -- (25,300) Preferred Shares.................................. -- -- -- -- -- (1,893) Acquisitions........................................ -- -- -- 3,601 39,084 -- Repurchase Common Shares............................ -- -- -- -- (69,942) -- Dividend reinvestment, incentive and benefit plans.............................................. 122 19 -- 4,707 176 -- Conversion of Preferred Shares...................... 68 -- -- 1,419 -- -- Shares issued pursuant to acquisition agreements.... 16 -- (723) 707 -- -- Other............................................... -- -- (239) (7,095) -- -- --------- ----------- --------- ------------ ---------- ----------- BALANCE, DECEMBER 31, 1997.......................... $ 54,443 $ 6,936 $ 499 $ 1,664,432 $ (30,682) $ 272,491 --------- ----------- --------- ------------ ---------- ----------- --------- ----------- --------- ------------ ---------- -----------
The accompanying notes to consolidated financial statements are an integral part of these statements. I-62 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--PROPOSED CORPORATE RESTRUCTURING The Board of Directors of Telephone and Data Systems, Inc. (the "Board") has adopted a proposal which, if approved by shareholders and implemented by the Board, would authorize the Board to issue three new classes of common stock and change the state of incorporation of the Company from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of the Company's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). The Tracking Stocks are intended to result in greater market recognition of the value (individually and collectively) of the Company and of the Company's three principal business groups ("Tracking Groups"), thereby enhancing shareholder value over the long term, while at the same time enabling the Company's businesses to preserve the benefits of being part of a consolidated enterprise. The Tracking Stock Proposal is expected to: - provide the Company with greater flexibility in raising capital and making acquisitions, using equity securities specifically related to the Tracking Groups, - enable the Company to more effectively tailor employee benefit plans to provide incentives to employees of the Tracking Groups, - provide shareholders with the opportunity to invest in separate securities that specifically reflect the underlying businesses, depending upon their investment objectives, and - permit shareholders to continue to invest in all of the TDS businesses through the Common Shares and the Series A Common Shares. The Cellular Group Shares, when issued, are intended to reflect the separate performance of the Cellular Group, which consists of the Company's interest in United States Cellular Corporation, a subsidiary of the Company. The Telecom Group Shares, when issued, are intended to reflect the separate performance of the Telecom Group, which primarily consists of the Company's interest in TDS Telecommunications Corporation, a subsidiary of the Company. The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Group, which consists of the Company's interest in Aerial Communications, Inc., a subsidiary of the Company. Subject to approval of the Tracking Stock Proposal by shareholders, the Company intends to: - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group, - issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by the Company, subject to approval by the board of directors and the shareholders of U.S. Cellular (the "U.S. Cellular Merger"), - issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by the Company, subject to approval by the board of directors and the shareholders of Aerial (the "Aerial Merger"), and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of the Company (the "Distribution"). It is currently expected that the Distribution would take place in July 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. The TDS Series A Common Shares and Common Shares will continue to be outstanding and are intended to reflect the performance of the Cellular Group, the Telecom Group and the Aerial Group to the extent of the Retained Interest in the respective groups, and to reflect the performance of the other assets and businesses attributed to the TDS Group. For additional information regarding the Tracking Stock Proposal, see "Proposed Corporate Restructuring" in Management's Discussion and Analysis of Results of Operations and Financial Condition. I-63 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 1--PROPOSED CORPORATE RESTRUCTURING (CONTINUED) PRO FORMA EARNINGS PER SHARE Pro forma net income attributable to the United States Cellular Group, the TDS Telecommunications Group, the Aerial Communications Group and to the TDS Group through Retained Interest assumes that the U.S. Cellular Merger, Aerial Merger and the Telecom Public Offering has not taken place and therefore 75% of net income of each Group (except for the TDS Group) is attributable to the United States Cellular Group Shares, the TDS Telecommunications Group Shares and the Aerial Communications Group Shares and 25% of net income is attributable to the Retained Interest for the TDS Group. A portion of the net income in the United States Cellular Group and the Aerial Communications Group is allocated to the minority public shareholders of the respective Groups prior to attributing the net income to the Groups and the TDS Group through Retained Interest. NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Telephone and Data Systems, Inc. ("TDS" or "the Company") is a diversified telecommunications company which, at December 31, 1997, provided high-quality telecommunications services to approximately 3.2 million cellular telephone, telephone, personal communications services ("PCS") and radio paging customers in 37 states and the District of Columbia. The Company conducts substantially all of its cellular telephone operations through its currently 81.1%-owned subsidiary, United States Cellular Corporation, its telephone operations through its currently wholly owned subsidiary, TDS Telecommunications Corporation, its PCS operations through its currently 82.5%-owned subsidiary, Aerial Communicatons, Inc., and its radio paging operations through its currently 81.9%-owned subsidiary, American Paging, Inc. ("American Paging"). See Note 14--Business Segment Information for summary financial information on each business segment. The Company has an agreement with a nonaffiliated third party to contribute assets and certain liabilities of American Paging to a newly formed company. See Note 5--Acquisitions, Exchanges and Divestitures. BASIS OF PRESENTATION The financial statements of the Groups comprise all of the accounts included in the corresponding consolidated financial statements of Telephone and Data Systems, Inc. The separate Cellular Group, Telecom Group, Aerial Group and TDS Group financial statements give effect to the management and accounting policies that would be applicable upon implementation of the Tracking Stock Proposal. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, TDS intends to terminate certain intercompany agreements between the Company and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the relationships between the Company and such subsidiaries would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The separate Group financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (1) the historical financial position, results of operations and cash flows of the businesses that comprise each of the Groups, (2) any assets and liabilities (including contingent liabilities) which have been attributed to any Group from any other Group, and (3) with respect to the TDS Group, the Retained Interest in each of the Tracking Groups. The effects of the issuance of the Tracking Stocks have not been reflected in these historical financial statements. Financial effects arising from the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group that affect the consolidated results of operations or financial condition of the Company could affect the results of operations or financial condition of the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, or could affect the market price of any or all classes of Common Stock. In addition, any net losses of the Company or the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends I-64 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) on any class of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group financial information. The management and accounting policies applicable to the preparation of the financial statements of the TDS Group could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of Telephone and Data Systems, Inc. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. Following the Distribution, subject to the legal and contractual restrictions on the payment of dividends, the Board currently intends to establish an annual dividend on the TDS Common Shares and Series A Common Shares in an amount equal to $.10 per share. The Board also currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $.48 per share. (Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, the dividend on Telecom Group Shares would equate to a per share dividend of $.32 per existing Common Share and Series A Common Share. The total of the dividend on TDS Common Shares and Series A Common Shares of $.10 and the equivalent dividend on Telecom Group Shares of $.32 equals the existing current annual dividend on the existing Common Shares and Series A Common Shares of $.42.) With regard to the Cellular Group Shares and the Aerial Group Shares, the Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. Future dividends on the shares of common stock will be payable when, as and if declared by the Board out of the lesser of (1) all funds of TDS legally available therefor and (2) the available dividend amount with respect to the relevant Group. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $1,222 million for the Cellular Group, $287 million for the Telecom Group and $144 million for the Aerial Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. With respect to the TDS Group, the Available Dividend Amount (approximately $602 million as of December 31, 1997) is an amount approximately equal to the greater of a) an amount (approximately $313 million) which is approximately equal to the Surplus of TDS less the sum of all Available Dividend Amounts of all Tracking Groups or b) an amount (approximately $602 million) which is approximately equal to the TDS Group Equity and Preferred Stock less the par or stated value of all Common and Series A Common Shares and Preferred Shares outstanding. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. I-65 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PRINCIPLES OF CONSOLIDATION The accounting policies of TDS conform to generally accepted accounting principles. The consolidated financial statements include the accounts of TDS, its majority-owned subsidiaries since acquisition and the cellular partnerships in which TDS has a majority general partnership interest. All material intercompany items have been eliminated. Investments in entities in which the Company does not have a controlling interest are generally accounted for using the equity method. TDS includes as investments in subsidiaries the value of the consideration given and all direct and incremental costs relating to acquisitions accounted for as purchases. All costs relating to unsuccessful negotiations for acquisitions are expensed. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts reported in prior years have been reclassified to conform to current period presentation. CASH AND CASH EQUIVALENTS AND TEMPORARY INVESTMENTS Cash and cash equivalents include cash and those short-term, highly-liquid investments with original maturities of three months or less. Those investments with original maturities of more than three months to 12 months are classified as temporary investments. Temporary investments are stated at cost. Those investments with original maturities of more than 12 months are classified as marketable securities and are stated at amortized cost. The carrying amounts of Cash and Cash Equivalents and Temporary Investments approximate fair value due to the short-term nature of these investments. INVESTMENTS Cellular license costs consist of costs incurred in acquiring Federal Communications Commission ("FCC") licenses or minority interests which have been awarded FCC licenses to provide cellular service. These costs include amounts paid to license applicants and owners of interests in cellular entities awarded licenses and all direct and incremental costs relating to acquiring the licenses. These costs are capitalized and amortized through charges to expense over 40 years upon commencement of operations. Amortization amounted to $29.8 million, $28.5 million and $27.8 million in 1997, 1996 and 1995, respectively. Accumulated amortization of cellular license costs was $129.6 million and $112.2 million at December 31, 1997 and 1996, respectively. Included in cellular license costs is approximately $281 million and $322 million at December 31, 1997 and 1996, respectively, of goodwill related to various acquisitions structured to be tax-free. Cellular minority interests consist of cellular entities in which TDS holds a minority interest. The Company follows the equity method of accounting, which recognizes TDS's proportionate share of the income and losses accruing to it under the terms of its partnership or shareholder agreements where the Company's ownership interest equals or exceeds 3% ($135.5 million and $196.0 million at December 31, 1997 and 1996, respectively). Income and losses from these entities are reflected in the consolidated income statements on a pretax basis. At December 31, 1997, the cumulative share of income from minority cellular investments accounted for under the equity method was $263.3 million, of which $121.9 million was undistributed. The cost method of accounting is followed for certain minority interests where the Company's ownership interest is less than 3% ($2.8 million and $10.4 million at December 31, 1997 and 1996, respectively). Broadband PCS license costs consist of costs incurred in acquiring PCS licenses ($284.9 million) and capitalized interest ($39.7 million). These costs are amortized over 40 years upon commencement of operations. Amortization amounted to $4.7 million in 1997. Accumulated amortization of Broadband PCS license costs was $4.7 million at December 31, 1997. I-66 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Franchise and other costs include the costs in excess of the underlying book value of acquired telephone companies. Costs aggregating $209.1 million and $205.1 million at December 31, 1997 and 1996, respectively, relating to acquisitions since November 1, 1970, are being amortized on a straight-line basis over a 40-year period. Amortization amounted to $5.2 million, $4.9 million and $4.4 million in 1997, 1996 and 1995, respectively. Accumulated amortization of excess cost was $34.9 million and $29.6 million at December 31, 1997 and 1996, respectively. Costs in excess of the underlying book value relating to acquisitions initiated before November 1, 1970, aggregating $6.5 million, are not being amortized. Included in franchise and other costs is approximately $135 million and $143 million at December 31, 1997 and 1996, respectively, of goodwill related to various acquisitions structured to be tax-free. Other investments consist of the following:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Narrowband PCS license costs........................................................................ $ 60,304 $ 60,304 Minority investments................................................................................ 25,073 23,633 Long-term notes receivable.......................................................................... 10,691 14,974 Rural Telephone Bank Stock, at cost................................................................. 7,175 6,639 Marketable equity securities........................................................................ 1,621 2,673 Marketable non-equity securities.................................................................... 31,024 29,735 Other............................................................................................... 6,825 6,882 ----------- ----------- $ 142,713 $ 144,840 ----------- ----------- ----------- -----------
At December 31, 1997, the cumulative share of income from minority investments accounted for under the equity method was $6.3 million, of which $3.9 million was undistributed. The Company's investment in debt securities with original maturities of more than 12 months are classified as marketable non-equity securities and held-to-maturity. They are stated at amortized cost. Information regarding the Company's marketable non-equity securities is summarized below.
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Held-to-Maturity U.S. Treasury and other U.S. government corporations and agencies Aggregate Fair Value Current.......................................................................................... $ 10,025 $ 46,622 Noncurrent....................................................................................... 31,921 29,882 Amortized Cost Basis Current.......................................................................................... 10,529 46,603 Noncurrent....................................................................................... 31,024 29,735 Gross Unrealized Holding Gains..................................................................... 393 174 Gross Unrealized Holding Losses.................................................................... $ -- $ 8
The noncurrent investments have contractual maturities of more than one to five years at December 31, 1997 and 1996. No sales or transfers of securities classified as held-to-maturity occurred during 1997 and 1996. IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Company implemented the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Under SFAS No. 121, the Company is required to review long-lived assets and certain identifiable I-67 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) intangibles for impairment whenever events or changes in circumstances indicate that the book value of a long-lived asset is not recoverable. An impairment loss would be recognized whenever the review demonstrates that the book value of a long-lived asset is not recoverable. The implementation of SFAS No. 121 did not have an impact on the Company's financial position or results of operations. REVENUE RECOGNITION TDS's revenues are recognized when earned. TDS's telephone subsidiaries participate in revenue pools with other telephone companies for interstate revenue and for certain intrastate revenue. Such pools are funded by toll revenue and/or access charges within state jurisdiction and by access charges in the interstate market. Revenues earned through the various pooling processes are initially recorded based on the Company's estimates. ADVERTISING COSTS The Company expenses advertising costs as incurred. EARNINGS PER COMMON SHARE The Company adopted SFAS No. 128, "Earnings per Share," effective December 31, 1997. Earnings per Common Share amounts for 1996 and 1995 have been restated to conform to current period presentation. The effect of this accounting change was to increase Earnings per Common Share--Basic by $.01 and $.03 in 1996 and 1995, respectively. The adoption of SFAS No. 128 had no effect on Earnings per Common Share--Diluted. The amounts used in computing Earnings per Common Share and the effect on income and the weighted average number of Common and Series A Common Shares of dilutive potential common stock are as follows:
YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1996 1995 ---------- ----------- ----------- (DOLLARS AND SHARES IN THOUSANDS) Net Income (Loss)...................................................................... $ (9,549) $ 128,139 $ 103,978 Less: Preferred Dividends.............................................................. (1,892) (1,957) (2,509) ---------- ----------- ----------- Net Income (Loss) Available to Common used in Earnings per Share-- Basic............... (11,441) 126,182 101,469 Reduction in preferred dividends if Preferred Shares converted into Common Shares...... -- 671 998 Minority Income Adjustment............................................................. (100) (152) (271) ---------- ----------- ----------- Net Income (Loss) Available to Common used in Earnings per Share-- Diluted............. $ (11,541) $ 126,701 $ 102,196 ---------- ----------- ----------- ---------- ----------- ----------- Weighted Average Number of Common Shares used in Earnings per Share--Basic............. 60,211 60,464 57,456 Effect of Dilutive Securities: Common Shares outstanding if Preferred Shares converted.............................. -- 543 1,033 Stock Options and Stock Appreciation Rights.......................................... -- 165 159 Common Shares issuable............................................................... -- 28 33 ---------- ----------- ----------- Weighted Average Number of Common Shares used in Earnings per Share--Diluted........... 60,211 61,200 58,681 ---------- ----------- ----------- ---------- ----------- -----------
For 1997, Preferred Shares convertible into 917,000 Common Shares, 130,000 stock options and stock appreciation rights and 15,000 Common Shares issuable in the future were not included in computing diluted Earnings per Common Share because their effects were antidilutive. For 1996 and 1995, Preferred Shares convertible into 428,000 and 477,000 Common Shares, respectively, were not included in computing diluted Earnings per Common Share because their effects were antidilutive. I-68 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The minority income adjustment reflects the additional minority share of U.S. Cellular's income computed as if all of U.S. Cellular's issuable securities were outstanding. SUPPLEMENTAL CASH FLOW DISCLOSURES Following are supplemental cash flow disclosures for interest and income taxes paid, acquisitions and certain noncash transactions.
YEAR ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- ----------- --------- (DOLLARS IN THOUSANDS) Interest paid............................................................................ $ 70,741 $ 52,835 $ 49,475 Income taxes paid........................................................................ 10,743 67,967 60,515 Common Shares issued for conversion of Preferred Shares.................................. 1,487 4,602 948 Increase in PCS network equipment and prepaid infrastructure costs through the issuance of long-term debt and interim financing................................................ 84,335 100,000 -- Additions to property, plant and equipment financed through accounts payable and accrued expenses............................................................................... $ 46,104 $ 87,109 $ 3,943
TDS has acquired operating telephone companies, certain cellular licenses and operating companies and certain other assets since January 1, 1995. In conjunction with these acquisitions, the following assets were acquired and liabilities assumed, and Common Shares and Preferred Shares issued:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Property, plant and equipment.......................................................... $ 120,365 $ 55,692 $ 56,132 Cellular licenses...................................................................... 137,409 95,447 129,510 (Decrease) increase in investment in cellular minority interests....................... (89,205) (3,641) 977 Franchise and other costs.............................................................. 2,452 17,679 25,657 Long-term debt......................................................................... (4,857) (22,979) (9,254) Deferred credits....................................................................... 1,104 (6,205) (538) Other assets and liabilities, excluding cash and cash equivalents...................... 7,396 8,188 (8,084) Common Shares issued and issuable...................................................... (42,685) (113,128) (127,836) Preferred Shares issued................................................................ (3,000) -- -- U.S. Cellular Common Shares issued and issuable........................................ -- (34) (12,794) ----------- ----------- ----------- Decrease in cash due to acquisitions................................................... $ 128,979 $ 31,019 $ 53,770 ----------- ----------- ----------- ----------- ----------- -----------
I-69 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3--INCOME TAXES TDS files a consolidated federal income tax return. Income tax provisions charged to net income are summarized as follows:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---------- ------------ ------------ (DOLLARS IN THOUSANDS) Current: Federal............................................................................ $ 4,533 $ 31,356 $ 44,690 State.............................................................................. 6,790 17,275 16,736 Deferred: Federal............................................................................ 13,302 67,040 19,253 State.............................................................................. 4,453 10,072 2,386 Amortization of deferred investment tax credits...................................... (519) (2,097) (2,036) ---------- ------------ ------------ Total income tax expense............................................................. $ 28,559 $ 123,646 $ 81,029 ---------- ------------ ------------ ---------- ------------ ------------
Investment tax credits resulting from investments in telephone plant and equipment have been deferred and are being amortized over the service lives of the related property. A reconciliation of income tax expense and the amount computed by applying the statutory federal income tax rate (35%) to income before income taxes is as follows:
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ----------- --------- (DOLLARS IN THOUSANDS) Statutory federal income tax rate........................................................ $ 6,653 $ 88,125 $ 64,752 State income taxes, net of federal benefit............................................... 6,958 17,358 12,067 Amortization of license acquisition costs and costs in excess of book value.............. 5,276 4,280 4,440 Dividend exclusion and other permanent items............................................. 752 377 (250) Amortization of deferred investment tax credits.......................................... (519) (2,014) (1,850) Effects of corporations not included in consolidated federal tax return.................. 1,409 2,351 2,035 Sale of cellular interests............................................................... 5,549 12,337 -- Rate difference of federal net operating loss............................................ 1,246 -- -- Regulatory adjustment.................................................................... 101 624 595 Deferred investment tax credit........................................................... 399 365 197 Other differences, net................................................................... 735 (157) (957) ---------- ----------- --------- Income tax expense....................................................................... $ 28,559 $ 123,646 $ 81,029 ---------- ----------- --------- ---------- ----------- ---------
Deferred income taxes are provided for the temporary differences between the amount of the Company's assets and liabilities for financial reporting purposes and their tax bases. The Company's current net deferred tax assets totaled $3.7 million and $2.7 million as of December 31, 1997 and 1996, respectively. The net current deferred tax asset primarily represents the deferred tax effects of unearned revenues. I-70 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3--INCOME TAXES (CONTINUED) The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of December 31, 1997 and 1996, are as follows:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Deferred Tax Asset: Net operating loss carryforwards.................................................................. $ 55,363 $ 17,055 Taxes on acquisitions............................................................................. 54,134 -- Alternative minimum tax credit carryforward....................................................... 21,205 10,433 Postretirement benefits........................................................................... 4,819 4,819 Amortization of deferred charges.................................................................. 1,614 10,990 Other............................................................................................. 3,511 4,069 ----------- ----------- 140,646 47,366 Less valuation allowance............................................................................ (29,001) (16,891) ----------- ----------- Net Deferred Tax Asset............................................................................ 111,645 30,475 ----------- ----------- Deferred Tax Liability: Property, plant and equipment..................................................................... 134,672 86,056 Investment in equity securities................................................................... 64,603 40,540 Licenses.......................................................................................... 55,756 38,656 Partnership investments........................................................................... 25,687 26,965 Capitalized interest.............................................................................. 18,721 17,810 Other............................................................................................. 14,886 4,240 ----------- ----------- Total Deferred Tax Liability........................................................................ 314,325 214,267 ----------- ----------- Net Deferred Income Tax Liability................................................................. $ 202,680 $ 183,792 ----------- ----------- ----------- -----------
At December 31, 1997, TDS had $21.2 million of federal alternative minimum tax credit carryforward available to offset regular income tax payable in future years. TDS had $60.5 million of federal net operating loss carryforward (generating a $19.9 million deferred tax asset) at December 31, 1997, expiring in 2012 which is available to offset future consolidated taxable income. In addition, TDS had $496.7 million of state net operating loss carryforward (generating a $35.5 million deferred tax asset) at December 31, 1997, expiring between 1997 and 2012 which is available to offset future taxable income primarily of the individual subsidiaries which generated the loss. A valuation allowance was established for the state operating loss carryforwards since it is more likely than not that a portion will expire before such carryforwards can be utilized. NOTE 4--PROPERTY PLANT AND EQUIPMENT CELLULAR Cellular property, plant and equipment is stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property, plant and equipment was 10.3%, 10.4% and 10.0% in 1997, 1996 and 1995, respectively. I-71 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED) Cellular property, plant and equipment in service and under construction consists of:
DECEMBER 31, -------------------------- 1997 1996 ------------- ----------- (DOLLARS IN THOUSANDS) Operating plant and equipment..................................................................... $ 923,480 $ 641,600 Buildings and leasehold improvements.............................................................. 136,023 86,533 Office furniture, equipment and vehicles.......................................................... 89,987 71,674 Land.............................................................................................. 63,085 46,198 ------------- ----------- $ 1,212,575 $ 846,005 ------------- ----------- ------------- -----------
TELEPHONE Telephone property, plant and equipment is stated at the original cost of construction including the capitalized costs of certain taxes, payroll-related expenses, and an allowance for funds used during construction ("AFUDC"). AFUDC, a noncash item of nonoperating income, totaled $686,000, $825,000 and $682,000 in 1997, 1996 and 1995, respectively. The composite weighted average rates were 5.5%, 7.3% and 9.3% in 1997, 1996 and 1995, respectively. The amount of such allowance has varied principally as a result of changes in the level of construction work in process and in the cost of capital. Renewals and betterments of units of property are added to telephone plant in service. The original cost of depreciable property retired is removed from plant in service and, together with removal cost less any salvage realized, is charged to accumulated depreciation. Repairs and renewals of minor items of property are included in plant operations expense. No gain or loss is recognized on ordinary retirements of depreciable telephone property. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. Composite depreciation rates, as applied to the average cost of depreciable property were 7.4%, 7.2% and 7.1% in 1997, 1996 and 1995, respectively. Telephone property, plant and equipment in service and under construction consists of:
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) Land and buildings.............................................................................. $ 67,203 $ 67,181 Central office equipment........................................................................ 399,016 372,008 Cable and wire.................................................................................. 719,945 639,537 Furniture and office equipment.................................................................. 112,921 77,046 Vehicles and other equipment.................................................................... 42,632 39,928 Plant under construction........................................................................ 52,677 59,213 Non-regulated investments and other............................................................. 26,496 38,866 ------------- ------------- $ 1,420,890 $ 1,293,779 ------------- ------------- ------------- -------------
The Company's telephone operations follow accounting for regulated enterprises prescribed by SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." Management periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. Management believes that such criteria are still being met and therefore has no current plans to change its method of accounting. In analyzing the effect of discontinuing the application of SFAS No. 71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally accepted accounting principles and therefore, any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. I-72 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED) PCS PCS property, plant and equipment is stated at original cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property, plant and equipment was 10.9%, 20.2% and 2.2% in 1997, 1996 and 1995, respectively. PCS property, plant and equipment in service and under construction consists of:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Network............................................................................................. $ 514,525 $ -- Information systems................................................................................. 83,950 15,951 Office equipment.................................................................................... 15,800 3,180 Leasehold improvements and other.................................................................... 8,466 1,442 Work in process..................................................................................... 19,381 233,830 Prepaid network infrastructure costs................................................................ -- 70,300 ----------- ----------- $ 642,122 $ 324,703 ----------- ----------- ----------- -----------
Work in process includes expenditures for the design, construction and testing of the Company's PCS networks as well as the cost to relocate dedicated private microwave links currently operating in the Company's spectrum in its PCS markets. Work in process also includes the costs associated with developing information systems. The Company capitalized interest on certain of its work in process expenditures totaling $6.0 million and $1.2 million in 1997 and 1996, respectively. When assets are placed in service, the Company transfers the assets to the appropriate property and equipment category. Prepaid network infrastructure costs include the excess of the proceeds from the sale of notes over the Company's current obligations (i.e. financed purchases under a Credit Agreement with Nokia Telecomunications, Inc.) to Nokia. The Company paid Nokia for a portion of 1997 equipment purchases by reducing the amount of the prepaid balance by the cost of the equipment purchased. Nokia paid the Company monthly interest on the unused portion of the note proceeds. RADIO PAGING Radio Paging property, plant and equipment is stated at original cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property, plant and equipment was 24.6%, 27.9% and 22.1% in 1997, 1996 and 1995, respectively. Radio Paging property, plant and equipment in service and under construction consists of:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Subscriber devices.................................................................................. $ 41,059 $ 39,714 Terminals and transmitters.......................................................................... 48,181 44,251 Computer equipment.................................................................................. 16,402 16,595 Furniture and fixtures.............................................................................. 10,515 10,314 Other............................................................................................... 2,118 2,126 ----------- ----------- $ 118,275 $ 113,000 ----------- ----------- ----------- -----------
I-73 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 4--PROPERTY PLANT AND EQUIPMENT (CONTINUED) OTHER Other property, plant and equipment is stated at original cost. Depreciation is provided using the straight-line method over the estimated useful lives of assets. The provision for depreciation as a percentage of depreciable property, plant and equipment was 12.3%, 15.9% and 10.0% in 1997, 1996 and 1995, respectively. Other property, plant and equipment in service and under construction consists of:
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Computer equipment..................................................................................... $ 54,062 $ 42,682 Furniture and fixtures................................................................................. 18,710 15,772 Cable, printing and other equipment.................................................................... 12,138 11,737 Work in progress....................................................................................... 11,899 5,055 Capital leases......................................................................................... -- 7,535 --------- --------- $ 96,809 $ 82,781 --------- --------- --------- ---------
Certain costs relating to the development of computer software for internal use are capitalized and are amortized over the estimated five-year life of the software. NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES During 1997, 1996 and 1995, TDS and its subsidiaries completed the following business combinations:
CONSIDERATION ----------------------------- TDS AND USM COMMON STOCK, AND TDS CASH PREFERRED SHARES ----------- ---------------- (DOLLARS IN THOUSANDS) Acquisitions During 1997 Cellular interests........................................................................... $ 128,828 $ 32,486 Telephone interests.......................................................................... 151 13,200 Acquisitions During 1996 Cellular interests........................................................................... $ 13,596 $ 42,499 Telephone interests.......................................................................... 17,423 70,663 Acquisitions During 1995 Cellular interests........................................................................... $ 41,885 $ 94,542 Telephone interests.......................................................................... 250 46,087 Paging interests............................................................................. 5,656 -- ----------- --------
Assuming that these acquisitions had taken place on January 1, 1996, unaudited pro forma results of operations from continuing operations would have been as follows:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Operating Revenues.............................................................................. $ 1,576,361 $ 1,277,309 Net Income...................................................................................... 11,680 142,078 Earnings per Common Share--Basic................................................................ .19 2.29 Earnings per Common Share--Diluted.............................................................. $ .19 $ 2.27 ------------- -------------
I-74 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES (CONTINUED) EXCHANGE OF MARKETS WITH BELLSOUTH In October 1997, U.S. Cellular completed an exchange with BellSouth Corporation. Pursuant to the exchange, U.S. Cellular received majority interests representing approximately 4.0 million population equivalents in exchange for majority interests representing 2.0 million population equivalents, minority interests representing 1.2 million population equivalents and a net amount of $86.7 million in cash. The majority interests U.S. Cellular received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters. SALES OF CELLULAR AND OTHER INVESTMENTS The $41.4 million gain in 1997 reflects the sales of non-strategic cellular and other investments. U.S. Cellular sold its majority interests in one market and one market partition, minority interests in two other markets and received cash from the settlement of a legal matter. These sales, along with the sales of certain other investments by TDS, generated net cash proceeds of $84.2 million. The $138.7 million gain in 1996 reflects the sales of non-strategic cellular and other investments. U.S. Cellular sold its majority interests in eight markets and minority interests in two other markets, received cash from the settlement of two separate legal matters and received cash in an exchange of markets with another cellular operator. Aerial sold its majority interests in two markets. These transactions, along with the sales of certain other investments by TDS, generated net cash proceeds of $221.5 million. The $86.6 million gain in 1995 reflects the sales and exchanges of non-strategic cellular and other investments. U.S. Cellular sold its majority interests in six markets and its minority interests in six markets during 1995. These sales, along with the sales of marketable equity securities and certain other investments by TDS, generated net cash proceeds of $197.6 million. PENDING SALES OF MINORITY INTERESTS In December 1997, the Company announced that AirTouch Communications, Inc. ("AirTouch") will acquire interests owned by U.S. Cellular and TDS in cellular systems in 11 markets. AirTouch will issue approximately 5,000,000 shares of its common stock and pay approximately $54.2 million in cash to U.S. Cellular and TDS in exchange for these interests, which represent approximately 900,000 population equivalents. U.S. Cellular has also entered into an agreement to sell its minority interests in two other markets for $37.6 million in cash. Management expects that it will record a significant pretax gain upon the completion of the sales transaction. The sales are expected to be completed in the first half of 1998. AMERICAN PAGING MERGER In December 1997, the Company announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. On February 10, 1998, the board of directors of American Paging approved a merger agreement providing for the acquisition by TDS of all of the issued and outstanding shares of American Paging not owned by TDS for cash in an amount equal to $2.50 per share, approximately $9.1 million in total. Upon consummation of the merger, TDS will contribute substantially all of the assets and certain, limited liabilities of American Paging, and TSR will contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company. TDS will not have any funding requirements once the combination is completed. I-75 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 5--ACQUISITIONS, EXCHANGES AND DIVESTITURES (CONTINUED) The following table summarizes the assets and liabilities which TDS would contribute to the new company.
DECEMBER 31, 1997 -------------------- (DOLLARS IN THOUSANDS) Current assets Cash.................................................................................................. $ 3,058 Temporary investments................................................................................. 61 Accounts receivable................................................................................... 9,051 Inventory............................................................................................. 6,851 Other................................................................................................. 1,076 Property, plant and equipment, net...................................................................... 41,762 Narrowband PCS license.................................................................................. 60,901 Other investments....................................................................................... 429 Deferred assets......................................................................................... 10,959 Current liabilities Accounts payable...................................................................................... (942) Advance billings and customer deposits................................................................ (6,827) Accrued taxes......................................................................................... (42) ---------- $ 126,337 ---------- ----------
NOTE 6--NOTES PAYABLE TDS has used short-term debt to finance its investments in PCS and radio paging operations, for acquisitions and for general corporate purposes. Long-term debt and equity financing from time to time, including sales of debt and equity securities by subsidiaries, have reduced such short-term debt. Proceeds from the issuance of long-term debt and equity securities retired $241.4 million, $131.2 million and $131.4 million of short-term debt in 1997, 1996 and 1995, respectively. Proceeds from the sales of non-strategic cellular and other investments from time to time in 1997, 1996 and 1995 have also been used to retire short-term debt. TDS had $644.2 million of bank lines of credit for general corporate purposes at December 31, 1997, all of which were committed. Unused amounts of such lines totaled $117.9 million, all of which were committed. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate. U.S. Cellular had $500.0 million of bank lines of credit for general corporate purposes as of December 31, 1997, all of which were unused. These line of credit agreements provide for borrowings at the London InterBank Offered Rate ("LIBOR") plus 26.5 basis points, due quarterly. The carrying amount of short-term debt approximates fair value due to the short-term nature of these instruments. Information concerning notes payable is shown in the table below:
DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Balance at end of period......................................................... $ 527,587 $ 160,537 $ 184,320 Weighted average interest rate at end of period.................................. 6.3% 6.0% 6.3% Maximum amount outstanding during the period..................................... $ 587,683 $ 204,140 $ 184,320 Average amount outstanding during the period (1)................................. $ 407,965 $ 112,341 $ 139,671 Weighted average interest rate during the period (1)............................. 6.1% 5.8% 6.4% ----------- ----------- -----------
- --------- (1) The average was computed based on month-end balances. I-76 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7--LONG-TERM DEBT Long-term debt is as follows:
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) Telephone and Data Systems, Inc. (Parent) Medium-term notes, 8% to 10%, due through 2025................................................ $ 239,200 $ 239,200 Purchase contracts and other long-term notes, 9% to 14%, due through 2003..................... 2,440 3,175 ------------- ------------- Total Parent................................................................................ 241,640 242,375 ------------- ------------- Subsidiaries RUS, RTB and FFB Mortgage Notes, due through 2031, various rates averaging 5.5% in 1997, 5.4% in 1996 and 5.4% in 1995.................................................................... 313,012 308,371 ------------- ------------- 6% zero coupon convertible redeemable debentures, maturing in 2015............................ 745,000 745,000 Unamortized discount.......................................................................... (479,670) (494,893) ------------- ------------- 265,330 250,107 ------------- ------------- 7.25% notes, maturing in 2007................................................................. 250,000 -- ------------- ------------- Vendor financing, approximating 90-day Commercial Paper Rate plus 1.4% due through 2002....... -- 103,654 ------------- ------------- 8.34% zero coupon notes, maturing in 2006..................................................... 226,245 226,245 Unamortized discount.......................................................................... (114,161) (122,502) ------------- ------------- 112,084 103,743 ------------- ------------- Interim vendor financing...................................................................... 84,355 -- ------------- ------------- Other long-term notes, 0% to 12.6%, due through 2009.......................................... 12,613 10,601 ------------- ------------- Total Subsidiaries.......................................................................... 1,037,394 776,476 ------------- ------------- Total long-term debt............................................................................ 1,279,034 1,018,851 ------------- ------------- Less current portion.......................................................................... 14,816 36,619 ------------- ------------- Total long-term debt............................................................................ $ 1,264,218 $ 982,232 ------------- ------------- ------------- -------------
The Medium-Term Notes ("MTNs") carry original maturities of 12 to 30 years, maturing at various times from 2003 to 2025. The MTNs may be redeemed by the Company at par value beginning in 1999. The RUS, RTB and FFB Mortgage Notes issued under certain loan agreements with the Rural Utilities Service ("RUS"), Rural Telephone Bank ("RTB") and Federal Financing Bank ("FFB"), agencies of the United States of America, are to be repaid in equal monthly or quarterly installments covering principal and interest beginning six months to three years after dates of issue and expiring through 2031. Substantially all telephone plant is pledged under RUS and RTB mortgage notes and various other obligations of the telephone subsidiaries. U.S. Cellular sold $745 million principal amount at maturity of 20-year zero coupon 6% yield to maturity convertible redeemable debt in June 1995 with proceeds to the Company of $221.5 million. The unsecured notes are due in 2015 and there is no periodic payment of interest. The notes are convertible at any time into 9.475 U.S. Cellular Common Shares per $1,000 of notes. Beginning in 2000, U.S. Cellular may redeem, or the holder may call, the notes at the issue price plus accrued interest. U.S. Cellular sold $250 million principal amount of 7.25% unsecured senior notes in 1997 with proceeds to the Company of $247.0 million. The notes are due 2007 and interest is payable semi-annually. Beginning 2004, U.S. Cellular may redeem the notes at principal amount plus accrued interest. U.S. Cellular used a portion of the net proceeds to repay the outstanding vendor financing balance. I-77 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7--LONG-TERM DEBT (CONTINUED) U.S. Cellular had financing arrangements with an equipment vendor for cellular system equipment and construction costs. The borrowings were collateralized by a secured interest in some or all of the assets of U.S. Cellular's operating subsidiaries. Borrowings had terms of seven years at an interest rate of 1.4% over the 90-day Commercial Paper Rate (for a rate of 7.03% at December 31, 1996). Aerial sold $226 million principal amount at maturity of 10-year zero coupon 8.34% yield to maturity debt in 1996 at an issue price of $100 million. The unsecured notes are due in 2006 and there is no periodic payment of interest. The proceeds were paid to Aerial's equipment vendor in satisfaction of all then outstanding and future obligations up to $100 million. The notes are fully and unconditionally guaranteed by TDS. The notes are subject to optional redemption beginning in 2001 at redemption prices which reflect original issue discount accrued since issuance. The annual requirements for principal payments on long-term debt are approximately $14.8 million, $15.8 million, $15.6 million, $15.3 million and $15.2 million for the years 1998 through 2002, respectively. The carrying value and estimated fair value of the Company's Long-term Debt were approximately equal at December 31, 1997 and 1996, respectively. The fair value of the Company's long-term debt was estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. NOTE 8--MINORITY INTEREST IN SUBSIDIARIES The following table summarizes the minority shareholders' and partners' interests in the equity of consolidated subsidiaries.
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) U.S. Cellular U.S. Cellular shareholders'....................................................................... $ 305,478 $ 285,835 U.S. Cellular subsidiaries' partners'............................................................. 53,908 48,715 ----------- ----------- 359,386 334,550 Aerial shareholders'................................................................................ 33,692 75,897 TDS Telecom telephone subsidiaries'................................................................. 23,293 21,810 Other............................................................................................... 195 86 ----------- ----------- $ 416,566 $ 432,343 ----------- ----------- ----------- -----------
SALE OF STOCK BY SUBSIDIARIES Aerial issued 12.3 million Common Shares in 1996 in an initial public offering (at a price of $17 per share). The initial public offering reduced TDS's ownership percentage from 100% to 82.8%. The Aerial Common Share offering was recorded at a fair market value which was more than TDS's book value investment in Aerial. TDS adjusted its book value investment as a result of this issue and increased capital in excess of par value $114.1 million in 1996. NOTE 9-- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES In November 1997, TDS Capital I, a subsidiary trust (the "Trust") of TDS, issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities (the "Preferred Securities") at $25 per Preferred Security. Net proceeds from the issuance totaled $144.8 million and were used to retire short-term debt. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due December 31, 2037. There is a full and unconditional guarantee by TDS of the Trust's obligations under the I-78 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 9-- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (CONTINUED) Preferred Securities issued by the Trust. However, TDS's obligations are subordinate and junior in right of payment to certain other indebtedness of TDS. TDS has the right to defer payments of interest on the Subordinated Debentures by extending the interest payment period, at any time, for up to 20 consecutive quarters. If interest payments on the Subordinated Debentures are so deferred, distributions on the Preferred Securities will also be deferred. During any deferral, distributions will continue to accrue with interest thereon. In addition, during any such deferral, TDS may not declare or pay any dividend or other distribution on, or redeem or purchase, any of its common stock. The Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after November 18, 2002, or, in whole but not in part, at any time in the event of certain income tax circumstances. If the Subordinated Debentures are redeemed, the Trust must redeem Preferred Securities on a pro rata basis having an aggregate liquidation amount equal to the aggregate principal amount of the Subordinated Debentures so redeemed. In the event of the dissolution, winding up or termination of the Trust, the holders of Preferred Securities will be entitled to receive, for each Preferred Security, a liquidation amount of $25 plus accrued and unpaid distributions thereon to the date of payment, unless, in connection with the dissolution, winding up or termination, Subordinated Debentures are distributed to the holders of the preferred securities. NOTE 10--PREFERRED SHARES TDS Cumulative Voting Preferred Shares have a stated value of $100 per share. The 5,000,000 authorized Preferred Shares are issuable in series by the Board of Directors who establish the terms of the issue. Those issues which contain mandatory redemption features or which are redeemable at the option of the holder are classified as Redeemable Preferred Shares. Those issues which are not redeemable or which are redeemable at the option of TDS are classified as Nonredeemable Preferred Shares. REDEEMABLE PREFERRED SHARES Redeemable Preferred Shares include outstanding series of TDS Cumulative Voting Preferred Shares with mandatory redemption features or which are redeemable at the option of the holder. At December 31, 1997, 14,794 shares of Redeemable Preferred Shares were outstanding, redeemable at $100 per share. The annual requirements for redemption of Redeemable Preferred Shares are $1,299,100, $103,000 and $77,300 for the years 1998 through 2000, respectively. I-79 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10--PREFERRED SHARES (CONTINUED) The following is a schedule of the Redeemable Preferred Shares' activity.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Balance, beginning of period................................................................ $ 1,858 $ 15,093 $ 25,001 Add: Stock dividends........................................................................... -- 113 546 Less: Redemption of preferred................................................................... (359) (9,456) (9,608) Conversion of preferred................................................................... -- (3,872) -- Expiration of redemption feature.......................................................... (20) (20) (839) Change in redemption feature.............................................................. -- -- (7) --------- --------- --------- 1,479 1,858 15,093 Less current portion........................................................................ 1,299 1,578 13,506 --------- --------- --------- Balance, end of period...................................................................... $ 180 $ 280 $ 1,587 --------- --------- --------- --------- --------- ---------
NONREDEEMABLE PREFERRED SHARES Nonredeemable Preferred Shares include outstanding series of TDS Cumulative Voting Preferred Shares which have no mandatory redemption features. At December 31, 1997, 309,873 shares of Nonredeemable Preferred Shares were outstanding. Outstanding Nonredeemable Preferred Shares are generally redeemable at the option of TDS at $100 per share, plus accrued and unpaid dividends. At December 31, 1997, certain series of Preferred Shares are convertible into TDS Common Shares. (See Note 11--Convertible Preferred Shares) The following is a schedule of the Nonredeemable Preferred Shares activity.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Balance, beginning of period............................................................... $ 29,000 $ 29,710 $ 29,819 Add: Acquisition.............................................................................. 3,000 -- -- Reclassification from Redeemable Preferred Shares........................................ 20 20 839 Less: Conversion of preferred.................................................................. (1,031) (730) (948) Redemption of preferred.................................................................. (2) -- -- --------- --------- --------- Balance, end of period..................................................................... $ 30,987 $ 29,000 $ 29,710 --------- --------- --------- --------- --------- ---------
NOTE 11--COMMON STOCK COMMON STOCK ACQUISITIONS During 1997, 1996 and 1995, TDS issued 998,783, 2,634,408 and 2,947,777 Common Shares, respectively, for the acquisition of cellular and telephone interests. The 1997 Common Shares issued for acquisitions are reissued Treasury Shares. (See Common Share Repurchase Program) COMMON SHARES ISSUABLE A certain acquisition agreement requires TDS to deliver 10,480 Common Shares in 1998. I-80 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11--COMMON STOCK (CONTINUED) DIVIDEND REINVESTMENT, INCENTIVE AND COMPENSATION PLANS The following table summarizes Common and Series A Common Shares issued for the employee stock ownership plans and dividend reinvestment plans described below.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Common Shares Tax-deferred savings plan................................................................ 32,354 36,269 40,624 Dividend reinvestment plan............................................................... 25,273 28,827 105,001 Stock-based compensation plans........................................................... 64,367 35,273 40,025 --------- --------- --------- 121,994 100,369 185,650 --------- --------- --------- --------- --------- --------- Series A Common Shares Dividend reinvestment plan............................................................... 19,731 26,445 17,855 --------- --------- --------- --------- --------- ---------
TAX-DEFERRED SAVINGS PLAN. TDS had reserved 78,558 Common Shares for issue under the TDS Tax-Deferred Savings Plan, a qualified profit-sharing plan pursuant to Sections 401(a) and 401(k) of the Internal Revenue Code. Participating employees have the option of investing their contributions in TDS Common Shares, U.S.Cellular Common Shares, Aerial Common Shares, American Paging Common Shares or five nonaffiliated funds. DIVIDEND REINVESTMENT PLANS. TDS had reserved 460,742 Common Shares for issue under the Automatic Dividend Reinvestment and Stock Purchase Plan and 172,523 Series A Common Shares for issue under the Series A Common Share Automatic Dividend Reinvestment Plan. These plans enable holders of TDS's Common Shares and Preferred Shares to reinvest cash dividends in newly issued Common Shares and holders of Series A Common Shares to reinvest cash dividends in newly issued Series A Common Shares. The purchase price of the shares is 95% of the market value, based on the average of the daily high and low sales prices for TDS's Common Shares on the American Stock Exchange for the ten trading days preceding the date on which the purchase is made. STOCK-BASED COMPENSATION PLANS TDS had reserved 1,291,107 Common Shares for options granted and to be granted to key employees. TDS has established certain plans that provide for the grant of stock options to officers and employees. The options are exercisable over a specified period not in excess of ten years. The options expire from 1998 to 2006 or the date of the employee's termination of employment, if earlier. TDS accounts for stock options, stock appreciation rights ("SARs") and employee stock purchase plans under Accounting Principles Board ("APB") Opinion No. 25. No compensation costs have been recognized for the stock option and employee stock purchase plans. Compensation expense for SARs, measured on the difference between the year-end market price of the Common Shares and SAR prices, was $91,000, $263,000 and $408,000 in 1997, 1996 and 1995, respectively. Had compensation cost for all plans been determined consistent with SFAS I-81 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11--COMMON STOCK (CONTINUED) No. 123, the Company's net income (loss) and earnings per share would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net Income (Loss) As Reported......................................................................... $ (9,549) $ 128,139 $ 103,978 Pro Forma........................................................................... (13,506) 126,495 103,316 Earnings per Common Share-Basic As Reported......................................................................... (.19) 2.09 1.77 Pro Forma........................................................................... (.26) 2.06 1.75 Earnings per Common Share-Diluted As Reported......................................................................... (.19) 2.07 1.74 Pro Forma........................................................................... $ (.26) $ 2.05 $ 1.73 ------------ ----------- -----------
Because SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. A summary of the status of the Company's stock option plans at December 31, 1997, 1996 and 1995 and changes during the years ended is presented in the table and narrative below:
WEIGHTED WEIGHTED NUMBER OF AVERAGE AVERAGE SHARES OPTION PRICES FAIR VALUES --------- ------------- ----------- Stock Options: Outstanding January 1, 1995 (172,689 exercisable)...................................... 485,597 $ 30.25 Granted.............................................................................. 59,995 $ 38.67 $ 14.84 Exercised............................................................................ (26,101) $ 5.52 Cancelled............................................................................ (3,046) $ 43.32 --------- Outstanding December 31, 1995 (240,160 exercisable).................................... 516,445 $ 32.47 Granted.............................................................................. 89,228 $ 41.00 $ 13.30 Exercised............................................................................ (11,025) $ 13.10 Cancelled............................................................................ (3,210) $ 39.89 --------- Outstanding December 31, 1996 (405,996 exercisable).................................... 591,438 $ 34.08 Granted.............................................................................. 68,137 $ 43.90 $ 10.61 Exercised............................................................................ (43,824) $ 19.51 Cancelled............................................................................ (41,243) $ 40.78 --------- Outstanding December 31, 1997 (492,917 exercisable).................................... 574,508 $ 35.87 --------- ------------- --------- -------------
STOCK OPTIONS. The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.1%, 5.6% and 6.6%; expected dividend yields of 1.0%, 1.0% and 1.0%; expected lives of 5.0 years, 5.1 years and 6.9 years and expected volatility of 19.2%, 20.5% and 25.0%. STOCK APPRECIATION RIGHTS allowed the grantee to receive an amount in cash or Common Shares, or a combination thereof, equivalent to the difference between the exercise price and the fair market value of the Common Shares on the exercise date. The following table summarizes the SARs outstanding at $4.43 to $36.60 per share. These rights expired March 1997. The fair value of each stock appreciation right grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 4.9%, 5.2% and 5.5%; expected dividend I-82 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11--COMMON STOCK (CONTINUED) yields of 1.0%, 1.0% and 1.0%; expected lives of 0.1 year, 0.2 year and 0.7 year; and expected volatility of 20.5%, 18.4% and 20.2%.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Outstanding beginning of period............................................................. 10,070 16,034 12,096 Granted................................................................................... 630 5,923 8,174 Exercised................................................................................. (10,700) (11,887) (4,236) --------- --------- --------- Outstanding end of period................................................................... -- 10,070 16,034 --------- --------- --------- --------- --------- ---------
EMPLOYEE STOCK PURCHASE PLAN. TDS had reserved 159,816 Common Shares for sale to the employees of TDS and its subsidiaries. The fair value of the employees' purchase rights was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants rights in 1997 and 1996, respectively: risk-free interest rate of 5.6% and 5.6%; expected dividend yield of 1.0% and 1.0%; expected lives of 1.2 years and 0.5 year; and expected volatility of 16.9% and 15.3%. CONVERTIBLE PREFERRED SHARES TDS convertible Preferred Shares are convertible into 932,011 Common Shares. (See Note 10--Nonredeemable Preferred Shares) TDS issued 56,365, 347,707 and 40,734 Common Shares in 1997, 1996 and 1995, respectively, for TDS preferred shares converted and 11,345 and 3,781 Common Shares in 1997 and 1996, respectively, for subsidiary preferred stock converted. SERIES A COMMON SHARES The holders of Common Shares and the outstanding Preferred Shares are entitled to one vote per share. The holders of Series A Common Shares are entitled to ten votes per share. Series A Common Shares are convertible, on a share-for-share basis, into Common Shares. TDS has reserved 6,936,277 Common Shares for possible issuance upon such conversion. COMMON SHARE REPURCHASE PROGRAM In December 1996, the Company authorized the repurchase of up to 3.0 million TDS Common Shares over a period of three years. The Company plans to finance the repurchase program using internally generated funds and borrowings under short-term lines of credit. The Company may use repurchased shares to fund acquisitions and for other corporate purposes. Subject to prevailing market conditions, purchases may be made from time to time through open market purchases or at negotiated prices in private transactions. The actual number of Common Shares which may be repurchased will be subject to the trading price of the Common Shares, the Company's financial position and other factors. Through December 31, 1997, the Company purchased 1,798,100 Common Shares for $69.9 million. The Company reissued 1,003,524 Common Shares primarily for acquisitions. NOTE 12--EMPLOYEE BENEFIT PLANS PENSION PLAN The Company sponsors two qualified noncontributory defined contribution pension plans. One plan (the "TDS Plan") provides benefits for the employees of TDS, TDS Telecom and substantially all of the telephone company subsidiaries. (Employees of certain telephone subsidiaries are covered under other pension plans or receive direct pension payments.) The other plan provides pension benefits for U.S. Cellular and Aerial employees. Under these plans, pension costs are calculated separately for each participant and are funded currently. TDS also sponsors an unfunded non-qualified deferred compensation plan to supplement the benefits under these plans to offset the reduction of benefits caused by the limitation on annual employee compensation under the tax laws. I-83 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12--EMPLOYEE BENEFIT PLANS (CONTINUED) Total pension costs were $5.3 million, $4.6 million and $4.6 million in 1997, 1996 and 1995, respectively. OTHER POSTRETIREMENT BENEFITS The Company sponsors two defined benefit postretirement plans that cover most of the employees of TDS, TDS Telecom and its telephone subsidiaries. One plan provides medical benefits and the other plan provides life insurance benefits. Both plans are contributory, with retiree contributions adjusted annually. The medical plan anticipates future cost sharing changes that are consistent with the Company's intent to increase retiree contributions by the health care cost trend rate. An amount not to exceed 25% of the total contribution to the TDS Plan will be contributed to fund the cost of the medical benefits annually. An additional contribution equal to a reasonable amortization of the past service cost may be made without regard to the 25% limitation described above. The Company will limit overall contributions to the aggregate accruals recorded by its subsidiaries. The Company's postretirement medical and life insurance plans are currently underfunded. Total contributions to fund postretirement medical and life insurance plans were $1.9 million, $2.2 million and $3.1 million in 1997, 1996 and 1995, respectively. The following table sets forth the plans' funded status reconciled with the amount shown in the Company's consolidated balance sheet at December 31, 1997:
LIFE INSURANCE HEALTH CARE PLAN PLAN TOTAL ------------- ----------- --------- (DOLLARS IN THOUSANDS) Accumulated postretirement benefit obligation: Retirees........................................................................... $ 2,002 $ 5,196 $ 7,198 Fully eligible active plan participants............................................ 588 2,427 3,015 Other active plan participants..................................................... 1,111 10,015 11,126 ------------- ----------- --------- 3,701 17,638 21,339 Plan assets at fair value............................................................ 1,635 12,969 14,604 ------------- ----------- --------- Accumulated postretirement benefit obligation in excess of plan assets............... 2,066 4,669 6,735 Unrecognized prior service cost...................................................... (290) (1,801) (2,091) Unrecognized net gain from past experience different from that assumed and from changes in assumptions............................................................. (34) 6,754 6,720 ------------- ----------- --------- Accrued postretirement benefit cost at December 31, 1997............................. $ 1,742 $ 9,622 $ 11,364 ------------- ----------- --------- ------------- ----------- ---------
Net postretirement cost for 1997, 1996 and 1995 includes the following components:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Service cost................................................................................... $ 875 $ 796 $ 588 Interest cost on accumulated postretirement benefit obligation................................. 1,346 1,125 1,082 Actual return on plan assets................................................................... (632) (753) (656) Net amortization and deferral.................................................................. (344) 99 204 --------- --------- --------- Net postretirement cost........................................................................ $ 1,245 $ 1,267 $ 1,218 --------- --------- --------- --------- --------- ---------
For measurement purposes, a 9.6% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1997; the rate was assumed to decrease over six years to 6.1% and to remain at 6.1% thereafter. The assumed rate of return on plan assets was 8.0%. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997, by $3.5 million and the aggregate of the service and interest cost components of postretirement expense for the year then ended by $506,000. I-84 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 12--EMPLOYEE BENEFIT PLANS (CONTINUED) The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0%. NOTE 13--COMMITMENTS AND CONTINGENCIES CONSTRUCTION AND EXPANSION The primary purpose of TDS's construction and expansion program is to provide for normal growth, to upgrade communications service, to expand into new communication areas, and to take advantage of service-enhancing and cost- reducing technological developments. The cellular capital additions budget totals approximately $330 million for 1998, including about $240 million for new cell sites and about $90 million for various information systems initiatives. The telephone capital additions budget totals approximately $140 million for 1998, including about $50 million for new digital switches and other switching facilities and $35 million for improvements to outside plant facilities. The PCS capital additions budget totals approximately $75 million for 1998, including $20 million for cell sites, $25 million for switching equipment and $15 million for systems development. PENDING ACQUISITIONS At December 31, 1997, TDS and U.S. Cellular have entered into definitive agreements to acquire a majority interest in one cellular market, the remaining minority interest in one cellular market already controlled by U.S. Cellular and one telephone company for an aggregate consideration of approximately $62.0 million, primarily cash and TDS Common Shares. LEASE COMMITMENTS TDS and its subsidiaries have leases for certain cellular plant facilities, office space and data processing equipment, most of which are classified as operating leases. For the years 1997, 1996 and 1995, rent expense for noncancelable, long-term leases was $36.9 million, $20.9 million and $13.6 million, respectively, and rent expense under cancelable, short-term leases was $8.7 million, $7.6 million and $7.5 million, respectively. At December 31, 1997, the aggregate minimum rental commitments under noncancelable, long-term operating leases were as follows:
MINIMUM FUTURE RENTAL PAYMENTS -------------------- (DOLLARS IN THOUSANDS) 1998................................................................................ $ 38,594 1999................................................................................ 34,476 2000................................................................................ 30,490 2001................................................................................ 28,367 2002................................................................................ 18,960 Thereafter.......................................................................... $ 96,578 --------
LEGAL PROCEEDINGS The Company is involved in legal proceedings before the FCC and various state and federal courts from time to time. Management does not believe that any of such proceedings should have a material adverse impact on the financial position or results of operations of the Company. On December 29, 1997, a party which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, U.S. Cellular and the directors of U.S. Cellular. The complaint alleges a breach of fiduciary duties by the defendents and seeks to have the U.S. Cellular Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. A virtually identical complaint has been filed by an individual. None of the defendants have been served with this complaint. I-85 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 13--COMMITMENTS AND CONTINGENCIES (CONTINUED) On January 5, 1998, an individual, who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants, TDS, Aerial and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. A virtually identical complaint has been filed by a second individual. None of the defendants have been served with this complaint. The Company intends to vigorously defend against these lawsuits. I-86 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 14--BUSINESS SEGMENT INFORMATION TDS's businesses are classified into four principal segments: Cellular, Telephone, PCS and Radio Paging operations.
YEAR ENDED OR AT DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN MILIONS) Revenues Cellular..................................................................................... $ 877 $ 680 $ 480 Telephone.................................................................................... 444 396 355 PCS.......................................................................................... 56 -- -- Paging....................................................................................... 95 104 107 --------- --------- --------- Total...................................................................................... $ 1,472 $ 1,180 $ 942 --------- --------- --------- --------- --------- --------- Operating Income (Loss) Cellular..................................................................................... $ 130 $ 87 $ 43 Telephone.................................................................................... 99 103 98 PCS.......................................................................................... (197) -- -- Paging....................................................................................... (36) (37) (9) --------- --------- --------- Total...................................................................................... $ (4) $ 153 $ 132 --------- --------- --------- --------- --------- --------- Depreciation and Amortization Expense Cellular..................................................................................... $ 132 $ 109 $ 90 Telephone.................................................................................... 98 88 77 PCS.......................................................................................... 39 -- -- Paging....................................................................................... 33 34 25 --------- --------- --------- Total...................................................................................... $ 302 $ 231 $ 192 --------- --------- --------- --------- --------- --------- Identifiable Assets Cellular..................................................................................... $ 2,549 $ 2,117 $ 1,891 Telephone.................................................................................... 1,221 1,181 1,058 PCS.......................................................................................... 961 638 318 Paging....................................................................................... 136 153 159 Parent and Other............................................................................. 105 112 43 --------- --------- --------- Total...................................................................................... $ 4,972 $ 4,201 $ 3,469 --------- --------- --------- --------- --------- --------- Capital Expenditures Cellular..................................................................................... $ 319 $ 248 $ 211 Telephone.................................................................................... 151 144 104 PCS.......................................................................................... 275 113 9 Paging....................................................................................... 19 33 27 Parent and Other............................................................................. 22 12 9 --------- --------- --------- Total...................................................................................... $ 786 $ 550 $ 360 --------- --------- --------- --------- --------- ---------
I-87 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 15--INVESTMENTS IN UNCONSOLIDATED ENTITIES The following summarizes the unaudited combined assets, liabilities and equity, and the unaudited results of operations of the cellular and telephone companies in which TDS's investments are accounted for by the equity method.
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN MILLIONS) Assets Current assets......................................................................................... $ 425 $ 325 Due from affiliates.................................................................................... 3 6 Property and other..................................................................................... 1,159 1,122 --------- --------- $ 1,587 $ 1,453 --------- --------- --------- --------- Liabilities and Equity Current liabilities.................................................................................... $ 287 $ 278 Due to affiliates...................................................................................... 38 21 Deferred credits....................................................................................... 9 3 Long-term debt......................................................................................... 70 42 Partners' capital and stockholders' equity............................................................. 1,183 1,109 --------- --------- $ 1,587 $ 1,453 --------- --------- --------- ---------
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN MILIONS) Results of Operations Revenues.................................................................................... $ 1,740 $ 1,395 $ 1,174 Costs and expenses.......................................................................... (1,256) (958) (808) Other income................................................................................ 5 7 8 Interest expense............................................................................ (10) (6) (6) Income taxes................................................................................ (6) (3) (5) Extraordinary item.......................................................................... -- (2) -- --------- --------- --------- Net income.................................................................................. $ 473 $ 433 $ 363 --------- --------- --------- --------- --------- ---------
NOTE 16--SUBSEQUENT EVENTS COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES In February 1998, TDS Capital II, a subsidiary trust of TDS, issued 6,000,000 of its 8.04% Company-Obligated Manditorily Redeemable Preferred Securities at $25 per Preferred Security. Net proceeds from the issuance totaled $145 million and were used to retire short-term debt. The sole asset of TDS Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated Debentures due March 31, 2038 or such date to which the maturity is extended by TDS, but in no event later than March 31, 2047. The Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after March 31, 2003, or, in whole but not in part, at any time in the event of certain income tax circumstances. All other terms and conditions are identical to those of TDS Capital I. (See Note 9--Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Company Subordinated Debentures) AERIAL 8.05% ZERO COUPON NOTES Aerial sold $100 million principal amount at maturity of 10-year zero coupon 8.05% yield to maturity debt in February 1998 at an issue price of $100 million. The unsecured notes are due in 2008 and there is no periodic payment of interest. The proceeds were paid to Aerial's equipment vendor in satisfaction of all then outstanding obligations and future obligations up to $100 million. The notes are fully and unconditionally guaranteed by TDS. The notes are subject to optional redemption beginning in 2003 at redemption prices which reflect original issue discount accrued since issuance. These notes will replace the $84.4 million of Interim vendor financing. (See Note 7--Long-Term Debt) I-88 CONSOLIDATED QUARTERLY INCOME INFORMATION (UNAUDITED)
QUARTER ENDED MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 Operating Revenues....................................................... $ 314,735 $ 356,344 $ 388,122 $ 412,332 Operating Income (Loss).................................................. 41,941 7,354 (3,990) (49,007) Gain on Sale of Cellular and Other Investments........................... -- 10,598 13,767 17,073 Net Income (Loss)........................................................ 9,617 6,821 9,019 (35,006) Net Income (Loss) Available to Common.................................... 9,136 6,351 8,549 (35,476) From Operations........................................................ 9,136 2,344 106 (38,940) From Gains............................................................. $ -- $ 4,007 $ 8,443 $ 3,464 Weighted Average Common Shares (000s).................................... 61,184 60,051 59,511 60,099 Earnings per Common Share-Basic.......................................... $ .15 $ .11 $ .14 $ (.59) Earnings per Common Share-Diluted........................................ .15 .11 .14 (.59) From Operations........................................................ .15 .04 -- (.65) From Gains............................................................. $ -- $ .07 $ .14 $ .06 1996 Operating Revenues....................................................... $ 259,063 $ 293,701 $ 308,548 $ 318,545 Operating Income......................................................... 30,957 49,081 41,263 32,147 Gain on Sale of Cellular and Other Investments........................... 41,758 86,494 7,797 2,686 Net Income............................................................... 33,689 59,692 22,669 12,089 Net Income Available to Common........................................... 33,190 59,201 22,185 11,606 From Operations........................................................ 12,882 18,720 19,256 10,852 From Gains............................................................. $ 20,308 $ 40,481 $ 2,929 $ 754 Weighted Average Common Shares (000s).................................... 59,035 60,610 61,084 61,127 Earnings per Common Share-Basic.......................................... $ .56 $ .98 $ .36 $ .19 Earnings per Common Share-Diluted........................................ .56 .97 .36 .19 From Operations........................................................ .22 .31 .32 .18 From Gains............................................................. $ .34 $ .66 $ .04 $ .01
Note: Certain 1996 amounts were reclassified for current period presentation. Net Income Available to Common for 1997 and 1996 included significant gains from the sales of cellular and other investments. The table above summarizes the effect of the gains on Net Income (Loss) Available to Common and Earnings per Common Share--Diluted. Management believes there exists a seasonality at U.S. Cellular in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth. This seasonality may cause operating income to vary from quarter to quarter. Aerial began commercial service in 1997 which resulted in Aerial's revenue and expenses being included in operating income. The significant decrease in Operating Income (Loss) and Net Income (Loss) beginning in the second quarter of 1997 is primarily a result of the commencement of PCS operations. I-89 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Telephone and Data Systems, Inc.: We have audited the accompanying consolidated balance sheets of Telephone and Data Systems, Inc. (an Iowa corporation) and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Telephone and Data Systems, Inc. and Subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois January 28, 1998 (except with respect to the matters discussed in Note 5, "American Paging Merger"; and in Note 16, as to which the date is February 18, 1998) I-90 ANNEX II DESCRIPTION OF THE UNITED STATES CELLULAR GROUP The United States Cellular Group ("Cellular Group") consists solely of United States Cellular Corporation ("U.S. Cellular"), an 81%-owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which operates and invests in cellular telephone companies and properties. The Cellular Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Cellular Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Cellular Group, as determined by the Board of Directors of TDS. The Cellular Group serves 1,710,000 customers through 134 majority-owned and managed cellular systems at December 31, 1997. Overall, U.S. Cellular owned 26.2 million population equivalents in 192 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 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 the Cellular Group's markets, and the Cellular Group expects PCS operators to complete initial deployment of PCS in portions of all of its market clusters by the end of 1998. 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 of the Cellular Group markets. The services available to cellular customers and the sources of revenue available to cellular system operators are similar to those provided by conventional landline telephone companies. Customers may be charged a separate fee for system access, airtime, long-distance calls, and ancillary services. Cellular system operators often provide service to customers of other operators' cellular systems while the customers are temporarily located within the operators' service areas. Customers using service away from their home system are called "roamers." Roaming is 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 the Cellular Group, 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, on certain cellular systems the radio transmission is done on an analog basis. During 1992, a new transmission technique was approved for implementation by the cellular industry. Time Division Multiple Access ("TDMA") technology was selected as one industry standard by the cellular industry and has been deployed in several markets, including the Cellular Group's operations in portions of several clusters. Another digital technology, Code Division Multiple Access ("CDMA"), is being deployed by the Cellular Group in portions of certain clusters. 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 is continuing on an industry-wide basis; however this process is expected to II-1 take a number of years. PCS operators have deployed TDMA, CDMA and a third digital technology, Global Systems for Mobile Communications ("GSM"), in the markets where they have begun operations. The cellular telephone industry is characterized by high initial fixed costs. Accordingly, if and when revenues less variable costs exceed fixed costs, incremental revenues should yield an operating profit. The amount of profit, if any, under such circumstances is dependent on, among other things, prices and variable marketing costs which in turn are affected by the amount and extent of competition. Until technological limitations on total capacity are approached, additional cellular system capacity can normally be added in increments that closely match demand and at less than the proportionate cost of the initial capacity. CELLULAR OPERATIONS From its inception in 1983 until 1993, the Cellular Group had principally been in a start-up phase. During that time, the Cellular Group'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. The Cellular Group experienced operating losses and net losses from its inception until 1993. During the past four years, the Cellular Group has generated operations-driven net income and has significantly increased its operating cash flows during that time. Management anticipates further growth in cellular units in service and revenues as the Cellular Group 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 increased growth. In addition, the Cellular Group anticipates that the seasonality of revenue streams and operating expenses may cause the Cellular Group's operating income to vary from quarter to quarter. While the Cellular Group produced operating income and net income during the last four years, changes in any of several factors may reduce the Cellular Group's growth in operating income and net income over the next few years. These factors include: (i) the growth rate in the Cellular Group'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. The Cellular Group is building a substantial presence in selected geographic areas throughout the United States where it can efficiently integrate and manage cellular telephone systems. Its cellular interests include regional market clusters in the following areas: Wisconsin/Illinois/Indiana, Iowa/Missouri, Eastern North Carolina/ South Carolina, West Virginia/Maryland/Pennsylvania/Ohio, Virginia, Washington/Oregon/Idaho, Oregon/California, Maine/New Hampshire/Vermont, Florida/Georgia, Oklahoma/Missouri/Kansas, Texas/Oklahoma, Eastern Tennessee/Western North Carolina, and Southwestern Texas. See "The Cellular Group's Cellular Interests." The Cellular Group has acquired its cellular interests through the wire line application process (17%), including settlements and exchanges with other applicants, and through acquisitions (83%), including acquisitions from TDS and third parties. CELLULAR SYSTEMS DEVELOPMENT ACQUISITIONS. During the last five years, the Cellular Group has expanded its size, particularly in contiguous or adjacent markets, through acquisitions which have been aimed at strengthening the Cellular Group'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. Including acquisitions of cellular interests from TDS, the Cellular Group has increased its population equivalents by 17% from approximately 22.5 million at December 31, 1992, to approximately 26.2 million at December 31, 1997. Markets managed by the Cellular Group have increased from 116 markets at December 31, 1992, to 143 markets at December 31, 1997. As of December 31, 1997, 88% of the Cellular Group's population equivalents represented interests in markets it manages compared to 75% at December 31, 1992. Recently, the pace of acquisitions has slowed as industry-wide consolidation has reduced the number of markets available for acquisition. The Cellular Group's population equivalents grew at a compound annual rate of just 3% over the last five years due to the increased number of exchange and divestiture transactions in the past few years. The Cellular Group may continue to make opportunistic acquisitions or exchanges in markets that further strengthen its market clusters and in other attractive markets. The Cellular Group also seeks to acquire minority II-2 interests in markets where it already owns the majority interest. There can be no assurance that the Cellular Group, or TDS for the benefit of the Cellular Group, will be able to negotiate additional acquisitions or exchanges on terms acceptable to it or that regulatory approvals, where required, will be received. The Cellular Group plans to retain minority interests in certain cellular markets which it believes will earn a favorable return on investment. Other minority interests may be exchanged for interests in markets which enhance U.S. Cellular's market clusters or may be sold for cash or other consideration. U.S. Cellular also continues to evaluate the disposition of certain managed interests which are not essential to its corporate development strategy. The Cellular Group, or TDS for the benefit of the Cellular Group, 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 the Cellular Group. At that time, the Cellular Group reimbursed TDS for the value of TDS securities issued in such transactions, generally by issuing U.S. Cellular Common Shares to TDS or by increasing the balance due TDS under the Cellular Group'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 four years, the Cellular Group 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 the Cellular Group's clusters. COMPLETED ACQUISITIONS. During 1997, the Cellular Group or TDS for the benefit of the Cellular Group purchased majority interests in two markets and several additional minority interests, representing approximately 534,000 population equivalents. The total consideration paid for these purchases, primarily in the form of cash (including cash borrowed under the Revolving Credit Agreement with TDS) and U.S. Cellular Common Shares issued to TDS to reimburse TDS for the value of TDS Common Shares issued to third parties, totaled $81.4 million. During 1997, the Cellular Group completed the divestiture of majority interests in one market plus one market partition and minority interests in two other markets, representing approximately 358,000 population equivalents, for an aggregate consideration of $54.5 million in cash and receivables. The two minority interests involved interests the Cellular Group had previously acquired from TDS pursuant to an agreement between the two companies signed in June 1996. Also during 1997, the Cellular Group completed an exchange with BellSouth Corporation ("BellSouth"). Pursuant to the exchange, the Cellular Group received majority interests, representing approximately 4.0 million pops in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests the Cellular Group received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters. PENDING ACQUISITIONS. At December 31, 1997, the Cellular Group had entered into agreements to acquire a majority interest in one market and a minority interest in a market in which the Cellular Group owns a majority interest, representing 410,000 population equivalents, for $51.3 million in cash. If the majority interest is acquired as expected, the Cellular Group will subsequently sell that interest to BellSouth for cash. PENDING DIVESTITURES. At December 31, 1997, the Cellular Group had entered into agreements with Airtouch Communications, Inc. ("AirTouch") to divest minority interests in nine markets, representing approximately 759,000 population equivalents. In exchange, the agreements provided that the Cellular Group will receive approximately 4.0 million shares of AirTouch stock and cash totaling approximately $54.2 million. In addition, the Cellular Group will receive approximately $27.0 million in cash from TDS pursuant to a contract right termination agreement entered into between the Cellular Group and TDS. This agreement is related to two interests which are to be sold directly by TDS to AirTouch and which were to be acquired by the Cellular Group as part of the June 1996 agreement between the Cellular Group and TDS. The contract right termination agreement will enable the Cellular Group to receive cash equal to the value of the gain the Cellular Group would have realized had it purchased the interests from TDS and sold them to AirTouch under terms similar to those in the agreement between TDS and AirTouch. Additionally, the Cellular Group has entered into an agreement to sell its minority interests in two other markets, representing 176,000 population equivalents, for $37.6 million in cash. The sales are expected to be completed II-3 during the first half of 1998. The Cellular Group anticipates that it will record significant book gains on these divestitures when the transactions are completed. 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. CELLULAR INTERESTS AND CLUSTERS The Cellular Group 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 the Cellular Group 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 the Cellular Group 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 the Cellular Group's per customer cost of service. The extent to which the Cellular Group benefits from these revenue enhancements and economies of operation is dependent on market conditions, population size of each cluster and engineering considerations. The Cellular Group may continue to make opportunistic acquisitions and exchanges which will complement its established market clusters. From time to time, the Cellular Group may also consider exchanging or selling its interests in markets which do not fit well with its long-term strategies. The Cellular Group owned interests in cellular telephone systems in 192 markets at December 31, 1997, representing 26.2 million population equivalents. Including the 11 interests to be sold during 1998, the Cellular Group owned or had the right to acquire 181 markets, representing 25.3 million population equivalents, at December 31, 1997. The following table summarizes the growth in the Cellular Group's population equivalents in recent years and the development status of these population equivalents.
DECEMBER 31, ---------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- --------- --------- --------- --------- (THOUSANDS OF POPULATION EQUIVALENTS)(1) Operational Markets: Majority-Owned and Managed........................................ 22,778 20,389 20,104 18,829 19,086 Minority-Owned and Managed (2).................................... 401 401 514 1,234 1,263 Markets to be Managed, Net of Markets to be Divested: (3) To Be Majority-Owned ........................................... -- 216 273 2,220 1,035 To Be Minority-Owned (2)........................................ -- -- -- -- 6 ------- --------- --------- --------- --------- Total Markets Managed and to be Managed........................... 23,179 21,006 20,891 22,283 21,390 Minority Interest in Markets Managed by Others...................... 2,121 4,511 4,026 3,779 3,577 ------- --------- --------- --------- --------- Total............................................................. 25,300 25,517 24,917 26,062 24,967 ------- --------- --------- --------- --------- ------- --------- --------- --------- ---------
- ------------ (1) Based on 1997 Claritas estimates for all years. (2) Includes markets where the Cellular Group 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 the Cellular Group's cellular interests, including those it owned or had the right to acquire as of December 31, 1997. The table presented therein lists clusters of markets that the Cellular Group manages or anticipates managing. The Cellular Group's market clusters show the areas in which the Cellular Group 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 the Cellular Group'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. II-4 THE CELLULAR GROUP'S CELLULAR INTERESTS The table below sets forth certain information with respect to the interests in cellular markets which the Cellular Group and TDS owned or had the right to acquire pursuant to definitive agreements as of December 31, 1997.
TOTAL CURRENT PERCENTAGE AND CURRENT CHANGE PURSUANT ACQUIRABLE 1997 PERCENTAGE TO DEFINITIVE POPULATION CLUSTER/MARKET POPULATION INTEREST AGREEMENTS (1) TOTAL EQUIVALENTS - ------------------------------------------------------- ------------- ----------- --------------- --------- ------------- MARKETS MANAGED BY THE COMPANY: MIDWEST REGIONAL MARKET CLUSTER: WISCONSIN/ILLINOIS/INDIANA: Milwaukee, WI...................................... 1,460,000 100.00% 100.00% 1,460,000 Columbia (WI 9).................................... 386,000 100.00 100.00 386,000 Madison, WI........................................ 398,000 92.50 92.50 368,000 Peoria, IL......................................... 347,000 100.00 100.00 347,000 Appleton, WI....................................... 344,000 100.00 100.00 344,000 Jo Daviess (IL 1).................................. 318,000 100.00 100.00 318,000 Rockford, IL....................................... 304,000 100.00 100.00 304,000 Wood (WI 7)........................................ 290,000 100.00 100.00 290,000 Vernon (WI 8)...................................... 236,000 100.00 100.00 236,000 Adams (IL 4) * (2)................................. 214,000 100.00 100.00 214,000 Green Bay, WI...................................... 215,000 99.01 99.01 213,000 Mercer (IL 3)...................................... 202,000 100.00 100.00 202,000 Racine, WI......................................... 186,000 89.64 89.64 167,000 Kenosha, WI........................................ 143,000 99.09 99.09 142,000 Janesville-Beloit, WI.............................. 152,000 80.54 12.00% 92.54 141,000 Door (WI 10)....................................... 130,000 100.00 100.00 130,000 La Crosse, WI...................................... 103,000 95.11 95.11 98,000 Sheboygan, WI...................................... 110,000 86.66 86.66 96,000 Wausau, WI *....................................... 122,000 71.76 71.76 88,000 Trempealeau (WI 6) (2)............................. 83,000 100.00 100.00 83,000 Miami (IN 4) *..................................... 179,000 28.57 28.57 51,000 Warren (IN 5) *.................................... 123,000 33.33 33.33 41,000 Alton, IL.......................................... 21,000 100.00 100.00 21,000 Pierce (WI 5) (2).................................. 14,000 100.00 100.00 14,000 ------------- ------------- 6,080,000 5,754,000 ------------- ------------- IOWA/MISSOURI: Des Moines, IA..................................... 431,000 100.00 100.00 431,000 Davenport, IA-IL................................... 358,000 97.37 97.37 349,000 Humboldt (IA 10)................................... 180,000 100.00 100.00 180,000 Cedar Rapids, IA................................... 181,000 96.00 96.00 174,000 Iowa (IA 6)........................................ 156,000 100.00 100.00 156,000 Muscatine (IA 4)................................... 155,000 100.00 100.00 155,000 Waterloo-Cedar Falls, IA........................... 146,000 93.03 93.03 136,000 Columbia, MO *..................................... 127,000 100.00 100.00 127,000 Stone (MO 15)...................................... 118,000 100.00 100.00 118,000 Hardin (IA 11)..................................... 113,000 100.00 100.00 113,000 Jackson (IA 5)..................................... 109,000 100.00 100.00 109,000 Kossuth (IA 14).................................... 107,000 100.00 100.00 107,000 Lyon (IA 16)....................................... 103,000 100.00 100.00 103,000 Iowa City, IA...................................... 102,000 100.00 100.00 102,000 Laclede (MO 16).................................... 100,000 100.00 100.00 100,000 Washington (MO 13)................................. 94,000 100.00 100.00 94,000 Callaway (MO 6) *.................................. 85,000 100.00 100.00 85,000 Dubuque, IA........................................ 88,000 95.90 95.90 84,000
II-5
TOTAL CURRENT PERCENTAGE AND CURRENT CHANGE PURSUANT ACQUIRABLE 1997 PERCENTAGE TO DEFINITIVE POPULATION CLUSTER/MARKET POPULATION INTEREST AGREEMENTS (1) TOTAL EQUIVALENTS - ------------------------------------------------------- ------------- ----------- --------------- --------- ------------- Mitchell (IA 13)................................... 67,000 100.00% 100.00% 67,000 Mills (IA 1)....................................... 62,000 100.00 100.00 62,000 Schuyler (MO 3).................................... 56,000 100.00 100.00 56,000 Shannon (MO 17).................................... 56,000 100.00 100.00 56,000 Audubon (IA 7)..................................... 55,000 100.00 100.00 55,000 Linn (MO 5) (2).................................... 55,000 100.00 100.00 55,000 Union (IA 2)....................................... 50,000 100.00 100.00 50,000 Monroe (IA 3)...................................... 91,000 49.00 49.00 44,000 Winneshiek (IA 12)................................. 116,000 24.50 24.50 28,000 Ida (IA 9) *....................................... 63,000 16.67 16.67 11,000 ------------- ------------- 3,424,000 3,207,000 ------------- ------------- TOTAL MIDWEST REGIONAL MARKET CLUSTER 9,504,000 8,961,000 ------------- ------------- ------------- ------------- MID-ATLANTIC REGIONAL MARKET CLUSTER: EASTERN NORTH CAROLINA/SOUTH CAROLINA: Harnett (NC 10).................................... 294,000 100.00 100.00 294,000 Northampton (NC 8)................................. 292,000 100.00 100.00 292,000 Rockingham (NC 7).................................. 291,000 100.00 100.00 291,000 Greene (NC 13)..................................... 246,000 100.00 100.00 246,000 Greenville (NC 14)................................. 242,000 100.00 100.00 242,000 Hoke (NC 11)....................................... 226,000 100.00 100.00 226,000 Chesterfield (SC 4)................................ 213,000 100.00 100.00 213,000 Ashe (NC 3)........................................ 162,000 100.00 100.00 162,000 Chatham (NC 6)..................................... 162,000 81.16 81.16 132,000 Sampson (NC 12).................................... 132,000 100.00 100.00 132,000 Camden (NC 9)...................................... 119,000 100.00 100.00 119,000 ------------- ------------- 2,379,000 2,349,000 WEST VIRGINIA/MARYLAND/PENNSYLVANIA/OHIO: Monongalia (WV 3) *................................ 269,000 100.00 100.00 269,000 Raleigh (WV 7) *................................... 256,000 100.00 100.00 256,000 Grant (WV 4) *..................................... 174,000 100.00 100.00 174,000 Tucker (WV 5) *.................................... 132,000 100.00 100.00 132,000 Hagerstown, MD *................................... 128,000 100.00 100.00 128,000 Ross (OH 9) *...................................... 249,000 49.00 49.00 122,000 Cumberland, MD *................................... 100,000 100.00 100.00 100,000 Bedford (PA 10) * (2).............................. 49,000 100.00 100.00 49,000 Garrett (MD 1) *................................... 30,000 100.00 100.00 30,000 ------------- ------------- 1,387,000 1,260,000 VIRGINIA: Roanoke, VA........................................ 234,000 100.00 100.00 234,000 Giles (VA 3)....................................... 201,000 100.00 100.00 201,000 Bedford (VA 4)..................................... 176,000 100.00 100.00 176,000 Lynchburg, VA...................................... 160,000 100.00 100.00 160,000 Charlottesville, VA................................ 146,000 94.44 94.44 138,000 Buckingham (VA 7).................................. 91,000 100.00 100.00 91,000 Tazewell (VA 2) (2)................................ 83,000 100.00 100.00 83,000 Bath (VA 5)........................................ 61,000 100.00 100.00 61,000 ------------- ------------- 1,152,000 1,144,000 ------------- ------------- TOTAL MID-ATLANTIC REGIONAL MARKET CLUSTER 4,918,000 4,753,000 ------------- ------------- ------------- -------------
II-6
TOTAL CURRENT PERCENTAGE AND CURRENT CHANGE PURSUANT ACQUIRABLE 1997 PERCENTAGE TO DEFINITIVE POPULATION CLUSTER/MARKET POPULATION INTEREST AGREEMENTS (1) TOTAL EQUIVALENTS - ------------------------------------------------------- ------------- ----------- --------------- --------- ------------- NORTHWEST REGIONAL MARKET CLUSTER: WASHINGTON/OREGON/IDAHO: Clark (ID 6)....................................... 294,000 100.00% 100.00% 294,000 Pacific (WA 6) *................................... 184,000 100.00 100.00 184,000 Richland-Kennewick-Pasco, WA *..................... 183,000 100.00 100.00 183,000 Butte (ID 5)....................................... 160,000 100.00 100.00 160,000 Yakima, WA *....................................... 219,000 54.55 58.54 128,000 Okanogan (WA 4).................................... 118,000 100.00 100.00 118,000 Umatilla (OR 3) *.................................. 151,000 60.42 60.42 91,000 Kittitas (WA 5) * (2).............................. 71,000 83.50 85.20 61,000 Hood River (OR 2) *................................ 74,000 45.10 45.10 34,000 Skamania (WA 7) *.................................. 28,000 45.10 45.10 13,000 ------------- ------------- 1,482,000 1,266,000 OREGON/CALIFORNIA: Coos (OR 5)........................................ 260,000 100.00 100.00 260,000 Del Norte (CA 1)................................... 209,000 100.00 100.00 209,000 Medford, OR *...................................... 171,000 100.00 100.00 171,000 Mendocino (CA 9)................................... 139,000 100.00 100.00 139,000 Crook (OR 6) *..................................... 196,000 62.50 62.50 122,000 Modoc (CA 2)....................................... 63,000 100.00 100.00 63,000 ------------- ------------- 1,038,000 964,000 TOTAL NORTHWEST REGIONAL MARKET CLUSTER 2,520,000 2,230,000 ------------- ------------- ------------- ------------- MAINE/NEW HAMPSHIRE/VERMONT MARKET CLUSTER: Manchester-Nashua, NH.............................. 357,000 92.49 92.49 330,000 Coos (NH 1) *...................................... 224,000 100.00 100.00 224,000 Kennebec (ME 3).................................... 221,000 100.00 100.00 221,000 Carroll (NH 2)..................................... 216,000 100.00 100.00 216,000 Somerset (ME 2).................................... 148,000 100.00 100.00 148,000 Bangor, ME......................................... 145,000 91.47 91.47 132,000 Addison (VT 2) * (2)............................... 107,000 100.00 100.00 107,000 Washington (ME 4) *................................ 86,000 100.00 100.00 86,000 Lewiston-Auburn, ME................................ 101,000 82.67 82.67 84,000 Oxford (ME 1)...................................... 83,000 100.00 100.00 83,000 TOTAL MAINE/NEW HAMPSHIRE/ VERMONT MARKET CLUSTER 1,688,000 1,631,000 ------------- ------------- ------------- ------------- FLORIDA/GEORGIA MARKET CLUSTER: Fort Pierce, FL * (3).............................. 291,000 49.00 51.00% 100.00 291,000 Tallahassee, FL.................................... 280,000 100.00 100.00 280,000 Worth (GA 14)...................................... 253,000 100.00 100.00 253,000 Gainesville, FL.................................... 222,000 100.00 100.00 222,000 Toombs (GA 11)..................................... 155,000 100.00 100.00 155,000 Walton (FL 10)..................................... 119,000 100.00 100.00 119,000 Putnam (FL 5) (2).................................. 70,000 100.00 100.00 70,000 Dixie (FL 6)....................................... 57,000 100.00 100.00 57,000 Jefferson (FL 8) (2)............................... 49,000 100.00 100.00 49,000 Calhoun (FL 9)..................................... 43,000 100.00 100.00 43,000 ------------- ------------- TOTAL FLORIDA/GEORGIA MARKET CLUSTER 1,539,000 1,539,000 ------------- ------------- ------------- -------------
II-7
TOTAL CURRENT PERCENTAGE AND CURRENT CHANGE PURSUANT ACQUIRABLE 1997 PERCENTAGE TO DEFINITIVE POPULATION CLUSTER/MARKET POPULATION INTEREST AGREEMENTS (1) TOTAL EQUIVALENTS - ------------------------------------------------------- ------------- ----------- --------------- --------- ------------- TEXAS/OKLAHOMA/MISSOURI/KANSAS REGIONAL MARKET CLUSTER: OKLAHOMA/MISSOURI/KANSAS: Tulsa, OK *........................................ 798,000 55.06% 55.06% 440,000 Joplin, MO *....................................... 147,000 100.00 100.00 147,000 Seminole (OK 6).................................... 219,000 55.06 55.06 120,000 Elk (KS 15) *...................................... 154,000 75.00 75.00 116,000 Nowata (OK 4) * (2)................................ 102,000 55.06 55.06 56,000 ------------- ------------- 1,420,000 879,000 ------------- ------------- TEXAS/OKLAHOMA: Garvin (OK 9)...................................... 203,000 100.00 100.00 203,000 Haskell (OK 10).................................... 83,000 100.00 100.00 83,000 Wichita Falls, TX *................................ 140,000 51.65 51.65 72,000 Lawton, OK *....................................... 111,000 51.65 51.65 57,000 Jackson (OK 8) *................................... 97,000 51.65 51.65 50,000 Hardeman (TX 5) * (2).............................. 38,000 51.65 51.65 19,000 Briscoe (TX 4) * (2)............................... 13,000 51.65 51.65 6,000 Beckham (OK 7) * (2)............................... 10,000 51.65 51.65 5,000 ------------- ------------- 695,000 495,000 ------------- ------------- TOTAL TEXAS/OKLAHOMA/MISSOURI/ KANSAS REGIONAL MARKET CLUSTER 2,115,000 1,374,000 ------------- ------------- ------------- ------------- EASTERN TENNESSEE/WESTERN NORTH CAROLINA MARKET CLUSTER: Knoxville, TN *.................................... 556,000 96.03 96.03 534,000 Asheville, NC *.................................... 212,000 100.00 100.00 212,000 Henderson (NC 4) * (2)............................. 194,000 100.00 100.00 194,000 Bledsoe (TN 7) * (2)............................... 151,000 96.03 96.03 145,000 Hamblen (TN 4) * (2)............................... 135,000 100.00 100.00 135,000 Macon (TN 3) *..................................... 344,000 16.67 16.67 57,000 Yancey (NC 2) * (2)................................ 31,000 100.00 100.00 31,000 ------------- ------------- TOTAL EASTERN TENNESSEE/ WESTERN NORTH CAROLINA MARKET CLUSTER 1,623,000 1,308,000 ------------- ------------- ------------- ------------- SOUTHWESTERN TEXAS MARKET CLUSTER: Corpus Christi, TX................................. 388,000 100.00 100.00 388,000 Atascosa (TX 19)................................... 231,000 100.00 100.00 231,000 Edwards (TX 18).................................... 223,000 100.00 100.00 223,000 Laredo, TX......................................... 182,000 93.74 93.74 171,000 Wilson (TX 20)..................................... 148,000 100.00 100.00 148,000 Victoria, TX....................................... 82,000 100.00 100.00 82,000 ------------- ------------- TOTAL SOUTHWESTERN TEXAS MARKET CLUSTER 1,254,000 1,243,000 ------------- ------------- ------------- ------------- OTHER OPERATIONS: Hawaii (HI 3)...................................... 140,000 100.00 100.00 140,000 ------------- ------------- Total Managed Markets.......................... 25,301,000 23,179,000
II-8
TOTAL CURRENT PERCENTAGE AND CURRENT CHANGE PURSUANT ACQUIRABLE 1997 PERCENTAGE TO DEFINITIVE POPULATION CLUSTER/MARKET POPULATION INTEREST AGREEMENTS (1) TOTAL EQUIVALENTS - ------------------------------------------------------- ------------- ----------- --------------- --------- ------------- ------------- ------------- ------------- ------------- MARKETS MANAGED BY OTHERS: Los Angeles/Oxnard, CA *........................... 15,645,000 5.50% 5.50% 861,000 Oklahoma City, OK *................................ 1,003,000 14.60 14.60 146,000 Portland, ME *..................................... 288,000 49.00 49.00 141,000 McAllen, TX........................................ 509,000 26.20 26.20 133,000 Portsmouth-Dover-Rochester, NH-ME *................ 280,000 40.00 40.00 112,000 Others (Fewer than 100,000 population equivalents each)............................................ 728,000 ------------- Total Population Equivalents of Markets Managed by Others...................................... 2,121,000 ------------- Total Population Equivalents..................... 25,300,000 ------------- -------------
- --------- * Designates wireline market. (1) Interests under these agreements are expected to be acquired at the time specified therein, following the satisfaction of customary closing conditions. (2) These markets have been partitioned into more than one licensed area. The 1997 population, percentage ownership and number of population equivalents shown are for the licensed areas within the markets in which the Cellular Group owns an interest. (3) The Cellular Group owns 80% of the entity which owns and operates this market but has only a 49% interest in the earnings and profits. Pursuant to a definitive agreement, the Cellular Group has rights to acquire the remaining 20% of the equity and 51% of the earnings and profits of this entity. SYSTEM DESIGN AND CONSTRUCTION. The Cellular Group 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 the Cellular Group personnel or independent engineering firms. The Cellular Group'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, the Cellular Group has selected high capacity digital cellular switching systems that are capable of serving multiple markets through a single MTSO. The Cellular Group's cellular systems are designed to facilitate the installation of equipment which will permit microwave interconnection between the MTSO and the cell site. The Cellular Group has implemented such microwave interconnection in most of the cellular systems it manages. In other systems in which the Cellular Group owns a majority interest and where it is believed to be cost-efficient, such microwave technology will also be implemented. Otherwise, such systems will rely upon landline telephone connections 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 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. The Cellular Group expanded its internal network in 1996 to encompass all of its managed markets. This network provides automatic call delivery for the Cellular Group'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, Airtouch/US West, Ameritech, BellSouth, Centennial Cellular Corp., Southwestern Bell, AT&T Wireless Communications, Vanguard Cellular Systems and others. Additionally, the Cellular Group has implemented certain Signal Transfer Points which have allowed it to interconnect efficiently with network providers such as Illuminet and the North American Cellular Network. II-9 The Cellular Group plans to integrate the systems in the markets acquired in the exchange with BellSouth into its internal network as quickly as possible. This may involve changing out certain system equipment and replacing it with new equipment which will allow for more efficient networking. During 1997, the Cellular Group has extended the network for its customers through interconnection with additional system operators for call delivery and hand-off. This expanded network increases 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. The Cellular Group believes that currently available technologies will allow sufficient capacity on the Cellular Group'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. The Cellular Group, 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, the Cellular Group 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 the Cellular Group owns an interest have historically been financed through capital contributions or intercompany loans from the Cellular Group to the entities owning the systems, and through certain vendor financing. In recent years, these funding requirements have been met with cash generated from operations, proceeds from debt and equity offerings and proceeds from the sales of cellular interests. MARKETING The Cellular Group'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 the Cellular Group'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. The Cellular Group's distribution channels include direct sales personnel, agents and retail service centers in the vast majority of its markets. In late 1996, the Cellular Group implemented its new site on the WorldWideWeb to support its marketing efforts and to be a future distribution channel. Customers may now order U.S. Cellular service through this web site. These Cellular Group-owned and managed locations are designed to market cellular service to the consumer segment in a familiar setting. The Cellular Group manages each cluster of markets from an administrative office with a local staff, including sales, customer service, engineering and in some cases installation personnel. Direct sales consultants market cellular service to business customers throughout each cluster. Retail associates work out of the retail locations and market cellular service primarily to the consumer and small business segment. The Cellular Group 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. The Cellular Group continues to expand its relationships with agents, dealers and non-Cellular Group retailers to obtain customers. Agents and dealers are independent business people who obtain customers for U.S. Cellular on a commission basis. The Cellular Group's agents are generally in the business of selling cellular telephones, cellular service packages and other related products. The Cellular Group's dealers include car stereo companies and other companies whose customers are also potential cellular customers. The non-Cellular Group retailers include car dealers, major appliance dealers, office supply dealers and mass merchants. The Cellular Group opened its first retail locations in late 1993, expanding to 260 stand-alone retail stores by December 31, 1997. These Cellular Group-owned and operated businesses utilize rental facilities in high-traffic areas. The Cellular Group has implemented a uniform appearance in these stores, with all having similar displays II-10 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 the Cellular Group has traditionally provided. During 1996, the Cellular Group further expanded its retail presence by opening smaller retail kiosks within other larger merchandisers and grocery stores. At December 31, 1997, the Cellular Group had opened over 140 "stores within a store," primarily in Wal-Mart locations. In addition to its own retail centers, the Cellular Group actively pursues national retail accounts, as agents for the Cellular Group, which yield new customer additions in multiple markets. Agreements have been entered into with such national distributors as Ford Motor Company, General Motors, Radio Shack, Best Buy, Circuit City, Staples, Office Depot and Sears, Roebuck & Co. in certain of the Cellular Group's markets. Upon the sale of a cellular telephone by one of these national distributors, the Cellular Group receives, often exclusively within the territories served, the resulting cellular customer. The Cellular Group 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. In 1997, the Cellular Group increased its focus on brand advertising, using the tag line "The Way People Talk Around Here"-SM- to promote the United States Cellular-Registered Trademark- brand. 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 the Cellular Group. The Cellular Group attempts to select the advertising and promotion media that are most appealing to the targeted groups of potential customers in each local market. The Cellular Group utilizes local advertising media and public relations activities and establishes programs to enhance public awareness of the Cellular Group, 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, the Cellular Group is providing cellular service to consumers and to customers who use their cellular telephones for security purposes. Although some of the Cellular Group'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. The Cellular Group'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 the Cellular Group's consolidated systems used their cellular systems approximately 103 minutes per unit each month and generated retail revenue of approximately $36 per month during 1997, compared to 107 minutes and $40 per month in 1996. Revenue generated by roamers, together with local retail, toll and other revenues, brought the Cellular Group's total average monthly service revenue per customer unit in consolidated markets to $54 during 1997. Average monthly service revenue per customer unit decreased approximately 15% during 1997 compared to the same period in 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. The Cellular Group 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. The Cellular Group 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 the Cellular Group's increasing number of customers; therefore, the Cellular Group expects total revenues to continue to grow for the next few years. In addition to revenue from local retail customers, the Cellular Group generates revenue from roaming customers and other services. The Cellular Group'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. The Cellular Group 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 the Cellular Group's systems in the other carriers' systems. Also, a customer of a participating system roaming (i.e. traveling) in a Cellular Group market where this arrangement is in effect is able to make and receive calls on the Cellular Group's system. The charge for this service is typically at premium rates and is billed by the Cellular Group to the customer's home system, which then bills the customer. II-11 The Cellular Group has entered into agreements with other cellular carriers to transfer roaming usage at agreed-upon rates. In some instances, based on competitive factors, the Cellular Group may charge a lower amount to its customers than the amount actually charged to the Cellular Group by another cellular carrier for roaming. The following table summarizes, by operating cluster, the total population, the Cellular Group's customer units and penetration for the Cellular Group's majority-owned and managed markets that were operational as of December 31, 1997.
OPERATING CLUSTERS POPULATION CUSTOMERS PENETRATION - ----------------------------------------------------------------------------------- ------------- ----------- ------------- Wisconsin/Illinois/Indiana ........................................................ 5,778,000 452,000 7.82% Iowa/Missouri...................................................................... 3,154,000 257,000 8.15 Eastern North Carolina/South Carolina ............................................. 2,379,000 124,000 5.21 West Virginia/Maryland/Pennsylvania/Ohio .......................................... 1,138,000 69,000 6.06 Virginia .......................................................................... 1,152,000 70,000 6.08 Washington/Oregon/Idaho ........................................................... 1,380,000 102,000 7.39 Oregon/California ................................................................. 1,038,000 71,000 6.84 Maine/New Hampshire/Vermont ....................................................... 1,688,000 103,000 6.10 Florida/Georgia ................................................................... 1,539,000 115,000 7.47 Oklahoma/Missouri/Kansas .......................................................... 1,420,000 111,000 7.82 Texas/Oklahoma .................................................................... 695,000 46,000 6.62 Eastern Tennessee/Western North Carolina .......................................... 1,279,000 117,000 9.15 Southwestern Texas ................................................................ 1,254,000 56,000 4.47 Other Operations .................................................................. 140,000 17,000 12.14 ------------- ----------- ----- 24,034,000 1,710,000 7.11% ------------- ----------- ----- ------------- ----------- -----
The following table summarizes certain information about customers and market penetration in the Cellular Group's managed operations.
YEAR ENDED OR AT DECEMBER 31, -------------------------------------------------------------- 1997 1996 1995 1994 1993 -------------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Majority-owned and managed markets: Cellular markets in operation (1)........................ 134 131 137 130 116 Total population of markets in service (000s)............ 24,034 21,712 22,309 21,314 19,383 Customer Units: at beginning of period (2)............................. 1,073,000 710,000 421,000 261,000 150,800 additions during period (2)............................ 941,000 561,000 426,000 250,000 165,300 disconnects during period (2).......................... 304,000 198,000 137,000 90,000 55,100 at end of period (2)................................... 1,710,000 1,073,000 710,000 421,000 261,000 Market penetration at end of period (3).................. 7.11% 4.94% 3.18% 1.98% 1.35% Consolidated revenues (4).................................. $ 876,965 $ 680,068 $ 480,316 $ 327,630 $ 210,344 Depreciation expense....................................... 97,591 74,631 57,302 39,520 25,665 Amortization expense....................................... 34,788 34,208 32,156 25,934 19,362 Operating income (loss).................................... 129,543 87,366 42,755 17,385 (8,656) Capital expenditures....................................... 318,748 248,123 210,878 167,164 92,915 Identifiable assets........................................ $ 2,548,909 $2,116,592 $1,890,621 $1,584,142 $1,275,569
- ------------ (1) Represents the number of markets in which the Cellular Group owned at least a 50% interest and which it managed. The revenues and expenses of these cellular markets are included in the Cellular Group'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 (Claritas in 1997). (4) Consolidated revenues for 1997 reflect the Cellular Group's change in financial reporting presentation of certain credits given to customers on their monthly bills. 1993-1996 consolidated revenues have been reclassified to conform to 1997 presentation. 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. The Cellular Group offers a full range of vehicle- II-12 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. The Cellular Group negotiates volume discounts from its cellular telephone suppliers. The Cellular Group 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 the Cellular Group. The Cellular Group also cooperates with cellular equipment manufacturers in local advertising and promotion of cellular equipment. The Cellular Group 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 the Cellular Group to improve its service by promptly assisting customers who experience equipment problems. Additionally, the Cellular Group maintains a repair facility in Tulsa, Oklahoma, which handles more complex service and repair issues. CELLULAR SERVICES. The Cellular Group's customers are able to choose from a variety of packaged pricing plans which are designed to fit different calling patterns. The Cellular Group has 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. The Cellular Group'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 the Cellular Group include wide-area call delivery, call forwarding, call waiting, three-way calling and no-answer transfer. The Cellular Group 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 the Cellular Group are subject to FCC and state regulation. The cellular telephone licenses held by the Cellular Group 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 Cellular Group. The construction, operation and transfer of cellular systems in the United States are regulated to varying degrees by the FCC pursuant to the Communications Act of 1934 (the "Communications Act"). In 1996, Congress enacted the Telecommunications Act of 1996 (the "1996 Act"), which amended the Communications Act. The 1996 Act mandates significant changes in existing telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops 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 as well as local zoning requirements. II-13 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. The Cellular Group 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. Beginning in October 1997, cellular systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements (cellular towers of less than 10 meters in height, building mounted antennas and cellular telephones). After October 1997, all new cellular facilities must be in compliance when they are brought into service. Existing facilities must be brought into compliance with the requirements when their licenses are renewed. The Cellular Group believes that the great majority of its existing facilities already comply with the requirements, the remainder will be brought into compliance as required and that the cellular telephones it sells comply with the standards. Initial cellular telephone licenses were granted for ten-year periods. The FCC has established standards for conducting comparative renewal proceedings between a cellular licensee seeking renewal of its license and challengers filing competing applications. The FCC has: (i) established criteria for comparing the renewal applicant to challengers, including the standards under which a renewal expectancy will be granted to the applicant seeking license renewal; (ii) established basic qualifications standards for challengers; and (iii) provided procedures for preventing possible abuses in the comparative renewal process. The FCC has concluded that it will award a renewal expectancy if the licensee has (i) provided "substantial" performance, which is defined as "sound, favorable and substantially above a level of mediocre service just minimally justifying renewal," and (ii) complied with FCC rules, policies and the Communications Act. If a renewal expectancy is awarded to an existing licensee, its license is renewed and competing applications are not considered. The Cellular Group's Tulsa and Knoxville licenses were renewed in 1995, and the Cellular Group's Des Moines, Iowa; Peoria, Illinois; and Roanoke, Virginia licenses were renewed in 1996. In September 1997, the Cellular Group filed license renewal applications for its Davenport, Iowa; Tallahassee, Florida; Asheville, North Carolina; Manchester, New Hampshire; Columbia, Missouri; Wichita Falls, Texas; Gainesville, Florida; Lewiston, Maine; Joplin, Missouri; Cedar Rapids, Iowa; LaCrosse, Wisconsin; Bangor, Maine; Fort Pierce, Florida; Victoria, Texas; Evansville, Indiana and Owensboro, Kentucky licenses. Those applications were unopposed and are now grantable. On October 30, 1997, the Cellular Group assigned its Evansville and Owensboro licenses to a subsidiary of BellSouth Cellular Corporation as part of the larger Cellular Group-BellSouth transaction. As part of the same transaction, BellSouth assigned its Appleton, Wisconsin; Rockford, Illinois; Green Bay, Wisconsin and Janesville, Wisconsin licenses to the Cellular Group. Unopposed grantable renewal applications are pending for those licenses as well. The Cellular Group expects all of those license renewal applications to be granted shortly. The Cellular Group 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, the Cellular Group believes that current regulations will have no significant effect on its operations and financial condition. However, changes in the regulation of cellular operators or their activities and of other mobile service providers could have a material adverse effect on the Cellular Group'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 the Cellular Group and others. The Cellular Group's strategy with respect to system construction in its markets has been and will be to build cells covering areas within such markets that the Cellular Group considers economically feasible to serve or might conceivably wish to serve and to do so within the five-year period following issuance of the license. In cases where applications for unserved areas are filed which are mutually exclusive and would result in overlapping service areas, the FCC decides between the competing applicants by an auction process. Pursuant to 1993 amendments to the Communications Act, cellular service is classified as a Commercial Mobile Radio Service ("CMRS"), in that it is service offered to the public, for a fee, which is interconnected to the public switched telephone network. The FCC has determined that it will forebear from requiring CMRS carriers to comply with a number of statutory provisions otherwise applicable to common carriers, such as the filing of tariffs. RECENT EVENTS. There are certain regulatory proceedings currently pending before the FCC which are of particular importance to the cellular industry. In one proceeding, the FCC has imposed new "enhanced 911" regulations on cellular carriers. Enhanced 911 capabilities will enable cellular systems to determine the precise location of persons making emergency calls. The new rules will require cellular carriers to work with local public II-14 safety officials to process 911 calls, including those made from mobile telephones not registered with the cellular system, will require carriers by April 1998 to be able to identify the cell from which the call has been made, 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 roaming subscribers of broadband PCS providers, among others, even though the subscribers involved have no pre-existing service relationship with that carrier. Under these new policies, broadband PCS providers 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 vacated the FCC's rules. However, the FCC's rules requiring reciprocal and symmetrical compensation remain in effect as applied to the cellular industry. 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 other parts of the 1996 Act. The 1996 Act provides that implementing its legislative objectives will be the task of the FCC, the state public utilities commissions and a Federal-state Joint Board. Much of this implementation is proceeding in numerous, concurrent proceedings with aggressive deadlines. The Company cannot predict the full extent, 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 provisions 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 has implemented the mandate of the 1996 Act to create a new universal service support mechanism "to ensure that all Americans have access to telecommunications services." The 1996 Act requires all interstate telecommunications providers, including wireless service providers, to "make an equitable and non-discriminatory contribution," to support the cost of providing universal service, unless their contribution would be de minimis. At present, the provision of landline telephone service in high cost areas is subsidized by access charges and other payments by interexchange carriers to LECs. The obligation to make payments to support universal service has been expanded to include other telecommunications service providers, including cellular carriers. Such payments, which are to be based on a percentage of the total "billed revenue" of carriers for a given previous half year, are to begin being made in the first quarter of 1998. Carriers are free to pass such charges on to their customers. Cellular carriers are also eligible to receive universal service support payments in certain circumstances under the new systems if they provide specified services in II-15 "high cost" areas. the Cellular Group has sought designation as an "eligible telecommunications carrier" qualified to receive universal service support in certain states. 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. 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 services and will result in increased competition with the Cellular Group'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 the Cellular Group. There can be no assurance that the Cellular Group 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. The Cellular Group 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. STATE AND LOCAL REGULATION. The Cellular Group is also subject to state and local regulation in some instances. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure. In 1993, Congress preempted states from regulating the entry of cellular systems into service and the rates charged by cellular systems to customers. The siting and construction of the cellular facilities, including transmitter towers, antennas and equipment shelters are still subject to state or local zoning and land use regulations. However, in 1996, Congress amended the Communications Act to provide that states could not discriminate against wireless carriers in tower zoning proceedings and had to decide on zoning requests with reasonable speed. In addition, states may still regulate other terms and conditions of cellular service. The FCC is currently considering whether to take action to pre-empt moratoria imposed by certain localities on the construction of wireless towers. the Cellular Group has supported such FCC action. The FCC is required to forbear from applying any statutory or regulatory provision that is not necessary to keep telecommunications rates and terms reasonable or to protect consumers. A state may not apply a statutory or regulatory provision that the FCC decides to forbear from applying. In addition, the FCC must review its telecommunications regulations every two years and change any that are no longer necessary. Further, the FCC is empowered under certain circumstances to preempt state regulatory authorities if a state is obstructing the Communications Act's basic purposes. The Cellular Group 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. The Cellular Group is unable to predict the scope, pace or financial impact of policy changes which could be adopted in these proceedings. COMPETITION The Cellular Group'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 the Cellular Group has an interest have financial resources which are substantially greater than those of the Cellular Group and its partners in such markets. II-16 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. The Cellular Group 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 ESMR systems were implemented in 1993 in Los Angeles and are being constructed in several other cities across the United States. In 1995, an ESMR provider initiated service in Tulsa, Oklahoma, where the Cellular Group operates a cellular system. 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 many markets across the United States, including a number of markets where the Cellular Group 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. The Cellular Group expects PCS operators to complete initial deployment of PCS in portions of all of the Cellular Group clusters by the end of 1998. 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. II-17 EXPLANATORY NOTE REGARDING FINANCIAL INFORMATION Effective upon completion of the Transactions, Telephone and Data Systems, Inc. will have outstanding five classes of Common Stock: United States Cellular Group Common Shares, which are intended to reflect the performance of the United States Cellular Group; TDS Telecommunications Group Common Shares, which are intended to reflect the performance of the TDS Telecommunications Group; Aerial Communications Group Common Shares, which are intended to reflect the performance of the Aerial Communications Group; and Common Shares and Series A Common Shares which are intended to reflect the performance of a residual group (the TDS Group) (which will also reflect the performance of the United States Cellular Group, the TDS Telecommunications Group, and the Aerial Communications Group to the extent of the Retained Interest in those groups.) Although the financial statements of the United States Cellular Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of Telephone and Data Systems, Inc. attributed to the United States Cellular Group such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of United States Cellular Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares are, shareholders of TDS. TDS and its subsidiaries would each continue to be responsible for their respective liabilities. Financial results arising from the business of Telephone and Data Systems, Inc. (including its Retained Interest in the United States Cellular Group) or from the business of the United States Cellular Group could affect the market price of all classes of Common Stock. In addition, any net losses of any of the Groups, including the United States Cellular Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on all classes of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the United States Cellular Group's financial information. II-18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR THE THREE YEARS ENDED DECEMBER 31, 1997 The United States Cellular Group ("Cellular Group") consists solely of United States Cellular Corporation ("U.S. Cellular"), an 81%-owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which operates and invests in cellular telephone companies and properties. The Cellular Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Cellular Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Cellular Group, as determined by the Board of Directors of TDS. RESULTS OF OPERATIONS The Cellular Group owned either majority or minority cellular interests in 192 markets at December 31, 1997, representing 26,179,000 population equivalents ("pops"). The Cellular Group included the operations of 134 majority-owned and managed cellular markets, representing 22.6 million pops, in consolidated operations ("consolidated markets") as of December 31, 1997. Minority interests in 51 markets, representing 3.5 million pops, were accounted for using the equity method and were included in investment income at that date. All other interests, representing less than 100,000 pops in the aggregate, were accounted for using the cost method. Following is a table of summarized operating data for the Cellular Group's consolidated operations.
YEAR ENDED OR AT DECEMBER 31, --------------------------------------------- 1997 1996 1995 ------------- --------------- ------------- Total market population (in thousands) (1)............... 24,034 21,712 22,309 Customers................................................ 1,710,000 1,073,000 710,000 Market penetration....................................... 7.11% 4.94% 3.18% Markets in operation..................................... 134 131 137 Cell sites in service.................................... 1,748 1,328 1,116 Average monthly revenue per customer..................... $ 54.18 $ 63.69(2) $ 70.64(2) Churn rate per month..................................... 1.9% 1.9% 2.1% Marketing cost per net customer addition................. $ 528 $ 505(2) $ 515(2)
- --------- (1) Calculated using the respective Donnelley Marketing Service estimates for each year (Claritas for 1997). (2) Recomputed to show the effect of change in current year presentation of certain revenues and expenses. The Cellular Group's operating income for 1997 and 1996, which includes 100% of the revenues and expenses of its consolidated markets plus its corporate office operations, primarily reflects improvement in the Cellular Group's overall operations compared to 1996 and 1995. The improvements resulted from growth in the Cellular Group's customer base and revenues in each year, coupled with increasing economies of scale in both years. Operating revenues, driven by increases in customers served, rose $196.9 million, or 29%, in 1997 and $199.8 million, or 42%, in 1996. Operating expenses rose $154.7 million, or 26%, in 1997 and $155.1 million, or 35%, in 1996. Operating cash flow (operating income before minority share plus depreciation and amortization expense) increased $65.7 million, or 33%, in 1997 and $64.0 million, or 48%, in 1996. Beginning on January 1, 1997, the Cellular Group changed its income statement presentation of certain credits given to customers on their monthly bills. Customer incentive programs which result in either new or current customers receiving free or reduced-price airtime or access are now reported as a reduction of local retail revenue. Prior to January 1, 1997, the Cellular Group reported the foregone revenues resulting from these incentive programs as marketing and selling expense (for new customers) and general and administrative expense (for current customers). Amounts in the currently affected revenue and expense categories have been reclassified for previous years. Operating income and net income are not affected by this change. Investment and other income decreased $83.5 million, or 44%, to $107.6 million in 1997, due primarily to the decrease of $102.4 million in gains on the sales of cellular interests. Investment and other income increased $66.4 million, or 53%, in 1996, due primarily to the increase of $49.2 million in gains on the sales of cellular interests. Interest expense increased $6.3 million, or 27%, in 1997 and decreased $4.2 million, or 15%, in 1996. Income tax expense decreased $27.7 million to $83.9 million in 1997, as improved operating results were more than offset by decreased gains on the sales of cellular interests. Income tax expense increased $79.1 million in 1996, primarily due to the increase in gains on the sales of cellular interests. II-19 Net income totaled $111.5 million in 1997, a decrease of $18.4 million, or 14%, from 1996, and totaled $129.9 million in 1996, an increase of $30.2 million, or 30%, over 1995. In all three years, net income included gains on sales of cellular interests. A summary of the after-tax effects of these gains on net income is shown below.
YEAR ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ----------- ----------- --------- (DOLLARS IN THOUSANDS) Net income before after-tax effects of gains........................ $ 95,302 $ 62,504 $ 43,918 Add: After-tax effects of gains..................................... 16,237 67,425 55,824 ----------- ----------- --------- Net income as reported.............................................. $ 111,539 $ 129,929 $ 99,742 ----------- ----------- --------- ----------- ----------- ---------
OPERATING REVENUES OPERATING REVENUES totaled $877.0 million in 1997, up $196.9 million, or 29%, over 1996. Operating revenues totaled $680.1 million in 1996, up $199.8 million, or 42%, over 1995. As explained previously, operating revenues for 1996 and 1995 have been reclassified to conform to current period presentation of customer incentive program credits. SERVICE REVENUES primarily consist of: (i) charges for access, airtime and value-added services provided to the Cellular Group's local retail customers who use the local systems operated by the Cellular Group ("local retail"); (ii) charges to customers of other systems who use the Cellular Group's cellular systems when roaming ("inbound roaming"); and (iii) charges for long-distance calls made on the Cellular Group's systems. Service revenues totaled $853.0 million in 1997, up $190.3 million, or 29%, over 1996. Service revenues totaled $662.7 million in 1996, up $198.1 million, or 43%, over 1995. The increases in both years were primarily due to the growing number of local retail customers and the growth in inbound roaming revenue. The reclassification of customer bill credits reduced service revenues from what would have been reported by $49.0 million, or 5%, in 1997, and from what was reported by $27.8 million, or 4%, in 1996 and $12.1 million, or 3%, in 1995. Average monthly service revenue per customer totaled $54.18 in 1997, $63.69 in 1996 and $70.64 in 1995, representing declines of 15% in 1997 and 10% in 1996. The decrease in average monthly service revenue per customer in both years resulted from a decrease in average revenue per minute of use from both local retail customers and inbound roamers. Also contributing was slower growth in inbound roaming minutes of use when compared to the growth in the Cellular Group's customer base. The reclassification of customer bill credits reduced average monthly service revenue per customer from what would have been reported by $3.11, or 5%, in 1997, and from what was reported by $2.67, or 4%, in 1996 and $1.84, or 3%, in 1995. Competitive pressures and the Cellular Group's increasing use of pricing and other incentive programs that encourage weekend and off-peak usage at reduced rates, in order to stimulate overall usage, plus increasing amounts of bill credits given to new and current customers as incentives to become or remain the Cellular Group's customers, resulted in a decrease in average local retail revenue per minute of use during both 1997 and 1996. The Cellular Group's average inbound roaming revenue per minute of use also decreased during both 1997 and 1996, in line with the ongoing trend toward reduced per minute prices for roaming negotiated between the Cellular Group and other cellular operators. Also, the Cellular Group 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. Inbound roaming minutes of use have been growing at a slower rate than the Cellular Group's customer base (27% and 31% growth in inbound roaming minutes in 1997 and 1996, respectively, compared to 59% and 51% growth in the Cellular Group's customer base). LOCAL RETAIL REVENUE increased $153.8 million, or 37%, in 1997 and $137.4 million, or 50%, in 1996. Growth in the Cellular Group's customer base was the primary reason for the increases in local revenue in both years. The number of customers increased 59% to 1,710,000 at December 31, 1997, and increased 51% to 1,073,000 at December 31, 1996. The Cellular Group added 442,000 net new customers from its marketing channels in 1997 compared to 365,000 in 1996. Management anticipates that the growth rate in the Cellular Group's customer base will be lower in the future, primarily as a result of an increase in the number of competitors in its markets. The reclassification of customer bill credits reduced local retail revenue from what would have been reported by $49.0 million, or 8%, in 1997, and from what was reported by $27.8 million, or 6%, in 1996 and $12.1 million, or 4%, in 1995. Average monthly local retail revenue per customer declined to $36.11 in 1997 from $39.87 in 1996 and $42.19 in 1995. Monthly local retail minutes of use per customer decreased less than 4% to 103 in 1997, and increased 13% II-20 to 107 in 1996. Average revenue per minute of use decreased in both years as a result of the pricing and other incentive programs stated previously. Average local retail revenue per minute totaled $.35 in 1997 compared to $.37 in 1996 and $.44 in 1995. The decrease in average monthly local retail revenue per customer is part of an industry-wide trend and is believed to be related to the tendency of the early customers in a market to be the heaviest users during peak business hours. It also reflects the increasing level of competition for wireless services and the Cellular Group's and the industry's continued penetration of the consumer market, which tends to include fewer peak business hour-usage customers. The reclassification of customer bill credits reduced average monthly local retail revenue per customer from what would have been reported by $3.11, or 8%, in 1997, and from what was reported by $2.67, or 6%, in 1996 and $1.84, or 4%, in 1995. INBOUND ROAMING REVENUE increased $24.2 million, or 13%, in 1997 and $45.3 million, or 31%, in 1996. Both the 1997 and 1996 increases were attributable to the respective 27% and 38% increases in the number of minutes used by customers from other wireless systems when roaming in the Cellular Group's service areas. Also contributing were the increased number of cell sites within the Cellular Group's service areas. These effects were offset somewhat by the decrease in average revenue per minute due to the downward trend in negotiated rates. Average inbound roaming revenue per minute totaled $.83 in 1997, $.92 in 1996 and $.99 in 1995. Monthly inbound roaming revenue per Cellular Group customer averaged $13.81 in 1997, $18.58 in 1996 and $22.51 in 1995. The decreases in monthly inbound roaming revenue per Cellular Group customer are related to both the decreases in inbound roaming revenue per minute and the faster increases in the Cellular Group's customer base as compared to the growth in inbound roaming minutes of use. LONG-DISTANCE REVENUE increased $12.0 million, or 23%, in 1997 and $17.3 million, or 49%, in 1996 as the volume of long-distance calls billed by the Cellular Group increased. Monthly long-distance revenue per customer averaged $4.10 in 1997, $5.05 in 1996 and $5.36 in 1995. The decrease in monthly long-distance revenue per customer is primarily due to the dilution of the portion of long-distance revenue that comes from inbound roaming customers. In a manner similar to inbound roaming revenue, this revenue is not growing as fast as the Cellular Group's customer base. EQUIPMENT SALES REVENUES increased $6.6 million, or 38%, in 1997 and $1.6 million, or 10%, in 1996. Equipment sales reflect the sale of 587,000, 449,000 and 296,000 cellular telephone units in 1997, 1996 and 1995, respectively, plus installation and accessories revenue. The average revenue per unit was $41 in 1997, $39 in 1996 and $53 in 1995. The average revenue per unit in all years is significantly less than the Cellular Group's cost per unit, which partially reflects the Cellular Group's decision to reduce sales prices on cellular telephones to stimulate growth in the number of customers, to maintain its market position and to meet competitive prices as well as to pass through reduced manufacturers' prices to customers. Also, the Cellular Group uses promotions which are based on increased equipment discounting. The success of these promotions has led to both an increase in units sold and a general decline in average equipment sales revenue per unit over the last several years. OPERATING EXPENSES OPERATING EXPENSES totaled $747.4 million in 1997, up $154.7 million, or 26%, over 1996. Operating expenses totaled $592.7 million in 1996, up $155.1 million, or 35%, over 1995. As explained previously, operating expenses for 1996 and 1995 have been reclassified to conform to current period presentation of customer incentive program credits. The reclassification of customer bill credits reduced operating expenses from what would have been reported by $49.0 million, or 6%, in 1997, and from what was reported by $27.8 million, or 4%, in 1996 and $12.1 million, or 3%, in 1995. SYSTEM OPERATIONS EXPENSES increased $35.8 million, or 30%, in 1997 and $46.9 million, or 67%, in 1996. These increases were primarily due to increases in customer usage expenses and costs associated with serving the Cellular Group's increased number of customers, which include the costs of roaming fraud, and the growing number of cell sites within the Cellular Group's systems. In 1997, the Cellular Group significantly reduced its expenses related to roaming fraud, resulting in a decline in the percentage increase in total system operations expenses during the year. In total, system operations costs are expected to continue to increase as the number of customers using and the number of cell sites within the Cellular Group's systems grows. Customer usage expenses represent charges from other telecommunications service providers for the Cellular Group's customers' use of their facilities as well as for the Cellular Group's inbound roaming traffic on these facilities. Also included are costs related to local interconnection to the landline network, toll charges and expenses incurred by the Cellular Group when its customers use systems other than their local systems ("outbound II-21 roaming"). These expenses are offset somewhat by amounts the Cellular Group bills to its customers for outbound roaming. Customer usage expenses increased $24.3 million, or 32%, in 1997 and $40.4 million, or 116%, in 1996. The increase in 1997 is primarily due to the increase in net outbound roaming expense, which has resulted from the Cellular Group offering its customers increasingly larger service footprints in which their calls are billed at local rates. In certain cases these service areas include other operators' service areas. The Cellular Group pays roaming rates to the other carriers for calls the Cellular Group's customers make in these areas, while charging those customers a local rate which is usually lower than the roaming rate. Also contributing to the increase in 1997 were costs related to the increase in minutes used on the Cellular Group's systems, partially offset by the reduction in costs related to fraudulent use of the Cellular Group's customers' cellular telephone numbers. The increase in 1996 is due to both an increase in net outbound roaming expense and an increase in fraud-related costs. These fraud-related costs totaled $6.5 million in 1997, $18.0 million in 1996 and $4.1 million in 1995. The Cellular Group continues to implement procedures in its markets to combat this fraud, which is primarily related to roaming usage. Customer usage expenses represented 12% of service revenues in 1997, 11% in 1996 and 7% in 1995. Maintenance, utility and cell site expenses increased $11.5 million, or 27%, in 1997, and $6.5 million, or 18%, in 1996. The increases primarily reflect an increase in the number of cell sites in the Cellular Group's systems each year, to 1,748 in 1997 from 1,328 in 1996 and 1,116 in 1995. Monthly maintenance, utility and cell site expenses totaled $2,900, $2,866 and $3,107 per average cell site in 1997, 1996 and 1995, respectively. MARKETING AND SELLING EXPENSES increased $47.4 million, or 37%, in 1997 and $35.5 million, or 39%, in 1996. Marketing and selling expenses primarily consist of salaries, commissions and expenses of field sales and retail personnel and offices; agent expenses; local advertising and public relations expenses. The 1997 increase was primarily due to a 33% rise in the number of gross customer activations (excluding acquisitions and divestitures), to 746,000 in 1997 from 563,000 in 1996. Also in 1997, the Cellular Group increased its advertising expenses, particularly brand advertising, to promote the United States Cellular-Registered Trademark- brand. The 1996 increase was primarily due to a 44% rise in the number of gross customer activations (excluding acquisitions and divestitures), to 563,000 in 1996 from 392,000 in 1995. Cost per gross customer activation, including losses on equipment sales, decreased to $313 in 1997 from $327 in 1996 and $335 in 1995. While cost per gross customer activation in total decreased in 1997 and 1996, the percentage of cost per gross customer activation attributable to marketing and selling expenses increased to 75% in 1997 from 69% in 1996 and 70% in 1995. The percentage increase from 1996 to 1997 is primarily due to the additional advertising expenses coupled with decreased losses on equipment sales due to lower per unit manufacturer equipment prices. The reclassification of customer bill credits reduced cost per gross addition from what would have been reported by $52, or 14%, in 1997, and from what was reported by $40, or 11%, in 1996 and $26, or 7%, in 1995; in total, the reclassification reduced marketing and selling expenses from what would have been reported by $38.6 million, or 18%, in 1997, and from what was reported by $22.3 million, or 15%, in 1996 and $10.2 million, or 10%, in 1995. COST OF EQUIPMENT SOLD increased $8.3 million, or 11%, in 1997 and $19.1 million, or 35%, in 1996. The increase reflects the growth in unit sales related to the rise in gross customer activations made through the Cellular Group's direct and retail distribution channels, offset somewhat by falling manufacturer prices per unit. The average cost to the Cellular Group of a telephone unit sold, including accessories and installation, was $140 in 1997, $165 in 1996 and $186 in 1995. GENERAL AND ADMINISTRATIVE EXPENSES increased $39.7 million, or 24%, in 1997 and $34.2 million, or 26%, in 1996. These expenses include the costs of operating the Cellular Group's local business offices and its corporate expenses. The increase includes the effects of increases in expenses required to serve the growing customer base in existing markets and an expansion of both local administrative office and corporate staff, necessitated by growth in the Cellular Group's business. Employee-related expenses increased $19.4 million, or 26%, in 1997 and $15.6 million, or 27%, in 1996, primarily due to increases in the number of administrative employees in each year. Also, bad debt expense increased $8.0 million, or 46%, in 1997 and $5.0 million, or 40%, in 1996, primarily due to the Cellular Group's increased penetration of the consumer market. The Cellular Group is using an ongoing clustering strategy to combine local and customer service operations wherever feasible in order to gain operational efficiencies and reduce its per unit administrative expenses. Monthly general and administrative expenses per customer decreased to $12.99 in 1997 from $15.84 in 1996 and $19.85 in 1995. The reclassification of customer bill credits reduced general and administrative expenses from what would have been reported by $10.4 million, or 5%, in 1997, and from what was reported by $5.5 million, or 2%, in 1996 and $1.9 million, or 1%, in 1995. II-22 Operating cash flow increased $65.7 million, or 33%, to $261.9 million in 1997 and increased $64.0 million, or 48%, to $196.2 million in 1996. The improvement was primarily due to substantial growth in customers and service revenues and the effects of improved operational efficiencies on cash operating expenses. Operating cash flow margins were 30.7% in 1997, 29.6% in 1996 and 28.5% in 1995; had the reclassification of customer bill credits not been made, operating cash flow margins would have been 29.0% in 1997, 28.4% in 1996 and 27.7% in 1995. DEPRECIATION EXPENSE increased $23.0 million, or 31%, in 1997 and $17.3 million, or 30%, in 1996. The increase reflects rising average fixed asset balances, which increased 35% in 1997 and 34% in 1996. Increased fixed asset balances primarily result from the increase in cell sites built to improve coverage and capacity in the Cellular Group's markets. OPERATING INCOME BEFORE MINORITY SHARE OPERATING INCOME before minority share totaled $129.5 million in 1997, $87.4 million in 1996 and $42.8 million in 1995. The operating income margin (as a percent of service revenues) was 15.2% in 1997, 13.2% in 1996 and 9.2% in 1995; had the reclassification of customer bill credits not been made, operating income margins would have been 14.4% in 1997, 12.7% in 1996 and 9.0% in 1995. The improvement in operating income and operating income margin reflects increased revenues resulting from growth in the number of customers served by the Cellular Group's systems and the effect of improved operational efficiencies on total operating expenses. The Cellular Group expects service revenues to continue to grow during 1998; however, management anticipates that average monthly revenue per customer will continue to decrease as local retail and inbound roaming revenue per minute of use decline and as the Cellular Group further penetrates the consumer market. Additionally, the Cellular Group expects expenses to increase during 1998 as it incurs costs associated with both customer growth and cell sites added. Management believes there exists a seasonality in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth, which may cause operating income to vary from quarter to quarter. Additionally, competitors licensed to provide personal communications services ("PCS") have initiated service in certain of the Cellular Group's markets over the past eighteen months. The Cellular Group expects PCS operators to complete initial deployment of PCS in portions of all of the Cellular Group's clusters by the end of 1998. The Cellular Group has increased its advertising, particularly brand advertising, in 1997 to promote the United States Cellular-Registered Trademark- brand and distinguish the Cellular Group's service from other wireless communications providers. The Cellular Group's management continues to monitor other wireless communications providers' strategies to determine what effects additional competition will have on the Cellular Group's future strategies and results. While the effects of additional wireless competition have slowed customer growth in certain of the Cellular Group's markets, the overall effect on the Cellular Group's total customer growth to date has not been material. INVESTMENT AND OTHER INCOME INVESTMENT AND OTHER INCOME totaled $107.6 million in 1997, $191.1 million in 1996 and $124.7 million in 1995. GAIN ON SALE OF CELLULAR INTERESTS totaled $30.3 million in 1997, reflecting gains recorded on the sales of the Cellular Group's majority interests in one market and one market partition and minority interests in two other markets, and on cash received from the settlement of a legal matter. Gain on sale of cellular interests totaled $132.7 million in 1996, reflecting gains recorded on the sales of the Cellular Group's majority interests in eight markets and minority interests in two other markets, on cash received in an exchange of markets with another cellular operator and on cash received from the settlement of two separate legal matters. Gain on sale of cellular interests totaled $83.5 million in 1995, reflecting gains recorded on the sales of majority interests in six markets and minority interests in six markets, on cash received in an exchange of markets with another cellular operator and on the sale of certain marketable equity securities. INVESTMENT INCOME was $77.1 million in 1997 compared to $51.5 million in 1996 and $39.8 million in 1995. Investment income primarily represents the Cellular Group's share of net income from the markets managed by others that are accounted for by the equity method. Although investment income increased significantly in 1996 and 1997, future investment income will be negatively impacted by the completion of the exchange transaction with BellSouth Corporation ("BellSouth") and the divestitures of certain minority interests to AirTouch Communications ("AirTouch"). See "Financial Resources and Liquidity--Acquisitions, Divestitures and Exchanges" for further discussions of these transactions. II-23 INTEREST AND INCOME TAXES INTEREST EXPENSE totaled $29.4 million in 1997 compared to $23.1 million in 1996 and $27.3 million in 1995. Interest expense in 1997 is primarily related to Liquid Yield Option Notes ("LYONs") ($15.2 million); the Cellular Group's 7.25% notes (the "Notes") issued during the third quarter of 1997 ($6.3 million); borrowings under vendor financing agreements ($4.5 million); and borrowings under the Revolving Credit Agreement with TDS ($1.9 million). Interest expense in 1996 is primarily related to LYONs ($14.4 million) and borrowings under vendor financing agreements ($8.0 million). Interest expense in 1995 is primarily related to borrowings under the Revolving Credit Agreement with TDS ($10.4 million), borrowings under vendor financing agreements ($9.2 million) and LYONs ($7.4 million). In August 1997, U.S. Cellular sold $250 million principal amount of 7.25% Notes under a shelf registration statement, priced to yield 7.33% to maturity. The Notes are unsecured and become due on August 15, 2007. Interest on the Notes is payable semi-annually on February 15 and August 15 of each year, commencing February 15, 1998. The Notes will be redeemable, in whole or in part, at the option of U.S. Cellular at any time on or after August 15, 2004. The LYONs are zero coupon convertible debentures which accrete interest at 6% annually, but do not require current cash payments of interest. All accreted interest is added to the outstanding principal balance on June 15 and December 15 of each year. All borrowings under the vendor financing agreements were repaid in August 1997 with a portion of the proceeds from the Notes offering. Borrowings under the Revolving Credit Agreement with TDS were outstanding from April 1997 through August 1997, at which time all outstanding amounts were repaid with a portion of the proceeds from the Notes offering. Borrowings under the Revolving Credit Agreement with TDS were also outstanding from January 1995 through June 1995, at which time all outstanding amounts were repaid with a portion of the proceeds from the LYONs offering. INCOME TAX EXPENSE was $83.9 million in 1997, $111.6 million in 1996 and $32.5 million in 1995. In 1997, $14.1 million of income tax expense related to the gains on sales of cellular interests compared to $65.3 million in 1996 and $27.7 million in 1995. The effective tax rates were 43% in 1997, 46% in 1996 and 25% in 1995. The fluctuation in each year's effective tax rate is primarily due to the different amounts of gains on sales of cellular interests in each year; these gains are generally taxed at a higher rate than income from operations, due to the lower tax basis of certain interests which were originally acquired in transactions structured to be tax-deferred. In 1997, 1996 and 1995, state income taxes and gains on sales of cellular interests increased the effective rate above the statutory federal income tax rate. In 1995, this effect was offset by the effect of the valuation allowance on the deferred tax asset, which decreased the effective rate below the statutory rate. TDS and the Cellular Group are parties to a Tax Allocation Agreement, pursuant to which the Cellular Group is included in a consolidated federal income tax return with other members of the TDS consolidated group. For financial reporting purposes, the Cellular Group computes federal income taxes as if it were filing a separate return as its own affiliated group and was not included in the TDS consolidated tax return. NET INCOME NET INCOME totaled $111.5 million in 1997, $129.9 million in 1996 and $99.7 million in 1995. Net income in all three years included gains on the sales of cellular interests. FINANCIAL RESOURCES AND LIQUIDITY The Cellular Group operates a capital and marketing-intensive business. In recent years, the Cellular Group has generated operating cash flow and received cash proceeds from divestitures to fund most of its construction costs and substantially all of its operating expenses. The Cellular Group anticipates further substantial increases in cellular units in service, revenues and cell sites as it continues its growth strategy. Operating cash flow may fluctuate from quarter to quarter depending on the seasonality of each of these growth factors. Cash flows from operating activities provided $222.1 million in 1997, $137.5 million in 1996 and $115.9 million in 1995. Operating cash flow provided $261.9 million in 1997, $196.2 million in 1996 and $132.2 million in 1995. Cash flows from other operating activities (investment and other income, interest expense, changes in working capital and changes in other assets and liabilities) required cash investments totaling $39.8 million in 1997, $58.7 million in 1996 and $16.3 million in 1995. II-24 Cash flows from financing activities provided $135.9 million in 1997, required $11.2 million in 1996 and provided $19.3 million in 1995. In August 1997, the Notes offering provided $243.1 million of cash. A portion of the proceeds from the Notes offering was used to repay all outstanding borrowings under the Revolving Credit Agreement with TDS and under vendor financing agreements, aggregating $160.5 million. Repayments of borrowings under the vendor financing agreements earlier in 1997 totaled $13.7 million. In 1996, issuances of U.S. Cellular Common Shares, primarily to TDS, provided $10.5 million while repayments of debt under the vendor financing agreements required $21.5 million. In 1995, the sale of LYONs provided cash totaling $221.5 million and borrowings under the vendor financing agreements provided cash totaling $59.5 million. This cash was used to repay amounts owed under the Revolving Credit Agreement with TDS totaling $251.2 million and amounts owed under the vendor financing agreements totaling $13.4 million. Cash flows from investing activities required $358.5 million in 1997, $150.3 million in 1996 and $102.6 million in 1995. The Cellular Group received net cash proceeds totaling $61.1 million in 1997, $213.0 million in 1996 and $151.1 million in 1995 related to the sales and exchanges of cellular interests. Cash distributions from cellular entities in which the Cellular Group has an interest provided $52.4 million in 1997, $23.5 million in 1996 and $8.7 million in 1995. Cash required for property, plant and equipment and system development expenditures totaled $318.7 million in 1997, financed primarily with internally generated cash and the proceeds from the Notes offering, $248.1 million in 1996, financed primarily with internally generated funds and proceeds from the sales of cellular interests, and $206.2 million in 1995, financed primarily with internally generated funds and proceeds from the LYONs offering. These expenditures primarily represent the construction of 331, 242 and 292 cell sites, respectively, plus other plant additions and costs related to the development of the Cellular Group's office systems. Acquisitions required $128.8 million in 1997, $116.4 million in 1996 and $29.3 million in 1995. Anticipated capital requirements for 1998 primarily reflect the Cellular Group's construction and system expansion program. The Cellular Group's construction and system expansion budget for 1998 is approximately $330 million, primarily for new cell sites to expand and enhance the Cellular Group's coverage in its service areas and for the enhancement of the Cellular Group's office systems. ACQUISITIONS, DIVESTITURES AND EXCHANGES The Cellular Group assesses its cellular holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. As the Cellular Group's clusters have grown, the Cellular Group's focus has shifted toward exchanges and divestitures of managed and investment interests. Over the past few years, the Cellular Group has completed exchanges of controlling interests in its less strategic markets for controlling interests in markets which better complement its clusters. The Cellular Group has also completed outright sales of other less strategic markets. The proceeds from these sales have been used to further the Cellular Group's growth. In 1997, the Cellular Group, or TDS for the benefit of the Cellular Group, purchased majority interests in two markets and several minority interests, representing approximately 534,000 pops. The total consideration paid for these purchases, primarily in the form of cash (including cash borrowed under the Revolving Credit Agreement with TDS) and U.S. Cellular Common Shares issued to TDS to reimburse TDS for the value of TDS Common Shares issued to third parties, totaled $81.4 million. Also in 1997, the Cellular Group completed an exchange with BellSouth. Pursuant to the exchange, the Cellular Group received majority interests representing approximately 4.0 million pops in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests the Cellular Group received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters. In 1996, the Cellular Group purchased majority interests in two markets and several minority interests, representing 1.0 million pops, and received a majority interest in another market through an exchange with another cellular operator. The total consideration paid for these purchases, primarily in the form of cash and U.S. Cellular Common Shares issued to TDS to reimburse TDS for the value of TDS Common Shares issued to third parties, totaled $158.9 million. Included in these acquisitions are minority interests representing 598,000 pops the Cellular Group acquired from TDS for $102.8 million in cash, pursuant to an agreement entered into in June 1996. In 1995, the Cellular Group purchased majority interests in 11 markets and several minority interests, representing 1.7 million pops. The total consideration paid for these purchases, primarily in the form of cash and U.S. Cellular Common Shares issued or issuable to TDS to reimburse TDS for the value of TDS Common Shares issued and issuable and cash paid to third parties, totaled $151.0 million. The Cellular Group also acquired majority II-25 interests in 12 markets, representing 2.0 million pops, as a result of six separate exchange transactions completed during 1995. In 1997, the Cellular Group sold majority interests in one market plus one market partition and minority interests in two other markets, representing 358,000 pops, for an aggregate consideration of $54.5 million in cash and receivables. The two minority interests involved interests the Cellular Group had previously acquired from TDS pursuant to the June 1996 agreement between the two companies. In the aggregate, the Cellular Group recorded a substantial book gain on the divestitures of the interests acquired from TDS. In 1996, the Cellular Group sold majority interests in eight markets and one market partition, plus minority interests in two other markets, representing 1.2 million pops, and divested a majority interest in another market through an exchange with another cellular operator. The Cellular Group received cash consideration totaling $187.8 million from these sales and from the exchange. The Cellular Group also settled two separate legal matters during 1996, receiving $30.3 million in cash from those transactions. In total, sales, exchanges and litigation settlements provided the Cellular Group with cash totaling $218.1 million in 1996. In 1995, the Cellular Group sold majority interests in six markets and minority interests in six markets, representing 1.1 million pops. The Cellular Group received consideration of cash and receivables totaling $128.2 million from these sales. The Cellular Group also divested majority interests in 10 markets plus three market partitions, representing 2.1 million pops, as a result of the exchange transactions completed during 1995. At December 31, 1997, the Cellular Group had entered into agreements to acquire a majority interest in one market and a minority interest in a market in which the Cellular Group owns a majority interest, representing 410,000 pops, for $51.3 million in cash. If the majority interest is acquired as expected, the Cellular Group will subsequently sell that interest to BellSouth for cash. Also at December 31, 1997, the Cellular Group had entered into agreements with AirTouch to divest minority interests in nine markets, representing approximately 759,000 pops. In exchange, the agreements provided that the Cellular Group will receive approximately 4.0 million shares of AirTouch stock and cash totaling $54.2 million. In addition, the Cellular Group will receive approximately $27.0 million in cash from TDS pursuant to a contract right termination agreement entered into between the Cellular Group and TDS. This agreement is related to two interests which are to be sold directly by TDS to AirTouch and which were to be acquired by the Cellular Group as part of the June 1996 agreement between the Cellular Group and TDS. The contract right termination agreement will enable the Cellular Group to receive cash equal to the value of the gain the Cellular Group would have realized had it purchased the interests from TDS and sold them to AirTouch under terms similar to those in the agreement between TDS and AirTouch. Additionally, the Cellular Group has entered into an agreement to sell its minority interests in two other markets, representing 176,000 pops, for $37.6 million in cash. The Cellular Group expects these pending transactions to be completed during the first half of 1998. The Cellular Group anticipates that it will record significant book gains on these divestitures when the transactions are completed. LIQUIDITY The Cellular Group anticipates that the aggregate resources required for 1998 will include approximately $330 million for capital spending and approximately $51 million to complete pending acquisitions. The Cellular Group is generating substantial cash from its operations and anticipates financing its capital spending for 1998 primarily with internally generated cash. The Cellular Group had $14 million of cash and cash equivalents at December 31, 1997 and expects to receive approximately $119 million from pending divestitures and the contract right termination agreement during 1998. Additionally, in August 1997 U.S. Cellular established a $500 million revolving credit facility with a group of banks. This seven-year facility replaces the Cellular Group's Revolving Credit Agreement with TDS. No borrowings have been made under the new credit facility through December 31, 1997. U.S. Cellular filed a shelf registration statement in July 1997 covering $400 million of debt securities, and in August 1997 sold $250 million of Notes under such shelf registration statement. The remaining $150 million is available for future transactions. Management believes that the nature of the interest rate bases related to the Cellular Group's current and potential future debt financing sources do not subject the Cellular Group to material market risk exposures. II-26 Management believes that the Cellular Group's operating cash flows and sources of external financing, including the above-referenced revolving credit facility and shelf registration, provide substantial financial flexibility for the Cellular Group to meet both its short and long-term needs. The Cellular Group also currently has access to public and private capital markets to help meet its long-term financing needs. The Cellular Group anticipates issuing debt and equity securities only when capital requirements (including acquisitions), financial market conditions and other factors warrant. The Cellular Group has assessed, and continues to assess, the impact of the Year 2000 on its reporting systems and operations (the "Year 2000 Issue"), and is taking steps to make its systems Year 2000 compliant. The Year 2000 Issue exists because many computer systems and applications abbreviate dates by eliminating the first two digits of the year, assuming that these two digits will always be "19." Unless corrected, this shortcut is expected to cause problems beginning on January 1, 2000. On that date, some computer programs may recognize the date as January 1, 1900. This may cause systems to incorrectly process critical financial and operational information, or stop processing altogether. Additionally, computer applications may be affected before January 1, 2000, if calculations into the year 2000 are involved. The costs to date of addressing the Year 2000 Issue have not been material to the Cellular Group's results of operations or financial condition, and management believes that the costs to be incurred in the future will not be material to future results or financial condition. If management's steps are not successful in making the systems Year 2000 compliant, it could have a material adverse effect on results of operations. PROPOSED TDS CORPORATE RESTRUCTURING In December 1997, U.S. Cellular received a proposal from TDS to acquire all of the issued and outstanding Common Shares of U.S. Cellular not already owned by TDS. The offer was made in connection with, and is subject to TDS shareholder approval of and the effectiveness of, TDS's proposed corporate restructuring. The Board of Directors of TDS (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"). The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of TDS's interest in United States Cellular Corporation. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to, among other things, issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not currently owned by TDS, subject to approval by U.S. Cellular's board of directors and shareholders. In January 1998, U.S. Cellular's board of directors created a special committee of the Board (the "Special Committee") to review the proposal from TDS. The Special Committee, consisting of one independent director of U.S. Cellular, has engaged a financial advisor and legal advisor to assist in reviewing the proposal. The Special Committee will consider how U.S. Cellular should respond to the TDS proposal, take the steps it deems appropriate to respond to the TDS proposal and, at such time as it considers it appropriate, report its recommendations to U.S. Cellular's Board of Directors. Subsequent to TDS shareholder approval of the Tracking Stock Proposal, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular. Thereafter, some or all of the policies between TDS and U.S. Cellular would be determined solely by methods that TDS management believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Cellular Group and does not anticipate paying dividends on the Cellular Group Shares into the foreseeable future. LEGAL PROCEEDINGS. On December 29, 1997, a party, which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The compliant names as defendants TDS, U.S. Cellular, and the directors of U.S. II-27 Cellular. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the U.S. Cellular Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. A virtually identical complaint has been filed by an individual. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. II-28 PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AND OTHER SECTIONS OF THIS PROXY STATEMENT/PROSPECTUS 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 TDS'S BELIEFS AND EXPECTATIONS, ARE FORWARD-LOOKING STATEMENTS. THESE STATEMENTS CONTAIN POTENTIAL RISKS AND UNCERTAINTIES; 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 THE CELLULAR GROUP 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 CELLULAR GROUP'S MARKETS. READERS SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS. II-29 THE UNITED STATES CELLULAR GROUP STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) OPERATING REVENUES Service.............................................................................. $ 852,991 $ 662,681 $ 464,555 Equipment sales...................................................................... 23,974 17,387 15,761 ----------- ----------- ----------- Total Operating Revenues....................................................... 876,965 680,068 480,316 ----------- ----------- ----------- OPERATING EXPENSES System operations.................................................................... 153,137 117,368 70,442 Marketing and selling................................................................ 175,117 127,689 92,180 Cost of equipment sold............................................................... 82,302 74,023 54,948 General and administrative........................................................... 204,487 164,783 130,533 Depreciation......................................................................... 97,591 74,631 57,302 Amortization of intangibles.......................................................... 34,788 34,208 32,156 ----------- ----------- ----------- Total Operating Expenses....................................................... 747,422 592,702 437,561 ----------- ----------- ----------- OPERATING INCOME BEFORE MINORITY SHARE................................................. 129,543 87,366 42,755 Minority share of operating income..................................................... (12,298) (13,743) (7,902) ----------- ----------- ----------- OPERATING INCOME....................................................................... 117,245 73,623 34,853 ----------- ----------- ----------- INVESTMENT AND OTHER INCOME Investment income.................................................................... 77,121 51,518 39,833 Amortization of licenses related to investments...................................... (2,084) (1,391) (1,089) Interest income...................................................................... 5,863 10,093 5,008 Other (expense), net................................................................. (3,614) (1,881) (2,578) Gain on sale of cellular and other investments....................................... 30,318 132,718 83,494 ----------- ----------- ----------- Total Investment and Other Income.............................................. 107,604 191,057 124,668 ----------- ----------- ----------- INCOME BEFORE INTEREST AND INCOME TAXES................................................ 224,849 264,680 159,521 ----------- ----------- ----------- INTEREST EXPENSE Interest expense--other.............................................................. 27,414 23,111 16,881 Interest expense--affiliate.......................................................... 1,948 -- 10,406 ----------- ----------- ----------- Total Interest Expense......................................................... 29,362 23,111 27,287 ----------- ----------- ----------- INCOME BEFORE INCOME TAXES............................................................. 195,487 241,569 132,234 Income tax expense..................................................................... 83,948 111,640 32,492 ----------- ----------- ----------- NET INCOME............................................................................. 111,539 129,929 99,742 Net Income to Minority Shareholders of U.S. Cellular................................... (21,264) (25,179) (19,046) ----------- ----------- ----------- Net Income to TDS...................................................................... $ 90,275 $ 104,750 $ 80,696 ----------- ----------- ----------- ----------- ----------- ----------- Pro forma (Unaudited): (See Note 1 and 2) Net Income Attributable to the TDS Group through Retained Interest..................... $ 22,569 $ 26,188 $ 20,174 Net Income Attributable to the United States Cellular Group Common Shares.............. $ 67,706 $ 78,562 $ 60,522
The accompanying notes to financial statements are an integral part of these statements. II-30 THE UNITED STATES CELLULAR GROUP BALANCE SHEETS--ASSETS
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents General funds............................................................................... $ 13,851 $ 802 Affiliated cash equivalents................................................................. -- 13,575 ------------- ------------- 13,851 14,377 Temporary investments......................................................................... 218 -- Accounts receivable Customers, less allowance of $5,259 and $4,199, respectively................................ 81,387 58,034 Roaming..................................................................................... 30,689 29,742 Affiliates.................................................................................. 170 607 Other....................................................................................... 17,536 7,568 Inventory..................................................................................... 11,836 11,893 Prepaid expenses.............................................................................. 15,714 2,622 Other current assets.......................................................................... 3,963 3,776 ------------- ------------- 175,364 128,619 ------------- ------------- PROPERTY, PLANT AND EQUIPMENT In service and under construction............................................................. 1,212,575 846,005 Less accumulated depreciation................................................................. 272,322 195,251 ------------- ------------- 940,253 650,754 ------------- ------------- INVESTMENTS Licenses, net of accumulated amortization of $127,783 and $110,727, respectively.............. 1,150,924 1,044,141 Cellular entities............................................................................. 128,810 186,791 Notes and interest receivable................................................................. 10,673 14,943 Marketable non-equity securities.............................................................. 870 -- ------------- ------------- 1,291,277 1,245,875 ------------- ------------- DEFERRED CHARGES System development costs, net of accumulated amortization of $18,117 and $11,089, respectively................................................................................ 78,306 44,319 Other, net of accumulated amortization of $4,639 and $5,276, respectively..................... 23,716 16,332 ------------- ------------- 102,022 60,651 ------------- ------------- TOTAL ASSETS............................................................................ $ 2,508,916 $ 2,085,899 ------------- ------------- ------------- -------------
The accompanying notes to financial statements are an integral part of these statements. II-31 THE UNITED STATES CELLULAR GROUP BALANCE SHEETS--LIABILITIES AND GROUP EQUITY
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Current portion of long-term debt............................................................. $ -- $ 23,065 Notes payable................................................................................. 1,302 1,375 Accounts payable Affiliates.................................................................................. 2,466 2,729 Other....................................................................................... 101,263 66,638 Accrued taxes................................................................................. 41,606 18,781 Accrued interest.............................................................................. 6,534 204 Accrued compensation.......................................................................... 9,112 3,231 Customer deposits and deferred revenues....................................................... 21,019 16,410 Other current liabilities..................................................................... 20,934 14,021 ------------- ------------- 204,236 146,454 ------------- ------------- LONG-TERM DEBT 6% zero coupon convertible debentures......................................................... 265,330 250,107 7.25% unsecured notes......................................................................... 250,000 -- Vendor financing, excluding current portion................................................... -- 80,589 ------------- ------------- 515,330 330,696 ------------- ------------- DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability............................................................. 100,725 78,833 Other......................................................................................... 5,397 2,444 ------------- ------------- 106,122 81,277 ------------- ------------- MINORITY INTEREST............................................................................... 53,908 51,270 ------------- ------------- UNITED STATES CELLULAR GROUP EQUITY............................................................. 1,629,320 1,476,202 ------------- ------------- TOTAL LIABILITIES AND GROUP EQUITY...................................................... $ 2,508,916 $ 2,085,899 ------------- ------------- ------------- -------------
The accompanying notes to financial statements are an integral part of these statements. II-32 THE UNITED STATES CELLULAR GROUP STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income........................................................................ $ 111,539 $ 129,929 $ 99,742 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization................................................. 132,379 108,839 89,458 Investment income............................................................. (77,121) (51,518) (39,833) Gain on sale of cellular and other investments................................ (30,318) (132,718) (83,494) Minority share of operating income............................................ 12,298 13,743 7,902 Other noncash expense......................................................... 18,786 19,260 30,597 Change in accounts receivable................................................. (10,038) (16,706) (27,878) Change in accounts payable.................................................... (1,646) 12,709 (1,819) Change in accrued taxes....................................................... 26,297 (10,185) 27,127 Change in deferred taxes...................................................... 24,077 63,137 8,660 Change in accrued interest.................................................... 6,413 204 (4,309) Change in unearned revenue.................................................... 5,083 5,254 5,265 Change in other assets and liabilities........................................ 4,388 (4,439) 4,516 ------------ ------------ ------------ 222,137 137,509 115,934 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Issuance of 7.25% unsecured notes................................................. 243,053 -- -- Vendor financing borrowings....................................................... -- 3,922 59,460 Repayment of vendor financing..................................................... (103,827) (21,519) (13,353) Issuance of convertible debentures................................................ -- -- 221,466 Borrowings from Revolving Credit Agreement--TDS................................... 70,444 -- -- Repayment of Revolving Credit Agreement--TDS...................................... (70,444) -- (251,230) Common Shares issued.............................................................. 2,503 10,483 1,563 Capital (distributions) contributions (to)/from minority partners................. (5,849) (4,099) 1,411 ------------ ------------ ------------ 135,880 (11,213) 19,317 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures.............................................................. (277,799) (219,370) (200,554) System development costs.......................................................... (40,949) (28,753) (5,628) Investments in and advances to investment entities................................ (20,084) (22,256) (26,966) Distributions from investment entities............................................ 52,365 23,464 8,679 Proceeds from sales of cellular and other investments............................. 61,145 212,979 151,137 Acquisitions, excluding cash acquired............................................. (128,828) (116,387) (29,315) Other investments................................................................. (3,305) -- -- Change in temporary investments and marketable non-equity securities.............. (1,088) -- -- ------------ ------------ ------------ (358,543) (150,323) (102,647) ------------ ------------ ------------ NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS................................ (526) (24,027) 32,604 CASH AND CASH EQUIVALENTS-- Beginning of period............................................................... 14,377 38,404 5,800 ------------ ------------ ------------ End of period..................................................................... $ 13,851 $ 14,377 $ 38,404 ------------ ------------ ------------ ------------ ------------ ------------
The accompanying notes to financial statements are an integral part of these statements. II-33 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS The United States Cellular Group ("Cellular Group") consists solely of United States Cellular Corporation and its subsidiaries ("U.S. Cellular"), currently an 81.1%-owned subsidiary of Telephone and Data Systems Inc. ("TDS") which operates and invests in cellular telephone companies and properties. The Cellular Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Cellular Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Cellular Group, as determined by the Board of Directors of TDS. 1. PROPOSED TDS CORPORATE RESTRUCTURING In December 1997, U.S. Cellular received a proposal from TDS to acquire all of the issued and outstanding Common Shares of U.S. Cellular not already owned by TDS. The offer was made in connection with, and is subject to, TDS shareholder approval of and the effectiveness of, TDS's proposed corporate restructuring. The Board of Directors of TDS (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"). The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of TDS's interest in United States Cellular Corporation. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to, among other things, issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not currently owned by TDS, subject to approval by U.S. Cellular's board of directors and shareholders (the "Merger"). In January 1998, U.S. Cellular's board of directors created a special committee of the Board (the "Special Committee") to review the proposal from TDS. The Special Committee, consisting of one independent director of U.S. Cellular, has engaged a financial advisor and legal advisor to assist in reviewing the proposal. The Special Committee will consider how U.S. Cellular should respond to the TDS proposal, take the steps it deems appropriate to respond to the TDS proposal and, at such time as it considers it appropriate, report its recommendations to U.S. Cellular's Board of Directors. Subsequent to TDS shareholder approval of the Tracking Stock Proposal, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular. Thereafter, some or all of the policies between TDS and U.S. Cellular would be determined solely by methods that TDS management believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Cellular Group and does not anticipate paying dividends on the Cellular Group Shares in the foreseeable future. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The Cellular Group owns, manages and invests in cellular systems throughout the United States and is the nation's eighth largest cellular telephone company in terms of population equivalents ("pops"). The Cellular Group owns interests in 192 cellular markets, representing approximately 26.2 million pops, as of December 31, 1997. The Cellular Group's 134 majority-owned and managed markets, primarily mid-sized and rural markets, covered 24 states and served 1,710,000 customers as of December 31, 1997. The Cellular Group's Midwest Regional Market Cluster, which includes markets in Iowa, Wisconsin, Illinois and Missouri, served 709,000 customers at December 31, 1997, which represents approximately 41% of the Cellular Group's total customers served as of that date. II-34 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) BASIS OF PRESENTATION The financial statements of the Groups comprise all of the accounts included in the corresponding consolidated financial statements of Telephone and Data Systems, Inc. The separate Cellular Group financial statements give effect to the management and accounting policies that would be applicable upon implementation of the Tracking Stock Proposal. Subject to the completion of the U.S. Cellular Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular. Thereafter, some or all of the relationships between TDS and U.S. Cellular would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The separate Group financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (1) the historical financial position, results of operations and cash flows of the businesses that comprise each of the Groups, (2) any assets and liabilities (including contingent liabilities) which have been attributed to any Group from any other Group, and (3) with respect to the TDS Group, the Retained Interest in each of the Tracking Groups. The effects of the issuance of the Tracking Stocks have not been reflected in these historical financial statements. Financial effects arising from the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group that affect the consolidated results of operations or financial condition of TDS could affect the results of operations or financial condition of the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, or could affect the market price of any or all classes of Common Stock. In addition, any net losses of TDS or the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on any class of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the Cellular Group financial information. The management and accounting policies applicable to the preparation of the financial statements of the TDS Group could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of Telephone and Data Systems, Inc. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $1,222 million for the Cellular Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Cellular Group and does not anticipate paying dividends on the Cellular Group Shares into the foreseeable future. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' II-35 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Cellular Group, its majority-owned subsidiaries and partnerships in which the Cellular Group has a majority partnership interest. All material intercompany accounts and transactions have been eliminated. Investments in entities in which the Cellular Group does not have a majority interest are generally accounted for using the equity method. The preparation of consolidated 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 reported period. Actual results could differ from those estimates, but management believes any differences will not be material. Certain amounts reported in prior years have been reclassified to conform to current period presentation. CASH AND CASH EQUIVALENTS AND TEMPORARY INVESTMENTS Cash and cash equivalents include cash and those short-term, highly-liquid investments with original maturities of three months or less. Those investments with original maturities of more than three months to 12 months are classified as temporary investments. Temporary investments are stated at cost. Those investments with original maturities of more than 12 months are classified as marketable securities and are stated at amortized cost. The carrying amounts of Cash and Cash Equivalents and Temporary Investments approximate their fair value due to the short-term nature of these investments. ACCOUNTS RECEIVABLE Accounts receivable consists of amounts owed by customers for both service provided and equipment sales, by other cellular carriers whose customers have used the Cellular Group's cellular systems, by affiliated entities and by other partners for capital contributions and distributions. NOTES AND INTEREST RECEIVABLE Notes and interest receivable primarily consist of loans to other partners for capital calls paid on their behalf. The interest charged on these loans is at varying annual rates. The Cellular Group also has an outstanding loan to the operators of another cellular company in which the Cellular Group has no equity. The interest charged on this loan is at an annual rate of prime plus 1 1/2%. The carrying amount reported in the balance sheet for notes and interest receivable approximates their fair value. DEFERRED CHARGES Deferred system development costs represent costs incurred for the development of new information systems. Capitalized costs of information systems development are amortized over a five-year period, starting when each new system is placed in service. Other deferred charges primarily represent legal and other charges incurred relating to the preparation of the agreements related to the Cellular Group's various borrowing instruments, and are amortized over the respective financing periods of each instrument (seven to 20 years). II-36 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Cellular Group implemented the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Under SFAS No. 121, the Cellular Group is required to review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the book value of a long-lived asset is not recoverable. An impairment loss would be recognized whenever the review demonstrates that the book value of a long-lived asset is not recoverable. The implementation of SFAS No. 121 did not have an impact on the Celluar Group's financial position or results of operations. REVENUES Revenues from operations primarily consist of charges to customers for monthly access, cellular airtime, data usage, vertical services, roaming charges, long-distance charges and equipment sales. Revenues are recognized as services are rendered. Unbilled revenues, resulting from cellular service provided from the billing cycle date to the end of each month and from other cellular carriers' customers using the Cellular Group's cellular systems for the last half of each month, are estimated and recorded. Equipment sales are recognized upon delivery to the customer and reflect charges to customers for cellular telephone user equipment purchased. ADVERTISING COSTS The Cellular Group expenses advertising costs as incurred. Advertising costs totaled $41.4 million, $24.4 million and $14.1 million for the years ended December 31, 1997, 1996 and 1995, respectively. PENSION PLAN Telephone and Data Systems, Inc. Wireless Companies' Pension Plan (the "Pension Plan"), a qualified noncontributory defined contribution pension plan, was adopted effective January 1, 1994. It provides pension benefits for the employees of the Cellular Group and its subsidiaries. Under this plan, pension benefits and costs are calculated separately for each participant and are funded currently. Pension costs were $1.0 million, $1.5 million and $1.2 million in 1997, 1996 and 1995, respectively. PRO FORMA NET INCOME AND EARNINGS PER SHARE Pro forma net income attributable to the Cellular Group and to the TDS Group through Retained Interest assumes that the Cellular Merger has not taken place and therefore 75% of net income is attributable to the Cellular Group Shares and 25% of net income is attributable to the Retained Interest for the TDS Group. A portion of the Net Income is allocated to the minority public shareholders of U.S. Cellular prior to attributing the Net Income to the Cellular Group and the TDS Group through Retained Interest. Earnings per Share was omitted from the historical statements of earnings since the Cellular Group Shares were not a part of the equity structure of TDS and the Articles of Incorporation did not allow for the issuance of the Cellular Group Shares for the periods presented. II-37 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SUPPLEMENTAL CASH FLOW DISCLOSURES The Cellular Group acquired certain cellular licenses and other cellular interests during 1997, 1996 and 1995. In conjunction with these acquisitions, the following assets were acquired, liabilities assumed and Common Shares issued:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ------------ ---------- (DOLLARS IN THOUSANDS) Property, plant and equipment, net................................................... $ 112,696 $ 7,069 $ 29,622 Cellular licenses.................................................................... 130,336 90,341 138,600 (Decrease) increase in equity-method investments in cellular interests............... (90,332) 13,971 (5,921) Accounts receivable.................................................................. 26,032 1,332 1,760 Revolving Credit Agreement--TDS...................................................... -- -- (15,493) Accounts payable..................................................................... (31,117) (1,081) (5,051) Other assets and liabilities, excluding cash acquired................................ 13,699 1,493 (998) Common Shares issued and issuable.................................................... (32,486) 3,262 (113,204) ------------ ------------ ---------- Decrease in cash due to acquisitions................................................. $ 128,828 $ 116,387 $ 29,315 ------------ ------------ ---------- ------------ ------------ ----------
Following are supplemental cash flow disclosures regarding interest and income taxes paid and certain noncash transactions:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ------------ ---------- (DOLLARS IN THOUSANDS) Interest paid........................................................................ $ 6,816 $ 7,001 $ 4,112 Income taxes paid.................................................................... 40,316 64,402 3,035 Noncash interest expense............................................................. 15,379 16,110 23,175 Accrued interest converted into debt under the Revolving Credit Agreement............ -- -- 14,432 Additions to Property, Plant and Equipment financed through Accounts Payable-- Other............................................................................... 5,778 (4,679) 1,929 Common Shares issued by U.S. Cellular for redemption of U.S. Cellular Preferred Stock and TDS Preferred Shares............................................................ $ 36 $ 18,450 $ 22,236 ------------ ------------ ----------
3. INCOME TAXES The Cellular Group is included in a consolidated federal income tax return with other members of the TDS consolidated group. TDS and the Cellular Group are parties to a Tax Allocation Agreement (the "Agreement"). The Agreement provides that the Cellular Group and its subsidiaries be included with the TDS affiliated group in a consolidated federal income tax return and in state income or franchise tax returns in certain situations. The Cellular Group and its subsidiaries calculate their losses and credits as if they comprised a separate affiliated group. Under the Agreement, the Cellular Group is able to carry forward its losses and credits and use them to offset any future income tax liabilities to TDS. Subject to the completion of the Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular. See Note 1 -- Proposed TDS Corporate Restructuring for a discussion of the proposed merger. II-38 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. INCOME TAXES (CONTINUED) Income tax provisions charged to net income are summarized below:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ------------ ---------- (DOLLARS IN THOUSANDS) Federal income taxes Current............................................................................ $ 46,357 $ 35,613 $ 14,882 Deferred........................................................................... 22,109 54,509 8,468 State income taxes Current............................................................................ 13,514 12,890 8,306 Deferred........................................................................... 1,968 8,628 836 ------------ ------------ ---------- Total income tax expense............................................................. $ 83,948 $ 111,640 $ 32,492 ------------ ------------ ---------- ------------ ------------ ----------
The statutory federal income tax rate is reconciled to the Cellular Group's effective income tax rate below:
YEAR ENDED DECEMBER 31, -------------------- 1997 1996 --------- --------- Statutory federal income tax rate..................................................................... 35.0% 35.0% State income taxes, net of federal benefit............................................................ 5.1 5.7 Amortization of license costs......................................................................... 1.7 1.1 Effects of corporations not included in consolidated federal income tax return........................ .4 .8 Effects of valuation allowance on deferred tax asset.................................................. (.1) (1.2) Gains on sales........................................................................................ .8 4.8 --- --- Effective income tax rate............................................................................. 42.9% 46.2% --- --- --- --- 1995 --------- Statutory federal income tax rate..................................................................... 35.0% State income taxes, net of federal benefit............................................................ 4.4 Amortization of license costs......................................................................... 2.2 Effects of corporations not included in consolidated federal income tax return........................ 1.1 Effects of valuation allowance on deferred tax asset.................................................. (18.1) Gains on sales........................................................................................ -- --------- Effective income tax rate............................................................................. 24.6% --------- ---------
Deferred income taxes are provided for the temporary differences between the amount of the Cellular Group's assets and liabilities for financial reporting purposes and their tax basis. The Cellular Group had current deferred tax assets totaling $2.5 million and $2.4 million at December 31, 1997 and 1996, respectively, resulting primarily from the allowance for customer receivables. II-39 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. INCOME TAXES (CONTINUED) The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of December 31, 1997 and 1996, are as follows:
DECEMBER 31, -------------------------- 1997 1996 ------------ ------------ (DOLLARS IN THOUSANDS) Deferred Tax Asset Net operating loss carryforward................................................................. $ 14,725 $ 14,121 Taxes on acquisitions........................................................................... 56,384 -- Alternative minimum tax credit carryforward..................................................... 7,121 24,545 Stock appreciation rights....................................................................... 386 299 Other........................................................................................... 233 -- ------------ ------------ 78,849 38,965 Less valuation allowance.......................................................................... 10,233 13,150 ------------ ------------ Total Deferred Tax Asset........................................................................ 68,616 25,815 ------------ ------------ Deferred Tax Liability Equity investments.............................................................................. 65,956 41,482 Property, plant and equipment................................................................... 52,668 23,402 Licenses........................................................................................ 40,624 24,759 Partnership investments......................................................................... 10,093 15,005 ------------ ------------ Total Deferred Tax Liability...................................................................... 169,341 104,648 ------------ ------------ Net Deferred Tax Liability...................................................................... $ 100,725 $ 78,833 ------------ ------------ ------------ ------------
The amount of state net operating loss carryforward (generating a $12.2 million deferred tax asset) available to offset future taxable income, primarily of the individual subsidiaries which generated the loss, aggregated approximately $221 million at December 31, 1997 and expires between 1998 and 2012. A valuation allowance has been provided when it is more likely than not that some portion of the deferred tax asset will not be realized. At December 31, 1997, the Cellular Group had $7.1 million of federal alternative minimum tax credit carryforward available to offset regular income tax payable in future years. The Cellular Group has certain subsidiaries which are not included in the federal consolidated income tax return, but file separate tax returns. These subsidiaries had a federal net operating loss carryforward (generating a $2.5 million deferred tax asset) available to offset future taxable income aggregating approximately $7.2 million at December 31, 1997 which expires between 2004 and 2012. 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property, plant and equipment was 10.3% , 10.4% and 10.0% in 1997, 1996 and 1995, respectively. Property, plant and equipment in service and under construction consists of:
DECEMBER 31, ------------------------------ 1997 1996 -------------- -------------- (DOLLARS IN THOUSANDS) Operating plant and equipment................................................................. $ 923,480 $ 641,600 Buildings and leasehold improvements.......................................................... 136,023 86,533 Office furniture, equipment and vehicles...................................................... 89,987 71,674 Land.......................................................................................... 63,085 46,198 -------------- -------------- $ 1,212,575 $ 846,005 -------------- -------------- -------------- --------------
II-40 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. ACQUISITIONS, EXCHANGES AND DIVESTITURES The Cellular Group has acquired cellular interests for cash, promissory notes and U.S. Cellular and TDS Common Shares. The Cellular Group has also divested cellular interests for cash and notes receivable and has completed exchanges of cellular interests with other cellular companies. COMPLETED ACQUISITIONS During 1997, the Cellular Group completed the acquisition of majority interests in two markets and several minority interests, representing approximately 534,000 pops, for a total consideration of $81.4 million as shown in the following table:
CONSIDERATION ------------- (MILLIONS) 1.0 million U.S. Cellular Common Shares to TDS (1)............................................................. $ 32.5 Increase in Revolving Credit Agreement with TDS................................................................ 39.0 Cash........................................................................................................... 9.9 ------ Total........................................................................................................ $ 81.4 ------ ------
- --------- (1) Issued to reimburse TDS for TDS securities issued to third parties in connection with the acquisitions. During 1996, the Cellular Group completed the acquisition of majority interests in two markets and several minority interests, representing approximately 1.0 million pops, for a total consideration of $158.9 million as shown in the following table:
CONSIDERATION ------------- (MILLIONS) 1.3 million U.S. Cellular Common Shares to TDS (1)............................................................. $ 42.4 Common Shares issued to third parties.......................................................................... .1 Cash........................................................................................................... 116.4 ------------- Total........................................................................................................ $ 158.9 ------------- -------------
- --------- (1) Issued to reimburse TDS for TDS securities issued and cash paid to third parties in connection with the acquisitions. EXCHANGE OF MARKETS WITH BELLSOUTH In October 1997, the Cellular Group completed an exchange with BellSouth Corporation. Pursuant to the exchange, the Cellular Group received majority interests representing approximately 4.0 million pops in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests the Cellular Group received are in 12 markets adjacent to its Iowa/Missouri and Wisconsin/Illinois/Indiana clusters. PURCHASE OF MINORITY INTERESTS BY THE COMPANY FROM TDS Included in the interests the Cellular Group acquired in 1996 were minority interests in 13 markets, representing 598,000 pops, for $102.8 million in cash paid to TDS. These interests were acquired pursuant to an agreement entered into in June 1996 between U.S. Cellular and TDS. Due to the intercompany nature of the transactions, these acquisitions were recorded at TDS's book value of the interests. II-41 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. ACQUISITIONS, EXCHANGES AND DIVESTITURES (CONTINUED) Assuming that the 1997 and 1996 acquisitions discussed above, which were accounted for as purchases, had taken place on January 1, 1996, unaudited pro forma results of operations would have been as follows:
YEAR ENDED DECEMBER 31, -------------------------- 1997 1996 ------------ ------------ (DOLLARS IN THOUSANDS) Service Revenues.................................................................................. $ 947,520 $ 742,913 Equipment Sales................................................................................... 31,262 24,612 Interest Expense (including cost to finance acquisitions)......................................... 30,412 26,623 Net Income........................................................................................ $ 139,107 $ 147,413 ------------ ------------
DIVESTITURES OF CELLULAR AND OTHER INVESTMENTS Gain on sale of cellular and other investments in 1997 primarily reflects gains recorded on the sales of the Cellular Group's majority interest in one market and minority interests in two markets and on cash received from the settlement of a legal matter. Gain on sale of cellular and other investments in 1996 primarily reflects gains recorded on the sales of the Cellular Group's majority interests in eight markets and minority interests in two markets, on cash received in an exchange of markets with another cellular operator and on cash received from the settlement of two separate legal matters. Gain on sale of cellular and other investments in 1995 primarily reflects gains recorded on the sales of the Cellular Group's majority interests in six markets and minority interests in six markets, on cash proceeds received in an exchange of cellular markets and on the sale of marketable equity securities for cash. PENDING ACQUISITIONS At December 31, 1997, the Cellular Group had entered into agreements with third parties to acquire a majority interest in one market and a minority interest in a market in which the Cellular Group owns a majority interest, representing 410,000 pops, for $51.3 million in cash. These transactions are expected to be completed during 1998. PENDING SALES OF MINORITY INTERESTS In December 1997, the Cellular Group entered into agreements with AirTouch Communications, Inc. ("AirTouch") to divest minority interests in nine markets, representing 759,000 pops. In exchange, the agreements provided that the Cellular Group will receive approximately 4.0 million shares of AirTouch stock and cash totaling $54.2 million. In addition, the Cellular Group will receive approximately $27.0 million in cash from TDS pursuant to a contract right termination agreement entered into between the Cellular Group and TDS. This agreement is related to two interests which are to be sold directly by TDS to AirTouch and which were to be acquired by the Cellular Group as part of the June 1996 agreement between U.S. Cellular and TDS. The contract right termination agreement will enable the Cellular Group to receive cash equal to the value of the gain the Cellular Group would have realized had it purchased the interests from TDS and sold them to AirTouch under terms similar to those in the agreement between TDS and AirTouch. Additionally, the Cellular Group has entered into an agreement to sell its minority interests in two other markets, representing 176,000 pops, for $37.6 million cash. The Cellular Group expects these pending sales transactions to be completed during the first half of 1998. The Cellular Group anticipates that it will record significant book gains on these divestitures when the transactions are completed. 6. INVESTMENT IN LICENSES Investment in licenses consists of the costs incurred in acquiring Federal Communications Commission ("FCC") licenses or interests in entities which have filed for or have been awarded FCC licenses to provide cellular II-42 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INVESTMENT IN LICENSES (CONTINUED) service. These costs include amounts paid to license applicants and owners of interests in cellular entities awarded licenses and all direct and incremental costs relating to acquiring the licenses. These costs are capitalized and amortized through charges to expense over 40 years, upon commencement of operations. Costs applicable to unsuccessful license applications and acquisitions are charged to expense. Investment in licenses at December 31, 1997 and 1996, include approximately $281 million and $322 million, respectively, of goodwill related to various acquisitions structured to be tax-free. 7. REVOLVING CREDIT FACILITY In August 1997, the Cellular Group established a $500 million revolving credit facility with a group of banks ("Revolving Credit Facility"). This seven-year facility replaces the Cellular Group's Revolving Credit Agreement with TDS as its primary short-term borrowing facility. As of December 31, 1997, no borrowings were outstanding under the Revolving Credit Facility. The terms of the Revolving Credit Facility provide for borrowings with interest, at the London InterBank Offered Rate plus 26.5 basis points (for a rate of 6.2% at December 31, 1997), due quarterly. No principal under the Revolving Credit Facility is due until August 29, 2004, on which date the Revolving Credit Facility terminates and all unpaid principal and accrued interest thereon are due and payable. 8. 6% ZERO COUPON CONVERTIBLE DEBENTURES During 1995, U.S. Cellular sold $745 million principal amount at maturity of zero coupon 6% yield to maturity convertible debt with proceeds to U.S. Cellular of $221.5 million. This 20-year fixed rate debt, in the form of Liquid Yield Option Notes ("LYONs"), is subordinated to all senior indebtedness of U.S. Cellular. At December 31, 1997 and 1996, U.S. Cellular's senior indebtedness totaled $260.0 million and $113.7 million, respectively. Each LYON is convertible at the option of the holder at any time at a conversion rate of 9.475 U.S. Cellular Common Shares per LYON. Upon conversion, U.S. Cellular may elect to deliver U.S. Cellular Common Shares or cash equal to the market value of the U.S. Cellular Common Shares. Beginning June 15, 2000, the LYONs may be redeemed at any time for cash at the option of U.S. Cellular at the issue price plus accrued original issue discount through the date of redemption. U.S. Cellular will purchase LYONs, at the option of the holder, as of June 15, 2000, at the issue price plus accrued original issue discount through that date. U.S. Cellular will have the option of purchasing such LYONs with cash, U.S. Cellular Common Shares or TDS common equity securities, or any combination thereof. During 1997, 25 LYONs were converted for approximately $7,600 in cash. The carrying values at December 31, 1997 of U.S. Cellular's 6% Zero Coupon Convertible Debentures, $265.3 million and $250.1 million, respectively, are greater than their fair values, estimated to be $255.6 million and $248.4 million, respectively. The fair values were estimated using discounted cash flow analysis. The increase in estimated fair value in 1997 was due to a change in the incremental borrowing rate. 9. 7.25% UNSECURED NOTES During 1997, U.S. Cellular sold $250 million principal amount of 7.25% notes ("Notes"), priced to yield 7.33% to maturity. The Notes were sold under U.S. Cellular's $400 million shelf registration. The Notes are unsecured and become due on August 15, 2007. Interest on the Notes is payable on February 15 and August 15 of each year. The Notes will be redeemable, in whole or in part, at the option of U.S. Cellular at any time on or after August 15, 2004, at a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued interest thereon, if any, to the date of redemption. The carrying value at December 31, 1997 of U.S. Cellular's 7.25% unsecured notes, $250 million, is less than its fair value, estimated to be $252.9 million. The fair value was estimated using discounted cash flow analysis. 10. VENDOR FINANCING The Cellular Group repaid approximately $90.1 million principal amount of borrowings, representing all amounts outstanding under its long-term vendor financing agreements, with the proceeds of its 7.25% unsecured II-43 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. VENDOR FINANCING (CONTINUED) notes offering in August 1997. See Note 9--7.25% Unsecured Notes for a discussion of the notes offering. Scheduled repayments of borrowings under the vendor financing agreements in 1997, all made prior to the final repayment, totaled $13.7 million. The carrying value at December 31, 1996 of the Cellular Group's current and long-term vendor financing, $103.7 million, was approximately equal to its estimated fair value. Vendor financing at December 31, 1996 included $101.1 million (including deferred interest) under a 1994 agreement and $2.6 million assumed pursuant to a 1993 acquisition. The current portion of outstanding vendor financing borrowings was $23.1 million at December 31, 1996. 11. UNITED STATES CELLULAR GROUP EQUITY The changes in the United States Cellular Group equity for the periods presented is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1996 1995 ------------- ------------- ------------- (DOLLARS IN THOUSANDS) Balance at beginning of period.................................................. $ 1,476,202 $ 1,329,454 $ 1,093,967 Net income...................................................................... 111,539 129,929 99,742 Issuance of Common Shares....................................................... 35,015 16,825 137,116 Other........................................................................... 6,564 (6) (1,371) ------------- ------------- ------------- Balance at end of period........................................................ $ 1,629,320 $ 1,476,202 $ 1,329,454 ------------- ------------- ------------- ------------- ------------- -------------
U.S. Cellular has 54,232,486 Common Shares and 33,005,877 Series A Common Shares issued and outstanding as of December 31, 1997. Cellular Group Shares will be exchanged for all of the Common Shares of U.S. Cellular which are not owned by TDS, subject to approval by the board of directors and the shareholders of U.S. Cellular. See Note 1--Proposed TDS Corporate Restructuring. EMPLOYEE BENEFIT PLANS The following table summarizes Common Shares issued for the employee benefit plans described below:
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ Tax-Deferred Savings Plan........................................................... 42,400 23,302 26,357 Employee stock options, stock appreciation rights and awards........................ 65,029 16,380 10,713 Employee Stock Purchase Plan........................................................ 10,134 22,366 25,000 ------------ ------------ ------------ 117,563 62,048 62,070 ------------ ------------ ------------ ------------ ------------ ------------
TAX-DEFERRED SAVINGS PLAN. The Cellular Group had reserved 139,168 U.S. Cellular 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 U.S. Cellular Common Shares, TDS Common Shares, American Paging, Inc. (an 81.9%-owned subsidiary of TDS) Common Shares, Aerial Communications, Inc. (an 82.5%-owned subsidiary of TDS) Common Shares or five other nonaffiliated funds. STOCK-BASED COMPENSATION PLANS. The Cellular Group 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 SAR prices and the year-end market price of the II-44 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. UNITED STATES CELLULAR GROUP EQUITY (CONTINUED) U.S. Cellular Common Shares, aggregated $285,000, ($224,000) and $168,000 in 1997, 1996 and 1995, respectively. Had compensation cost for all plans been determined consistent with SFAS No. 123, the Cellular Group's net income would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ------------ ---------- (DOLLARS IN THOUSANDS) Net Income: As Reported........................................................................ $ 111,539 $ 129,929 $ 99,742 Pro Forma.......................................................................... $ 110,317 $ 129,166 $ 98,960 ------------ ------------ ----------
Because the 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 Cellular Group's stock option plans at December 31, 1997, 1996 and 1995 and changes during the years then ended is presented in the table and narrative below:
WEIGHTED WEIGHTED NUMBER AVERAGE AVERAGE OF SHARES OPTION PRICES FAIR VALUES --------- ------------- ----------- Stock Options: Outstanding January 1, 1995 (80,164 exercisable)....................................... 224,259 $ 27.63 Granted.............................................................................. 106,406 $ 27.76 $ 14.02 Exercised............................................................................ (10,713) $ 15.67 Outstanding December 31, 1995 (177,675 exercisable).................................... 319,952 $ 28.07 Granted.............................................................................. 103,326 $ 25.12 $ 16.59 Exercised............................................................................ (16,380) $ 16.98 Cancelled............................................................................ (15,851) $ 30.05 Outstanding December 31, 1996 (271,866 exercisable).................................... 391,047 $ 29.47 Granted.............................................................................. 250,393 $ 13.41 $ 18.77 Exercised............................................................................ (68,563) $ 17.56 Cancelled............................................................................ (18,594) $ 26.85 Outstanding December 31, 1997 (293,418 exercisable).................................. 554,283 $ 24.23
STOCK OPTION AND STOCK APPRECIATION RIGHTS PLAN. The Cellular Group had reserved 748,596 U.S. Cellular Common Shares for options granted and to be granted to key employees. The Cellular Group has established a Stock Option plan as of November 9, 1994 that provides for the grant of stock options to officers and employees. The options under the 1994 plan are exercisable from the date of vesting through November 9, 2004, or thirty days following the date of the employee's termination of employment, if earlier. Under the 1994 Stock Option Plan, 293,418 stock options were outstanding at December 31, 1997, at a weighted average price of $30.76 per share. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997 and 1996, respectively: risk-free interest rates of 6.3% and 5.9%; expected dividend yields of zero for both years; expected lives of 4.8 years and 4.0 years and expected volatility of 20.8% and 22.7%. Stock Appreciation Rights (as amended on February 1, 1991) allow the grantee to receive an amount in U.S. Cellular Common Shares or cash, or a combination thereof, equivalent to the difference between the exercise price and the fair market value of the U.S. Cellular Common Shares on the exercise date. At December 31, 1997, 38,050 U.S. Cellular Common Share SARs and 36,000 Series A Common Share SARs were outstanding at $15 per share. These rights expire from 1998 to 2003 or the date of the person's termination of employment, if earlier. During 1997 and 1996, 3,950 and 300 Common Share SARs were exercised, respectively. No SARs were exercised in 1995. There were no SARs granted in 1997 or 1996. EMPLOYEE STOCK PURCHASE PLAN. The Cellular Group had 115,498 U.S. Cellular Common Shares reserved under the 1997 Employee Stock Purchase Plan ("1997 ESPP"). During 1996, the 1997 ESPP was approved, which II-45 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. UNITED STATES CELLULAR GROUP EQUITY (CONTINUED) became effective January 1, 1997. The fair value of the employees' purchase rights was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants rights in 1997: risk-free interest rate of 5.7%; expected dividend yield of zero; expected life of .7 years; and expected volatility of 17.6%. SERIES A COMMON SHARES Series A Common Shares are convertible on a share-for-share basis into Common Shares and each share is entitled to ten votes per share, compared to one vote for each Common Share. As of December 31, 1997, all of U.S. Cellular's outstanding Series A Common Shares were held by TDS. 12. RELATED PARTIES The Cellular Group is billed for all services it receives from TDS, consisting primarily of information processing and general management services. Such billings are based on expenses specifically identified to the Cellular Group and on allocations of common expenses. Such allocations are based on the relationship of the Cellular Group's assets, employees, investment in plant and expenses to the total assets, employees, investment in plant and expenses of TDS. Management believes the method used to allocate common expenses is reasonable and that all expenses and costs applicable to the Cellular Group are reflected in the accompanying financial statements on a basis which is representative of what they would have been if the Cellular Group operated on a stand-alone basis. Billings to the Cellular Group from TDS totaled $36.2 million, $28.1 million and $26.1 million in 1997, 1996 and 1995, respectively. The Cellular Group has a Cash Management Agreement with TDS under which the Cellular Group may from time to time deposit its excess cash with TDS for investment under TDS's cash management program. Deposits made under the agreement are available to the Cellular Group on demand and bear interest each month at the 30-day Commercial Paper Rate as reported in The Wall Street Journal, plus 1/4%, or such higher rate as TDS may at its discretion offer on such deposits. Interest income from such deposits was $1.3 million, $4.8 million and $701,000 in 1997, 1996 and 1995, respectively. Subject to the completion of the Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular. See Note 1 -- Proposed TDS Corporate Restructuring for a discussion of the proposed merger. All markets managed by the Cellular Group are billed for services they receive from the Cellular Group. Such billings are based on expenses specifically identified to each market and on allocations of common expenses. Such allocations are primarily based on the relationships of each market's assets and revenues to the total assets and revenues of all the markets managed by the Cellular Group. Management believes that all expenses and costs applicable to each market are representative of what they would have been if each managed market operated on a stand-alone basis. See Note 5-- Acquisitions, Exchanges and Divestitures, Purchase of Minority Interests by the Cellular Group from TDS for a discussion of a purchase of minority interests by the Cellular Group from TDS. 13. COMMITMENTS AND CONTINGENCIES CONSTRUCTION AND EXPANSION The partnerships and corporations in which the Cellular Group is a partner or shareholder are in various stages of development. The Cellular Group expects to spend approximately $330 million during 1998, including about $240 million for new cell sites to expand and enhance the Cellular Group's coverage in its service areas and about $90 million for the enhancement of the Cellular Group's office systems. Under the terms of certain partnership and shareholder agreements, the Cellular Group may be committed to funding other partners' or shareholders' portions II-46 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. COMMITMENTS AND CONTINGENCIES (CONTINUED) of construction and other costs, if sufficient financing is not available to the individual entities. The Cellular Group does not expect such individual financing shortfalls to be material. From time to time the Cellular Group may acquire attractive markets to maximize its clustering strategy. See Note 5-- Acquisitions, Exchanges and Divestitures for a discussion of pending acquisitions and divestitures. LEASE COMMITMENTS The Cellular Group and certain of its majority-owned partnerships and subsidiaries lease certain office and cell site locations under operating leases. Future minimum rental payments required under operating leases that have noncancelable lease terms in excess of one year as of December 31, 1997 are as follows:
MINIMUM FUTURE RENTALS -------------------- (DOLLARS IN THOUSANDS) 1998 $ 14,436 1999 11,127 2000 8,099 2001 7,515 2002 4,864 Thereafter $ 36,475 --------
Rent expense totaled $17.2 million, $12.4 million and $9.8 million in 1997, 1996 and 1995, respectively. LEGAL PROCEEDINGS The Cellular Group is involved in a number of legal proceedings before the FCC and various state and federal courts from time to time. Management does not believe that any of such proceedings should have a material adverse impact on the financial position or results of operations of the Cellular Group. On December 29, 1997, a party, which claims to be a holder of U.S. Cellular Common Shares, filed a putative class action complaint on behalf of common stockholders of U.S. Cellular in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, U.S. Cellular, and the directors of U.S. Cellular. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. A virtually identical complaint has been filed by an individual. None of the defendents have been served with this complaint. The Cellular Group intends to vigorously defend against these lawsuits. 14. INVESTMENTS IN CELLULAR ENTITIES Investments in cellular entities consist of amounts invested in cellular entities in which the Cellular Group holds a minority interest. These investments are accounted for using either the equity or cost method, as shown in the following table:
DECEMBER 31, -------------------------- 1997 1996 ------------ ------------ (DOLLARS IN THOUSANDS) Equity method investments: Capital contributions, loans and advances.................................................... $ 66,182 $ 93,209 Cumulative share of income................................................................... 177,798 172,974 Cumulative share of distributions............................................................ (117,174) (88,862) ------------ ------------ 126,806 177,321 Cost method investments: Capital contributions, net of partnership distributions...................................... 2,004 9,470 ------------ ------------ Total investment in nonconsolidated entities................................................... $ 128,810 $ 186,791 ------------ ------------ ------------ ------------
II-47 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. INVESTMENTS IN CELLULAR ENTITIES (CONTINUED) As of December 31, 1997, the Cellular Group followed the equity method of accounting for minority interests in 51 markets where the Cellular Group's ownership interest is 3% or greater. This method recognizes, on a current basis, the Cellular Group's proportionate share of the incomes and losses accruing to it under the terms of the respective partnership and shareholder agreements. As of December 31, 1997, the Cellular Group follows the cost method of accounting for its investments in seven markets where the Cellular Group's ownership interest is less than 3%. It is not practicable to estimate the fair value of the Cellular Group's investments accounted for using the cost method due to the lack of quoted market prices and the inability to estimate fair values without incurring excessive costs. The $2.0 million and $9.5 million carrying amounts at December 31, 1997, and 1996, respectively, represent primarily the original amounts invested, which management believes are not impaired. The following summarizes the unaudited balance sheets and results of operations of the cellular system entities in which the Cellular Group's investments are accounted for by the equity method:
DECEMBER 31, ------------------------------ 1997 1996 -------------- -------------- (DOLLARS IN THOUSANDS) Assets Current..................................................................................... $ 361,561 $ 249,077 Due from affiliates......................................................................... 2,724 6,165 Property and other.......................................................................... 1,050,755 1,000,537 -------------- -------------- $ 1,415,040 $ 1,255,779 -------------- -------------- -------------- -------------- Liabilities and Partners' capital Current liabilities......................................................................... $ 249,587 $ 226,606 Due to affiliates........................................................................... 38,429 20,614 Deferred credits............................................................................ 6,604 791 Long-term debt.............................................................................. 27,195 16,144 Partners' capital........................................................................... 1,093,225 991,624 -------------- -------------- $ 1,415,040 $ 1,255,779 -------------- -------------- -------------- --------------
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1997 1996 1995 -------------- -------------- -------------- (DOLLARS IN THOUSANDS) Results of Operations Revenues...................................................................... $ 1,652,683 $ 1,269,835 $ 1,078,413 Costs and expenses............................................................ 1,178,970 859,026 730,873 Other (expense) income........................................................ (7,292) 832 1,418 -------------- -------------- -------------- Net income.................................................................... $ 466,421 $ 411,641 $ 348,958 -------------- -------------- -------------- -------------- -------------- --------------
II-48 THE UNITED STATES CELLULAR GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATED QUARTERLY INCOME INFORMATION (UNAUDITED)
QUARTER ENDED ------------------------------------------------------ MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS) 1997 - ---------------------------------------------------------------------- Revenues.............................................................. $ 184,584 $ 217,579 $ 231,959 $ 242,843 Operating Income Before Minority Share................................ 23,445 42,154 44,912 19,032 Normal Gain on Sale of Cellular and Other Investments................. -- 8,237 5,208 16,873 Net Income............................................................ 18,468 31,692 36,222 25,157 From Operations..................................................... 18,468 28,781 32,014 16,039 From Gains.......................................................... $ -- $ 2,911 $ 4,208 $ 9,118 1996 - ---------------------------------------------------------------------- Revenues.............................................................. $ 143,642 $ 169,470 $ 180,219 $ 186,737 Operating Income Before Minority Share................................ 11,822 30,021 33,094 12,429 Gain on Sale of Cellular and Other Investments........................ 38,691 86,305 7,797 (75) Net Income............................................................ 29,387 63,055 26,140 11,347 From Operations..................................................... 8,547 19,694 23,899 10,364 From Gains.......................................................... $ 20,840 $ 43,361 $ 2,241 $ 983
Note: Certain 1996 amounts were reclassified for current year presentation. Net income for 1997 and 1996 included significant gains from the sales of cellular and other investments. The table above summarizes the effect of the gains on net income. Management believes there exists a seasonality at the Cellular Group 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. II-49 TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF TELEPHONE AND DATA SYSTEMS, INC.: We have audited the accompanying balance sheets of the United States Cellular Group (representing a business unit of Telephone and Data Systems, Inc.) as of December 31, 1997 and 1996, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Telephone and Data Sytems, Inc. 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 the United States Cellular Group as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois January 28, 1998 II-50 ANNEX III DESCRIPTION OF THE TDS TELECOMMUNICATIONS GROUP The TDS Telecommunications Group ("Telecom Group") primarily consists of TDS Telecommunications Corporation and its subsidiaries ("TDS Telecom"), a wholly owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which operates landline telephone companies. The Telecom Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Telecom Group and such other businesses, assets and liabilities as TDS of any of its subsidiaries may in the future acquire for the Telecom Group, as determined by the Board of Directors of TDS. OVERVIEW The Telecom Group provides modern, high-quality telecommunications services to rural and suburban communities. Through its network of ILECs, The Telecom Group served approximately 515,500 access lines as of December 31, 1997 and on this basis is the ninth largest non-Bell local exchange telephone company in the United States. The Telecom Group ILEC markets are located in 28 states throughout the United States. The table below sets forth, as of December 31, 1997, (i) the eight largest states of operations of the Telecom Group based on the number of access lines and (ii) the total number of access lines operated by all of the telephone subsidiaries of the Telecom Group.
NUMBER OF ACCESS LINES STATE AT DECEMBER 31, 1997 % OF TOTAL - ---------------------------------------------------------------------------------------- ------------------------ ----------- Tennessee............................................................................... 87,910 17.1% Wisconsin............................................................................... 86,262 16.7 Georgia................................................................................. 37,729 7.3 Minnesota............................................................................... 30,054 5.8 Indiana................................................................................. 26,977 5.2 Alabama................................................................................. 25,535 5.0 Michigan................................................................................ 23,786 4.6 Maine................................................................................... 23,055 4.5 -------- ----- Total for 8 Largest States.......................................................... 341,308 66.2 -------- ----- Other States............................................................................ 174,170 33.8 -------- ----- Total............................................................................. 515,478 100.0% -------- ----- -------- -----
The Telecom Group recently began providing telecommunications services as a competitive local exchange carrier ("CLEC") in Madison, Wisconsin and is developing CLEC operations in selected additional markets in Wisconsin and Minnesota. The Telecom Group is also pursuing emerging markets such as data and Internet services. TDS Telecom is a business unit of TDS, founded in 1968. The Telecom Group primarily consists of TDS Telecom, a wholly-owned subsidiary of TDS, and may include such other businesses, assets and liabilities of TDS as the Board may in the future determine to attribute to the Telecom Group. TDS Telecom's corporate headquarters are located in Madison, Wisconsin. TELECOMMUNICATIONS SERVICES MARKET The market for local telecommunications services has historically consisted of firms offering traditional landline telephone service along with complementary services and equipment in a highly regulated environment. The Telecom Group's ILEC business has traditionally focused primarily on providing service to rural and suburban areas. The Telecom Group's ILEC markets are geographically dispersed throughout the United States with a significant concentration in the Upper Midwest and the Southeast. The ILEC business of The Telecom Group is being changed by telecommunications reform legislation, the growth of the Internet and rapid advances in technology. With the passage of the 1996 Act, competition in the local telecommunications marketplace is increasing because of the removal of certain state and local entry barriers and the introduction of ILEC facility interconnection requirements. These changes will create challenges for the Telecom III-1 Group in its existing ILEC business but will also create growth opportunities for the Telecom Group in connection with its entry into CLEC markets. BUSINESS STRATEGY The Telecom Group has historically produced revenue growth in its ILEC markets by providing its customers with state-of-the-art telecommunications solutions, maintaining a high quality of on-going service and selectively acquiring landline telephone companies. Management believes that the Telecom Group has a number of advantages as an ILEC, including (i) a modern network substantially upgraded to provide a variety of Advanced Calling Services, (ii) a strong local presence and established brand name, (iii) economies of scale not available to smaller independent operators, (iv) attractive, growing markets and (v) a favorable regulatory environment which is likely to be less competitive than urban markets. The Telecom Group intends to: (i) grow and protect the Telecom Group's core local exchange business, (ii) provide service to targeted CLEC markets by leveraging its technical and managerial expertise and telecommunications infrastructure from its ILEC's existing operations, (iii) pursue emerging markets, such as data and Internet services, to become a leading provider of electronically deliverable products and services in all of its markets and (iv) enhance profitability through improved operating efficiencies. GROW CORE ILEC BUSINESS Management of the Telecom Group believes that the key to growing and protecting its existing ILEC markets is to continue to build customer loyalty by providing superior customer service, offering a full range of standardized products and services not typically available in rural markets and rapidly developing new data products and services. Management of the Telecom Group maintains a local presence in each of its ILEC markets in order to provide superior customer service. With respect to products and services, the Telecom Group offered Advanced Calling Services to 78% of its customers at December 31, 1997. The Telecom Group increasingly markets itself to consumers as a single telecommunications provider offering bundled packages of advanced telecommunications services including local, long distance, Internet and data services. These service packages will further build brand equity in the TDS Telecom name. In addition, management of the Telecom Group believes it can achieve cost economies through selective acquisitions designed to increase the geographic clustering of the Telecom Group's ILEC markets. LEVERAGE ILEC STRENGTHS INTO CLEC MARKETS The Telecom Group is providing CLEC services in certain targeted third-tier cities which are geographically proximate to existing Telecom Group facilities and service areas. Management of the Telecom Group believes that service levels have deteriorated in certain markets due to a lack of focus by the ILECs thereby creating an opportunity for the Telecom Group to compete effectively in those markets. In addition, management of the Telecom Group believes that the smaller size of these markets may discourage competition from additional CLECs. Through February 28, 1998, the Telecom Group had invested $13 million to install a digital switch and to construct 54 miles of fiber optic cable in and around Madison, Wisconsin. The Telecom Group initiated service as a CLEC in Madison in January 1998 and is providing service to approximately 4,000 business access lines. In addition, the Telecom Group commenced operations as a CLEC in secondary markets in Minnesota in January 1998, initially as a reseller, through its regional long-distance reseller, USLink, and is providing service to approximately 3,000 business access lines in those markets. The Telecom Group intends to initiate service in Appleton and Green Bay, Wisconsin in mid-1998. The geographic focus of the Telecom Group's CLEC strategy is designed to leverage TDS Telecom's existing infrastructure to facilitate early entry into new CLEC markets and to complement the Telecom Group's ILEC clustering strategy. The Telecom Group believes that significant synergies exist between its ILEC and CLEC businesses. The Telecom Group is able to utilize existing resources and business processes that currently serve ILEC markets in developing and expanding its CLEC operations, including administrative and financial support, marketing and new product development support, information technology and systems, and shared network systems support. These synergies reduce the overall time to market and cost required for the Telecom Group to expand into its new CLEC markets. PURSUE EMERGING DATA MARKETS Data communications is one of the fastest growing segments of the telecommunications services industry. In light of the growth of the use of the Internet and rapid introduction of new telecommunications technology, the Telecom Group intends to offer a full range of data products to its customers, including Internet access and III-2 potentially, ATM, Frame Relay and other products, if appropriate, in all of its markets, thereby positioning itself as a full-service data communications service provider. Most of the Telecom Group's data products are in the early stages of development. The Telecom Group has, however, developed a LAN wiring business and currently provides Internet access service to approximately 40,000 customers. NETWORK INFRASTRUCTURE The Telecom Group plans to provide its operating telephone companies with the most advanced central office switching equipment that is economically feasible in order to offer customers up-to-date services, such as advanced calling services, high-speed data access and Internet access services. The Telecom Group plans to provide its customers bundled service offerings and to become a single source for their telecommunications needs as an Integrated Communications Provider ("ICP"). In furtherance of this objective, in 1997, the Telecom Group continued its program of enhancing and expanding its service providing network. The Telecom Group intends to meet competition by providing its customers with high-quality telecommunications services and building its network to take full advantage of advanced telecommunications technologies such as Signaling System 7, fiber optic fed Digital Serving Areas, Integrated Services Digital Network and Advanced Calling Services. The following table illustrates that the Telecom Group continues to make these advanced features available to a large majority of its customers:
% EQUIPPED LINES # EQUIPPED LINES 1997 1997 ------------------- ------------------ Signaling System 7................................................ 86% 478,690 Advanced Calling Services......................................... 86% 478,690 Integrated Services Digital Network............................... 68% 378,570
As the Telecom Group upgrades and expands its network, it is also standardizing equipment and processes to increase efficiency and has centralized the monitoring and management of its network to reduce costs and improve service reliability. Strategic alliances with Lucent Technologies and Siemens Telecom Networks to modernize and standardize the Telecom Group's switching platform with the Lucent 5ESS-2000 and Siemens EWSD switches assisted TDS Telecom in implementing its 24 hour-a-day/7 day-per-week Network Management Center. The Network Management Center continuously monitors the network in an effort to proactively identify and correct network faults prior to any customer impact. By the end of 1998, the Network Management Center is expected to be proactively monitoring 100% of the Telecom Group's network. The Telecom Group's total 1998 capital budget is $140 million compared to actual capital expenditures of $151.5 million in 1997 and $144.4 million in 1996. Financing for the 1998 capital additions will be primarily provided by internally generated funds and supplemented by federal long-term financing. ILEC TELEPHONE MARKETS The Telecom Group's goal is to be a leading provider of electronically deliverable products in its ILEC markets. According to published sources, the Telecom Group is currently the ninth largest non-Bell local exchange telephone company in the United States, based on the number of telephone access lines served. At December 31, 1997, the telephone subsidiaries of the Telecom Group served approximately 515,500 access lines in 28 states. The Telecom Group currently operates over 378 central office and remote switching centers in its telephone operating areas. Substantially all of the Telecom Group's access lines are served by digital switching technology, which, in conjunction with other technologies, allows the Telecom Group to offer additional premium services to its customers, including call forwarding, conference calling, caller identification, selective call ringing and call waiting. As one of the major independent telephone companies in the United States, the Telecom Group's ILECs provide both local telephone service and access to the long distance network for customers in their respective service areas. The ILECs also provide directory advertising through a contract with another company and billing and collection services to inter-exchange carriers ("IXCs"). The Telecom Group provides centralized administrative and support services to field operations from its corporate offices in Madison, Wisconsin. III-3 The following table summarizes certain information regarding the Telecom Group's telephone operations:
AT OR FOR THE YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------- ------------- ------------- ------------- ----------- (DOLLARS IN THOUSANDS) Telephone Operations Access lines(1)..................................... 515,500 484,500 425,900 392,500 356,200 % Residential....................................... 78.3% 79.9% 80.6% 81.3% 82.0% % Business (nonresidential)......................... 21.7% 20.1% 19.4% 18.7% 18.0% Total Revenues...................................... $ 444,203 $ 395,602 $ 354,841 $ 306,341 $ 268,122 % Local service..................................... 27.7% 27.9% 26.8% 26.8% 26.9% % Network access and long-distance.................. 53.1% 53.9% 55.1% 56.9% 59.3% % Miscellaneous and other........................... 19.2% 18.2% 18.1% 16.3% 13.8% Depreciation and amortization expense............... 98,066 $ 88,459 $ 77,354 $ 68,878 $ 59,562 Operating income.................................... 98,613 102,708 98,240 91,606 78,585 Construction expenditures........................... 151,460 144,440 104,372 115,483 80,818 Total identifiable assets........................... $ 1,221,463 $ 1,181,084 $ 1,058,241 $ 984,563 $ 829,489
- --------- (1) An "access line" is a single or multi-party circuit between the customer's establishment and the central switching office. RETAIL MARKETS The Telecom Group's existing ILEC business consists of two major customer focused organizations addressing the retail and wholesale marketplace for its services. The Retail Markets Group focuses on the Telecom Group's retail customers and is comprised of the Telecom Group's 106 operating companies. The Retail Markets Group serves a mix of rural and suburban customers, with a significant geographic concentration in the Upper Midwest and Southeast. Approximately 78% of the Telecom Group's retail customers are residential and approximately 22% are businesses, most of which are of the small business or small office/home office segments. The Retail Markets Group has identified three primary goals to grow and protect its existing ILEC business: (i) build customer loyalty, (ii) develop revenue growth, and (iii) implement cost control. Management of the Telecom Group believes it can achieve these goals by offering bundled services to its customers, by building brand equity in the TDS Telecom brand name, and by providing superior customer service to its retail customers. In addition, the Telecom Group will continue to standardize operations, improve cost controls and selectively invest in network facilities in order to enhance efficiency and reduce costs. BUNDLED SERVICE OFFERINGS. Management of the Telecom Group believes that its consumer and business customers have a strong preference to purchase all of their telecommunications services from a single provider. The Telecom Group believes that by offering a full complement of telecommunications services and bundling those services in customer-friendly packages it can build customer loyalty and reduce customer churn. Implementing a full-service strategy requires the Telecom Group to combine the services of its network with the products and services of carefully selected strategic partners. The Telecom Group plans to pursue such relationships to develop the long distance, video, and wireless components of its product mix. BRAND EQUITY. In 1996, the Telecom Group adopted the TDS Telecom name as a unified brand name across its ILEC markets to build its brand image. Prior to 1996, the local identity of each operating company enjoyed a higher profile than TDS Telecom. The Telecom Group has subsequently implemented a customer awareness campaign to build brand awareness of the TDS Telecom name. For example, all bills now contain the TDS Telecom name and all customer checks are made payable to TDS Telecom. The change in branding has been reinforced by a comprehensive media campaign that includes television, radio, newspaper, bill inserts and direct mail advertising. Management of the Telecom Group believes that branding will increase the loyalty of its customers and also reduce expenses through more cost effective marketing. CUSTOMER SERVICE. The Telecom Group maintains a local business office in each of its ILEC markets to ensure high levels of customer service. Management believes that its community-based business offices offering full-service, face-to-face customer service are a fundamental competitive advantage for the Telecom Group. To further the Telecom Group's goal of enhancing service to its customers, the Telecom Group is implementing a VBO initiative. The VBO builds on the Telecom Group's current community oriented customer service by linking business III-4 offices through technology, standardizing processes, expanding hours of operations, and providing management information on operations and service quality. VBO technology will be deployed across the Telecom Group's business offices to enable multiple local business offices to perform customer sales and service functions as if they were one "virtual" office in the eyes of the customer. Unlike traditional call centers where service representatives and technology are centrally located, the VBO environment distributes call center technology to the individual business offices enabling customer service representatives to remain in their local communities. WHOLESALE MARKETS The Wholesale Markets Group focuses on the Telecom Group's wholesale customers and has traditionally provided a majority of the Telecom Group's revenues. The Telecom Group receives much of its ILEC revenue from the sale of traditional wholesale services, such as access charges and billing and collections services. As a result, the Telecom Group continues to provide a high level of service to traditional wholesale customers such as AT&T, MCI, Sprint and the RBOCs. The Telecom Group intends to grow its wholesale business by pursuing opportunities created by the 1996 Act. The Telecom Group plans to expand into new wholesale groups by targeting two groups of customers. First, the Telecom Group will provide new entrants to markets, such as CLECs and PCS carriers, with access to the public network, as well as dedicated services. Second, the Telecom Group will supply existing businesses such as cable television providers, electric utilities and long distance resellers with network services needed to complement their existing assets. The Telecom Group also intends to pursue other wholesale opportunities, such as network management and Internet access, as demand for those services increases. The primary source of the Telecom Group's wholesale business revenues are access revenues. The Telecom Group's operating telephone subsidiaries receive access revenue as compensation for carrying interstate and intrastate long-distance traffic on its network. The interstate and intrastate access rates charged include the cost of providing service plus a fair rate of return on the capital allocated to such services. Access revenues account for approximately 57% of the revenue generated by the Telecom Group's ILEC subsidiaries. The Telecom Group's ILECs participate in the National Exchange Carrier Association ("NECA") interstate common line and traffic sensitive tariffs for all but one portion of one ILEC's interstate access. 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 access rates and other matters relating to interstate telephone service. On May 16, 1997, the FCC released an order on access reform. This order applies primarily to price cap local exchange carriers ("LECs"). However, non-price cap companies, such as the Telecom Group, were also affected in certain areas by this order. The FCC is expected to release an order on access charge reform for non-price cap companies in mid-1998. Depending on the outcome of the order for non-price cap companies, the source and nature of the operating companies' recovery of costs from interstate services will be affected. The 1996 Act provides for reciprocal compensation for parties to 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 pay access charges to wireless carriers to terminate calls from LEC customers. Since this order raises interconnection costs, the operating companies may adjust their charges to recover such increased costs. On October 7, 1997, the FCC released a Notice of Proposed Rulemaking ("NPRM") on jurisdictional separations reform. In the NPRM, the FCC reviews the current procedures for separating LECs' service costs between the state and federal jurisdictions. Many of the proposals in the NPRM seek to limit costs assigned to the interstate jurisdiction and seek to assign greater costs to the intrastate jurisdiction. To the extent that the costs are not made up in the new federal and state universal service mechanisms, the Telecom Group may seek rate increases in local service rates to offset any reductions in interstate revenues. Where applicable and subject to state regulatory approval, the Telecom Group's ILEC subsidiaries utilize intrastate access tariffs and participate in intrastate revenue pools. However, many intrastate toll revenue pooling arrangements, historically a source of substantial revenues to the Telecom Group'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 has accelerated the pace of regulatory re-evaluation at both the state and federal level. To the extent that state-ordered access charge revisions reduce revenues, the Telecom Group may seek adjustments in other rates. Some states are utilizing a state high cost fund III-5 to offset access charge reductions. Given the many regulatory issues still unresolved, the Telecom Group cannot predict the cumulative nature or extent of impacts from federal and state regulatory reform. TELEPHONE ACQUISITIONS TDS and the Telecom Group continually review attractive opportunities to acquire operating telephone companies. Since January 1, 1993, TDS has acquired 17 telephone companies serving a total of 89,600 access lines for an aggregate consideration totaling $188.0 million, all of which were attributed to the Telecom Group. During the past five years, TDS acquired one telephone company in 1997 serving 3,200 access lines, five telephone companies in 1996 serving an aggregate of 33,100 access lines, four telephone companies in 1995 serving an aggregate of 13,500 access lines, three telephone companies in 1994 serving an aggregate of 19,700 access lines and four telephone companies in 1993 serving an aggregate of 20,100 access lines. Recently, the Telecom Group has modified its acquisition strategy to focus on geographic clustering of telephone companies to achieve cost economies and to complement the the Telecom Group's growth strategy. It is the Telecom Group's policy to preserve, in so far as possible, the local management of each telephone company it acquires. The Telecom Group provides the telephone companies with centralized purchasing and general management and other services, at cost plus a reasonable rate of return on invested capital. These services afford the subsidiaries expertise in finance; accounting and treasury services; marketing; customer service; traffic; network management; engineering and construction; customer billing; rate administration; credit and collection; and the development of administrative and procedural practices. FEDERAL FINANCING The Telecom Group'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"), each of which is an agency of the United States of America. The RUS has made primarily 35-year loans to telephone companies since 1949, at interest rates of 2% and 5%, for the purpose of improving telephone service in rural areas. Currently, the RUS is authorized to issue hardship loans at a 5% interest 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 (6.54% for its fiscal year ended September 30, 1997), 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 (6.01% for a 35-year note at December 31, 1997). Substantially all of the Telecom Group's telephone plant is pledged under, or is otherwise subject to, mortgages securing obligations of the operating telephone companies to the RUS, RTB and FFB. The amount of dividends on common stock that may be paid by the operating telephone companies is limited by certain financial requirements set forth in the mortgages. Effective October 6, 1997, the RUS revised its regulations on the amount of allowable distributions a borrower can make in any calendar year. For those companies with greater than 40% net worth to total assets, the entire amount above 40% net worth to total assets can be distributed. The majority of the Telecom Group's telephone subsidiaries exceed this percentage. At December 31, 1997, the Telecom Group's operating telephone companies had unadvanced loan commitments under the RUS, RTB and FFB loan programs aggregating approximately $112.0 million, at a weighted average annual interest rate of 5.71%, to finance specific construction activities in 1998 and future years. These loan commitments are generally issued for five-year periods and may be extended under certain circumstances. The Telecom Group'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 government loan programs will continue to be available or that these applications will be accepted or what the terms or interest rates of any future loan commitments will be. FEDERAL AND STATE SUPPORT MECHANISMS 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 the Telecom Group's ILEC subsidiaries provide telephone service in rural areas and all of them offer service to low-income customers. The 1996 Act codified universal service goals and support; set forth clear principles for ensuring affordable access to modern telephone service nationwide; established discounts for schools, libraries and rural health care III-6 facilities; and established a federal-state joint board to make recommendations to the FCC regarding implementation of the universal service provisions of the 1996 Act. On May 8, 1997, the FCC released an order on universal service, adopting many of the joint board's recommendations. The FCC adopted the use of forward-looking proxy cost models to determine costs rather than relying on actual costs. However, rural ILECs will continue to receive support based on their actual costs through December 31, 2000. After December 31, 2000, rural ILECs will transition to the use of proxy cost models over an additional three-year period. To date, management of the Telecom Group believes that no proxy cost models have proven to provide sufficient and predictable revenue support for the provision of universal service by rural ILECs. The FCC has not adopted any proxy cost model for rural ILECs. Both petitions for review and judicial appeals of portions of the FCC's universal service rules and policies remain pending, and Congress legislated a requirement for the FCC to report on its implementation of universal service in its appropriations legislation. The FCC's order also mandated that all telecommunications providers contribute to the universal service fund beginning January 1, 1998. However, the order allows ILECs to recover these contributions through their interstate access rates. The final rules to implement the universal service provisions of the 1996 Act will involve development of new support mechanisms and changes in the eligibility criteria. In addition, some of the Telecom Group's ILEC subsidiaries operate in states where support and rate structures are either being re-evaluated or have already been changed. Full recovery of universal service costs in the future through interstate and intrastate mechanisms is uncertain. If interstate or intrastate support decreases, the Telecom Group's ILEC subsidiaries may pursue local service rate increases to recover the difference. Historically, telephone company acquisition and investment decisions assumed the ability to recover the cost and a reasonable rate of return through local service, access and support revenues. Significant changes in the universal service funding system could affect TDS's and the Telecom Group's acquisition and investment strategy. CLEC TELEPHONE MARKETS The 1996 Act facilitates entry of the Telecom Group into new markets by requiring non-exempted ILECs (e.g., RBOCs, GTE and other-ILECs, based on state regulators' determinations) to provide reasonable and non-discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. The Telecom Group, through TDS METROCOM, a wholly-owned subsidiary of the Telecom Group, has targeted certain third-tier cities, geographically proximate to existing The Telecom Group facilities and service areas, for facilities-based entry as a CLEC. Management of the Telecom Group believes that the size of the target markets will sustain one or two facilities-based competitors in addition to the ILEC. While additional competitors may enter such markets as resellers, the Telecom Group believes facility-based CLECs will have a long-run cost advantage, establish a barrier to entry and enable an alternative wholesale strategy for growth. To this end, the Telecom Group plans to build fiber-ring, switching and other network facilities in its targeted CLEC markets. The Telecom Group plans to follow a "clustering" approach to building its CLECs which will allow it to seek regional long distance traffic, share service and repair resources, and realize marketing efficiencies. As in its ILEC markets, the Telecom Group intends to become an ICP in its CLEC markets. The Telecom Group will provide local, long-distance, Internet access and other services through its own facilities and via resale. The Telecom Group also intends to resell mobile services in many markets. The Telecom Group's first CLEC in Madison, Wisconsin became operational in January 1998. The Madison CLEC is a facilities-based, full-service alternative to Madison's existing ILECs, Ameritech and Mid-Plains Telephone Companies, providing both voice and data services to commercial and consumer accounts, as well as wholesale services to IXCs and other carriers. While the Telecom Group is beginning its CLEC venture in its Madison and Minnesota markets, it plans to expand operations to Appleton and Green Bay, Wisconsin. As of December 31, 1997, the Telecom Group has invested $12 million in constructing its facilities in the Madison market and plans to invest $18 million during 1998. The CLEC strategy will place primary emphasis on small and medium-sized commercial and wholesale customers such as IXCs, Internet Service Providers ("ISPs") and cellular, paging and PCS companies. The Telecom Group expects to pursue consumer markets approximately six months after the CLEC enters the commercial market. Wholesale customers purchase transmission capacity and access services from CLECs. These services will be available to wholesale customers shortly after network completion. The Telecom Group believes that these customers are generally more sophisticated and are more likely to switch providers to obtain network reliability, redundancy and more flexible pricing. Medium-sized commercial prospects are characterized by above-average III-7 access line-to-employee ratios, heavier utilization of data services, and a focus on using telecommunications for business improvement rather than by concerns for cost reduction. These companies are generally growth-oriented and may be underserved by the ILEC or major IXCs. The Telecom Group will pursue a personal selling approach for its primary target markets. This approach builds on customer preference for integrated communication services and the customer's perception that the quality of the product is in the personalized service. While the CLEC is positioning itself as a high-quality provider, it expects price competition from the ILECs as they attempt to retain and regain their customers. The CLEC will seek to maintain an efficient cost structure to ensure it can match price-based initiatives from competitors. The Telecom Group expects to be more flexible in responding to customer needs than its ILEC competitors. To effectively compete in this new environment, the Telecom Group will enhance its efforts at product development to provide high-quality, cutting-edge services to its customers. DATA INITIATIVES In 1997, the Telecom Group continued to expand its investments into data communications in order to offer a full suite of data products in its CLEC and many of its ILEC markets. The Telecom Group believes the targeted third-tier markets present a significant opportunity to market data services as the major carriers serving these locations have typically underinvested in these markets despite the growing demand. Switched data communications represent one of the fastest growing segments of the telecommunications services market. Computer proliferation, connectivity via local and wide area networks, the Internet and the emergence of multimedia applications are all driving demand. As a result, the domestic network infrastructure is strained at both the local and national levels. The Telecom Group CLEC initiative will add local capacity in its selected cities designed to capture this growth. The Telecom Group has developed a LAN wiring business as part of its data services business. The LAN wiring business provides in-building wiring services to its customers. The Telecom Group assists its customers in designing and constructing specialized wiring networks for their business needs. Customers of the LAN wiring business include traditional in-market business customers of the Telecom Group and also non-traditional business customers located in ILEC markets not currently served by the Telecom Group. At December 31, 1997, TDS DATACOM, the Telecom Group's LAN wiring entity, operated in 14 markets and generated approximately $6.6 million in revenue for the year then ended. In furtherance of the Telecom Group's strategy to position itself as a full-service, networking service provider, it plans to make high-speed Digital Subscriber Loop ("xDSL") based services available to customers in many of its ILEC markets. The Telecom Group believes xDSL technology will form the foundation for new, high-speed data services and applications and is currently conducting trials of xDSL modems manufactured by several vendors. This technology will be employed to offer high-speed Internet access as well as high-speed LAN connectivity. In addition, the Telecom Group plans to develop Frame Relay and ATM services in select markets. TDSNET, the Telecom Group's ISP, is expanding its existing business offerings to include web hosting services and customized web content development. TDSNET expanded its operation in 1997 by adding an additional 13 operating markets to bring its total operating markets to 49. It served approximately 30,000 customers and generated approximately $4 million in revenue for the year then ended. SALES AND MARKETING The Telecom Group seeks to leverage its networks through sales and marketing activities targeted at two separate customer groups: retail and wholesale. Retail customers are composed primarily of residential customers, businesses, government and institutional telecommunications users. Wholesale customers consist of IXCs and information service providers such as commercial data processing service providers and ISPs. RETAIL MARKETS COMMERCIAL MARKETS. Businesses account for approximately 22% of the Telecom Group's access lines. The Telecom Group focuses its business customer marketing on information-intensive industries such as financial services, health services, realty, hotels and motels, education and government. The Telecom Group uses its direct sales force, targeted mailings, and telemarketing to sell products and services to the commercial markets, which are segmented into tiers based on size and strategic importance. Different sales and distribution channels are employed for each segment. Specific account executives focus on the most profitable commercial customers by staying in contact with them on a regular basis. In 1996, the Telecom Group adopted a more aggressive compensation plan for its account executives targeted at revenue and customer satisfaction results. III-8 CONSUMER MARKETS. The Telecom Group's promotional and sales strategy with respect to its residential customers consists of two major initiatives: building brand equity by creating awareness of the TDS Telecom brand name; and using direct marketing to sell specific products and product groupings. Approximately 78% of the Telecom Group's total access lines are residential. The nature of the Telecom Group's residential markets has historically made direct marketing more effective than mass media such as radio and television. In addressing its consumer markets, the Telecom Group has made extensive and aggressive use of direct mail. The Telecom Group has been more selective in the use of telemarketing as a means of generating awareness, qualified leads, and sales. Increasingly, uniform branding has made the use of mass media more attractive, and the Telecom Group is beginning to increasingly incorporate these elements into its marketing program. In nearly all of its markets, the Telecom Group offers a complete family of custom calling services, including call waiting, call forwarding, three-way calling, and speed dialing. In 1997, the Telecom Group sold 27,700 residential second lines, an increase of 46% over 1996. The Telecom Group recently launched its Advanced Calling Services family, which is centered around Caller ID service. In 1997, the Advanced Calling Services family of services were available to 78% of the lines in service compared to 66% in 1996. In 1997, penetration of Caller ID increased from 13% in 1996 to 16% of lines equipped and aggregate penetration of ACS increased from 25% in 1996 to 30% of lines equipped. WHOLESALE MARKETS Access charges, billing and collection services and other traditional wholesale offerings generated $253 million, or approximately 61 percent, of the Telecom Group's ILEC subsidiaries revenue for the year ended December 31, 1997. The Telecom Group seeks to establish close working relationships with the IXCs. The Telecom Group is working to establish systems to support "electronic bonding" of its operations with those of the IXCs. Electronic bonding provides seamless integration of the Telecom Group's and the IXCs' networks, enabling the IXCs to access service, billing and other data directly from the Telecom Group's network. It will also permit the IXCs to enter access service requests electronically using the integrated network. The initial phase of establishing these systems has taken place with the establishment of a dedicated customer service team to provide a single point of contact for the IXCs. During 1998 and beyond, automated systems solutions will be implemented to fully support electronic bonding. The Telecom Group sees significant potential in leveraging its infrastructure to provide new wholesale offerings to non-traditional customers. The Telecom Group has targeted high growth industry sectors such as CLECs, independent telephone companies, cable television companies, electric utilities and other telecommunications service providers for purchase of its wholesale offerings. Additionally, existing cellular wireless carriers are expanding their services in and near the Telecom Group's territories and new PCS wireless carriers are, or soon will be, offering service. COMPETITION ILEC MARKETS The 1996 Act was intended to promote competition in the telecommunications industry as a national policy and continue the process of deregulation. The 1996 Act requires ILECs to provide reasonable and non-discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. The 1996 Act also allows CLECs to co-locate network equipment on the ILEC's premises and prevents ILECs and CLECs from unduly restricting each other from use of facilities or information that would allow other organizations to effectively compete with them. All 106 telephone company subsidiaries of the Telecom Group are currently exempt from many of the interconnection provisions of the 1996 Act. According to the 1996 Act, a rural telephone company (which currently includes all 106 of the Telecom Group's ILECs) is exempt from the ILEC interconnection requirements until (i) such company has received a bona fide request for interconnection, resale of services, or network elements, and (ii) the state commission determines that such request is not unduly economically burdensome, is technically feasible, and is consistent with the universal service provisions of the 1996 Act. The party making a bona fide request must submit a notice of its request to the appropriate state commission which must then conduct an inquiry to determine whether to terminate the exemption. Within 120 days after a state commission receives notice of the request, it must determine if it will terminate the exemption. Upon termination of the exemption, the state commission must establish an implementation schedule for compliance with the request. Accordingly, the length of the Telecom Group's rural exemptions will vary based on the decisions of the various state commissions. Some the Telecom Group ILECs III-9 have already had requests filed by potential competitors seeking to terminate their exemptions and the Telecom Group believes there will eventually be open entry into nearly every aspect of the telephone industry, including local service, and, switched and special access services. The Telecom Group expects competition in the local telephone and access services businesses to be increased substantially as a result of the entrance of new competitors and the development of new technologies, products and services. Increased competition is expected from competitive access providers, IXCs, out-of-territory RBOCs and independent telephone companies, niche entrepreneurs, cable and utility companies, and wireless and satellite providers. To meet this increasing competition, the Telecom Group's strategy is to build customer loyalty by providing superior customer service, offering a full range of standardized products and services bundled in response to customer preferences and to rapidly develop new data products and services. The Telecom Group believes that the wireless companies pose the most significant threat in the long run to the local exchange industry. Although traditional analog cellular radio service cannot match the features or the clarity of communications provided via wireline networks, and as a result of high error rates and speed limitations is not currently suitable for data transmission, advances in digital PCS technology may permit wireless companies to eventually match the functionality and clarity of wireline communication and still allow customers the mobility of traditional wireless service. As the emerging PCS companies compete directly with established cellular radio companies, flat rate pricing alternatives may drive wireless rates towards or below wireline rates. In order to minimize the impact of wireless competition, the Telecom Group is pursuing wholesale service agreements with wireless companies to provide services to them and expects to provide wireless services through resale in many of its markets. CLEC MARKETS In Madison and in each city in which the Telecom Group expands as a CLEC, the Telecom Group faces, and expects to continue to face, significant competition from the ILECs which currently dominate their local telecommunications markets. The Telecom Group will compete with the ILECs on the basis of price, reliability, state-of-the-art technology, product offerings, route diversity, ease of ordering and customer service. However, the ILECs have long-standing relationships with their customers, have the potential to subsidize competitive services from monopoly service revenues, and benefit from favorable state and federal regulations. The Telecom Group expects its CLECs to provide a full range of local telecommunications services in order to compete effectively with the ILECs. Although the ILECs generally are subject to greater pricing and regulatory constraints than CLECs, ILECs are achieving increased pricing flexibility for their services as a result of, among other things, the 1996 Act. Existing competition for private line, special access and local exchange services is based primarily on quality, capacity and reliability of network facilities, customer service, response to customer needs, service features and price, and is not based on any proprietary technology. As a result of the technology used in its networks, the Telecom Group may have cost and service quality advantages over some currently available ILEC networks. In addition, the Telecom Group believes that, in general, it will provide more attention and responsiveness to its customers than its ILEC competitors. The Telecom Group may face competition from other CLECs and other potential competitors in certain of the cities in which the Telecom Group plans to offers its services. Many of the Telecom Group's existing and potential competitors have financial, personnel and other resources significantly greater than those of the Telecom Group. However, the Telecom Group believes that its strategy of targeting third tier cities, its capital, technical and management resources and its orientation toward IXCs and other commercial telecommunications users will enable it to achieve its strategic objectives. CLECs' ability to compete depends in part on federal and state rules covering pricing and terms for ILECs' services provided by unbundled network elements and resale, as well as ILECs' operation support systems. In addition to the ILECs and other CLECs, potential competitors capable of offering private line, special access and local exchange services include long distance carriers, cable television companies, electric utilities, microwave carriers, wireless telephone system operators, and private networks built by large end users. Previous impediments to certain utility companies entering telecommunications markets under the Public Utility Holding Company Act of 1935 were removed by the 1996 Act. REGULATION The intrastate, local and access services of the Telecom Group's ILEC subsidiaries are regulated by state regulatory agencies, and the Telecom Group seeks to maintain positive relationships with these regulators. Rate III-10 setting, including local rates, intrastate toll rates and intrastate access charges, are subject to state commission approval. The Telecom Group 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, and the FCC must pre-empt challenged state requirements if they impose such barriers to entry, a state retains limited authority to regulate certain competitive practices in rural telephone company service areas. The 1996 Act establishes a general duty for all telecommunications carriers, including wireless providers, to interconnect with other carriers. Congress prescribed a more specific list of interconnection requirements for all LECs including resale, number portability, dialing parity, access to rights-of-way and reciprocal compensation. The FCC has adopted or is considering rules and policies implementing the provisions of the 1996 Act. Unless exempted, or granted suspension or modification, ILECs have additional obligations: (a) to negotiate in good faith terms of interconnection; (b) to comply with more detailed interconnection terms, including non- discrimination and unbundling their network and service components so competitors may use only those elements they choose for providing their services; (c) to offer their retail services at wholesale rates to facilitate resale by their competitors; and (d) to allow other carriers to place equipment necessary for interconnection or access on their premises. Rural telephone companies are exempted from these obligations until they receive a bona fide request for interconnection, resale of services or network elements and the applicable state commission determines that termination of the exemption is not unduly economically burdensome, is technically feasible and is consistent with universal service. Many of the FCC determinations made to implement the 1996 law and to facilitate competition in local service and other telephone services involve investment and upgrades to the Telecom Group networks. These investments and upgrades include requirements to implement local number portability so subscribers may change to competitors' services without changing their telephone numbers, network signaling information that must be provided to certain other carriers and pay phone providers, and other changes that require additional investments and expenses. The Telecom Group is seeking to comply with these requirements, and is pursuing policies that provide a fair opportunity to recover its costs, but in some cases is asking for waivers or delayed implementation deadlines. A new law also requires LECs to provide certain communications for law enforcement purposes. The full cost and the adequacy of the government compensation are not yet known, but the LEC industry is pursuing regulatory policies that cover any shortfall in available government compensation. As defined in the 1996 Act, all of the Telecom Group's ILEC subsidiaries qualify as rural telephone companies. Therefore, they enjoy an exemption from the ILEC interconnection requirements until they receive a bona fide request for interconnection from, and the state commission lifts the exemption. The Telecom Group has received two requests for interconnection, one of which has been withdrawn, and the other of which is currently pending. 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. A federal appellate decision striking down FCC pricing regulations for interconnection and several rules that limited the Telecom Group telephone companies' ability to obtain regulatory relief from stricter interconnection requirements for incumbent telephone companies has been accepted for review by the U.S. Supreme Court. TDS cannot predict the outcome of this or the numerous other court and FCC proceedings stemming from the 1996 Act. The Telecom Group seeks to maintain and enhance existing revenue streams despite heightened earnings review activity by state regulators and the advent of local exchange competition resulting from the 1996 Act. The Telecom Group is preparing for competition even though such changes will often require changes in state regulation or state regulatory approvals. For example, the Telecom Group is seeking the necessary pricing flexibility to adjust its rate structures to a more competitive model. The Telecom Group is also participating in state regulatory and legislative processes to urge that any telecommunications reform measures treat rural areas fairly and continue III-11 to provide sufficient contributions to high cost rural service areas to keep the Telecom Group ILECs' rates affordable. The ongoing changes in public policy and introduction of competition may negatively affect the earnings of the operating subsidiaries, and the Telecom Group is not able to predict the extent of any such negative impact. While the majority of the Telecom Group's ILEC subsidiaries continue to operate in a rate-of-return environment, a number of state commissions are negotiating, or have agreed to alternative regulation plans with ILECs. Price regulation, the most common form of alternative regulations, focuses on the price of telecommunications services rather than rules based on authorized costs and rates of return. The Telecom Group's ILEC subsidiaries in Alabama, Arkansas, Michigan and Pennsylvania are currently operating in a price-regulated environment, whereby the commissions in those states are no longer reviewing earnings annually. For several years, the RBOCs and some of the nation's larger ILECs have operated under an FCC "price cap" plan, modified in 1997, where earnings can be increased through productivity improvements. For 1998, the Telecom Group's telephone subsidiaries neither elected federal price caps nor an alternative FCC plan, which was designed for smaller LECs. Instead, the operating subsidiaries plan to continue to abide by traditional rate-of-return regulation for interstate purposes, unless those regulatory terms are changed. Since approximately one-third of the Telecom Group's telephone subsidiaries serve high-cost areas, important averaging mechanisms associated with the NECA pooling process would be lost if the Telecom Group elected either of the alternatives to traditional rate-of-return regulation. However, the FCC periodically considers whether to initiate a proceeding to lower the allowed rate-of-return for rate-of-return LECs. The FCC also plans to reform the rules that govern how rate-of-return regulated LECs, on their own or through NECA, charge IXCs for local distribution of their interstate calls. Some of the reforms already adopted for price cap regulated LECs, if expanded to cover the the Telecom Group LECs, could reduce interstate cost recovery, and could prompt the LECs to seek state commission approval of increased local rates. NECA is requesting access charge changes from the FCC which would use a "banded" rate structure to help pool members with lower costs charge more competitive rates. NECA's most recent access charges were approved effective January 1, 1998. Access to affordable long-distance service in rural areas was achieved because the FCC ordered AT&T to provide nationwide average rates. As a result of increasing competition, the FCC lifted all regulations relating to AT&T's interstate services in 1996. However, the 1996 Act preserves interstate toll rate averaging and endorses a nationwide policy that interstate and intrastate long-distance rates of all long-distance carriers should not be higher in rural areas than in urban areas they serve. The statute is intended to ensure affordable long distance services even in TDS Telecom's most remote exchanges. EMPLOYEES As of December 31, 1997, the Telecom Group had a total of 2,297 employees. There are 131 employees at the Telecom Group who are represented by labor unions. The Telecom Group considers its relations with its employees to be good. III-12 EXPLANATORY NOTE REGARDING FINANCIAL INFORMATION Effective upon completion of the Transactions, Telephone and Data Systems, Inc. will have outstanding five classes of Common Stock: United States Cellular Group Common Shares, which are intended to reflect the performance of the United States Cellular Group; TDS Telecommunications Group Common Shares, which are intended to reflect the performance of TDS Telecommunications Group; Aerial Communications Group Common Shares, which are intended to reflect the performance of the Aerial Communications Group; and Common Shares and Series A Common Shares which are intended to reflect the performance of a residual group (the "TDS Group") (which will also reflect the performance of the United States Cellular Group, the TDS Telecommunications Group, and Aerial Communications Group to the extent of the Retained Interest.) Although the financial statements of the TDS Telecommunications Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of Telephone and Data Systems, Inc. attributed to the TDS Telecommunications Group such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of TDS Telecommunications Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares are, shareholders of TDS. TDS and its subsidiaries would each continue to be responsible for their respective liabilities. Financial results arising from the business of Telephone and Data Systems, Inc. (including its Retained Interest in the TDS Telecommunications Group) or from the business of the TDS Telecommunications Group could affect the market price of all classes of Common Stock. In addition, any net losses of any of the Groups, including the TDS Telecommunications Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on all classes of Common Stock. Accordingly, TDS consolidated financial statements should be read in conjunction with the TDS Telecommunications Group's financial information. III-13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1997 The TDS Telecommunications Group ("Telecom Group") primarily consists of TDS Telecommunications Corporation and its subsidiaries ("TDS Telecom"), a wholly owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which operates landline telephone companies. The Telecom Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Telecom Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Telecom Group, as determined by the Board of Directors of TDS. OVERVIEW The Telecom Group is a full-service local exchange carrier providing modern, high-quality telecommunications services including local and long-distance telephone service and Internet access to rural and suburban communities through TDS Telecom's telephone company subsidiaries. Each of these telephone companies, ranging in size from less than 500 to more than 50,000 access lines, is an Incumbent Local Exchange Carrier ("ILEC"). At December 31, 1997, approximately 66% of the Telecom Group's access lines were in Tennessee, Wisconsin, Georgia, Minnesota, Indiana, Alabama, Michigan and Maine. Internal access line growth during 1997, 1996 and 1995 was 5.7%, 6.0% and 5.1%, respectively. The following table summarizes certain information regarding the Telecom Group.
YEAR ENDED OR AT DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- States of Operations................................................................... 28 28 28 Number of Companies.................................................................... 106 105 100 Access Lines........................................................................... 515,500 484,500 425,900 Percent Residential.................................................................. 78.3 79.9 80.6 Percent Business..................................................................... 21.7 20.1 19.4 Total Revenues (in thousands).......................................................... $ 444,203 $ 395,602 $ 354,841 Percent Local Service................................................................ 27.7 27.9 26.8 Percent Network Access and Long-Distance............................................. 53.1 53.9 55.1 Percent Miscellaneous and Other Services............................................. 19.2 18.2 18.1 Average Monthly Revenue per Access Line................................................ $ 68.78 $ 67.10 $ 66.82
The Telecom Group provides consumers and businesses with landline local telephone service through its switching and intra-city network. Long-distance or toll service is provided through connections with long-distance carriers, primarily AT&T and the Regional Bell Operating Companies ("RBOCs"), which purchase network access from the Telecom Group. Both the fees charged to the Telecom Group's customers for its services and the access charges to interexchange carriers are based upon rates established by the various state regulatory agencies for intrastate services and the Federal Communications Commission ("FCC") for interstate services. Generally, these fees are a function of a prescribed return on the telephone subsidiaries' investment in plant and equipment, and the cost of services provided to their subscribers. The Telecom Group also operates U.S. Link, a regional long-distance company, as well as new business ventures including TDSNET, an Internet access provider; TDS DATACOM, a structured wiring business; and TDS METROCOM, a competitive local exchange company ("CLEC"). The revenues and expenses from these businesses are included in Other Services. RESULTS OF OPERATIONS OPERATING REVENUES totaled $444.2 million in 1997, up 12% ($48.6 million) from 1996, and totaled $395.6 million in 1996, up 11% ($40.8 million) from 1995. The increases were due to growth in telephone revenues ($40.5 million in 1997 and $39.6 million in 1996) and other services ($8.8 million in 1997 and $1.0 million in 1996). TELEPHONE REVENUES Telephone revenues increased 11% ($40.5 million) in 1997 to $412.4 million and 12% ($39.6 million) in 1996 to $371.9 million from $332.3 million in 1995. The net effect of acquisitions increased telephone revenues 2% ($8.1 million) in 1997 and 6% ($18.8 million) in 1996. The average monthly revenue per access line was $68.78 in 1997, $67.10 in 1996 and $66.82 in 1995. III-14 LOCAL SERVICE REVENUES are derived from providing local telephone exchange service within the franchise serving area of the Telecom Group's telephone subsidiaries. Local service revenues increased 11% ($12.3 million) in 1997. The effects of acquisitions increased local service revenues $2.7 million in 1997. Internal access line growth of 5.7% increased local service revenues $5.7 million in 1997, while custom calling and advanced feature sales and other miscellaneous revenues increased revenues by $3.1 million. Local service revenues increased 16% ($15.3 million) in 1996. Acquisitions increased local service revenues by $6.0 million, while internal access line growth of 6.0% resulted in an increase of $5.2 million. The sales of custom calling and advanced features and other miscellaneous revenues increased local service revenues by $2.9 million in 1996. NETWORK ACCESS AND LONG DISTANCE REVENUES are compensation for carrying interstate and intrastate long-distance traffic on the Telecom Group's operating telephone subsidiaries' networks. The interstate and intrastate access rates charged include the cost of providing service plus a fair rate of return under cost separation procedures established by the FCC. The Telecom Group participates in the National Exchange Carrier Association ("NECA") interstate common line and traffic sensitive tariffs for all but one of its ILEC subsidiaries. These operating companies participate in the access revenue pools administered by NECA, which collect and distribute revenue from interstate access services. The FCC created NECA and it operates subject to FCC rules and oversight. Where applicable and subject to state regulatory approval, the Telecom Group's ILEC subsidiaries utilize intrastate access tariffs and participate in intrastate revenue pools. However, many intrastate toll revenue pooling arrangements, a source of substantial revenues to TDS Telecom's ILECs, have been replaced with access-charge-based arrangements. In these cases, access charges are typically set to generate revenue flows similar to those realized in the pooling process. The impact of the 1996 Telecommunications Act ("1996 Act") has accelerated the pace of regulatory re-evaluation at both the state and federal level. To the extent that state-ordered access charge revisions reduce revenues, the Telecom Group may seek adjustments in other rates. Some states are utilizing a state high cost fund to offset access charge reductions. The interstate portion of these revenues is initially received based on estimates of expenses, plant investment and rates of return for the settlement period (usually a calendar year). When the separations studies are approved and finalized, the estimates are adjusted to actual. The intrastate portion of these revenues, based on approved tariffs, is influenced by changes in traffic levels as measured by minutes of use. Network access and long distance revenues increased 11% ($22.6 million) in 1997. The effects of acquisitions increased network access revenues $4.5 million in 1997. Recovery of increased expense and investment levels for providing access service, as explained above, increased revenues $12.1 million in 1997 through state and national revenue pools. Increased usage of the network generated $5.7 million of additional intrastate revenues. Revenue adjustments due to updated cost separation and pool rate of return information increased network access revenues by $.5 million in 1997. Network access and long distance revenues increased 9.0% ($17.5 million) in 1996. The effects of acquisitions increased network access revenues $9.9 million. Increased expense and investment levels for providing access service increased revenues $8.1 million in 1996 through state and national revenue pools, and increased usage of the network generated $4.5 million of additional revenues. Revenue adjustments due to updated cost separation and pool rate of return information were $3.0 million less in 1996 than in 1995. The impact of extended area service plans implemented in Vermont and Ohio reduced access revenue $1.0 million in 1996. MISCELLANEOUS REVENUES include revenues related to (i) leasing, selling, installing, maintaining and repairing customer premise telecommunications equipment, such as telephone answering equipment or business systems and associated peripheral equipment, and wiring ("CPE services"), (ii) providing billing and collection services for interexchange carriers, (iii) leasing network facilities and (iv) sale of satellite dishes (Digital Broadcast Satellite or "DBS"). Miscellaneous revenues increased 11% ($5.5 million) in 1997. The effects of acquisitions increased miscellaneous revenues $1.0 million. Higher sales and leases of customer premise equipment, including satellite sales, increased revenues $6.1 million in 1997. Billing and collection revenues decreased $1.9 million compared to 1996, primarily due to reduced prices for billing and collection services and less services performed. Miscellaneous revenues increased 16% ($6.8 million) in 1996. The effects of acquisitions increased miscellaneous revenues $2.9 million. Higher sales and leases of customer premise equipment, including satellite sales, increased miscellaneous revenues $2.2 million in 1996. III-15 OTHER SERVICES REVENUES Other services revenues increased 35% ($8.8 million) in 1997 and 4% ($1.0 million) in 1996. Revenues from structured wiring increased $6.0 million in 1997, while revenues from Internet services increased $2.8 million in 1997. TDSNET (Internet service) began operations in early 1996 while TDS DATACOM (structured wiring) began operations in late 1996. TDS METROCOM (CLEC) began operations in early 1998. OPERATING EXPENSES totaled $345.6 million in 1997, up 18% ($52.7 million) from 1996, and totaled $292.9 million in 1996, up 14% ($36.3 million) from 1995. The increases were due to the growth in telephone expenses ($40.3 million in 1997 and $33.6 million in 1996) and other services ($13.1 million in 1997 and $2.5 million in 1996). TELEPHONE EXPENSES Operating expenses from local telephone operations increased 15% ($40.3 million) in 1997 to $309.4 million and 14% ($33.6 million) in 1996 to $269.1 million from $235.5 million in 1995. The net effect of acquisitions increased telephone expenses 2% ($6.2 million) in 1997 and 6% ($14.6 million) in 1996. NETWORK OPERATIONS EXPENSE consists of costs to maintain the high-quality telecommunications networks to provide advanced telecommunications services and the cost of CPE services, including DBS, sold to customers. Network operations expense increased 19% ($13.0 million) in 1997, with acquisitions increasing expenses $1.5 million. The increased sales activity from DBS, a new product offering in 1997, and increased sales and lease activity of CPE services, resulted in network operations expense increases of $5.2 million. General wage increases and inflation in 1997 increased network operations expenses by an additional $3.3 million. In 1997, the Telecom Group implemented the next phase of its program to upgrade, standardize and expand its network. This program is expected to monitor the network 24 hours-a-day, and to proactively identify and correct network faults to minimize interruption or degradation of service to the customer. The increased quality of the network is expected to provide long-term benefits in terms of future cost avoidance, the ability to offer advanced technological services to the customer, and to increase customer loyalty and satisfaction. The increase in staff to support this network increased network operations expense by $1.8 million. Network operations expense increased 23% ($12.6 million) in 1996, with acquisitions increasing expenses $4.1 million. The development of a centralized network management center to provide more effective network monitoring and maintenance caused an increase in operating expenses of $3.4 million in 1996. Other increases in operating expenses can be attributed to factors such as general wage increases and inflation. CUSTOMER OPERATIONS EXPENSE includes costs for marketing, sales, and product management, as well as expenses for establishing and servicing customer accounts. Customer operations expense increased 21% ($11.4 million) in 1997 and 15% ($6.9 million) in 1996. Acquisitions increased customer operations expense by $1.4 million in 1997 and $2.7 million in 1996. Increased product advertising in conjunction with aggressive sales and marketing campaigns for DBS and advanced calling features increased expenses by $4.7 million in 1997. Also in 1997, costs incurred to update customer billing systems and infrastructure support costs for customer service representatives increased expenses by $4.6 million. The cost to explore new business opportunities caused customer operations expenses to increase by $3.2 million in 1996. CORPORATE AND OTHER EXPENSES consist of costs incurred for executive administration and management, accounting, human resource management, information management, legal services, and property and other non-income taxes. Corporate and other expenses increased 10% ($6.2 million) in 1997 and 6% ($3.3 million) in 1996. Acquisitions increased expenses by $1.3 million in 1997 and $3.8 million in 1996. Costs incurred to support and maintain general computer applications and local and wide area networks increased by $3.8 million in 1997. DEPRECIATION AND AMORTIZATION EXPENSE increased 11% ($9.7 million) in 1997 and 14% ($10.8 million) in 1996. Acquisitions increased depreciation and amortization by $2.0 million in 1997 and $4.0 million in 1996. Increased investment in plant and equipment was the primary driver of the increase in depreciation expense in 1997 and 1996. The composite depreciation rate was 7.4% in 1997, 7.2% in 1996 and 7.1% in 1995. OTHER SERVICES EXPENSES OTHER SERVICES EXPENSES increased 53% ($13.1 million) in 1997 and 11% ($2.5 million) in 1996. The increase in other services expenses in 1997 primarily related to the growth at TDS DATACOM of $7.6 million and at TDSNET of $3.2 million. The remaining increase was primarily due to start-up activities at TDS METROCOM. OPERATING INCOME decreased 4% ($4.1 million) in 1997 and increased 5% ($4.5 million) in 1996. The operating margin declined to 22.2% in 1997 from 26.0% in 1996 and 27.7% in 1995 primarily due to increased costs III-16 associated with the development of the centralized network management center and new business opportunities, as well as earnings pressures from regulatory agencies and long-distance providers. The operating margin for the other services group is considerably lower than that of the typical telephone company, resulting in a reduction in overall margins. OTHER INCOME, NET decreased 13% ($2.7 million) in 1997 and 3% ($.6 million) in 1996. CELLULAR EQUITY INCOME decreased $2.0 million in 1997 due to the transfer of the majority of the cellular interests to TDS during 1996 and increased $3.5 million in 1996 reflecting increased earnings from minority interests in cellular partnerships. The cellular interests held by the Telecom Group were owned by telephone subsidiaries prior to being acquired by TDS. GAIN ON SALES OF INVESTMENTS decreased $4.1 million in 1996 as the Telecom Group sold a cellular interest, a telephone company and various marketable securities in 1995. INTEREST EXPENSE increased 3% ($1.6 million) in 1997 and 2% ($.9 million) in 1996, primarily due to the added interest expense from acquisitions. INCOME TAX EXPENSE decreased 12% ($3.1 million) in 1997 and increased 6% ($1.5 million) in 1996. The effective income tax rate was 42.7% in 1997 compared to 41.8% in 1996 and 41.5% in 1995. NET INCOME decreased 15% ($5.3 million) in 1997 and increased 5% ($1.5 million) in 1996. The decrease in net income in 1997 relates primarily to the reduction in operating income as well as the reduction in other income. OTHER MATTERS The Telecom Group is subject to the provisions of Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation." Criteria that would give rise to the discontinuance of SFAS No. 71 include: 1) increasing competition that would restrict the Telecom Group's ability to establish prices to recover specific costs, and 2) a significant change in the manner in which rates are set by regulators from cost- based regulation to another form of regulation. The Telecom Group periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. The Telecom Group 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. Therefore any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. INFLATION Management believes that inflation affects the Telecom Group's business to no greater extent than the general economy. FINANCIAL RESOURCES The Telecom Group operates a capital-intensive business. The Telecom Group has financed and plans to continue to finance its construction program primarily using internally generated cash supplemented by long-term financing from federal government programs and short-term financing from the TDS Group, as needed. Internally generated cash financed 90%, 92% and 88% of telecommunications plant and equipment additions in 1997, 1996 and 1995, respectively. Financing from federal government programs provided 10%, 8% and 12% of telecommunications plant and equipment additions in 1997, 1996 and 1995, respectively. CASH FLOWS FROM OPERATING ACTIVITIES decreased 3% ($3.7 million) to $134.9 million in 1997, and increased 13% ($15.9 million) to $138.7 million in 1996. Operating cash flow (operating income plus depreciation and amortization) totaled $196.7 million in 1997, $191.2 million in 1996 and $175.6 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 $61.8 million in 1997, $52.5 million in 1996 and $52.8 million in 1995. CASH FLOWS FROM FINANCING ACTIVITIES required $.5 million in 1997, $5.5 million in 1996, and $14.2 million in 1995, reflecting the payment of cash dividends to TDS, and borrowing and repayment of short- and long-term debt. CASH FLOWS FROM INVESTING ACTIVITIES required $133.3 million in 1997, $142.8 million in 1996 and $60.8 million in 1995. The maturing of temporary and longer-term cash investments provided cash of $11.2 million in 1997 and $29.1 million in 1995. In 1996, the investment in temporary and longer-term cash investments reduced cash by $2.9 III-17 million. Proceeds from the sales of certain investments and marketable securities provided $2.1 million in 1997, $5.9 million in 1996 and $10.1 million in 1995. The Telecom Group makes substantial investments each year to construct, operate and maintain modern high-quality telecommunications networks and facilities. In recent years, rapid changes in technology and new opportunities have required substantial investments in revenue-enhancing and cost-reducing upgrades of the Telecom Group's networks. Cash expenditures for telecommunications property and plant additions totaled $151.5 million in 1997, $144.4 million in 1996 and $104.4 million in 1995. The following table summarizes the Telecom Group's investments in telecommunications plant during the past three years.
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Central Office Equipment..................................................... $ 52,479 $ 47,208 $ 38,697 Outside Plant................................................................ 60,974 53,130 55,569 Systems Development.......................................................... 9,127 20,497 7,137 Other........................................................................ 28,880 23,605 2,969 ----------- ----------- ----------- $ 151,460 $ 144,440 $ 104,372 ----------- ----------- ----------- ----------- ----------- -----------
The Telecom Group's capital additions include expenditures for outside plant facilities and upgrades of recently acquired companies for new customer growth and switch modernization. The Telecom Group installed 32 digital switches in 1997, 35 in 1996, and 39 in 1995 and made substantial improvements in outside plant facilities during each year. Capital expenditures during 1998 are expected to total approximately $140 million, including about $50 million for new digital switches and other switching facilities, $35 million for improvements to outside plant facilities, $25 million for systems development and $20 million for other services, primarily CLEC expenditures. It is expected that internally generated funds will be primarily used to finance these improvements, supplemented by long-term financing from federal government programs. ACQUISITIONS The Telecom Group seeks to acquire telephone companies which add value to the Telecom Group. The Telecom Group acquired one telephone company in 1997, five in 1996, and five in 1995. A majority-owned telephone subsidiary also purchased an additional interest in a cellular entity in 1996. Consideration of $13.4 million was paid for the acquisition in 1997, consisting of approximately 240,000 TDS Common Shares, 30,000 TDS Preferred Shares and $200,000 in cash. The 1996 consideration of $88.1 million consisted of approximately 1.5 million TDS Common Shares and $17.4 million in cash. The 1995 consideration of $46.1 million consisted of approximately 1.0 million TDS Common Shares and $250,000 in cash. LIQUIDITY The Telecom Group is generating substantial internal funds to finance its construction program. Operating cash flow (operating income plus depreciation and amortization) increased 3% to $196.7 million in 1997 from $191.2 million in 1996, and 9% in 1996 from $175.6 million in 1995. Operating cash flows were 130% of capital additions in 1997, 132% in 1996 and 168% in 1995. The Telecom Group had cash and cash equivalents, temporary cash investments, construction funds and marketable securities totaling $230.7 million at December 31, 1997. These investments are primarily the result of internally generated cash from telephone operations. While certain debt agreements of the Telecom Group's telephone subsidiaries place limits on the transfer of funds to TDS Telecom, these restrictions are not expected to affect the parent's ability to meet its cash obligations. From time to time, the Telecom Group has borrowed funds from TDS to temporarily finance its construction program, acquisitions and for general corporate purposes. At December 31, 1997 the amount of such borrowings aggregated $28.2 million for such debt classified as current and $255.3 million classified as long-term debt. The Telecom Group plans to continue financing its telephone construction program primarily using internally generated cash supplemented by long-term financing from federal government programs and short-term financing from TDS. The Telecom Group's telephone subsidiaries had $112.0 million in unadvanced loan funds from federal government programs at December 31, 1997 to finance its telephone construction program. These loan commitments have a weighted average annual interest rate of 5.71%. III-18 Cash dividends paid by the Telecom Group totaled $18.1 million in 1997, $15.6 million in 1996 and $17.1 million in 1995. Subject to the approval of the Tracking Stock Proposal, the Board of Directors intends to establish an annual dividend on the Telecom Group Shares in an amount of $.48 per share. Based upon the the distribution of two-thirds of a Telecom Group Share for each outstanding Series A Common Share and Common Share of TDS, the Telecom Group would be required to pay approximately $19.5 million annually, not including any amounts for Telecom Group Shares issued in the public offering described below. The Telecom Group plans to finance the dividend requirements through internally generated cash flow. Subject to approval of the Tracking Stock Proposal by shareholders, TDS intends to, among other things, offer and sell Telecom Group Shares in a public offering for cash, and allocate the net proceeds to the Telecom Group. TDS intends to file with the Securities and Exchange Commission a registration statement on Form S-3 relating to the registration of between 10,000,000 and 17,000,000 Telecom Group Shares. This offering is expected to commence promptly after the approval of the Tracking Stock Proposal by shareholders, subject to prevailing market conditions and other factors. Management estimates proceeds of approximately $150 million from the offering which the Telecom Group would use to repay obligations to TDS. Management believes the Telecom Group has sufficient internal and external resources to finance the anticipated requirements of its business development and construction programs. The Telecom Group has assessed, and continues to assess, the impact of the Year 2000 Issue on its reporting systems and operations. The Telecom Group believes that modifying its reporting systems and operations is not a material event and is taking steps to make its systems Year 2000 compliant. The Year 2000 Issue exists because many computer systems and applications abbreviate dates by eliminating the first two digits of the year, assuming that these two digits would always be "19". Unless corrected, this shortcut is expected to cause problems when the century date occurs. On that date, some computer programs may recognize the date as January 1, 1900 instead of January 1, 2000. This may cause systems to incorrectly process critical financial and operational information, or stop processing altogether. The cost of addressing the Year 2000 Issue to date was not material to the Telecom Group's results of operations or financial condition, and management believes that the costs to be incurred in 1998 and 1999 will not be material to future operating results or financial condition. If management's steps are not successful in making the systems Year 2000 compliant, it could have a material adverse effect on results of operations. REGULATION The Telecom Group's ILEC subsidiaries are regulated by state regulatory agencies for rate setting, including local rates, and intrastate toll rates and intrastate access charges. State regulators can approve service areas and have traditionally regulated entry into local markets by designating a single carrier to be the universal service provider. The 1996 Act has almost completely pre-empted state authority over market entry, but states retain 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. Many of the FCC determinations made to implement the 1996 Act and to facilitate competition in local service and other telephone services require investment and upgrades to the Telecom Group ILEC networks, and other changes that require additional investments and expenses. The Telecom Group is seeking to comply with these requirements, and is pursuing policies that provide a fair opportunity to recover its costs, but in some cases is asking for waivers or delayed implementation deadlines. As defined in the 1996 Act, all of the Telecom Group's ILEC subsidiaries qualify as rural telephone companies. Therefore, they enjoy an exemption from the ILEC requirements until they receive a bona fide request for interconnection and the state commission lifts the exemption. Management of the Telecom Group does not anticipate significant requests in the near term. The FCC has also adopted extensive rules for state commissions to follow in mediating and arbitrating interconnection negotiations between incumbent ILECs 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. A federal appellate decision struck down FCC pricing regulations for interconnection and several rules that limited the Telecom Group telephone companies' ability to obtain regulatory relief from stricter interconnection requirements for incumbent telephone companies. The U.S. Supreme Court has agreed to review this case and certain other cases. TDS cannot predict the outcome of this or the numerous other court and FCC proceedings stemming from the 1996 Act. III-19 NECA requested access charge changes from the FCC which would use a "banded" rate structure to help pool members with lower costs charge more competitive rates. These changes were approved effective January 1, 1998. Management of the Telecom Group does not anticipate significant revenue impacts in the near term. Access to affordable long-distance service in rural areas was achieved because the FCC ordered AT&T to provide nationwide average rates. As a result of increasing competition, the FCC lifted all regulations relating to AT&T's interstate services in 1996. However, the 1996 Act preserves interstate toll rate averaging and endorses a nationwide policy that interstate and intrastate long-distance rates of all long-distance carriers should not be higher in rural areas than in urban areas they serve. The statute is intended to ensure affordable long distance services even in the Telecom Group's most remote exchanges. PROPOSED TDS CORPORATE RESTRUCTURING The board of directors of Telephone and Data Systems, Inc. (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as TDS Telecommunications Group Common Shares (the "Telecom Group Shares"). The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily consists of TDS's interest in TDS Telecommunications Corporation. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group. TDS also intends to distribute two-thirds of a Telecom Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of TDS (the "Distribution"). Following the Distribution, subject to the legal and contractual restrictions on the payment of dividends, the TDS Board currently intends to establish an annual dividend on the TDS Common Shares and Series A Common Shares in an amount equal to $.10 per share. The TDS Board also currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $.48 per share. (Based on the expected distribution ratio of two-thirds of a Telecom Group Shares for each existing Common Share and Series A Common Share, the dividend on Telecom Group shares would equate to a per share dividend of $.32 per existing Common Shares and Series A Common Share. The total of the dividend on TDS Common Shares and Series A Common shares of $.10 and the equivalent dividend on Telecom Group Shares of $.32 equals the existing current annual dividend on the existing Common Shares and Series A Common shares of $.42.) Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $287 million for the Telecom Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. Subsequent to TDS shareholder approval of the Tracking Stock Proposal, cash management, taxes and allocation of principal corporate activities between TDS and the Telecom Group would be based upon methods that TDS management believes to be reasonable and would be reflected in the Telecom Group's financial information. Many of the policies would continue the arrangements which presently exist between TDS and the Telecom Group. III-20 PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AND OTHER SECTIONS OF THIS PROXY STATEMENT/PROSPECTUS 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 TDS'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 THE TELECOM GROUP OPERATES; ADVANCES IN TELECOMMUNICATIONS TECHNOLOGY; CHANGES IN THE TELECOMMUNICATIONS REGULATORY ENVIRONMENT; PENDING AND FUTURE LITIGATION; AVAILABILITY OF FUTURE FINANCING; AND UNANTICIPATED CHANGES IN THE MIX OF PRODUCTS AND SERVICES OFFERED IN THE TELECOM GROUP'S MARKETS. READERS SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS. III-21 THE TDS TELECOMMUNICATIONS GROUP STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) OPERATING REVENUES Telephone Revenues Local service...................................................................... $ 122,826 $ 110,501 $ 95,184 Network access and long distance................................................... 235,725 213,113 195,575 Miscellaneous...................................................................... 53,829 48,299 41,528 ----------- ----------- ----------- Total Telephone Revenues......................................................... 412,380 371,913 332,287 Other services....................................................................... 33,516 24,747 23,764 Intercompany revenues................................................................ (1,693) (1,058) (1,210) ----------- ----------- ----------- Total Operating Revenues......................................................... 444,203 395,602 354,841 ----------- ----------- ----------- OPERATING EXPENSES Telephone Expenses Network operations................................................................. 80,487 67,521 54,964 Depreciation and amortization...................................................... 95,278 85,575 74,758 Customer operations................................................................ 65,167 53,764 46,818 Corporate operations............................................................... 68,454 62,276 58,998 ----------- ----------- ----------- Total Telephone Expenses......................................................... 309,386 269,136 235,538 Other services....................................................................... 37,897 24,816 22,273 Intercompany expenses................................................................ (1,693) (1,058) (1,210) ----------- ----------- ----------- Total Operating Expenses......................................................... 345,590 292,894 256,601 ----------- ----------- ----------- OPERATING INCOME....................................................................... 98,613 102,708 98,240 ----------- ----------- ----------- OTHER INCOME AND (EXPENSES) Interest and dividend income......................................................... 5,510 5,942 6,895 Interest and dividend income--affiliated............................................. 9,252 8,945 7,950 Cellular investment income........................................................... 5,553 7,556 4,039 Amortization of license related to cellular investment............................... (564) (1,156) (957) Allowance for funds used during construction......................................... 686 825 682 Gain on sale of investments.......................................................... 722 -- 4,094 Other (expenses), net................................................................ (3,630) (1,869) (1,909) ----------- ----------- ----------- 17,529 20,243 20,794 ----------- ----------- ----------- INCOME BEFORE INTEREST EXPENSE AND INCOME TAXES........................................ 116,142 122,951 119,034 ----------- ----------- ----------- Interest expense..................................................................... 39,542 39,317 37,765 Interest expense--affiliate.......................................................... 23,609 22,255 22,883 ----------- ----------- ----------- 63,151 61,572 60,648 ----------- ----------- ----------- INCOME BEFORE INCOME TAXES............................................................. 52,991 61,379 58,386 Income tax expense..................................................................... 22,603 25,685 24,231 ----------- ----------- ----------- NET INCOME............................................................................. $ 30,388 $ 35,694 $ 34,155 ----------- ----------- ----------- ----------- ----------- ----------- Proforma (Unaudited): See Note 1 Net Income Attributable to TDS Group through Retained Interest......................... $ 7,597 $ 8,924 $ 8,539 Net Income Attributable to TDS Telecommunications Group Common Shares............................................... $ 22,791 $ 26,770 $ 25,616
The accompanying notes to financial statements are an integral part of these statements. III-22 THE TDS TELECOMMUNICATIONS GROUP STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net Income........................................................................ $ 30,388 $ 35,694 $ 34,155 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization................................................... 98,066 88,459 77,355 Deferred income taxes, net...................................................... 2,439 (1,510) (3,172) Cellular investment income...................................................... (5,553) (7,556) (4,039) Gain on sale of investments..................................................... (722) -- (4,094) Other noncash expense........................................................... 28,387 29,188 28,844 Change in accounts receivable................................................... (9,260) (3,925) (7,663) Change in accounts payable...................................................... (461) (4,013) (4,943) Change in accrued federal income taxes.......................................... (8,890) 2,135 5,625 Change in other accrued taxes................................................... (879) 135 2,873 Change in other assets and liabilities.......................................... 1,412 62 (2,166) ------------ ------------ ------------ 134,927 138,669 122,775 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Long-term debt borrowing.......................................................... 30,097 34,056 25,563 Repayment of long-term debt....................................................... (16,942) (26,390) (17,769) Change in notes payable........................................................... 4,402 11,663 (5,118) Dividends paid.................................................................... (18,100) (24,824) (16,828) ------------ ------------ ------------ (543) (5,495) (14,152) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures.............................................................. (151,460) (144,440) (104,372) Proceeds from investment sales.................................................... 2,085 5,942 10,091 Acquisitions, excluding cash acquired............................................. 2,015 32 2,351 Change in temporary cash investments and marketable securities.................... 11,177 (2,879) 29,126 Investment in cellular partnerships............................................... 2,021 1,557 452 Change in investments............................................................. 824 (2,991) 1,518 ------------ ------------ ------------ (133,338) (142,779) (60,834) ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................ 1,046 (9,605) 47,789 CASH AND CASH EQUIVALENTS Beginning of period............................................................. 183,535 193,140 145,351 ------------ ------------ ------------ End of period................................................................... $ 184,581 $ 183,535 $ 193,140 ------------ ------------ ------------ ------------ ------------ ------------
The accompanying notes to financial statements are an integral part of these statements. III-23 THE TDS TELECOMMUNICATIONS GROUP BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents General funds............................................................................... $ 22,640 $ 33,519 Affiliated cash equivalents................................................................. 161,941 150,016 ------------- ------------- 184,581 183,535 Temporary cash investments.................................................................... 21,658 39,383 Construction funds............................................................................ 775 1,405 Accounts receivable Customers................................................................................... 33,482 25,821 Connecting companies........................................................................ 40,548 37,363 Affiliated.................................................................................. 1,213 2,004 Other....................................................................................... 5,971 6,260 Notes receivable--affiliated.................................................................. 3,746 3,660 Other current assets.......................................................................... 13,559 12,305 ------------- ------------- 305,533 311,736 ------------- ------------- INVESTMENTS Franchise and other costs in excess of underlying book value of subsidiaries, net of accumulated amortization of $34,942 and $29,705, respectively............................... 180,683 182,281 Cellular investments.......................................................................... 48,562 57,241 Marketable securities......................................................................... 23,729 17,626 Other investments............................................................................. 12,451 12,703 ------------- ------------- 265,425 269,851 ------------- ------------- TELECOMMUNICATIONS PLANT In service and under construction, substantially at original cost............................. 1,420,890 1,293,779 Less accumulated depreciation................................................................. 590,123 524,418 ------------- ------------- 830,767 769,361 ------------- ------------- OTHER ASSETS AND DEFERRED CHARGES............................................................... 4,323 1,981 ------------- ------------- TOTAL ASSETS.................................................................................... $ 1,406,048 $ 1,352,929 ------------- ------------- ------------- -------------
The accompanying notes to financial statements are an integral part of these statements. III-24 THE TDS TELECOMMUNICATIONS GROUP BALANCE SHEETS LIABILITIES AND GROUP EQUITY
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Current portion of long-term debt............................................................. $ 14,816 $ 13,554 Notes payable--affiliated..................................................................... 28,181 25,039 Accounts payable Connecting companies........................................................................ 13,833 17,852 Affiliated.................................................................................. 2,411 4,305 Other....................................................................................... 26,475 23,904 Advance bills and customer deposits........................................................... 5,329 5,423 Accrued federal income taxes due TDS.......................................................... 103 9,849 Other accrued taxes........................................................................... 7,764 8,426 Accrued compensation.......................................................................... 7,386 3,394 Other......................................................................................... 5,440 6,644 ------------- ------------- 111,738 118,390 ------------- ------------- DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability............................................................. 60,550 57,217 Postretirement benefits obligation other than pensions........................................ 10,668 10,804 Other......................................................................................... 12,079 14,064 ------------- ------------- 83,297 82,085 ------------- ------------- LONG-TERM DEBT Affiliated.................................................................................... 255,302 239,538 Other, excluding current portion.............................................................. 548,558 547,290 ------------- ------------- 803,860 786,828 ------------- ------------- MINORITY INTEREST IN SUBSIDIARIES............................................................... 23,394 21,810 ------------- ------------- TDS TELECOMMUNICATIONS GROUP EQUITY............................................................. 383,759 343,816 ------------- ------------- TOTAL LIABILITIES AND GROUP EQUITY.............................................................. $ 1,406,048 $ 1,352,929 ------------- ------------- ------------- -------------
The accompanying notes to financial statements are an integral part of these statements. III-25 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS The TDS Telecommunications Group ("Telecom Group") primarily consists of TDS Telecommunications Corporation and its subsidiaries ("TDS Telecom"), a wholly owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which operates landline telephone companies. The Telecom Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Telecom Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Telecom Group, as determined by the Board of Directors of TDS. (1) PROPOSED TDS CORPORATE RESTRUCTURING The board of directors of Telephone and Data Systems, Inc. (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as TDS Telecommunications Group Common Shares (the "Telecom Group Shares"). The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily consists of TDS's interest in TDS Telecommunications Corporation. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group. TDS also intends to distribute two-thirds of a Telecom Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of TDS (the "Distribution"). Subsequent to TDS shareholder approval of the Tracking Stock Proposal, cash management, taxes and allocation of principal corporate activities between TDS and the Telecom Group would be based upon methods that TDS management believes to be reasonable and would be reflected in the Telecom Group's financial information. Many of the policies would continue the arrangements which presently exist between TDS and the Telecom Group. (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies of the Telecom Group 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. BASIS OF PRESENTATION The financial statements of the Groups comprise all of the accounts included in the corresponding consolidated financial statements of Telephone and Data Systems, Inc. The separate Telecom Group financial statements give effect to the management and accounting policies that would be applicable upon implementation of the Tracking Stock Proposal. The separate Group financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (1) the historical financial position, results of operations and cash flows of the businesses that comprise each of the Groups, (2) any assets and liabilities (including contingent liabilities) which have been attributed to any Group from any other Group, and (3) with respect to the TDS Group, the Retained Interest in each of the Tracking Groups. The effects of the issuance of the Tracking Stocks have not been reflected in these historical financial statements. Financial effects arising from the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group that affect the consolidated results of operations or financial condition of TDS could affect the results of operations or financial condition of the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, or could affect the market price of any or all classes of Common Stock. In addition, any net losses of TDS or the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, and dividends or distributions on, or repurchases of, any class III-26 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) of Common Stock will reduce the assets of TDS legally available for payment of dividends on any class of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the Telecom Group financial information. The management and accounting policies applicable to the preparation of the financial statements of the TDS Group could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of Telephone and Data Systems, Inc. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. Following the Distribution, subject to the legal and contractual restrictions on the payment of dividends, the Board currently intends to establish an annual dividend on the TDS Common Shares and Series A Common Shares in an amount equal to $.10 per share. The Board also currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $.48 per share. (Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, the dividend on Telecom Group Shares would equate to a per share dividend of $.32 per existing Common Share and Series A Common Share. The total of the dividend on TDS Common Shares and Series A Common Shares of $.10 and the equivalent dividend on Telecom Group Shares of $.32 equals the existing current annual dividend on the existing Common Shares and Series A Common Shares of $.42.) Future dividends on the shares of common stock will be payable when, as and if declared by the Board out of the lesser of (1) all funds of TDS legally available therefor and (2) the available dividend amount with respect to the relevant Group. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $287 million for the Telecom Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. (A) NATURE OF OPERATIONS The Telecom Group operates 106 telephone companies serving 515,500 access lines in 28 states. The Telecom Group also operates a long-distance company, an Internet access provider, a structured wiring business and a competitive local exchange company. The Telecom Group expands its operations through internal access line growth, acquisitions, new services and entry into new territories. III-27 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (B) PRINCIPLES APPLIED IN THE FINANCIAL STATEMENTS The financial statements include the accounts of TDS Telecom and its majority-owned subsidiaries since acquisition and certain other telephone companies, assets and liabilities attributed to the Telecom Group, as determined by the Board of Directors of TDS. All material transactions between companies within the Telecom Group have been eliminated. Investments in entities in which the Telecom Group does not have a controlling interest are generally accounted for using the equity method. The Telecom Group includes as investments in subsidiaries the value of the consideration given and all direct and incremental costs relating to acquisitions accounted for as purchases. All costs relating to unsuccessful negotiations for acquisitions are expensed. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts reported in prior years have been reclassified to conform to current period presentation. (C) CASH AND CASH EQUIVALENTS, TEMPORARY CASH INVESTMENTS AND MARKETABLE SECURITIES Cash and cash equivalents consists of 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 cash investments. Temporary cash investments are stated at cost, which approximates market. Those investments with original maturities of more than 12 months are classified as marketable securities. Marketable non-equity securities are stated at amortized cost and held to maturity. Affiliated cash equivalents consist of cash invested with TDS. The investments earn interest at a rate equal to the average monthly rate paid on cash invested in the general cash management program (5.84% at December 31, 1997). The carrying amount of Cash and Cash Equivalents and Temporary Investments approximate face value due to the short-term nature of the investments. Marketable equity securities are stated at fair value. The market value of all marketable securities was $23.7 million and $17.6 million at December 31, 1997 and 1996, respectively. (D) NOTES RECEIVABLE--AFFILIATED Rural Development Acquisition Corporation ("RDAC"), a wholly owned subsidiary of TDS Telecom, has loaned $3.7 million to certain rural cable and service companies (subsidiaries of TDS) at December 31, 1997 and 1996, bearing interest at the prime rate plus 1/2 percent (9.0% at December 31, 1997). RDAC's intent is to further the interests of rural telecommunications companies by investing in telecommunications projects and acquisitions located in rural areas. (E) MATERIALS AND SUPPLIES Materials and supplies are stated at the lower of cost or market. (F) INVESTMENTS Franchise and other costs include the costs in excess of the underlying book value of acquired telephone companies. Costs aggregating $209.1 million and $205.5 million at December 31,1997 and 1996, respectively, relating to acquisitions since November 1, 1990, are being amortized on a straight-line basis over a 40-year period. Amortization amounted to $5.2 million, $4.9 million and $4.4 million in 1997, 1996 and 1995, respectively. Costs in excess of underlying book value relating to acquisitions initiated before November 1, 1970, aggregating $6.5 million, are not being amortized. Included in franchise and other costs is approximately $135 million and $143 million at December 31, 1997 and 1996, respectively, of goodwill related to various acquisitions structured to be tax-free. III-28 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Cellular investments includes amounts invested in cellular entities and costs incurred in acquiring cellular interests.
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Cellular Entities...................................................................................... $ 8,913 $ 13,317 Cellular License Costs, net of amortization............................................................ 39,649 43,924 --------- --------- $ 48,562 $ 57,241 --------- --------- --------- ---------
The Telecom Group follows the equity method of accounting, which recognizes the Telecom Group's proportionate share of the income and losses accruing to it under the terms of its partnership or shareholder agreements, for its more significant investments ($8.1 million and $12.4 million at December 31, 1997 and 1996, respectively). Income and losses from these entities are reflected in the income statements on a pretax basis. At December 31, 1997, the cumulative share of income from minority cellular investments accounted for under the equity method was approximately $10.8 million, of which $6.9 million was undistributed. The cost method of accounting is followed for those insignificant minority interests ($783,000 and $898,000 at December 31, 1997 and 1996, respectively). Cellular license costs consist of costs incurred in acquiring minority interests in cellular entities which have been awarded Federal Communications Commission ("FCC") licenses to provide cellular service. These costs include all direct and incremental costs relating to acquiring these interests. These costs are capitalized and amortized through charges to expense over 40 years. Amortization amounted to $564,000, $1.2 million and $957,000 in 1997, 1996 and 1995, respectively. Accumulated amortization of cellular license costs was $1.8 million and $1.5 million at December 31, 1997 and 1996, respectively. (G) IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Telecom Group implemented the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Under SFAS No. 121, the Telecom Group is required to review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the book value of a long-lived asset is not recoverable. An impairment loss would be recognized whenever the review demonstrates that the book value of a long-lived asset is not recoverable. The implementation of SFAS No. 121 did not have an impact on the Telecom Group's financial position or results of operations. (H) REVENUE RECOGNITION The Telecom Group's revenues are recognized when earned. 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 Federal Communications Commission on behalf of the Telecom Group. 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. (I) PRO FORMA NET INCOME AND EARNINGS PER SHARE Pro forma net income attributable to the Telecom Group and to the TDS Group through the Retained Interest assumes that the Telecom Public Offering has not taken place and therefore 75% of Net Income is attributable to the Telecom Group Shares and 25% of Net Income is attributable to the Retained Interest for the TDS Group. III-29 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Earnings per share was omitted from the historical statements of earnings since the Telecom Group Shares were not part of the equity structure of TDS and the Articles of Incorporation did not allow for the issuance of the Telecom Group Shares for the periods presented. (J) SUPPLEMENTAL CASH FLOW DISCLOSURES TDS has historically purchased controlling interests in telephone companies in exchange for stock, cash and deferred cash payments. TDS has then attributed the telephone subsidiary to the Telecom Group, which increased TDS's equity interest attributable to the Telecom Group. TDS acquired one telephone company in 1997, five telephone companies in 1996 and five telephone companies in 1995. In conjunction with these acquisitions, the following assets were acquired, liabilities assumed and equity was attributed to the Telecom Group. Also, in September 1996, the Telecom Group transferred interests in 13 cellular markets held by various telephone subsidiaries to TDS.
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Telecommunications plant, net........................................................... $ 7,669 $ 48,764 $ 20,804 Franchise and other costs in excess of underlying book value of subsidiaries............ 2,452 25,603 25,263 Cellular minority interests and licenses................................................ 8,200 (20,071) 7,952 Long-term debt.......................................................................... (4,857) (22,978) (5,943) Deferred credits........................................................................ (802) (6,239) (995) Other assets and liabilities, excluding cash and cash equivalents....................... 688 7,963 (3,079) TDS Telecommunications Group Equity..................................................... (15,365) (33,074) (46,353) ---------- ---------- ---------- (Increase) in cash and cash equivalents due to acquisition.............................. $ (2,015) $ (32) $ (2,351) ---------- ---------- ---------- ---------- ---------- ----------
The following table summarizes interest paid, income taxes paid and certain noncash transactions.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Interest paid.............................................................................. $ 23,367 $ 23,198 $ 20,562 Income taxes paid.......................................................................... 46,078 43,064 33,099 Additions to telecommunications plant financed through accounts payable.................... $ 3,034 $ 4,319 $ 3,233
The Board of Directors of TDS attributed TDS long-term debt to the Telecom Group. The long-term debt and the related interest expense of $21.8 million, $21.8 million and $21.6 million for 1997, 1996 and 1995, respectively, were recorded as noncash transactions through TDS Telecommunications Group Equity. (3) INCOME TAXES For federal income tax purposes, the Telecom Group is included in the TDS consolidated tax return. For financial reporting purposes, the Telecom Group computes its federal income tax as if it were not a member of the TDS consolidated group, but filed a separate return. The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods. Deferred income taxes are provided for certain temporary differences principally due to use of accelerated depreciation for income tax purposes. Investment tax credits resulting from investments in telecommunications plant and equipment prior to January 1, 1986, have been deferred and are being amortized to income over the service lives of the related property. III-30 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (3) INCOME TAXES (CONTINUED) Tax provisions charged to expense for the years ended December 31, 1997, 1996 and 1995 are summarized below.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Federal income tax provision: Current.................................................................................. $ 16,364 $ 21,037 $ 21,768 Deferred................................................................................. 2,784 (134) (2,120) State income tax provision: Current.................................................................................. 5,901 6,494 7,029 Deferred................................................................................. (944) (47) (673) Amortization of deferred investment tax credits............................................ (1,502) (1,665) (1,773) --------- --------- --------- Total Income tax expense............................................................... $ 22,603 $ 25,685 $ 24,231 --------- --------- --------- --------- --------- ---------
The statutory federal income tax rate is reconciled to the Telecom Group's effective income tax rate below:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Statutory federal income tax rate............................................................. 35.0% 35.0% 35.0% State income taxes, net of federal benefit.................................................... 5.7 5.1 5.4 Amortization of intangibles................................................................... 2.7 2.1 1.8 Amortization of deferred investment tax credits............................................... (2.8) (2.1) (2.3) Effects of corporations not in consolidated federal tax return................................ 3.5 1.9 2.5 Other......................................................................................... (1.4) (.2) (.9) --- --- --- Effective income tax rate..................................................................... 42.7% 41.8% 41.5% --- --- --- --- --- ---
Deferred income taxes are provided for the temporary differences between the amount of the Telecom Group's assets and liabilities for financial reporting purposes and their tax bases. The Telecom Group's current net deferred tax liability totaled $179,000 and $(191,000) as of December 31, 1997 and 1996, respectively. The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of December 31, 1997 and 1996, are as follows:
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Deferred Tax Asset: Postretirement benefits.............................................................................. $ 3,558 $ 3,558 Acquisition cost amortization........................................................................ 5,578 4,885 Regulatory........................................................................................... 2,184 2,064 Other................................................................................................ 447 -- --------- --------- Total Deferred Tax Asset........................................................................... 11,767 10,507 --------- --------- Deferred Tax Liability: Property, plant and equipment........................................................................ 72,051 66,821 Other................................................................................................ 266 903 --------- --------- Total Deferred Tax Liability....................................................................... 72,317 67,724 --------- --------- Net Deferred Income Tax Liability.................................................................... $ 60,550 $ 57,217 --------- --------- --------- ---------
III-31 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (3) INCOME TAXES (CONTINUED) The Telecom Group has recorded deferred income tax liabilities related to temporary differences not deferred under rate-making policy. As of December 31, 1997 a corresponding net regulatory asset of $612,000 has been established to reflect future rate treatment for the temporary differences. This amount is being amortized over the lives of the related temporary differences. (4) GAIN ON SALES OF INVESTMENTS The Telecom Group sold a cellular interest, a cable company and various marketable securities in 1997 for aggregate consideration of $2.1 million, resulting in a pre-tax gain of $722,000. The Telecom Group sold a telephone company, a cellular interest and various marketable securities in 1995 for aggregate consideration of $10.1 million, resulting in a pre-tax gain of $4.1 million. (5) TELECOMMUNICATIONS PLANT Telecommunications 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"). AFUDC, a noncash item of nonoperating income, totaled $686,000, $825,000 and $682,000 in 1997, 1996 and 1995, respectively. The composite weighted average rates were 5.5%, 7.3% and 9.3% in 1997, 1996 and 1995, respectively. The amount of such allowance has varied principally as a result of changes in the level of construction work in progress and in the cost of capital. Renewals and betterments of units of property are added to telecommunications 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 charged to plant operations expense. No gain or loss is recognized in connection with ordinary retirements of depreciable property. Depreciation is provided for financial reporting purposes using the straight-line method over the estimated useful lives of the assets. Composite depreciation rates, as applied to the average cost of depreciable property were 7.4%, 7.2% and 7.1% for 1997, 1996 and 1995, respectively. The following table summarizes the telecommunications plant in service and under construction at December 31, 1997 and 1996.
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) Land and Buildings.............................................................................. $ 67,203 $ 67,181 Central Office Equipment........................................................................ 399,016 372,008 Cable and Wire.................................................................................. 719,945 639,537 Furniture and Office Equipment.................................................................. 112,921 77,046 Vehicles and Other Equipment.................................................................... 42,632 39,928 Plant Under Construction........................................................................ 52,677 59,213 Non-regulated investments and Other............................................................. 26,496 38,866 ------------- ------------- $ 1,420,890 $ 1,293,779 ------------- ------------- ------------- -------------
The Telecom Group's telephone operations follow accounting for regulated enterprises prescribed by SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." The Telecom Group periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. The Telecom Group believes that such criteria are still being met and, therefore, has no current plans to change its method of accounting. In analyzing the effect of discontinuing the application of SFAS No.71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally III-32 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (5) TELECOMMUNICATIONS PLANT (CONTINUED) accepted accounting principles and, therefore, any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. (6) NOTES PAYABLE--AFFILIATED The Telecom Group had notes payable to a wholly owned subsidiary of TDS and to TDS (included in the TDS Group) totaling $28.2 million and $25.0 million at December 31, 1997 and 1996, respectively. Interest on notes payable is accrued at the prime rate plus 1/2 percent (for a rate of 9.0% at December 31, 1997). The carrying amounts of notes payable approximate fair values due to the short-term nature of these instruments. (7) LONG-TERM DEBT Long-term debt as of December 31, 1997 and 1996 is as follows:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) RUS, RTB, and FFB Mortgage Notes, due through 2031 Various rates averaging 5.5%, 5.4% and 5.4% in 1997, 1996 and 1995, respectively................ $ 313,012 $ 308,371 Other long-term notes, 0% to 12.6%, due through 2009................................................................... 8,722 10,601 ----------- ----------- Telecom Group debt.................................................................................. 321,734 318,972 Less current portion............................................................................ 14,577 13,322 ----------- ----------- Total Telecom Group long-term debt.................................................................. 307,157 305,650 ----------- ----------- Telephone and Data Systems, Inc. (Parent) Medium-term notes, 8% to 10%, due through 2025.................................................. 239,200 239,200 Purchase contracts and other long-term notes, 9% to 14%, due through 2003....................... 2,440 2,672 ----------- ----------- 241,640 241,872 Less current portion............................................................................ 239 232 ----------- ----------- Total parent debt................................................................................... 241,401 241,640 ----------- ----------- Total long-term debt................................................................................ 548,558 547,290 Long-term debt--affiliated.......................................................................... 255,302 239,538 ----------- ----------- $ 803,860 $ 786,828 ----------- ----------- ----------- -----------
Long-term debt includes the debt of the parent company, TDS totaling $241.4 million and $241.9 million at December 31, 1997 and 1996, respectively, which was attributed to the Telecom Group by the Board of Directors of TDS. The Medium Term Notes ("MTNs") carry original maturities of 12 to 30 years, maturing at various times from 2003 to 2025. The MTNs may be redeemed by TDS at par value beginning in 1999. TDS has also attributed certain other long-term debt (Long-term debt--affiliated) to the Telecom Group from the TDS Group. Such debt is being treated as an unsecured interest bearing instrument at an interest rate equal to 1/2% above the prime rate until the principal amount becomes due. Interest at a rate equal to 2 1/2% above such prime rate would accrue on any overdue principal or overdue installment of interest. No principal will be payable until maturity, January 4, 1999. TDS has also attributed the tax benefit relating to the interest expense of all attributed debt to the Telecom Group. The RUS, RTB and FFB Mortgage Notes issued under certain loan agreements with the Rural Utilities Service ("RUS"), Rural Telephone Bank ("RTB"), and Federal Financing Bank ("FFB"), agencies of the United States of America, are to be repaid in equal monthly or quarterly installments covering principal and interest beginning six III-33 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (7) LONG-TERM DEBT (CONTINUED) months to three years after dates of issue and expiring through 2031. The agreements with the RUS, RTB and FFB provide for additional borrowings of up to $112.0 million. Substantially all telephone plant is pledged under RUS and RTB mortgage notes and various other obligations of the subsidiaries. The annual requirements for principal payments on long-term debt are approximately $14.8 million, $15.2 million, $15.0 million, $14.7 million and $15.0 million for the years 1998 through 2002, respectively. The estimated fair value of the Telecom Group's non-affiliated long-term debt was $565.7 million and $515.8 million at December 31, 1997 and 1996, respectively. The fair value was estimated using discounted cash flow analysis based on the Telecom Group's current incremental borrowing rates for similar types of borrowing arrangements. (8) TDS TELECOMMUNICATIONS GROUP EQUITY The changes in the TDS Telecommunications Group equity for the periods presented is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Balance at the beginning of period..................................................... $ 343,816 $ 265,387 $ 228,800 Net income............................................................................. 30,388 35,694 34,155 Dividends to TDS....................................................................... (32,701) (71,719) (16,828) Equity contributions................................................................... 42,256 114,454 19,260 ----------- ----------- ----------- Balance at the end of period........................................................... $ 383,759 $ 343,816 $ 265,387 ----------- ----------- ----------- ----------- ----------- -----------
The Telecom Group transferred interests in 13 cellular markets held by various telephone subsidiaries to TDS in September 1996. Such cellular interests, with an aggregate book value of $47.2 million, were transferred by TDS Telecom to TDS via dividends. (9) EMPLOYEE BENEFIT PLANS (A) PENSION PLAN The Telecom Group participates in a qualified noncontributory defined contribution pension plan sponsored by TDS which provides pension benefits for most of the employees of the Telecom Group. Under this plan pension benefits and costs are calculated separately for each participant and are funded currently. TDS also sponsors an unfunded non-qualified deferred compensation plan to supplement pension plan benefits to offset the reduction of benefits caused by the limitation on annual employee compensation under the tax laws. Employees of certain of the telephone subsidiaries not covered by the pension plan are covered under other pension plans or receive direct pension payment. Total pension costs of the Telecom Group were $3.6 million, $2.8 million and $2.7 million in 1997, 1996 and 1995, respectively. (B) OTHER POSTRETIREMENT BENEFITS TDS sponsors two defined benefit postretirement plans that cover most of the employees of the Telecom Group. 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 TDS'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 pension 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. TDS will limit overall contributions to the aggregate accruals recorded by its subsidiaries. III-34 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (9) EMPLOYEE BENEFIT PLANS (CONTINUED) The following table sets forth the plans' funded status reconciled with the amount shown in the Telecom Group's consolidated balance sheet at December 31, 1997.
LIFE HEALTH INSURANCE CARE PLAN PLAN TOTAL ----------- --------- --------- (DOLLARS IN THOUSANDS) Accumulated postretirement benefit obligation: Retirees................................................................................. $ 1,888 $ 4,948 $ 6,836 Fully eligible active plan participants.................................................. 578 2,375 2,953 Other active plan participants........................................................... 1,039 9,303 10,342 ----------- --------- --------- 3,505 16,626 20,131 Plan assets at fair value.................................................................. 1,554 11,642 13,196 ----------- --------- --------- Accumulated postretirement benefit obligation in excess of plan assets..................... 1,951 4,984 6,935 Unrecognized prior service cost............................................................ (290) (1,801) (2,091) Unrecognized net gain from past experience different from that assumed and from changes in assumptions............................................................................... 797 5,027 5,824 ----------- --------- --------- Accrued postretirement benefit cost at December 31, 1997................................... $ 2,458 $ 8,210 $ 10,668 ----------- --------- --------- ----------- --------- ---------
Net postretirement cost for 1997, 1996 and 1995 includes the following components:
DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Service Cost................................................................................... $ 774 $ 695 $ 429 Interest cost on accumulated postretirement benefit obligation................................. 1,265 1,049 911 Actual return on plan assets................................................................... (565) (648) (549) Net amortization and deferral.................................................................. (297) 104 231 --------- --------- --------- Net postretirement cost........................................................................ $ 1,177 $ 1,200 $ 1,022 --------- --------- --------- --------- --------- ---------
For measurement purposes, a 9.6% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1997; the rate was assumed to decrease over six years to 6.1% and to remain at 6.1% thereafter. The assumed rate of return on plan assets was 8.0%. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997, by $3.3 million and the aggregate of the service and interest cost components of postretirement expense for the year then ended by $465,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0%. III-35 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (10) PRO FORMA ACQUISITION EFFECTS TDS purchased and subsequently attributed to the Telecom Group one telephone company in 1997 and five telephone companies in 1996. Assuming that these transfers had taken place on January 1, 1996, unaudited proforma results of operations would have been as follows:
YEAR ENDED DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Operating revenues.................................................................................. $ 447,213 $ 405,597 Net income.......................................................................................... $ 31,154 $ 37,501 ----------- ----------- ----------- -----------
(11) COMMITMENTS AND CONTINGENCIES CONSTRUCTION AND EXPANSION The primary purpose of the Telecom Group's construction and expansion program is to provide for normal growth, to upgrade telephone service, to expand into new communications areas and to take advantage of service-enhancing and cost-reducing technological developments. Telephone construction expenditures are estimated to be approximately $140 million during 1998, including about $50 million for new digital switches and other switching facilities and $35 million for improvements to outside plant facilities, $25 million for systems development and $20 million for other services, primarily CLEC expenditures. LEASE COMMITMENTS The Telecom Group has leases for office space and data processing equipment, most of which are classified as operating leases. For the years 1997, 1996 and 1995, rent expense for noncancelable, long-term leases was $1.2 million, $1.8 million and $1.6 million, respectively, and rent expense under cancelable, short-term leases was $3.3 million, $3.1 million and $2.4 million, respectively. At December 31, 1997, the aggregate minimum rental commitments under noncancelable, long-term operating leases were as follows:
MINIMUM FUTURE RENTAL PAYMENTS --------------------- (DOLLARS IN THOUSANDS) 1998................................................................................ $ 1,619 1999................................................................................ 1,609 2000................................................................................ 1,589 2001................................................................................ 1,571 2002................................................................................ 113 Thereafter.......................................................................... $ 47
LEGAL PROCEEDINGS The Telecom Group is involved in legal proceedings before various state and federal courts from time-to-time. Management does not believe that any of such proceedings should have a material adverse impact on the financial position or results of operations of the Telecom Group. (12) RELATED PARTY TRANSACTIONS The Telecom Group is billed for all services it receives from TDS, consisting primarily of information processing and general management services. Such billings are based on expenses specifically identified to the Telecom Group and on allocations of common expenses. Such allocations are based on the relationship of the Telecom Group's assets, employees, investment in plant and expenses to the total assets, employees, investment in plant and expenses of TDS. Management believes the method used to allocate common expenses is reasonable and that all expenses and costs applicable to the Telecom Group are reflected in the accompanying financial statements on a basis which is representative of what they would have been if the Telecom Group operated on a stand-alone III-36 THE TDS TELECOMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) (12) RELATED PARTY TRANSACTIONS (CONTINUED) basis. Billings to the Telecom Group from TDS totaled $28.0 million, $21.2 million and $28.4 million in 1997, 1996 and 1995, respectively. The Telecom Group transferred interests in 13 cellular markets held by various telephone subsidiaries to TDS in September 1996. Such cellular interests, with an aggregate book value of $47.2 million, were transferred by TDS Telecom to TDS via dividends. Long-term debt includes the debt of the parent company, TDS totaling $241.4 million and $241.9 million at December 31, 1997 and 1996, respectively, which was attributed to the Telecom Group by the Board of Directors of TDS. TDS has also attributed certain other long-term debt (Long-term debt-affiliated) to the Telecom Group from the TDS Group. Such debt is being treated as an unsecured interest bearing instrument at an interest rate equal to 1/2% above the prime rate until the principal amount becomes due. Interest at a rate equal to 2 1/2% above such prime rate would accrue on any overdue principal or overdue installment of interest. No principal will be payable until maturity, January 4, 1999. TDS has also attributed the tax benefit relating to the interest expense of all attributed debt to the Telecom Group. III-37 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Telephone and Data Systems, Inc.: We have audited, the accompanying balance sheets of the TDS Telecommunications Group (representing a business unit of Telephone and Data Systems, Inc.) as of December 31, 1997 and 1996, and the related statements of income and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Telephone and Data Systems, Inc. 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 the TDS Telecommunications Group as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Chicago, Illinois January 28, 1998 III-38 ANNEX IV DESCRIPTION OF THE AERIAL COMMUNICATIONS GROUP The Aerial Communications Group ("Aerial Group") consists solely of Aerial Communications, Inc. an 83%-owned subsidiary of TDS which is developing broadband personal communications services. The Aerial Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Aerial Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Aerial Group, as determined by the Board of Directors of TDS. Aerial Communications, Inc., together with its subsidiaries is a provider of Personal Communications Services ("PCS") in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major Trading Areas ("MTAs") (collectively, the "PCS Markets"). The PCS Markets include approximately 27.6 million population equivalents ("POPs"). The Aerial Group has constructed networks for its PCS Markets using Global Systems for Mobile Communications ("GSM") technology. The Aerial Group has commenced service in each of its markets. At December 31, 1997, the Aerial Group had expanded its system coverage to approximately 80% of the six MTAs' total population. PCS is the term used to describe the wireless telecommunications services that are offered by those companies that acquired licenses for radio spectrum (frequency range 1850-1990 MHz) in the Federal Communications Commission ("FCC") auctions and are the newest entrants in the wireless telecommunications market. PCS competes directly with existing cellular telephone, paging and specialized mobile radio services. The Aerial Group believes that PCS providers will be the first in most markets 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. The Aerial Group's strategic goal is to take full advantage of the potential of wireless telecommunications. The Aerial Group sees an opportunity for significant growth in the wireless telecommunications market through the shift of existing wireless usage patterns from applications focused on business use, special occasions and emergencies to much broader applications for everyday use. The Aerial Group is structured to meet the increasingly competitive challenges of the wireless telecommunications marketplace, and has a marketing-oriented approach focused on serving its customers and their needs. Since 1983, the demand for wireless telecommunications services has grown dramatically as cellular, paging and other emerging wireless personal communications services have become widely available and increasingly affordable. Since its introduction in 1983, the number of domestic cellular telephone subscribers, both analog and digital, has grown from approximately 91,600 in 1984 to an estimated 49 million at June 30, 1997, which represents U.S. market penetration of approximately 18%. During 1996 and early 1997, the Aerial Group contracted for network equipment, billing systems, support software and the equipment and services necessary to launch service. Additionally during this period, the Aerial Group completed the design for its PCS networks, acquired and built out the switching centers serving each market, leased and built out a National Operations Center, leased or purchased the cell sites required to launch and commenced zoning and building the sites. The Columbus MTA launched service on March 27, 1997. The Aerial Group's five remaining MTAs launched service during the second quarter of 1997. Across all six markets, the Aerial Group launched with approximately 600 cell sites in service. The Aerial Group launched service in its Orlando market in early November of 1997. Aerial had more than 1,000 cell sites in service by the end of 1997. The coverage of the Aerial Group's PCS networks includes the major metropolitan areas within the PCS Markets, as well as portions of the major highway corridors extending out from those areas. All of the senior management positions and other key management positions have been staffed. Key operating and marketing staff have been put in place in each of the PCS Markets. In November 1996, Aerial entered into a Member Control Agreement ("Agreement") forming a joint venture with Rural Cellular Corporation ("RCC") to build out certain rural areas covering approximately 530,000 POPs in the Minneapolis MTA. In 1997 RCC exercised its option in the Agreement to add an additional 156,000 POPs to the joint venture. Aerial has contributed 20 MHz of its Minneapolis MTA license covering certain territories as defined in the Agreement in return for a 49% equity interest in the joint venture. RCC will be responsible for building out the network and for the ongoing operations. It is anticipated that the joint venture will purchase network switching services from the Aerial Group. The network will use GSM technology. The Aerial Group expects to benefit from the joint venture by extending the GSM footprint without the capital investment required to build out the network. IV-1 TECHNOLOGY With GSM technology, the Aerial Group offers easy-to-use, interactive menu-driven phones, and advanced features such as caller identification and a smart card, as well as more complex features such as text messaging, which allows the GSM handset to function as a two-way messaging device. In the future, the Aerial Group intends to increasingly emphasize services which are expected to increase the size and scope of the wireless market, such as wireless data and information services as well as wireless local loop services. The Aerial Group anticipates that PCS will ultimately offer a competitive alternative to wireline telephone service as PCS networks are constructed and PCS operators form strategic alliances. GSM is not compatible with other PCS or cellular technologies. However, compatibility can be achieved through the use of handsets that support multiple technologies. The Aerial Group 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 1998. Because analog cellular service is available nationwide, the Aerial Group expects that PCS customers will be able to roam into service areas served by analog cellular providers. To date, 17 other North American PCS licensees have implemented or announced their intention to utilize the GSM protocol in the construction of their networks. GSM committed providers in the U.S. have licenses to cover approximately 260 million POPs (representing approximately 98% of the population of the United States) and approximately 25 million POPs in Canada, although their can be no assurance that all the licensees will build-out their licensed territory. GSM systems are currently in commercial operation in over 700 North American cities with more than one million customers. The Aerial Group anticipates that its customers will be able to roam substantially throughout the United States, either on other GSM-based PCS networks or by using dual-mode handsets that can also be used on existing cellular networks. Aerial is a member of the North American GSM Alliance LLC ("GSM Alliance"), an all-digital wireless PCS network of U.S. and Canadian carriers. The GSM Alliance was established to create a national network and develop seamless wireless communications for customers, whether at home, away or abroad. The GSM Alliance's collaborative efforts focus on serving the wireless customer efficiently by addressing the areas of roaming, customer care, national distribution, and data communications. Aerial is also a part of the GSM North America consortium, which is the North American interest group for the GSM MoU Association. Formed in 1995, GSM North America brings together service providers and equipment manufacturers to identify and resolve issues related to making GSM the premier PCS digital technology. WIRELESS TELECOMMUNICATIONS INDUSTRY OVERVIEW. Wireless service is currently available using analog or digital technology. Most wireless services currently transmit voice and data signals over analog-based networks by varying the amplitude or frequency of one continuous electronic signal transmitted over a single radio channel. Analog technology currently has several limitations, including inconsistent service quality, lack of privacy, limited capacity and less reliability in transferring data without errors. The Aerial Group has chosen GSM, which utilizes a digital technology, for use in the PCS Markets. Digital systems convert voice or data signals into a stream of digits that is compressed before transmission, enabling a single radio channel to carry multiple simultaneous signal transmissions. This additional capacity, along with improvements in digital protocols, allows digital-based wireless technologies to offer new and enhanced services, such as greater call privacy and more robust data transmission features, such as "mobile office" applications (including facsimile, electronic mail and wireless connections to computer/data networks, including the Internet). While digital technology serves generally to reduce transmission interference relative to analog technology, coding methods in the 8 Kb vocoder cellular digital handsets which have been deployed by several digital wireless operators using TDMA technology cause a perceptible decline in voice quality. This gap in voice quality has proven to be a significant barrier to cellular operators attempting to switch their customers from analog to digital service. Manufacturers have developed enhanced 13 Kb vocoder digital handsets for both PCS and digital cellular networks using GSM or CDMA technology and an 8Kb vocoder using TDMA technology. These new handsets are expected to offer digital voice transmission comparable to wireline quality. PCS spectrum differs from existing cellular and specialized mobile radio ("SMR") spectrum in three basic ways: frequency, spectrum and geographic division. PCS networks will operate in a higher-frequency range (1850-1990 MHz) compared to the cellular and SMR frequency (800-900 MHz). PCS is comprised of 30 or 10 MHz spectrum versus 25 MHz spectrum for cellular networks. As a result of the improved capacity of the infrastructure IV-2 and large allocation of spectrum in the A, B and C PCS frequency Blocks, PCS will have more capacity for new wireless services such as data and video transmission. Finally, the geographic areas for PCS licenses are divided differently than for cellular licenses. PCS is segmented among 51 MTAs and 493 Basic Trading Areas ("BTAs") as opposed to cellular's 306 Metropolitan Statistical Areas ("MSAs") and 428 Rural Service Areas ("RSAs"). An MTA license generally covers a much larger geographic area than a BTA, MSA or RSA license. OPERATION OF WIRELESS NETWORKS. Wireless service areas are divided into smaller geographic areas called "cells", each of which contains an antenna and a base transceiver station ("BTS") consisting of a low-power transmitter, a receiver and signaling equipment. The cells are typically configured on a grid in a honeycomb-like pattern, although terrain factors (including natural and man-made obstructions) and signal coverage patterns may result in irregularly shaped cells and overlaps or gaps in coverage. The BTS in each cell is connected by microwave, fiber optic cable or telephone wires to a switching office ("mobile switching center" or "MSC"). The MSC controls the operation of the wireless telephone network for its entire service area, performing inter-BTS hand-offs, managing call delivery to handsets, allocating calls among the cells within the network and connecting calls to local landline telephone systems or to long-distance telephone carriers. Wireless service providers have interconnection agreements with various local exchange carriers and interexchange carriers, thereby integrating the wireless telephone network with landline telecommunications systems. Because two-way wireless networks are 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 call may be "handed off" to another BTS that can establish a stronger signal with the handset. If a handset leaves the service area of the wireless service provider, the call is disconnected unless an appropriate technical interface is established to hand off the call to an adjacent service provider's system. Operators of wireless networks frequently agree to provide service to customers from other compatible networks who are temporarily located or traveling through the operator's service area. Such customers are called "roamers." Agreements among network operators allocate revenues received from roamers. With automatic roaming, wireless customers are preregistered in certain networks outside their home service area and receive service automatically while they are roaming. Other roaming features permit calls to a customer to follow the customer into different networks, so that the customer will continue to receive calls in a different network just as if the customer were within his or her service area. Wireless customers generally are charged separately for monthly access, airtime, 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 airtime usage rates, which usually are higher than standard airtime 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 The Aerial Group offers coverage in those areas of the PCS Markets where most of the population lives and works. Subsequent construction of its PCS networks will provide urban and suburban coverage which is competitive with that of current cellular operators. The Aerial Group provides roaming capabilities, through agreements with other GSM and cellular operators. The Aerial Group's two primary sources of revenues are similar to those available to other cellular system providers. Service revenue primarily consists of charges for access, airtime and value-added services provided to the Aerial Group's retail customers who use the network operated by the Aerial Group, and charges for long-distance calls made on the Aerial Group's systems. Equipment sales revenue consists of the sale of handsets and related accessories to retailers, independent agents and end user customers. At December 31, 1997, the Aerial Group had 125,000 customers. Service revenues and equipment sales revenues totaled $32.3 million and $23.6 million, respectively, for the year ended December 31, 1997. IV-3 THE AERIAL GROUP PROVIDES THE FOLLOWING SERVICES AND FEATURES: THE SMART CARD. GSM technology employs a Smart Card which contains a microchip containing detailed information about a customer's service profile. The Smart Card allows the Aerial Group 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, the Aerial Group provides easy-to-use, interactive menu-driven phones that enable customers to utilize the features available in a GSM network. These handsets primarily use words and easy-to-use menus rather than numeric codes to operate handset functions such as call-forwarding, call-waiting and text messaging. SHORT TEXT MESSAGING. GSM technology allows for the capability to send and receive short text messages, similar to two-way radio paging services. This service allows the Aerial Group to offer a quicker and less expensive form of wireless communication when a full conversation is not necessary. ENHANCED SECURITY. The Aerial Group's service provides 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, the Aerial Group 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 The Aerial Group'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. The Aerial Group has developed overall marketing strategies as well as certain, specific local marketing strategies for each PCS Market. The Aerial Group's mass marketing efforts emphasize the value of the Aerial Group's high-quality, innovative services and are supported by heavily promoting the Aerial brand name. This is supported by a substantial advertising program. The Aerial Group offers its services and products through traditional cellular sales channels as well as through new, lower cost channels. The Aerial Group utilizes traditional sales channels which include mass merchandisers and retail outlets, company retail stores, sales agents and a direct sales force. National distributors include Best Buy, Circuit City, Office Depot, Office Max and Radio Shack in certain markets. The Aerial Group currently also distributes its services and products through over 50 company retail locations (mall stores, strip mall stores and kiosks). Based in part upon the remote activation feature of the GSM Smart Card, the Aerial Group 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. SOURCES OF EQUIPMENT The Aerial Group does not manufacture any of the GSM network equipment, handsets or accessories ("equipment") used or anticipated to be used in its operations. The equipment that the Aerial Group uses or anticipates to use is available from multiple sources, and the Aerial Group anticipates such equipment will continue to be available to the Aerial Group in the foreseeable future, consistent with normal manufacturing and delivery lead times. As GSM uses an open system architecture, and due to the fact that GSM has well-developed features, software systems and equipment that are available "off the shelf", the Aerial Group is able to design its GSM networks and systems without being dependent upon any single manufacturing source. Nokia Telecommunications Inc. has been the Aerial Group's sole supplier of digital radio channel and switching infrastructure equipment during the initial build-out of its PCS networks. The Aerial Group's current handset vendors are Nokia Mobile Phones, Inc., Ericsson Inc., and Mitsubishi Wireless Communications, Inc. THE AERIAL GROUP'S PCS MARKETS The PCS Markets cover large areas which, in general, have attractive demographic characteristics including growing populations, high population densities, favorable commuting patterns, high median household incomes IV-4 and favorable business climates. The Aerial Group 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, the Aerial Group 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. The Aerial Group 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). The Aerial Group 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 the Aerial Group. Principal cellular providers in the PCS Markets are AT&T Wireless Services, Inc., BellSouth Mobility, Inc., GTE Mobile Communications Corporation, AirTouch Communications, Inc., Southwestern Bell, Bell Atlantic-NYNEX Mobile and Ameritech Cellular. Additionally, the Aerial Group competes with SMR provider Nextel Communications, Inc. in each of its six PCS Markets. The Aerial Group also expects to compete with other communications technologies that now exist, such as paging, enhanced specialized mobile radio ("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, the Aerial Group 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 the Aerial Group will be able to compete successfully in this environment or that new technologies and products that are more commercially effective than the Aerial Group's technologies and products will not be developed. In addition, many of the Aerial Group's competitors have substantially greater financial, technical, marketing, sales and distribution resources than those of the Aerial Group and have significantly greater experience than the Aerial Group 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 the Aerial Group'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 are not automatically compatible with cellular systems, and vice versa. The Aerial Group expects dual-mode handsets to be available in 1998, 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 the Aerial Group's ability to attract current cellular customers or potential new wireless communication customers that desire the ability to access service providers in several markets. The Aerial Group anticipates that market prices for two-way wireless services generally will decline in the future based on increased competition. The Aerial Group 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. The Aerial Group'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 the Aerial Group's operating margins. 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 IV-5 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 telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops and makes regulation less necessary. The FCC promulgated and continues to promulgate regulations governing construction and operation of wireless 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. 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 the Aerial Group. The Aerial Group is watching the FCC proceedings closely. The grants of licenses to the Aerial Group are conditioned upon timely compliance with the FCC's build-out requirements, I.E., coverage of one-third of the population of a PCS market within five years of initial license grant and coverage of two-thirds of that population within ten years. The FCC also imposes a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. The Aerial Group is currently engaged in this registration process. All new towers must be registered at the time of construction. The FCC licenses granted to the Aerial Group 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 the Aerial Group'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 the Aerial Group is unaware of any circumstances which would prevent the approval of any future renewal applications, there can be no assurance that the Aerial Group'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 the Aerial Group. RECENT EVENTS. There are certain regulatory proceedings currently pending before the FCC which are of particular importance to the broadband PCS industry. IV-6 In one proceeding, the FCC has 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. Beginning in October 1997, broadband PCS systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements. After October 1997, all new broadband PCS facilities must be in compliance when they are brought into service. 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 and nature of developments of the 1996 Act, which will depend, in part, upon interrelationships among state and federal regulators. The primary purpose and effect of the 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 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 of state and local regulators. 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 were 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. On July 18, 1997, the Eighth Circuit vacated the FCC's rules prescribing interim rates for reciprocal compensation because it has held that the 1996 Act requires that rate issues are to be decided by the states. It upheld the authority of the FCC to order LECs to interconnect with broadband PCS and other wireless providers and to issue rules relating to certain terms of interconnection between LECs and such providers. The 1996 Act establishes principles and a process for implementing a modified "universal service" policy. This policy seeks nationwide, affordable service and access to advanced telecommunications and information services. It calls for reasonably comparable urban and rural rates and services. The 1996 Act also requires universal service to schools, libraries and rural health facilities at discounted rates. In a series of Orders adopted in 1997, the FCC established universal service support mechanisms which require telecommunications providers, including all wireless carriers, to contribute. The Aerial Group has made the required Universal Service Worksheet filings and expects to make the required periodic payments starting in the first quarter of 1998. IV-7 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. The Aerial Group 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. The Aerial Group is unable to predict the scope, pace, or financial impact of policy changes which could be adopted in these proceedings. EMPLOYEES As of December 31, 1997, the Aerial Group had a total of 1,414 employees. None of the Aerial Group's employees is represented by a labor union. The Aerial Group considers its relations with its employees to be good. IV-8 EXPLANATORY NOTE REGARDING FINANCIAL INFORMATION Effective upon completion of the Transactions, Telephone and Data Systems, Inc. ("TDS") will have outstanding five classes of Common Stock: United States Cellular Group Common Shares, which are intended to reflect the performance of the United States Cellular Group; TDS Telecommunications Group Common Shares, which are intended to reflect the performance of the TDS Telecommunications Group; Aerial Communications Group Common Shares, which are intended to reflect the performance of the Aerial Communications Group; and Common Shares and Series A Common Shares which are intended to reflect the performance of Telephone and Data Systems (which will also reflect the performance of the United States Cellular Group, the TDS Telecommunications Group, and the Aerial Communications Group to the extent of the Retained Interest in those groups.) Although the financial statements of the Aerial Communications Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of Telephone and Data Systems, Inc. attributed to the Aerial Communications Group such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of Aerial Communications Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares are, shareholders of TDS. TDS and its subsidiaries would each continue to be responsible for their respective liabilities. Financial results arising from the business of Telephone and Data Systems, Inc. (including its Retained Interest in the Aerial Communications Group) or from the business of the Aerial Communications Group could affect the market price of all classes of Common Stock. In addition, any net losses of any of the Groups, including the Aerial Communications Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on all classes of Common Stock. Accordingly, TDS consolidated financial statements should be read in conjunction with the Aerial Communications Group's financial information. IV-9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR THE THREE YEARS ENDED DECEMBER 31, 1997 The Aerial Communications Group ("Aerial Group") consists solely of Aerial Communications, Inc. and its subsidiaries ("Aerial"), an 82.5%-owned subsidiary of Telephone and Data Systems, Inc. ("TDS") which is developing broadband personal communications services. The Aerial Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Aerial Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Aerial Group, as determined by the Board of Directors of TDS. OVERVIEW The Aerial Group was formed to acquire Personal Communications Services ("PCS") licenses from the Federal Communications Commission ("FCC"), construct PCS networks in its Major Trading Areas ("MTAs") and offer wireless PCS communications services in these areas. Since its acquisition of PCS licenses in the FCC broadband Block A and Block B PCS auction, which concluded in March of 1995, the Aerial Group has been devoting its efforts to recruiting an experienced management team, developing and executing a business plan, raising capital and designing and constructing a PCS network in each of its MTAs (Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus). The Aerial Group's focus in 1997 has been the preparation of each of its markets for initial service launch and the development of its PCS business. The Columbus MTA launched service on March 27, 1997. The Aerial Group's five remaining MTAs launched service during the second quarter of 1997. Across all six markets, the Aerial Group launched with approximately 600 cell sites in service. The Aerial Group currently has 1,044 cell sites in service across all its markets. With the launch of service in its MTAs between March and June of 1997, the Aerial Group transitioned from the development stage to being an operating enterprise. As a result of this transition, the Aerial Group experienced in 1997 increased revenues and operating expenses, and incurred substantial losses. The Aerial Group had no revenues and significantly less expenses in 1995, 1996 and for the first quarter of 1997. RESULTS OF OPERATIONS The Aerial Group's results of operations for 1997 compared to 1996 and 1995 reflect primarily increased activities undertaken to launch and grow PCS services in its MTAs. Such activities significantly increased the Aerial Group's net loss to $247.1 million from $37.9 million in 1996 and $6.5 million in 1995. During 1997 the Aerial Group ceased to be classified as a development stage enterprise with the launch of service in its six MTAs. In addition to launching PCS services, the Aerial Group's focus in 1997 was the continued build-out of its PCS network and expansion of its customer base. Building its customer base will be the Aerial Group's focus in 1998. OPERATING REVENUES OPERATING REVENUES totaled $55.9 million for the year ended December 31, 1997, reflecting the launch of service in all six MTAs during 1997. In late March 1997 the Aerial Group began offering PCS service in Columbus, Ohio and during the second quarter the Aerial Group began offering service in its remaining MTAs. The Aerial Group finished 1997 with approximately 125,000 customers. SERVICE REVENUE primarily consists of charges for access, airtime and value-added services provided to the Aerial Group's retail customers who use the network operated by the Aerial Group, and charges for long-distance calls made on the Aerial Group's systems. Service revenue totaled $32.3 million in 1997. EQUIPMENT SALES REVENUE totaled $23.6 million in 1997. Equipment sales revenue represents the sale of handsets and related accessories to retailers, independent agents, and end user customers. OPERATING EXPENSES OPERATING EXPENSES totaled $252.5 million for the year ended December 31, 1997, reflecting the Aerial Group's operating activities subsequent to the launch of service in its markets. IV-10 SYSTEM OPERATIONS EXPENSE totaled $30.7 million in 1997, reflecting the costs of operating the Aerial Group's network in all MTAs. Significant costs include cell site rent and maintenance, utilities, landline interconnection and toll charges and salaries and benefits of engineering and maintenance employees. MARKETING AND SELLING EXPENSE totaled $46.0 million in 1997, primarily reflecting the Aerial Group's aggressive marketing campaign that accompanied the launch of service and continued throughout the remainder of the year. Marketing and selling expenses primarily consist of salaries and benefits of sales and marketing personnel, sales commissions, the cost of promotions, and the cost of print, radio and television advertising. CUSTOMER SERVICE EXPENSE totaled $20.9 million in 1997, reflecting customer service activity at the Aerial Group's National Operations Center in connection with the launch and support of its six MTAs. COST OF EQUIPMENT SOLD totaled $71.5 million in 1997, reflecting the launch of service and filling of third-party distribution channels for handsets. GENERAL AND ADMINISTRATIVE EXPENSE totaled $44.5 million in 1997, reflecting expenses associated with the Aerial Group's management and operating teams required to launch service and transition to post-launch operations, and the resulting increases in salaries, employee benefits, and overhead expenses. The Aerial Group had 1,414 employees at December 31, 1997, compared to 424 employees at December 31, 1996, and less than 50 employees at December 31, 1995. OTHER DEVELOPMENT COSTS totaled $21.6 million in 1997 as compared to $44.0 million in 1996 and $7.8 million in 1995. The decrease in development costs in 1997 is primarily due to the Aerial Group being a development stage enterprise for all of 1996 while, in the second quarter of 1997, the Aerial Group ceased to be classified as a development stage enterprise with the launch of service in its six MTAs. INVESTMENT LOSSES totaled $2.5 million in 1997 as compared to $0.3 million in 1996. Investment losses represent Aerial's 49% share of the net loss of the Wireless Alliance, LLC, a joint venture associated with the Aerial Group's Minneapolis MTA and designed to extend the PCS footprint to areas that were not in the Aerial Group's initial build-out. INTEREST INCOME-AFFILIATE totaled $0.1 million in 1997 as compared to $4.5 million in 1996. Interest income-affiliate represents interest income earned on the proceeds of Aerial's April 1996 Initial Public Offering ("IPO") invested in the TDS cash management program pending use in PCS network development and construction. Proceeds from the IPO were fully utilized by the end of January 1997. INTEREST INCOME-OTHER totaled $2.4 million in 1997 as compared to $1.2 million in 1996. Interest income-other primarily represents interest income earned on the excess proceeds from Aerial's November 1996 sale of Series A Zero Coupon Notes pending use in PCS network development and construction. The proceeds from the sale of the Series A Zero Coupon Notes were fully utilized by the end of August 1997. Interest income-other was not significant in 1995. GAIN ON SALE OF PCS LICENSES represents the pretax gain of $0.2 million recognized on the sale of the Guam license in May 1996 and the pretax gain of $2.4 million recognized on the sale of the Alaska license in December 1996. INTEREST EXPENSE-AFFILIATE totaled $21.6 million in 1997 as compared to $2.0 million in 1996 and $1.1 million in 1995. The $19.6 million increase in 1997 is primarily due to the average outstanding balance of borrowings under the Revolving Credit Agreement with TDS being greater in 1997. Interest expense-affiliate in 1997 represents interest on amounts borrowed under the Revolving Credit Agreement and the TDS 3% guarantee fees primarily associated with the Series A Zero Coupon Notes, less interest capitalized of $2.7 million. The 1996 amount primarily represents interest on amounts borrowed under the Revolving Credit Agreement, less interest capitalized of $0.6 million. The 1995 amount represents interest on amounts borrowed under the Revolving Credit Agreement, less interest capitalized of $16.6 million. INTEREST EXPENSE-OTHER totaled $5.5 million in 1997 as compared to $0.8 million in 1996 and relates to the Series A Zero Coupon Notes issued in November 1996, less interest capitalized. The Aerial Group capitalized interest expense of $3.3 million and $0.6 million related to the Series A Zero Coupon Notes and interim financing under the Nokia Credit Agreement in 1997 and 1996, respectively. IV-11 Interest capitalization in 1997 and 1996 is based solely upon expenditures incurred related to PCS network construction and information system development. Interest capitalization in 1995 represents interest capitalized on the cost of licenses acquired prior to TDS's $289.2 million equity contribution which covered such costs. INCOME TAX EXPENSE totaled $1.8 million in 1997, as compared to a benefit of $0.9 million in 1996 and a benefit of $2.1 million in 1995. The $2.7 million increase in income tax expense is primarily due to an increase in the estimated valuation allowance associated with deferred tax assets generated by net operating losses. See "Income Taxes" below for a discussion of the Aerial Group's tax allocation agreement with TDS. INCOME TAXES The Aerial Group is included in a consolidated federal income tax return with other members of the TDS consolidated group. For financial reporting purposes, the Aerial Group computes federal income taxes as if it were filing a separate return as its own affiliated group and was not included in the TDS consolidated tax return. TDS and the Aerial Group are parties to a Tax Allocation Agreement under which the Aerial Group is able to carry forward any losses and credits and use them to offset any future income tax liabilities to TDS. For 1995 and prior years, TDS reimbursed the Aerial Group for the federal income tax benefit of any net operating loss of the Aerial Group which reduced the provision for income taxes reflected in TDS's consolidated statements of income. The Aerial Group and TDS entered into a Tax Allocation Agreement which became effective as of January 1, 1996 (the "1996 Tax Allocation Agreement"), pursuant to which, among other things, TDS no longer reimburses the Aerial Group on a current basis for losses or credits used by TDS in the year they are generated. Instead, the Aerial Group will be compensated (i.e., future tax liabilities will be reduced) for TDS's use of tax benefits at such time as the Aerial Group could utilize such benefits on a separate return basis. If the 1996 Tax Allocation Agreement had been in place during 1995, the Aerial Group would have recorded a deferred tax asset of $11.9 million (net of a valuation allowance of $6.2 million) and a deferred tax liability of $14.0 million, resulting in deferred tax expense of $2.1 million being recognized in the Consolidated Statements of Operations. The deferred tax asset primarily relates to the net operating loss ("NOL") carryforward, which requires a valuation allowance to be provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Due to the absence of an established earnings history of the Aerial Group, a valuation must be provided to the extent that temporary differences related to the deferred tax liability do not reverse in the 15 year NOL carryforward period. The deferred tax liability is primarily created due to the accelerated amortization of the PCS license cost and the current deduction of interest that was capitalized for book purposes. Therefore, the deferred tax expense represents that portion of the NOL which was created by accelerated tax amortization of the PCS licenses and the related interest deduction which may not be realized because those temporary differences reverse over 40 years. INFLATION Management believes that inflation affects the Aerial Group's business to no greater extent than the general economy. LIQUIDITY AND CAPITAL RESOURCES The costs of development, construction, start-up and post-launch activities of the Aerial Group require substantial capital. From inception through December 31, 1997, the Aerial Group had expended $304.4 million for licenses, including capitalized interest, $642.1 million for all other capital expenditures and incurred cumulative net losses of $292.9 million. The Aerial Group expects to incur significant operating losses and to generate negative cash flow from operating activities during the next several years as it continues to build its customer base. Cash flows used by operating activities were $206.9 million in 1997 and $17.8 million in 1996, and cash flows provided by operating activities were $0.1 million in 1995. Operating cash outflow (operating loss before depreciation and amortization expense) totaled $157.5 million in 1997. Cash flows used by other operating activities (investment and other income, interest expense, changes in working capital and changes in other assets and liabilities) required cash investments of $29.3 million in 1997. Cash flows from financing activities provided $449.9 million in 1997, $164.1 million in 1996 and $297.9 million in 1995. Cash provided in 1997 was due primarily to $448.2 million in borrowings under the Revolving Credit Agreement. In April 1996, Aerial received proceeds from its IPO of $195.3 million, net of underwriting discounts and commissions. The Aerial Group used a portion of the net proceeds to repay the then outstanding balance under the IV-12 Revolving Credit Agreement with TDS. In 1996 the Aerial Group received from TDS $28.8 million representing the balance due in connection with TDS's $289.2 million contribution to the equity capital of the Aerial Group in 1995. The 1995 equity contribution was made to cover the original cost of the licenses acquired in the FCC auction. Cash flows from financing activities in 1995 were generated by borrowings under the Revolving Credit Agreement with TDS. Cash flows used in investing activities totaled $273.3 million in 1997, $111.3 million in 1996 and $297.8 million in 1995. Cash used in 1997 resulted primarily from $274.7 million in additions to property and equipment, primarily launch-related network and information system assets. Total 1997 additions to property and equipment, including noncash transactions, were $387.7 million, including $291.9 million for cell sites, $38.4 million for switching equipment, $55.6 million for information system assets and $1.8 million for other activities. Cash used in 1996 resulted primarily from $112.9 million in additions to property and equipment, primarily network and information system assets, offset by $2.3 million in proceeds received from the sale of PCS licenses. Total 1996 additions to property and equipment, including noncash transactions, were $242.3 million, including $150.4 million for cell sites, $53.2 million for switching equipment, and $38.7 million for other activities, including information systems development and property and equipment in service (primarily computer equipment and software, office equipment, and leasehold improvements). Cash requirements in 1995 related largely to the Aerial Group's $285.4 million acquisition of eight licenses in the FCC auction and $12.1 million in additions to property and equipment and capitalized construction costs. The Aerial Group has substantially completed all phases of its network build-out and anticipates that the continuing development of its PCS networks and services will require substantial capital over the next several years. For 1998 the Aerial Group estimates that the aggregate funds required for capital expenditures will total approximately $75 million. The Aerial Group estimates requiring $235 million for working capital requirements to fund operations for all of 1998, including an estimated $57 million in interest expense related to the Revolving Credit Agreement. The Aerial Group expects 1998 capital and operating expenditures to be financed using a variety of sources, including but not limited to, additional borrowings under the TDS Revolving Credit Agreement, vendor financing and an investment by a minority equity investor. In March 1996, Aerial selected Nokia Telecommunications, Inc. ("Nokia") as its sole supplier of digital radio channel and switching infrastructure equipment during the initial build-out of its PCS networks. Nokia agreed to provide up to $200 million in financing for the equipment through a Credit Agreement with Aerial dated June 19, 1996 ("Credit Agreement"). In accordance with the provisions of the Credit Agreement, Aerial issued, in tranches, 10-year unsecured zero coupon promissory notes, the proceeds of which were paid to Nokia in satisfaction of borrowings by Aerial under the Credit Agreement. Pursuant to the Credit Agreement, on November 4, 1996, Aerial issued $226.2 million in aggregate principal amount at maturity Series A Zero Coupon Notes ("Series A Notes") due in 2006. The issue price of the Series A Notes was $100 million and there is no periodic payment of interest. The per annum yield to maturity on the Series A Notes is 8.34% (computed on a semi-annual bond equivalent basis). The proceeds of the sale of the Series A Notes were paid to Nokia in satisfaction of all then outstanding obligations and future obligations of Aerial up to $100 million under the Credit Agreement. Pursuant to the Credit Agreement, on February 5, 1998, Aerial issued $220.0 million in aggregate principal amount at maturity Series B Zero Coupon Notes ("Series B Notes") due in 2008 (representing the final issuance of zero coupon notes under the Credit Agreement). The issue price of the Series B Notes was $100 million and there is no periodic payment of interest. The per annum yield to maturity on the Series B Notes is 8.05% (computed on a semi-annual bond equivalent basis). The proceeds of the sale of the Series B Notes were paid to Nokia in satisfaction of all then outstanding obligations and future obligations of Aerial (to the extent not satisfied from the proceeds of the sale of the Series A Notes) up to $100 million under the Credit Agreement. The Series A and Series B Notes ("Notes") rank in the same priority with all other unsecured and unsubordinated indebtedness of the Aerial Group. The Notes and the obligations under the Credit Agreement are fully and unconditionally guaranteed by TDS at an annual fee rate of 3%. The Notes are subject to optional redemption by Aerial after five years from the applicable date of issuance at a purchase price equal to the issue price plus accrued interest through the date of redemption. The Notes are subject to optional redemption by Aerial after five years from the applicable date of issuance at redemption prices which reflect original issue discount accrued since issuance. In April of 1996, Aerial sold 12.3 million of its Common Shares, approximately 17.2% of the then total outstanding shares of common stock, at a price of $17 per share in its IPO. The net proceeds from the offering, after IV-13 underwriters fees, were $195.3 million. A portion of the net proceeds was applied to the repayment of the $64.1 million then outstanding indebtedness (including accrued interest) to TDS under the Revolving Credit Agreement. Proceeds from the IPO were fully utilized by the end of January 1997. At December 31, 1997, the Aerial Group had approximately $26.8 million available for borrowing under its $475 million Revolving Credit Agreement with TDS. In February 1998, the Aerial Group secured from TDS a $50 million increase in the amount it may borrow under the Revolving Credit Agreement to $525 million. In addition to the Revolving Credit Agreement with TDS, other sources of capital may include additional vendor financing as well as private equity and debt financing. If sufficient additional future funding is not made available to the Aerial Group on terms and prices acceptable to the Aerial Group, the Aerial Group would have to reduce its operating activities, which could have a material adverse impact on the Aerial Group's financial condition and results of future operations. The Aerial Group has assessed, and continues to assess, the impact of the Year 2000 Issue on its reporting systems and operations for purposes of ensuring its systems are Year 2000 compliant. The Aerial Group's major systems have been recently purchased or developed and management does not expect the effort needed to achieve Year 2000 compliance to be significant. The Year 2000 Issue exists because many computer systems and applications abbreviate dates by eliminating the first two digits of the year, assuming that these two digits would always be "19". Unless corrected, this shortcut is expected to cause problems when the century date occurs. On that date, some computer programs may recognize the date as January 1, 1900 instead of January 1, 2000. This may cause systems to incorrectly process critical financial and operational information, or stop processing altogether. Additionally, computer applications may be affected before January 1, 2000, if calculations into the year 2000 are involved. Management believes that the cost of addressing the Year 2000 Issue to be incurred in 1998 and 1999 will not be material to future results or financial condition. If management's steps are not successful in making its systems Year 2000 compliant, it could have a material adverse effect on results of operations. PROPOSED TDS CORPORATE RESTRUCTURING In December 1997, Aerial received a proposal from TDS to acquire all of the issued and outstanding Common Shares of Aerial not already owned by TDS. The offer was made in connection with, and is subject to TDS shareholder approval of and the effectiveness of, TDS's proposed corporate restructuring. The Board of Directors of TDS (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as Aerial Communications Group Common Shares (the "Aerial Group Shares"). The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group") which consists of TDS's interest in Aerial Communications, Inc. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to, among other things, issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not currently owned by TDS, subject to approval by Aerial's board of directors and shareholders. In January 1998, Aerial's board of directors created a special committee of the Board (the "Special Committee") to review the proposal from TDS. The Special Committee, consisting of two independent directors of Aerial, has engaged a financial advisor and legal advisor to assist in reviewing the proposal. The Special Committee will consider how Aerial should respond to the TDS proposal, take the steps it deems appropriate to respond to the TDS proposal and, at such time as it considers it appropriate, report its recommendations to Aerial's Board of Directors. Subsequent to TDS shareholder approval of the Tracking Stock Proposal, TDS intends to terminate certain intercompany agreements between TDS and Aerial. Thereafter, some or all of the policies between TDS and Aerial would be determined solely by methods that TDS management believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Aerial Group and does not anticipate paying dividends on the Aerial Group Shares in the foreseeable future. IV-14 LEGAL PROCEEDINGS. On January 5, 1998, an individual who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants TDS, Aerial, and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. The defendants have been served with the complaint in this case but have not yet responded to the complaint. The time for the defendants to respond has been extended. The timing for a response will be determined based on discussions between counsel for plaintiffs and defendants, but a response is not expected to take place for at least one or more months. A virtually identical complaint has been filed by a second individual. None of the defendants have been served with this complaint. It is expected that these cases will be consolidated. The Company intends to vigorously defend against these lawsuits. However, there can be no assurance that such lawsuits will not have a material adverse effect on the Company or the transactions contemplated by the Proxy Statement/Prospectus. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND OTHER SECTIONS OF THIS PROXY STATEMENT/PROSPECTUS 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 TDS'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 THE AERIAL GROUP'S MARKETS; ADVANCES IN TELECOMMUNICATIONS TECHNOLOGY; CHANGES IN THE TELECOMMUNICATIONS REGULATORY ENVIRONMENT; PENDING AND FUTURE LITIGATION; AVAILABILITY OF FUTURE FINANCING; AND UNANTICIPATED CHANGES IN GROWTH IN PCS CUSTOMERS, PENETRATION RATES, CHURN RATES AND THE MIX OF PRODUCTS AND SERVICES OFFERED IN THE AERIAL GROUP'S MARKETS. READERS SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS. IV-15 THE AERIAL COMMUNICATIONS GROUP STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ----------------------------------- 1997 1996 1995 ------------ ---------- --------- (DOLLARS IN THOUSANDS) OPERATING REVENUES Service............................................................................... $ 32,307 $ -- $ -- Equipment sales....................................................................... 23,645 -- -- ------------ ---------- --------- Total Operating Revenues............................................................ 55,952 -- -- ------------ ---------- --------- OPERATING EXPENSES System operations..................................................................... 30,655 -- -- Marketing and selling................................................................. 45,974 -- -- Customer service...................................................................... 20,882 -- -- Cost of equipment sold................................................................ 71,454 -- -- General and administrative............................................................ 44,467 -- -- Depreciation.......................................................................... 34,569 -- -- Amortization of intangibles........................................................... 4,502 -- -- ------------ ---------- --------- Total Operating Expenses............................................................ 252,503 -- -- ------------ ---------- --------- OPERATING (LOSS)........................................................................ (196,551) -- -- ------------ ---------- --------- INVESTMENT AND OTHER INCOME (EXPENSE) PCS development costs................................................................. (21,614) (43,950) (7,829) Investment (losses)................................................................... (2,518) (304) -- Interest income--affiliate............................................................ 95 4,488 -- Interest income--other................................................................ 2,402 1,158 48 Gain on sale of PCS licenses.......................................................... -- 2,582 -- Other income (expense)................................................................ -- -- 268 ------------ ---------- --------- Total Investment and Other Income (Expense)......................................... (21,635) (36,026) (7,513) ------------ ---------- --------- (LOSS) BEFORE INTEREST AND INCOME TAXES................................................. (218,186) (36,026) (7,513) Interest expense--affiliate........................................................... 21,558 1,960 1,051 Interest expense--other............................................................... 5,507 802 -- ------------ ---------- --------- Total Interest Expense.............................................................. 27,065 2,762 1,051 ------------ ---------- --------- (LOSS) BEFORE INCOME TAXES.............................................................. (245,251) (38,788) (8,564) Income tax expense (benefit)............................................................ 1,806 (867) (2,096) ------------ ---------- --------- NET (LOSS).............................................................................. (247,057) (37,921) (6,468) Net (Loss) to Minority Shareholders of Aerial........................................... 43,038 4,944 -- ------------ ---------- --------- Net (Loss) to TDS....................................................................... $ (204,019) $ (32,977) $ (6,468) ------------ ---------- --------- ------------ ---------- --------- Pro Forma (Unaudited): (See Note 2) Net (Loss) Attributable to the TDS Group through Retained Interest...................... $ (51,005) $ (8,244) $ (1,617) Net (Loss) Attributable to Aerial Communications Group Common Shares.................... $ (153,014) $ (24,733) $ (4,851)
The accompanying notes to financial statements are an integral part of these statements. IV-16 THE AERIAL COMMUNICATIONS GROUP STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net (Loss).......................................................................... $ (247,057) $ (37,921) $ (6,468) Add (Deduct) adjustments to reconcile net (loss) to net cash (used) provided by operating activities: Depreciation and amortization....................................................... 40,554 1,934 47 Noncash interest expense--Series A Notes............................................ 8,341 1,327 -- Investment losses................................................................... 2,518 304 -- Gain on sale of PCS licenses........................................................ -- (2,582) -- Change in accounts receivable--customer............................................. (24,030) -- -- Change in income tax refund receivable--affiliate................................... -- 12,502 (12,320) Change in inventory................................................................. (25,949) -- -- Change in accounts payable--affiliates.............................................. 284 (795) 1,284 Change in accounts payable--trade and other......................................... 30,606 3,491 6,401 Change in other accrued interest affiliates......................................... 3,665 (1,497) 1,392 Change in deferred tax liability--net............................................... 1,806 2,231 10,407 Change in other assets and liabilities.............................................. 2,399 3,225 (617) ------------ ------------ ------------ (206,863) (17,781) 126 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Change in Revolving Credit Agreement--TDS........................................... 448,234 (60,238) 297,937 Change in note receivable--affiliate................................................ -- 28,836 -- Issuance of common stock............................................................ 1,699 195,485 -- ------------ ------------ ------------ 449,933 164,083 297,937 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures................................................................ (274,709) (112,940) (12,134) Investment in PCS licenses.......................................................... -- -- (285,417) Change in note receivable--other.................................................... 1,925 -- -- Proceeds from sale of PCS licenses.................................................. -- 2,275 -- Change in temporary and other investments........................................... (558) (614) (261) ------------ ------------ ------------ (273,342) (111,279) (297,812) ------------ ------------ ------------ Net (Decrease) Increase in Cash and Cash Equivalents................................ (30,272) 35,023 251 Cash and Cash Equivalents-- Beginning of Period............................................................... 35,284 261 10 ------------ ------------ ------------ End of Period..................................................................... $ 5,012 $ 35,284 $ 261 ------------ ------------ ------------ ------------ ------------ ------------
The accompanying notes to financial statements are an integral part of these statements. IV-17 THE AERIAL COMMUNICATIONS GROUP BALANCE SHEETS ASSETS
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents: General funds................................................................................... $ 5,012 $ 869 Affiliated cash equivalents..................................................................... -- 34,415 ----------- ----------- 5,012 35,284 Temporary investments............................................................................. 197 315 Accounts receivable: Customers, less allowance of $7,252 in 1997..................................................... 24,030 -- Affiliates...................................................................................... 22 Other........................................................................................... 185 Interest receivable-affiliate..................................................................... -- 243 Interest receivable-other......................................................................... -- 508 Note receivable-other............................................................................. -- 1,925 Inventory......................................................................................... 25,949 -- Other............................................................................................. 2,808 704 ----------- ----------- 58,203 38,979 ----------- ----------- PROPERTY AND EQUIPMENT Property and equipment, net of accumulated depreciation of $38,018 in 1997 and $1,981 in 1996.................................................................................. 584,723 18,592 Work in process................................................................................... 19,381 233,831 Prepaid network infrastructure costs.............................................................. -- 70,300 ----------- ----------- 604,104 322,723 ----------- ----------- INVESTMENTS Investments in PCS licenses, net of accumulated amortization of $4,489 in 1997.................... 297,043 304,354 Other............................................................................................. 1,298 6,771 ----------- ----------- 298,341 311,125 ----------- ----------- TOTAL ASSETS........................................................................................ $ 960,648 $ 672,827 ----------- ----------- ----------- -----------
The accompanying notes to financial statements are an integral part of these statements. IV-18 THE AERIAL COMMUNICATIONS GROUP BALANCE SHEETS LIABILITIES AND GROUP EQUITY
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Accounts payable: Affiliates........................................................................................ $ 773 $ 489 Trade............................................................................................. 92,020 57,114 Other............................................................................................. -- 36,246 Accrued interest-affiliate.......................................................................... 3,665 -- Microwave relocation costs payable.................................................................. 7,354 17,046 Contribution payable................................................................................ -- 6,453 Other............................................................................................... 5,957 1,978 ----------- ----------- 109,769 119,326 ----------- ----------- REVOLVING CREDIT AGREEMENT--TDS..................................................................... 448,234 -- ----------- ----------- LONG-TERM DEBT...................................................................................... 196,439 103,743 ----------- ----------- DEFERRED TAX LIABILITY--NET......................................................................... 13,779 11,973 ----------- ----------- AERIAL COMMUNICATIONS GROUP EQUITY.................................................................. 192,427 437,785 ----------- ----------- TOTAL LIABILITIES AND GROUP EQUITY.................................................................. $ 960,648 $ 672,827 ----------- ----------- ----------- -----------
The accompanying notes to financial statements are an integral part of these statements. IV-19 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS The Aerial Communications Group ("Aerial Group") consists solely of Aerial Communications, Inc. and its subsidiaries ("Aerial"), currently an 82.5%-owned subsidiary of Telephone and Data Systems Inc. ("TDS") which is developing broadband personal communications services. The Aerial Group may in the future also include such other assets and liabilities of TDS as the Board of Directors of TDS may determine to attribute to the Aerial Group and such other businesses, assets and liabilities as TDS or any of its subsidiaries may in the future acquire for the Aerial Group, as determined by the Board of Directors of TDS. NOTE 1 PROPOSED TDS CORPORATE RESTRUCTURING In December 1997, Aerial received a proposal from TDS to acquire all of the issued and outstanding Common Shares of Aerial not already owned by TDS. The offer was made in connection with, and is subject to TDS shareholder approval of and the effectiveness of, TDS's proposed corporate restructuring. The Board of Directors of TDS (the "TDS Board") has adopted a proposal which, if approved by TDS shareholders and implemented by the TDS Board, would authorize the TDS Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). Under the Tracking Stock Proposal, one of the three new classes of common stock created by TDS would be designated as Aerial Communications Group Common Shares (the "Aerial Group Shares"). The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of TDS's interest in Aerial Communications, Inc. Subject to the approval of the Tracking Stock Proposal by TDS shareholders, TDS intends to, among other things, issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not currently owned by TDS, subject to approval by Aerial's board of directors and shareholders. In January 1998, Aerial's board of directors created a special committee of the Board (the "Special Committee") to review the proposal from TDS. The Special Committee, consisting of two independent directors of Aerial, has engaged a financial advisor and legal advisor to assist in reviewing the proposal. The Special Committee will consider how Aerial should respond to the TDS proposal, take the steps it deems appropriate to respond to the TDS proposal and, at such time as it considers it appropriate, report its recommendations to Aerial's Board of Directors. Subsequent to TDS shareholder approval of the Tracking Stock Proposal, TDS intends to terminate certain intercompany agreements between TDS and Aerial. Thereafter, some or all of the policies between TDS and Aerial would be determined solely by methods that TDS management believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Aerial Group and does not anticipate paying dividends on the Aerial Group Shares into the foreseeable future. NOTE 2 ORGANIZATION OF BUSINESS Aerial Communications, Inc. ("Aerial") is an 82.5%-owned subsidiary of Telephone and Data Systems, Inc. ("TDS"). Aerial was incorporated in Delaware on July 23, 1991, as American Portable Telecommunications, Inc. and changed its name to American Portable Telecom, Inc. ("APTI") effective January 18, 1996. On November 12, 1996, Aerial changed its name to Aerial Communications, Inc. Aerial was formed to acquire Personal Communications Services ("PCS") licenses, construct PCS networks in its Major Trading Areas ("MTAs") and offer wireless PCS communications services in these areas. Aerial acquired its licenses in the Federal Communications Commission ("FCC") broadband Block A and Block B PCS auction (the "PCS auction") which concluded in March 1995. Aerial acquired licenses in the Columbus (Ohio), Houston (Texas), Kansas City (Missouri), Minneapolis (Minnesota), Pittsburgh (Pennsylvania), and Tampa-St. Petersburg-Orlando (Florida) MTAs covering approximately 27.6 million population equivalents ("POPs"). IV-20 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The financial statements of the Groups comprise all of the accounts included in the corresponding consolidated financial statements of Telephone and Data Systems, Inc. The separate Aerial Group financial statements give effect to the management and accounting policies that would be applicable upon implementation of the Tracking Stock Proposal. Subject to the completion of the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and Aerial. Thereafter, some or all of the relationships between TDS and Aerial would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The separate Group financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (1) the historical financial position, results of operations and cash flows of the businesses that comprise each of the Groups, (2) any assets and liabilities (including contingent liabilities) which have been attributed to any Group from any other Group, and (3) with respect to the TDS Group, the Retained Interest in each of the Tracking Groups. The effects of the issuance of the Tracking Stocks have not been reflected in these historical financial statements. Financial effects arising from the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group that affect the consolidated results of operations or financial condition of the Company could affect the results of operations or financial condition of the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, or could affect the market price of any or all classes of Common Stock. In addition, any net losses of the Company or the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on any class of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the Aerial Group financial information. The management and accounting policies applicable to the preparation of the financial statements of the TDS Group could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of Telephone and Data Systems, Inc. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $144 million for the Aerial Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. The TDS Board currently intends to retain future earnings, if any, for the development of the business of the Aerial Group and does not anticipate paying dividends on the Aerial Group Shares in the foreseeable future. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group IV-21 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. (a) DEVELOPMENT STAGE COMPANY Effective with the second quarter of 1997, the Aerial Group ceased to be a development stage company and presents its 1997 results of operations, cash flows and financial position in a manner similar to other operating enterprises within the industry. (b) PRINCIPLES OF CONSOLIDATION The accounting policies of the Aerial Group conform to generally accepted accounting principles. The financial statements include the accounts of the Aerial Group. All material intercompany balances and transactions have been eliminated. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts reported in prior years have been reclassified to conform to the current year presentation. (c) REVENUE RECOGNITION AND INVENTORY Revenues from operations consist of charges to customers for monthly access, airtime, value-added services and long-distance charges. Revenues are recognized as the services are rendered. Unbilled revenues, resulting from PCS services provided from the billing cycle date to the end of each month, are estimated and recorded. Revenues from operations also consist of equipment sales to national retailers, independent agents and end user customers. Revenues from equipment sales are recognized upon the shipment of goods to retailers and independent agents or upon sale through direct distribution channels to end user customers. Handset inventory is stated at current replacement cost. (d) ADVERTISING COSTS The Aerial Group expenses advertising costs as incurred. Beginning with the launch of service during the second quarter of 1997 the Aerial Group's advertising costs are included in Marketing and selling expenses. Prior to launching service, the Aerial Group was a development stage enterprise and advertising costs were included in PCS Development Costs. (e) PENSION PLAN Effective July 1, 1995, the Aerial Group began providing pension benefits for its employees under a qualified, noncontributory, defined contribution pension plan. Under this plan, pension benefits and costs are calculated separately for each participant and are funded currently. Pension costs were $326,000, $72,000 and $11,000 in 1997, 1996 and 1995, respectively. (f) CASH AND CASH EQUIVALENTS, TEMPORARY INVESTMENTS AND MARKETABLE SECURITIES Cash and cash equivalents consists of cash on hand and those short-term, highly-liquid investments with original maturities of three months or less. Those investments with original maturities of greater than three but less than twelve months are classified as temporary investments. Temporary investments are stated at cost. Those investments with original maturities of more than twelve months are classified as marketable securities and are stated at amortized cost. The Aerial Group's investments in marketable non-equity securities, included in Other Investments, have maturities of one to five years and are classified as held-to-maturity. IV-22 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The carrying amounts of cash and cash equivalents and temporary investments approximate fair value due to the short-term nature of these investments. The amortized cost of the marketable non-equity securities approximate their aggregate fair value. (g) PROPERTY AND EQUIPMENT Property and equipment is stated at cost. Depreciation is provided based on the straight-line method over the estimated useful lives of the respective assets, generally ten years for network assets and five years for information system assets and office equipment. Leasehold improvements are amortized over ten years or the lease term, whichever is shorter. Property and equipment consists of:
DECEMBER 31, ---------------------- 1997 1996 ----------- --------- (DOLLARS IN THOUSANDS) Network.............................................................................................. $ 514,525 $ -- Information systems.................................................................................. 83,950 15,951 Office equipment..................................................................................... 15,800 3,180 Leasehold improvements and other..................................................................... 8,466 1,442 ----------- --------- 622,741 20,573 Accumulated depreciation............................................................................. (38,018) (1,981) ----------- --------- Property and equipment-net......................................................................... $ 584,723 $ 18,592 ----------- --------- ----------- ---------
(h) WORK IN PROCESS Work in process includes expenditures for the design, construction and testing of the Aerial Group's PCS networks as well as the cost to relocate dedicated private microwave links currently operating in the Aerial Group's spectrum in its MTAs. Work in process also includes the costs associated with developing information systems. The Aerial Group capitalizes interest on such expenditures where appropriate. When the assets are placed in service, the Aerial Group transfers the assets to the appropriate property and equipment category. (i) INVESTMENT IN PCS LICENSES Investment in licenses is recorded at historical cost, which includes the purchase price of the licenses acquired by the Aerial Group in the PCS auction plus capitalized interest of $16.6 million incurred while readying the licenses in the Aerial Group's MTAs for use. The Aerial Group recorded capitalized interest through December 31, 1995, when TDS contributed approximately $289.2 million in equity capital to the Aerial Group for the original cost of its licenses. The Aerial Group began amortizing the licenses straight-line over 40 years upon commencement of service in each respective MTA. Accumulated amortization on the licenses at December 31, 1997, totaled $4.5 million. (j) IMPAIRMENT OF LONG-LIVED ASSETS Effective January 1, 1996, the Aerial Group implemented the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Under SFAS No. 121, the Aerial Group is required to review long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the book value of a long-lived asset is not recoverable. An impairment loss would be recognized whenever the review demonstrates that the book value of a long-lived asset is not recoverable. The implementation of SFAS No. 121 did not have an impact on the Aerial Group's financial position or results of operations. (k) MICROWAVE RELOCATION COSTS PAYABLE Microwave relocation costs payable represent obligations of the Aerial Group to pay its share of the costs to relocate dedicated private microwave links currently operating in the Aerial Group's spectrum in its MTAs. The IV-23 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) carrying amount reported in the balance sheet for microwave relocation costs payable approximates fair value because of the short maturity of those instruments. (l) PRO FORMA NET (LOSS) AND (LOSS) PER SHARE Pro forma net (loss) attributable to the Aerial Group and to the TDS Group through the Retained Interest assumes that the Aerial Merger has not taken place and therefore 75% of Net (Loss) is attributable to the Aerial Group Shares and 25% of the Net (Loss) is attributable to the Retained Interest for the TDS Group. A portion of the Net (Loss) is allocated to the minority public shareholders of Aerial prior to attributing the Net (Loss) to the Aerial Group and the TDS Group through the Retained Interest. (Loss) per Share was omitted from the historical statements of operations since the Aerial Group Shares were not a part of the equity structure of TDS and the Articles of Incorporation had not been amended to allow for the issuance of the Aerial Group Shares for the periods presented. (m) SUPPLEMENTAL CASH FLOW DISCLOSURES The following summarizes interest and income taxes paid and certain noncash transactions.
YEAR ENDED DECEMBER 31, --------------------------------- 1997 1996 1995 --------- --------- ----------- (DOLLARS IN THOUSANDS) Income tax benefits--cash payments from TDS resulting from taxable losses generated by the Aerial Group in prior years......................................................... $ -- $ 15,598 $ 185 Interest paid to non-affiliates.......................................................... 428 1,107 -- Interest and guarantee fees paid to TDS or converted to debt under the Revolving Credit Agreement............................................................................... 24,297 3,496 17,699 TDS equity contribution-conversion of debt under the Revolving Credit Agreement to equity and receipt of note receivable-affiliate................................................ -- -- 289,194
In 1997, $113.0 million in additions to property and equipment (amounts in service and work in process, collectively) were financed through a combination of long-term debt, accounts payable-trade, microwave relocation costs payable and prepaid network infrastructure costs. In 1996, $199.6 million in additions to property and equipment and prepaid network infrastructure costs were financed through a combination of long-term debt, accounts payable-trade and other and microwave relocation costs payable. The Aerial Group incurred interest charges totaling $33.1 million in 1997. In 1997, the interest charges were comprised of $21.0 million paid to TDS relating to the Revolving Credit Agreement (See Note 5--Revolving Credit Agreement), $3.3 million paid to TDS for guarantee fees on the Series A Zero Coupon Notes and obligations under the Nokia Credit Agreement (See Note 6--Long-Term Debt), $0.4 million paid to Nokia for interest charges relating to the Credit Agreement, $8.3 million in accrued interest on the Series A Zero Coupon Notes and $0.1 million in other interest charges. Of these amounts, the Aerial Group capitalized $6.0 million relating to its work in process expenditures. The remaining $27.1 million was charged to expense. In 1996, the Aerial Group incurred interest charges of $4.0 million. The interest charges were comprised of $2.0 million paid to TDS relating to the Revolving Credit Agreement, $0.6 million paid to TDS for guarantee fees on the Series A Zero Coupon Notes and obligations under the Nokia Credit Agreement, $70,000 paid to Nokia for interest charges relating to the Credit Agreement and $1.3 million in accrued interest on the Series A Zero Coupon Notes. Of these amounts, the Aerial Group capitalized $1.2 million relating to its work in process expenditures. The remaining $2.8 million was charged to expense. During 1995, the Aerial Group incurred interest charges of $17.7 million related to its Revolving Credit Agreement with TDS. Of this amount, the Aerial Group capitalized $16.6 million relating to the development of its PCS licenses. The remaining $1.1 million was charged to expense. IV-24 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 4 INCOME TAXES Aerial entered into a tax allocation agreement with TDS under which Aerial will continue to join in filing consolidated federal income tax returns with the TDS affiliated group unless TDS's ownership of Aerial falls beneath 80%. For 1995, TDS reimbursed Aerial for the reduction in the provision for federal income taxes reflected in TDS's consolidated statements of income resulting from the inclusion of Aerial in the TDS affiliated group. Aerial had recorded these amounts in "Income tax refund receivable-affiliate" (See Note 3 (m)--Summary of Significant Accounting Policies--Supplemental cash flow disclosures). For tax years beginning after December 31, 1995, TDS no longer reimburses Aerial on a current basis for losses or credits used by the TDS affiliated group. Instead, Aerial is compensated (by an offset to amounts Aerial would otherwise be required to pay to TDS for federal income taxes) for TDS's use of tax benefits at such time as Aerial could utilize such benefits on a separate return basis. Aerial will be required to pay TDS an amount equal to the greater of the federal income tax liability of Aerial, calculated as if it were a separate affiliated group (including any minimum tax liability, notwithstanding the absence of consolidated group liability for minimum tax), or the tax calculated using the highest marginal tax rate (before taking into account tax credits) of the TDS affiliated group. Subject to the completion of the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and Aerial. See Note 1--Proposed TDS Corporate Restructuring for a discussion of the proposed merger. The Aerial Group records all deferred tax liabilities or assets for the deferred tax consequences of all temporary differences. Income tax provisions are summarized below:
YEAR ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 --------- --------- ---------- (DOLLARS IN THOUSANDS) Federal income tax provision (benefit): Current................................................................................... $ -- $ (3,098) $ (12,502) Deferred.................................................................................. 1,561 1,671 9,574 State income tax provision: Current................................................................................... -- -- -- Deferred.................................................................................. 245 560 832 --------- --------- ---------- Income tax expense (benefit)................................................................ $ 1,806 $ (867) $ (2,096) --------- --------- ---------- --------- --------- ----------
The temporary differences which gave rise to significant portions of the net deferred tax liability were as follows:
DECEMBER 31, ------------------------ 1997 1996 ------------ ---------- (DOLLARS IN THOUSANDS) Deferred tax asset: Net operating loss carryforwards.................................................................. $ 171,896 $ 26,419 Less: valuation allowance......................................................................... (129,412) (15,029) ------------ ---------- Total deferred tax asset............................................................................ 42,484 11,390 ------------ ---------- Deferred tax liability: Licenses.......................................................................................... 19,025 13,650 Property and equipment............................................................................ 19,004 435 Partnership investment............................................................................ 9,235 2,573 Deferred charges-interest......................................................................... 6,088 6,088 Other............................................................................................. 2,911 617 ------------ ---------- Total deferred tax liability........................................................................ 56,263 23,363 ------------ ---------- Net deferred tax liability.......................................................................... $ 13,779 $ 11,973 ------------ ---------- ------------ ----------
The Aerial Group records a deferred tax asset associated with net operating loss carryforwards and then assesses the need for any valuation allowance associated with those carryforwards. At December 31, 1997, the IV-25 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 4 INCOME TAXES (CONTINUED) federal net operating loss carryforward available to offset future taxable income is $377.8 million and expires between 2012 and 2013. The amount of state net operating loss carryforward available to offset future taxable income is $552.9 million and expires between 1998 and 2013. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. During 1997, the valuation allowance increased $114.4 million primarily due to the Aerial Group's increased net operating losses. The statutory federal income tax rate is reconciled to the Aerial Group's effective income tax rate below:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- Statutory federal income tax rate............................................................ 35.0% 35.0% 35.0% State income taxes, net of federal benefit................................................... (0.1) (0.9) (6.3) Effects of valuation allowance on deferred tax asset......................................... (35.6) (29.7) -- Other........................................................................................ -- (2.2) (4.2) ----------- ----------- --- Effective income tax rate.................................................................... (0.7)% 2.2% 24.5% ----------- ----------- --- ----------- ----------- ---
NOTE 5 REVOLVING CREDIT AGREEMENT Aerial entered into a Revolving Credit Agreement with TDS on August 1, 1995, as amended, under which all of the outstanding obligations of Aerial to TDS are incorporated. At December 31, 1997, Aerial had secured from TDS an agreement to borrow up to $475 million under the Revolving Credit Agreement. Pursuant to the Revolving Credit Agreement, the Aerial Group may borrow from TDS at an interest rate equal to 1.5% above prime rate until the principal amount becomes due, and pay on demand an interest rate equal to 3.5% above such prime rate on any overdue principal or overdue installment of interest. The advances made under the Revolving Credit Agreement are unsecured. Interest on the balance due under the Revolving Credit Agreement is payable quarterly and no principal is payable until its maturity, which is December 31, 1999. The terms of the Revolving Credit Agreement also include, among others, restrictions on incurring certain additional indebtedness and on paying dividends. The total amount advanced to the Aerial Group under the Revolving Credit Agreement as of December 31, 1997, was $448.2 million. The carrying value of the Aerial Group's borrowings under the Revolving Credit Agreement approximates the fair value of the borrowings, as the Revolving Credit Agreement is variable debt with the interest rate based on the prime lending rate. Subject to the completion of the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and Aerial. See Note 1--Proposed TDS Corporate Restructuring for a discussion of the proposed merger. NOTE 6 LONG-TERM DEBT On November 4, 1996, Aerial issued $226.2 million in aggregate principal amount at maturity Series A Zero Coupon Notes ("Series A Notes") due in 2006. The issue price of the Series A Notes was $100 million and there is no periodic payment of interest. The per annum yield to maturity on the Series A Notes is 8.34% (computed on a semi-annual bond equivalent basis) and the effective rate is 8.09%. The proceeds of the sale of the Series A Notes were paid to Nokia Telecommunications Inc. ("Nokia") in satisfaction of all then outstanding obligations and future obligations up to $100 million of Aerial under the June 19, 1996, Credit Agreement, as amended, with Nokia (the "Credit Agreement" or "Nokia Credit Agreement"). The excess of the proceeds from the sale of the Series A Notes over Aerial's current obligations (i.e., financed purchases under the Credit Agreement) to Nokia was recorded as "prepaid network infrastructure costs". Nokia paid Aerial monthly interest on the unused portion of the proceeds from the Series A Notes. At December 31, 1996, Aerial had recorded $70.3 million in prepaid network infrastructure costs. Aerial paid Nokia for future equipment purchases by reducing the amount of the prepaid balance by the cost of the equipment purchased. Prepaid network infrastructure costs were fully utilized for the purchase of equipment by the end of August 1997. IV-26 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 6 LONG-TERM DEBT (CONTINUED) The Series A Notes are unsecured obligations of Aerial and rank in the same priority with all other unsecured and unsubordinated indebtedness of Aerial. The Series A Notes and obligations of Aerial under the Credit Agreement are fully and unconditionally guaranteed by TDS at an annual fee rate of 3%. Guarantee fees owed TDS are payable semiannually. The Series A Notes are subject to optional redemption by Aerial after five years from the date of issuance at redemption prices which reflect original issue discount accrued since issuance. At December 31, 1997, the Aerial Group had a balance of $196.4 million in "long-term debt" which consisted of $112.1 million related to the Series A Notes and $84.3 million in obligations under the Nokia Credit Agreement. Aerial pays interest monthly to Nokia on the outstanding balance under the Credit Agreement. At December 31, 1996, the balance in long-term debt was $103.7 million which related entirely to the Series A Notes. The carrying value of Aerial's Series A Notes is greater than its fair value, estimated to be $108.8 million. The fair value was estimated using discounted cash flow analysis. The carrying value of Aerial's obligations under the Nokia Credit Agreement approximates the fair value of the obligations, as the Credit Agreement is variable debt with the interest rate based on the 30 day London Interbank Offered Rate rate plus 0.32%. NOTE 7 RELATED PARTY TRANSACTIONS The Aerial Group is billed for all services it receives from TDS and its subsidiaries, consisting primarily of information processing and general management services. Such billings are based on expenses specifically identified to the Aerial Group and on allocations of common expenses. Such allocations are based on the relationship of the Aerial Group's assets, employees, investment in plant and expenses to the total assets, employees, investment in plant and expenses of TDS. Management believes the method used to allocate common expenses is reasonable and that all expenses and costs applicable to the Aerial Group are reflected in the accompanying financial statements on a basis which is representative of what they would have been if the Aerial Group operated on a stand alone basis. Billings to the Aerial Group from TDS totaled $3.9 million, $2.0 million and $1.2 million during 1997, 1996 and 1995, respectively. In 1996, TDS completed development of a new financial reporting system for all of its subsidiaries, including the Aerial Group. The Aerial Group recorded approximately $2.4 million related to this system in "Property and Equipment." In 1997 and 1996, the Aerial Group deposited its excess cash in a cash management program administered by TDS. Deposits made into the program were generally available to the Aerial Group with interest each month equal to 30 day commercial paper rates plus 0.25%. On December 31, 1995, the Aerial Group received additional equity funding of $289.2 million from TDS. The Aerial Group recorded the $289.2 million in "Aerial Communications Group Equity." Subject to the completion of the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and Aerial. See Note 1--Proposed TDS Corporate Restructuring for a discussion of the proposed merger. NOTE 8 COMMITMENTS The costs of development, construction, start-up and post-launch activities of the Aerial Group require substantial capital. From inception through December 31, 1997, the Aerial Group had expended approximately $304.4 million for its six licenses, including capitalized interest, approximately $642.1 million for all other capital expenditures and incurred cumulative net losses of $292.9 million. At December 31, 1997, the Aerial Group had orders totaling approximately $12.9 million with Nokia and certain tower vendors for infrastructure equipment as part of the Aerial Group's initial build out of its PCS networks. Also at December 31, 1997, the Aerial Group had orders totaling approximately $27.1 million with various handset vendors for handsets and accessories. The Aerial Group expects to incur significant operating losses and to generate negative cash flow from operating activities during the next several years as it continues to build its PCS customer base. The Aerial Group estimates that its aggregate capital IV-27 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 8 COMMITMENTS (CONTINUED) requirements for 1998 will total approximately $310 million, with $75 million needed for capital additions and $235 million needed to fund operations. The Aerial Group has leases for certain office facilities, warehouses, retail store locations and cell sites which are classified as operating leases. For the years ended December 31, 1997, 1996 and 1995 rent expense for term leases was $10.3 million, $2.1 million and $0.2 million, respectively, and for cancelable leases $1.1 million, $0.5 million and $0.1 million, respectively. At December 31, 1997, the aggregate minimum rental commitments under noncancelable operating leases for the years 1998 through 2002 and 2003 and thereafter, are approximately $15.5 million, $15.5 million, $15.2 million, $14.2 million, $9.3 million and $14.3 million, respectively. LEGAL PROCEEDINGS. On January 5, 1998, an individual, who claims to be a holder of Aerial Common Shares, filed a putative class action complaint on behalf of common stockholders of Aerial in the Court of Chancery of the State of Delaware in New Castle County. The complaint names as defendants, TDS, Aerial and the directors of TDS and Aerial. The complaint alleges a breach of fiduciary duties by the defendants and seeks to have the Aerial Merger enjoined or, if it is consummated, to have it rescinded and to recover unspecified damages, fees and expenses. A virtually identical complaint has been filed by a second individual. None of the defendants have been served with this complaint. The Aerial Group intends to vigorously defend against these lawsuits. NOTE 9 AERIAL COMMUNICATIONS GROUP EQUITY The changes in the Aerial Group equity for the periods presented is as follows:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Balance at beginning of period......................................................... $ 437,785 $ 281,282 $ (1,444) Net (Loss)............................................................................. (247,057) (37,921) (6,468) Equity contribution.................................................................... -- -- 289,194 Initial Public Offering................................................................ -- 194,204 -- Other.................................................................................. 1,699 220 -- ----------- ----------- ----------- Balance at end of period............................................................... $ 192,427 $ 437,785 $ 281,282 ----------- ----------- ----------- ----------- ----------- -----------
TAX-DEFERRED SAVINGS PLAN Effective July 1, 1995, the Aerial Group adopted the TDS Tax-Deferred Savings Plan (the "Savings Plan"), a qualified profit sharing plan pursuant to Sections 401(a) and 401(k) of the Internal Revenue Code. As amended on August 15, 1996, participating employees have the option of investing their contributions in Aerial Common Shares, TDS Common Shares, United States Cellular Corporation (a subsidiary of TDS) Common Shares, American Paging, Inc. (a subsidiary of TDS) Common Shares, or five other non-affiliated funds. The Aerial Group has reserved 300,000 Aerial Common Shares for issuance under the Savings Plan. Employer matching contributions are made in Aerial Common Shares. The Aerial Group employees were issued 184,533 Aerial Common Shares in 1997 and 23,460 Common Shares in 1996 in connection with the Savings Plan. STOCK-BASED COMPENSATION PLANS The Aerial Group accounts for stock options and its employee stock purchase plan under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). No compensation costs have been recognized for the employee stock purchase plan. Some options granted in 1997 had exercise prices that were less than the quoted market price of Aerial's stock on the date they were granted. In accordance with APB 25, compensation expense of $26,000 was recorded related to these options in 1997. IV-28 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9 AERIAL COMMUNICATIONS GROUP EQUITY (CONTINUED) Had compensation expense for all plans been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", the Aerial Group's net (loss) would have been increased to the following pro forma amounts:
1997 1996 ------------ ---------- (DOLLARS IN THOUSANDS) Net (Loss) As Reported.................................................................................. $ (247,057) $ (37,921) Pro Forma.................................................................................... $ (250,957) $ (38,323)
A summary of the status of the Aerial Group's stock option plan at December 31, 1996 and 1997, and changes during the years ended is presented in the table and narrative below:
WEIGHTED AVERAGE -------------------- REMAINING NUMBER OF OPTION FAIR CONTRACTUAL SHARES PRICES VALUES LIFE ----------- --------- --------- --------------- Outstanding January 1, 1996................................................. -- Granted..................................................................... 310,305 $ 17.00 $ 7.41 ----------- Outstanding December 31, 1996 (61,397 exercisable at $17.00)................ 310,305 $ 17.00 9.33 Years Granted..................................................................... 1,137,435 $ 9.46 $ 4.42 Exercised................................................................... (2,553) $ 4.94 Forfeited................................................................... (56,450) $ 14.44 ----------- Outstanding December 31, 1997 (633,030 exercisable from $4.94 to $17.00).... 1,388,737 $ 10.95 8.51 Years ----------- -----------
EMPLOYEE STOCK OPTIONS. Effective April 25, 1996, the Aerial Group began providing long-term incentive benefits for its senior managers by adopting the Aerial Communications, Inc. Long-Term Incentive Plan (the "Stock Option Plan"). The Aerial Group has reserved 1.5 million Common Shares for option grants. During 1997, the Aerial Group employees were issued 767 Common Shares in connection with the Stock Option Plan. The options are exercisable over a specified period not in excess of ten years from the date they are granted. Options granted in 1996 and 1997 expire in 2006 and 2007, or the date of the employee's termination of employment, if earlier. Most options vest annually over five years in 20% increments, from December 15, 1996, through December 15, 2000. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1997 and 1996, respectively: risk free interest rates of 6.59% and 5.53%; dividend yield of 0%; expected lives of 9.4 years and 7.4 years; and volatility of 51.32% and 26.36%. EMPLOYEE STOCK PURCHASE PLAN. The Aerial Group adopted the 1996 APTI Employee Stock Purchase Plan (the "Stock Purchase Plan") effective October 1, 1996. The Aerial Group has reserved 200,000 Common Shares for sale to the employees of the Aerial Group and its subsidiaries in connection with the Stock Purchase Plan. Shares can be purchased twice a year and the price per share is 85% of the stock's closing price on designated purchase dates. During 1997, the Aerial Group employees were issued 59,822 Common Shares in connection with the Stock Purchase Plan. The fair value of the employees' purchase rights was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1997: risk free interest rate of 6.21%; dividend yield of 0%; expected life of 0.8 years; and volatility of 51.18%. NON-EMPLOYEE DIRECTOR COMPENSATION In April 1997, the Aerial Group established the Compensation Plan For Non-Employee Directors (the "Compensation Plan"). Under the Compensation Plan, Aerial's independent directors are to be paid an annual fee of $20,000 that is payable half in cash and half in Aerial stock. The number of Common Shares to be delivered to each independent director is based upon the average market value of Aerial's stock for a certain period prior to the date of the Annual Shareholder's Meeting. The Aerial Group has reserved 20,000 Aerial Common Shares for issuance to IV-29 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9 AERIAL COMMUNICATIONS GROUP EQUITY (CONTINUED) Aerial's independent director's under the Compensation Plan. In 1997, 6,003 shares were issued to non-employee directors under this plan. INITIAL PUBLIC OFFERING Aerial sold 12.3 million Common Shares at a price of $17 per share in an initial public offering on April 25, 1996. Proceeds of the offering, net of underwriting discounts and commissions, totaled $195.3 million. The Aerial Group used a portion of the net proceeds to repay TDS approximately $64.1 million, representing the then outstanding balance (including accrued interest) under the Revolving Credit Agreement, and used the balance of the funds to partially finance construction, development and operating costs incurred to establish its PCS networks. Proceeds of the offering were fully utilized by the end of January 1997. RECAPITALIZATION On March 28, 1996, TDS, as the sole shareholder of Aerial at such time, executed a consent to action in lieu of a meeting, voting all 1,000 shares of common stock of Aerial then outstanding for the approval of a Restated Certificate of Incorporation of Aerial. Such Restated Certificate of Incorporation authorized (a) 60 million Common Shares, $1.00 par value per share; (b) 60 million Series A Common Shares, $1.00 par value per share; (c) 60 million Series B Common Shares, $1.00 par value per share; and (d) 10 million Preferred Shares, $1.00 par value per share. Upon the filing of the Restated Certificate of Incorporation with the Secretary of State of the State of Delaware on April 19, 1996, the 1,000 shares of Common Stock of Aerial theretofore held by TDS were converted into 19.1 million Common Shares and 40 million Series A Common Shares of Aerial. SERIES A COMMON SHARES Series A Common Shares are convertible on a share-for-share basis into Common Shares and are entitled to 15 votes per share. No Series A Common Shares were converted during 1997 or 1996. NOTE 10 SUBSEQUENT EVENT Pursuant to the Credit Agreement, on February 5, 1998, Aerial issued $220.0 million in aggregate principal amount at maturity Series B Zero Coupon Notes ("Series B Notes") due in 2008. The issuance of the Series B Notes represents the final issuance of zero coupon notes under the Credit Agreement. The issue price of the Series B Notes was $100 million and there is no periodic payment of interest. The per annum yield to maturity on the Series B Notes is 8.05% (computed on a semi-annual bond equivalent basis). The proceeds from the sale of the Series B Notes were paid to Nokia in satisfaction of all then outstanding obligations and future obligations of the Aerial Group (to the extent not satisfied from the proceeds of the sale of the Series A Notes) up to $100 million under the Credit Agreement. The Series B Notes are unsecured obligations of Aerial and rank in the same priority with all other unsecured and unsubordinated indebtedness of Aerial. The Series B Notes are fully and unconditionally guaranteed by TDS at an annual fee rate of 3%. Guarantee fees owed TDS are payable semiannually. The Series B Notes are subject to optional redemption by Aerial after five years from the date of issuance at redemption prices which reflect original issue discount accrued since issuance. In February 1998, the Aerial Group secured from TDS a $50 million increase in the amount it may borrow under the Revolving Credit Agreement to $525 million. IV-30 THE AERIAL COMMUNICATIONS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 11 CONSOLIDATED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
QUARTER ENDED ---------------------------------------------- MARCH 31 JUNE 30 SEPT. 30 DEC. 31 ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) 1997 Operating Revenues......................................................... $ -- $ 7,143 $ 18,648 $ 30,161 Operating (Loss)........................................................... (21,614) (51,633) (64,537) (80,381) Net (Loss)................................................................. $ (22,340) $ (55,475) $ (76,598) $ (92,644) 1996 Operating Revenues......................................................... $ -- $ -- $ -- $ -- Operating (Loss)........................................................... (5,746) (7,761) (10,805) (19,638) Net (Loss)................................................................. $ (6,671) $ (7,206) $ (9,829) $ (14,215)
IV-31 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 the Aerial Communications Group (representing a business unit of Telephone and Data Systems, Inc.) as of December 31, 1997 and 1996, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Telephone and Data Systems, Inc. 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 the Aerial Communications Group as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois January 28, 1998 (Except with respect to the matters discussed in Note 10, as to which the date is February 5, 1998) IV-32 ANNEX V DESCRIPTION OF THE TDS GROUP The TDS Group is a residual group which is primarily intended to reflect (i) retained interests (the "Retained Interests") in the Company's common equity interest in each of the United States Cellular Group (the "Cellular Group"), the TDS Telecommunications Group (the "Telecom Group") and the Aerial Communications Group (the "Aerial Group") (collectively, the "Tracking Groups"); (ii) the effects of certain corporate management, intercompany financing, cash management and intercompany income tax allocation activities (the "Corporate Operations"); and (iii) the operations of American Paging, Inc., currently an 82%-owned subsidiary of TDS ("American Paging") and all other businesses and investments of the Company not attributed to a Tracking Group. Capitalized terms used herein are used as defined elsewhere in this Proxy Statement/Prospectus. See "Exhibit G - -Index of Certain Defined Terms." In structuring the terms of the Tracking Stock Proposal, the Board determined that the retention by the TDS Group of Retained Interests in the Cellular Group, the Telecom Group and the Aerial Group was appropriate. In making this determination, the Board concluded that it would be desirable for shareholders to have the opportunity of continuing to maintain a common equity investment in all of the businesses of the Company and its subsidiaries by retaining ownership of the Common Shares and Series A Common Shares. Accordingly, the Tracking Stock Proposal contemplates that, upon the completion of all of the Transactions as contemplated, the Series A Common Shares and the Common Shares of TDS Delaware would represent a common equity interest in the TDS Group. Following such Transactions, the Series A Common Shares and Common Shares of TDS Delaware are intended to reflect the interest of the TDS Group in the performance of each of the Tracking Groups of TDS, the effects of the Corporate Operations and the performance of American Paging and all other interests held by the Company which are not attributed to a Tracking Group. Holders of Common Shares and Series A Common Shares will continue to be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Common Shares will reflect the separate performance of the TDS Group or its Retained Interests in the Tracking Groups. The TDS Group would also include such other assets and liabilities of the Company as the Board may in the future determine to attribute to the TDS Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the TDS Group, as determined by the Board. The Board intends to adopt a policy providing that the TDS Group may own, invest or otherwise have an interest in, lease, operate or manage any business other than a Cellular Business, a Telecom Business or a PCS Business. At the present time, the TDS Group owns interests in businesses which may be considered to include such other businesses. The TDS Group will continue to be permitted to operate these existing businesses. Except with respect to such existing businesses, the TDS Group will generally not engage in the Cellular Business, the Telecom Business or the PCS Business, except through the Retained Interests, unless the Board determines to permit the TDS Group to pursue such opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the TDS Group in the future would not include assets and liabilities of the Cellular Group, the Telecom Group or the Aerial Group. The Board also determined that it would be desirable for the Company to have a Group such as the TDS Group which could enter into new ventures and possibly create additional tracking stocks for such ventures by designating series of Undesignated Shares. For example, such new shares of tracking stock could be distributed to the holders of Common Shares and Series A Common Shares upon the creation or separation of a business, sold for cash in a public or private offering to finance a new business for the benefit of the TDS Group or delivered in connection with the acquisition of a business by the TDS Group. The Company has no current plans to create any additional tracking stocks or to make any material investments in any new businesses. RETAINED INTERESTS Upon completion of all of the Transactions as described in this Proxy Statement/Prospectus, the outstanding shares of each class of Tracking Stock would initially represent in the aggregate an approximately 80% interest in the related Tracking Group. Approximately 20% of the common shareholders' value of the Company in each Tracking Group would initially be retained as Retained Interests of the TDS Group. The following briefly describes each of the Tracking Groups of TDS. V-1 THE CELLULAR GROUP. The Cellular Group consists of the Company's interest in U.S. Cellular, currently an 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties. TDS has made an offer to acquire all of the outstanding shares of common stock of U.S. Cellular which it does not own in exchange for Cellular Group Shares, in which case U.S. Cellular would become a wholly-owned subsidiary of TDS. The U.S. Cellular Restated Certificate of Incorporation currently provides that U.S. Cellular may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of cellular telephone systems (the "Cellular Business"), unless it first obtains the written consent of the Company. If U.S. Cellular becomes a wholly-owned subsidiary of the Company as contemplated, this provision is expected to be eliminated from the U.S. Cellular Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Cellular Group. Accordingly, the Cellular Group will generally only engage in the Cellular Business, unless the Board determines to permit the Cellular Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Cellular Group in the future would not include assets and liabilities of the TDS Group, the Telecom Group or the Aerial Group. A more complete description of the Cellular Group is included in Annex II of this Proxy Statement/Prospectus. THE TELECOM GROUP. The Telecom Group consists of the Company's interest in TDS Telecom, a wholly-owned subsidiary of the Company which operates landline telephone companies, and includes the allocation of certain corporate debt. The Board intends to adopt a policy providing that the Telecom Group may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of landline telephone systems (the "Telecom Business"), unless it first obtains the consent of the Board. At the present time, the Telecom Group operates certain businesses which are not considered Telecom Business. The Telecom Group will initially be permitted to continue to operate these existing businesses. Except with respect to such existing businesses, the Telecom Group will generally only engage in the Telecom Business, unless the Board determines to permit the Telecom Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Telecom Group in the future would not include assets and liabilities of the TDS Group, the Cellular Group or the Aerial Group. A more complete description of the Telecom Group is included in Annex III of this Proxy Statement/Prospectus. THE AERIAL GROUP. The Aerial Group consists of the Company's interest in Aerial, currently an 82%-owned subsidiary of the Company which is developing broadband personal communications services. TDS has made an offer to acquire all of the outstanding shares of common stock of Aerial which it does not own in exchange for Aerial Group Shares, in which case Aerial would become a wholly-owned subsidiary of TDS. The Aerial Restated Certificate of Incorporation currently provides that Aerial may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of personal communications services (the "PCS Business"), unless it first obtains the written consent of the Company. If Aerial becomes a wholly-owned subsidiary of the Company as contemplated, this provision is expected to be eliminated from the Aerial Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Aerial Group. Accordingly, the Aerial Group will generally only engage in the PCS Business, unless the Board determines to permit the Aerial Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Aerial Group in the future would not include assets and liabilities of the TDS Group, the Cellular Group or the Telecom Group. A more complete description of the Aerial Group is included in Annex IV of this Proxy Statement/Prospectus. NUMBER OF SHARES ISSUABLE WITH RESPECT TO RETAINED INTEREST. The amount of the Retained Interest in a Tracking Group at any point in time would be expressed in terms of the "Number of Shares Issuable With Respect to Retained Interest," which is intended to provide a measure of the Retained Interest on a basis as if the TDS Group held shares of Tracking Stock in the Tracking Groups. The Retained Interest will not be represented by issued and outstanding shares of Tracking Stock. Accordingly, the TDS Group will not have any voting rights with respect to any Retained Interest, and the outcome of any vote of any class of Tracking Stock would be determined by the holders of the outstanding shares of such Tracking Stock. The Number of Shares Issuable with Respect to Retained Interest would (i) be adjusted from time to time as appropriate to reflect (a) subdivisions (by stock split or otherwise) and combinations (by reverse stock split or V-2 otherwise) of any Tracking Stock, (b) dividends or distributions payable in shares of Tracking Stock to holders of such Tracking Stock and (c) reclassifications of Tracking Stock and (ii) be decreased by the number of shares of Tracking Stock (a) issued upon conversion, exercise or exchange of Convertible Securities that are attributed to the TDS Group or (b) issued by the Company as a dividend or distribution or by reclassification or exchange to holders of Common Shares, Series A Common Shares or any issued Special Common Shares. In the event of any dividend or other distribution paid or distributed in respect of the outstanding shares of any class of Tracking Stock (other than in shares of Tracking Stock, which will result in the adjustment to the Number of Shares Issuable with Respect to Retained Interest, as described in the preceding paragraph), the TDS Group's combined financial statements would be credited, and the related Tracking Group's combined financial statements would be charged (in addition to the charge for such dividend or other distribution paid upon outstanding shares of Tracking Stock), with an amount equal to the product of (i) the aggregate amount of such dividend or other distribution paid or distributed in respect of outstanding shares of Tracking Stock (including any dividend related to the Fair Value of the Net Proceeds from the Disposition of all or substantially all of the assets and properties of a Tracking Group), times (ii) a fraction, the numerator of which is the Retained Interest Fraction and the denominator of which is the Outstanding Interest Fraction for such Tracking Group. The "Outstanding Interest Fraction" represents the percentage interest in the common shareholders' equity value of the Company attributable to a Tracking Group that is represented at any time by the outstanding shares of Tracking Stock, and the "Retained Interest Fraction" represents any remaining percentage interest in the common shareholders' equity value of the Company attributable to a Tracking Group that is attributed to the TDS Group by virtue of a Retained Interest. Assuming no Inter-Group Interest Fractions, the sum of the Outstanding Interest Fraction and the Retained Interest Fraction for a Tracking Group will always equal 100%. The Board could, in its sole discretion, determine from time to time to have the TDS Group contribute cash or other property as additional equity to any Tracking Group, and have this be reflected as an increase in the Number of Shares Issuable with Respect to Retained Interest. In such event, the Retained Interest Fraction with respect to such Tracking Group will increase and the related Outstanding Interest Fraction will decrease accordingly. The Board could, in its sole discretion, determine from time to time to transfer cash or other property of a Tracking Group to the TDS Group and have such transfer reflected as a reduction in the Retained Interest, in which case the Number of Shares Issuable with Respect to Retained Interest would be decreased. In such event, such Retained Interest Fraction would decrease and the related Outstanding Interest Fraction would increase accordingly. In general, if the Retained Interest is increased by a transfer of funds or other assets from the TDS Group to a Tracking Group, the Number of Shares Issuable with Respect to Retained Interest would be increased by an amount determined by dividing the amount of funds or value of assets transferred by the Market Value of a share of Tracking Stock of such Group as of the date of such transfer. Any transfer of funds or other assets from a Tracking Group to the TDS Group in respect of a decrease in the Number of Shares Issuable with Respect to Retained Interest would be similarly calculated. To the extent outstanding shares of Tracking Stock are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group, the Number of Shares Issuable with Respect to Retained Interest would increase on a share-for-share basis. Tracking Stock purchased with funds attributed to the TDS Group which remain outstanding (as a result of being held by a subsidiary included in the TDS Group) would not increase the Retained Interest but would represent an outstanding interest in the common shareholders' equity value of the TDS Group attributable to such Tracking Group. Whenever shares of Tracking Stock are issued or sold by the Company, the Company will identify (i) the number of shares of Tracking Stock issued and sold that represent a Retained Interest, if any, the sale of which shares will reduce the Number of Shares Issuable with Respect to Retained Interest on a share-for-share basis and the net proceeds of which sale will be reflected entirely in the combined financial statements of the TDS Group, and (ii) the number of such shares that represent an additional equity interest in the Tracking Group, the sale of which shares will reduce the available shares of Tracking Stock and the net proceeds of which sale will be reflected entirely in the combined financial statements of the applicable Tracking Group. If shares of Tracking Stock are retired or otherwise cease to be outstanding following their purchase with funds attributed to the TDS Group, the Number of Shares Issuable with Respect to Retained Interest would increase on a share-for-share basis and the related Retained Interest Fraction would increase and the related Outstanding Interest Fraction would decrease accordingly. If the purchase of shares of Tracking Stock were made with funds V-3 attributed to the Tracking Group, the Number of Shares Issuable with Respect to Retained Interest would not be increased, but the Retained Interest Fraction would increase and the Outstanding Interest Fraction would decrease accordingly. If the Number of Shares Issuable with Respect to Retained Interest is reduced to zero as a result of any combination of one or more of issuances or sales of shares of Tracking Stock for the benefit of the TDS Group or other events, shares of Tracking Stock could no longer be issued or sold by the Company for the benefit of the TDS Group unless a further Retained Interest is subsequently created or some other appropriate allocation is made. CORPORATE OPERATIONS The Company and certain affiliates provide the Cellular Group, the Telecom Group and the Aerial Group with centralized management, accounting, commercial, engineering, and data processing services. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, the Company intends to terminate certain intercompany agreements between TDS and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the relationships between the Company and such subsidiaries would be determined solely by methods that management of the Company believes to be reasonable. Many of such policies would continue the arrangements which presently exist between the Company and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. Management and accounting policies could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of TDS. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. CORPORATE MANAGEMENT. The Company and certain subsidiaries make available to affiliates from time-to-time management and consulting services such as general management oversight; marketing and customer support, counsel and advice; financial services including general accounting, business planning and budgeting counsel and support, financial reporting, income and other tax consulting and return preparation services, internal auditing, financial information systems support, and treasury services. Unless otherwise specified by written agreement, services provided are charged on the basis of time reports. The costs of such services and any other expenses incurred jointly on behalf of a number of subsidiaries are charged to those subsidiaries on the basis of the subsidiaries' relative operating revenues and total assets, the number of employees or other basis. Management believes that these methods of allocation are reasonable. INTERCOMPANY FINANCING. The Cellular Group, the Telecom Group and the Aerial Group operate relatively capital-intensive businesses. Rapid growth has required and may in the future require substantial expenditures for construction, expansion and development. The Tracking Groups may finance these investments in the form of loans from the TDS Group to the Tracking Groups or by increases in the Retained Interests in the Tracking Groups. Loans to the Tracking Groups will bear interest at such rates and have such repayment terms and other terms as are established from time-to-time by management. Management will consider, in establishing such rates and terms, either in specific instances or by setting generally applicable policies from time-to-time, such factors including, without limitation, the needs of the Company, the financing needs and objectives of the Groups, the investment objectives of the Groups, the availability, cost and time associated with alternative financing sources, prevailing interest rates and general economic conditions. V-4 The TDS Group had loans outstanding to the Groups as follows:
DECEMBER 31, --------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Current Telecom Group......................... $ 28,181 $ 25,039 $ 15,464 $ 14,812 $ 11,830 ----------- ----------- ----------- ----------- ----------- Long-term Cellular Group........................ -- -- -- 230,745 141,032 Telecom Group......................... 255,302 239,538 233,176 224,742 229,015 Aerial Group.......................... 448,233 -- 60,238 650 650 ----------- ----------- ----------- ----------- ----------- 703,535 239,538 293,414 456,137 370,697 ----------- ----------- ----------- ----------- ----------- $ 731,716 $ 264,577 $ 308,878 $ 470,949 $ 382,527 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
The TDS Group expects to continue to use short-term debt, long-term debt and equity to finance these investments. CASH MANAGEMENT SERVICES. The TDS Group administers cash management programs whereby the Tracking Groups may deposit excess cash for investment. Cash deposited by U.S. Cellular and Aerial in the cash management programs are available on demand and bear interest each month at the 30-day Commercial Paper Rate reported in THE WALL STREET JOURNAL on the last business day of the preceding month, plus 1/4%, (5.85% at December 31, 1997) or such higher rate as the Company may in its discretion offer on such demand deposits. U.S. Cellular or Aerial may elect to place funds for a longer period than on demand in which event they will bear interest at the Commercial Paper Rate for investments of similar maturity plus 1/4%, or such higher rate as the Company may in its discretion cause the TDS Group to offer on such investment deposits. The amounts of such investments totaled zero, $47.9 million, $30.1 million, $1.2 million and $1.2 million at December 31, 1997, 1996, 1995, 1994 and 1993, respectively. Certain subsidiaries of TDS Telecom also deposit their excess cash with the TDS Group. Such investments earn interest at a rate equal to the average monthly rate paid on cash invested in the general cash management program (5.84% at December 31, 1997). The amounts of such investments totaled $161.9 million, $150.0 million, $153.8 million, $127.3 million and $122.3 million at December 31, 1997, 1996, 1995, 1994 and 1993, respectively. INCOME TAX ALLOCATION. The Company has entered into Tax Allocation Agreements with U.S. Cellular and Aerial. The Agreements provide that U.S. Cellular and Aerial and their respective subsidiaries are included in a consolidated federal income tax return and in state income or franchise tax returns in certain situations with the TDS affiliated group. U.S. Cellular and Aerial and their respective subsidiaries calculate their losses and credits as if they comprised separate affiliated groups. Under the Agreements, the Company does not reimburse U.S. Cellular or Aerial on a current basis for their respective losses and credits, if any, used by the affiliated group. U.S. Cellular and Aerial are able to carry forward their losses and credits, if any, and use them to offset any future income tax liabilities to TDS. After all loss and credit carryforwards have either been utilized or expired, U.S. Cellular and Aerial compute income taxes as defined in the agreements and pay to the Company the required income tax due. All of the benefits and obligations of the Company under these Tax Allocation Agreements have been attributed to the TDS Group. TDS Telecom and its subsidiaries are included in a consolidated federal income tax return and in state income or franchise tax returns in certain situations with the TDS affiliated group. TDS Telecom and its subsidiaries currently calculate income taxes on a separate company basis. The separate companies pay TDS for income tax liabilities and are reimbursed by TDS for any losses or credits. The Board expects to follow a policy with respect to the Telecom Group which is similar to the policies which are expected to be followed for U.S. Cellular and Aerial based on the existing Tax Allocation Agreements. Under this policy, in general, TDS Telecom would continue to join in the filing of consolidated income tax returns with TDS and its subsidiaries which are part of the TDS affiliated group for tax purposes. Provided that the Telecom Group continues to have taxable income, the Telecom Group will be required to reimburse the TDS Group for Federal income taxes paid by the TDS affiliated group in an amount equal to the greater of the Federal income tax liability of the Telecom Group calculated as if it were a separate affiliated group, or the tax calculated using the average tax rate (before taking into account tax credits) of the TDS affiliated group. In the event that the Telecom Group incurs any tax losses which it cannot utilize, the tax benefits of such losses would be allocated to the TDS Group, and the V-5 TDS Group would be required to reimburse the Telecom Group at such time that it would be able to utilize such tax benefits as a stand-alone entity. AMERICAN PAGING AND OTHER BUSINESSES At the present time, the TDS Group's other businesses consist primarily of the Company's investment in American Paging. American Paging is currently an 82%-owned subsidiary of the Company which offers radio paging and related services. In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. Pursuant to the agreement, TDS made an offer to American Paging to negotiate and enter into a merger agreement pursuant to which TDS would acquire all of the outstanding Common Shares of American Paging held by persons other than TDS (the "Minority Shareholders") for cash in an amount equal to $2.25 per American Paging Common Share. The TDS offer was considered by a special committee of the Board of Directors of American Paging, which consisted of two independent directors of American Paging. Following review of the offer by the special committee and negotiations between the special committee and TDS, TDS increased its offer to $2.50 per American Paging Common Share. On February 10, 1998, the special committee approved the revised offer and recommended that the full Board of Directors of American Paging approve the revised offer. As a result, on February 10, 1998, the Board of Directors of each of American Paging and TDS approved a merger agreement providing for the acquisition by TDS (through a wholly-owned subsidiary ("TDS Sub")) of all the issued and outstanding American Paging Common Shares held by the Minority Shareholders for cash in an amount equal to $2.50 per American Paging Common Share. The merger agreement provides that TDS Sub will initially commence a tender offer for each of the American Paging Common Shares held by the Minority Shareholders in exchange for $2.50 in cash. Following the offer, TDS will effect a merger of American Paging and TDS Sub. In such merger, all Minority Shareholders will receive $2.50 in cash for each American Paging Common Share. Following the effectiveness of such merger, American Paging Common Shares will cease to be traded on the American Stock Exchange and American Paging will cease to be a reporting company under the Securities Exchange Act of 1934. Upon consummation of the merger, TDS will cause American Paging to contribute substantially all of its assets and certain, limited liabilities, and TSR would contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company upon the completion of the merger. A more complete description of the business of American Paging is included in Annex I of this Proxy Statement/ Prospectus. V-6 EXPLANATORY NOTE REGARDING FINANCIAL INFORMATION Effective upon completion of the Transactions, Telephone and Data Systems, Inc. will have outstanding five classes of Common Stock: United States Cellular Group Common Shares, which are intended to reflect the performance of the United States Cellular Group; TDS Telecommunications Group Common Shares, which are intended to reflect the performance of the TDS Telecommunications Group; Aerial Communications Group Common Shares, which are intended to reflect the performance of the Aerial Communications Group; and Common Shares and Series A Common Shares which are intended to reflect the performance of a residual group (the "TDS Group") (which will also reflect the performance of the United States Cellular Group, the TDS Telecommunications Group, and the Aerial Communications Group to the extent of the Retained Interests in those groups.) Although the financial statements of the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of Telephone and Data Systems, Inc. attributed to the TDS Group such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of United States Cellular Group Common Shares, TDS Telecommunications Group Common Shares, and Aerial Communications Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares are, shareholders of TDS. TDS and its subsidiaries would each continue to be responsible for their respective liabilities. Financial results arising from the business of the TDS Group (including its Retained Interests in the United States Cellular Group, the TDS Telecommunications Group, and the Aerial Communications Group) or from the business of the United States Cellular Group, the TDS Telecommunications Group and the Aerial Communications Group, could affect the market price of all classes of Common Stock. In addition, any net losses of any of the Groups, including the United States Cellular Group, the TDS Telecommunications Group, or the Aerial Communications Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on all classes of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the TDS Group's financial information. V-7 TDS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR THE THREE YEARS ENDED DECEMBER 31, 1997 The TDS Group is a residual group which is primarily intended to reflect (i) retained interests (the "Retained Interests") in the Company's common equity interest in each of the United States Cellular Group (the "Cellular Group"), the TDS Telecommunications Group (the "Telecom Group"), and the Aerial Communications Group (the "Aerial Group") (collectively, the "Tracking Groups"); (ii) the effects of certain corporate management, intercompany financing, cash management and intercompany income tax allocation activities (the "Corporate Operations"); and (iii) the operations of American Paging, Inc., currently an 82%-owned subsidiary of TDS ("American Paging") and all other businesses and investments of the Company not attributed to a Tracking Group. Capitalized terms used herein are used as defined elsewhere in this Proxy Statement / Prospectus. See "Exhibit G--Index of Certain Defined Terms." The Tracking Stock Proposal contemplates that, upon completion of all of the Transactions as contemplated, the Common Shares and Series A Common Shares would represent a common equity interest in the TDS Group. Following such Transactions, the Common Shares and Series A Common Shares are intended to reflect the interest of the TDS Group in the performance of each of the Tracking Groups of TDS, the effects of the Corporate Operations and the performance of American Paging and all other interests held by the Company which are not attributed to a Tracking Group. Holders of Common Shares and Series A Common Shares will continue to be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Common Shares will reflect the separate performance of the TDS Group or its Retained Interests in the Tracking Groups. The TDS Group financial statements have been prepared reflecting the TDS Group's equity interest in the Cellular Group, the Telecom Group and the Aerial Group through the Retained Interests attributed to the TDS Group. AMERICAN PAGING, INC. In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. On February 10, 1998, the board of directors of American Paging approved a merger agreement providing for the acquisition by TDS of all of the issued and outstanding shares of American Paging not owned by TDS for cash in an amount equal to $2.50 per share, approximately $9.1 million in total. Upon consummation of the merger, TDS will contribute substantially all of the assets and certain, limited liabilities of American Paging, and TSR will contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company. TDS will not have any funding requirements once the combination is completed. RESULTS OF OPERATIONS RETAINED INTEREST IN INCOME OF THE CELLULAR GROUP, THE TELECOM GROUP AND THE AERIAL GROUP reflects the Net Income Attributable to the TDS Group through Retained Interest from the Cellular Group, the Telecom Group and the Aerial Group, respectively. See the Telephone and Data Systems, Inc. Consolidated Financial Statements and Management's Discussion as well as the Cellular Group, the Telecom Group and the Aerial Group Financial Statements and Management's Discussions for a discussion of the operations and results for the Cellular Group, the Telecom Group and the Aerial Group. Income from Retained Interests totaled $(20.8 million) in 1997, $26.9 million in 1996 and $27.1 million in 1995. The decrease in Income from Retained Interests in 1997 reflects the large start-up losses from the Aerial Group due to the costs associated with the launch of service in its markets. Retained Interest from the Aerial Group was $(51.0 million) in 1997 compared to $(8.2 million) in 1996 and $(1.6 million) in 1995. Retained Interest from the Cellular Group was $22.6 million in 1997 compared to $26.2 million in 1996 and $20.2 million in 1995 reflecting the rapid growth in cellular operations and gains (which vary from year to year) from the sales of cellular interests. V-8 Retained Interest from the Telecom Group was $7.6 million in 1997 compared to $8.9 million in 1996 and $8.5 million in 1995 reflecting the steady growth in telephone operations offset somewhat in 1997 by increased costs associated with the development of a centralized network management center and new business opportunities. INVESTMENT AND OTHER INCOME (EXPENSE) totaled $29.6 million in 1997 compared to $34.9 million in 1996 and $27.6 million in 1995. Investment and other income primarily includes (i) interest earned on funds advanced to the Cellular Group, the Telecom Group and the Aerial Group (INTEREST INCOME-AFFILIATES), (ii) interest expense on excess cash of the Cellular Group, the Telecom Group and the Aerial Group deposited with the TDS Group (INTEREST EXPENSE-AFFILIATES), (iii) interest on borrowed funds (INTEREST EXPENSE-OTHER), (iv) distributions on the 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities of TDS Capital I, a subsidiary trust (MINORITY INTEREST IN INCOME OF SUBSIDIARY TRUST) and all other income and expenses of the TDS Group, excluding American Paging which is presented separately. INTEREST INCOME-AFFILIATES totaled $48.1 million in 1997 compared to $24.3 million in 1996 and $46.0 million in 1995. Interest income-affiliates is related to loans to companies within the affiliated groups. The amount of loans to affiliated companies varies from year to year reflecting the affiliated companies' financing needs and their ability to secure more permanent financing arrangements. The increase in 1997 reflects primarily the increase in borrowings by the Aerial Group to fund construction of its PCS systems and for operations. During 1995 the Aerial Group purchased certain PCS licenses which were financed with affiliated debt increasing interest income-affiliates in 1995. Such debt was converted to equity at the end of 1995 reducing interest income-affiliates in 1996. Also during 1995, the Cellular Group repaid its affiliated debt reducing interest income-affiliates in 1996. The following table summarizes interest income-affiliates by affiliated group.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Telecom Group.......................................................... $ 23,622 $ 22,114 $ 22,883 Aerial Group........................................................... 22,577 2,139 12,884 Cellular Group......................................................... 1,948 -- 10,213 --------- --------- --------- $ 48,147 $ 24,253 $ 45,980 --------- --------- --------- --------- --------- ---------
INTEREST EXPENSE-AFFILIATES totaled $10.4 million in 1997 compared to $17.9 million in 1996 and $8.7 million in 1995 relating primarily to interest paid to affiliates on their excess cash balances deposited with the parent. The Aerial and Cellular Groups had larger average balances of excess cash invested with the TDS Group in 1996 increasing interest expense-affiliates in that year. The following table summarizes interest expense-affiliates by affiliated group.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Telecom Group.......................................................... $ 9,062 $ 8,549 $ 7,765 Aerial Group........................................................... 95 4,487 -- Cellular Group......................................................... 1,289 4,839 907 --------- --------- --------- $ 10,446 $ 17,875 $ 8,672 --------- --------- --------- --------- --------- ---------
INTEREST EXPENSE-OTHER totaled $25.1 million in 1997 compared to $6.6 million in 1996 and $9.3 million in 1995 primarily from interest on short-term borrowings under Telephone and Data Systems, Inc.'s bank lines of credit. The increase in 1997 reflects the increase in the average amount of short-term borrowings outstanding to $406.6 million in 1997 from $111.1 million in 1996 and $139.5 million in 1995. The weighted average interest rate on such short-term debt was 6.0% in 1997, 5.7% in 1996 and 6.4% in 1995. The TDS Group financial statements do not reflect interest expense totaling $21.8 million in 1997, $21.8 million in 1996 and $21.6 million in 1995 related to certain long-term debt of Telephone and Data Systems, Inc. attributed to the Telecom Group. The long-term debt and related interest expense is reflected on the balance sheet and income statement of the Telecom Group. MINORITY INTEREST IN INCOME OF SUBSIDIARY TRUST totaled $1.5 million in 1997 reflecting distributions on the 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities of TDS Capital I, a subsidiary trust, issued in V-9 November 1997. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due 2037. CAPITALIZED INTEREST totaled $6.8 million and $22.7 million during 1997 and 1996, respectively, reflecting interest capitalized on qualifying PCS investments. The TDS Group began amortizing these costs through charges to expense in 1997 upon commencement of PCS operations. GAIN (LOSS) ON SALE OF INVESTMENTS represents gains (losses) on the sale of certain minority cellular telephone interests in 1997 and miscellaneous investments in 1996 and 1995. INVESTMENT INCOME reflects equity income from minority investments and has varied as the net income from such investments has varied. NET (LOSS) OF AMERICAN PAGING, INC. reflects net loss to the Telephone and Data Systems, Inc. Common and Series A Common Shareholders from American Paging, Inc. See the Telephone and Data Systems, Inc. Consolidated Financial Statements and Management's Discussion for a discussion of the operations and results for American Paging, Inc. INCOME TAX (BENEFIT) EXPENSE totaled ($79.8 million) in 1997 compared to ($13.2 million) in 1996 and $26.1 million in 1995. The benefit in 1997 and 1996 compared to the expense in 1995 reflects primarily the tax benefits and credits generated by the Aerial Group in 1997 and 1996 which the Aerial Group could not use on a separate company basis but which TDS could use in the consolidated federal income tax return along with the tax benefits and credits generated by the TDS Group. The expense in 1995 reflects primarily the tax benefits and credits of U.S. Cellular which TDS had used in prior years but which U.S. Cellular could use on a separate company basis. The Company has entered into Tax Allocation Agreements with U.S. Cellular and Aerial. The Agreements provide that U.S. Cellular, Aerial and their respective subsidiaries are included in a consolidated federal income tax return and in state income or franchise tax returns in certain situations with the TDS affiliated group. U.S. Cellular, Aerial and their respective subsidiaries calculate their losses and credits as if they comprised separate affiliated groups. Under the Agreements, the Company does not reimburse U.S. Cellular and Aerial on a current basis for their respective losses and credits, if any, used by the affiliated group. U.S. Cellular and Aerial are able to carry forward their losses and credits, if any, and use them to offset any future income tax liabilities to TDS. After all loss and credit carryforwards have either been utilized or expired, U.S. Cellular and Aerial compute income taxes as defined in the agreements and pay to the Company the required income tax due. All of the benefits and obligations of the Company under these Tax Allocation Agreements have been attributed to the TDS Group. The Telecom Group currently calculates income taxes on a separate company basis. The separate companies pay TDS for income tax liabilities and are reimbursed by TDS for any losses or credits. The Board expects to follow a policy with respect to the Telecom Group which is similar to the policies which are expected to be followed for U.S. Cellular and Aerial based on the existing Tax Allocation Agreements. Under this policy, in general, the Telecom Group would continue to join in the filing of consolidated income tax returns with TDS and its subsidiaries which are part of the TDS affiliated group for tax purposes. Provided that the Telecom Group continues to have taxable income, the Telecom Group will be required to reimburse the TDS Group for Federal income taxes paid by the TDS affiliated group in an amount equal to the greater of the Federal income tax liability of the Telecom Group calculated as if it were a separate affiliated group, or the tax calculated using the average tax rate (before taking into account tax credits) of the TDS affiliated group. In the event that the Telecom Group incurs any tax losses which it cannot utilize, the tax benefits of such losses would be allocated to the TDS Group, and the TDS Group would be required to reimburse the Telecom Group at such time that it would be able to utilize such tax benefits as a stand-alone entity. INFLATION Management believes that inflation affects the TDS Group's business to no greater extent than the general economy. FINANCIAL RESOURCES The Cellular Group, the Telecom Group and the Aerial Group operate relatively capital-intensive businesses. Rapid growth has required substantial expenditures for construction, expansion and development. The TDS Group provides financing to affiliates as required by the affiliates' operating plans. The TDS Group has provided this financing primarily with short-term debt. Long-term debt and equity financing from time to time, including sales of debt and equity securities by subsidiaries, have reduced such short-term debt. CASH FLOWS FROM OPERATING ACTIVITIES provided cash totaling $57.3 million in 1997, $33.2 million in 1996 and $2.9 million in 1995. The increase in cash flows from operating activities is primarily due to the excess of the income V-10 taxes received from the Tracking Groups over income taxes paid to taxing authorities. The following table summarizes the taxes received from the Groups and income taxes paid to taxing authorities.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Income taxes received from Tracking Groups............................. $ 76,282 $ 84,640 $ 27,939 Less: Income taxes paid to taxing authorities.......................... 3,358 55,380 52,101 --------- --------- --------- Net income taxes received (paid)....................................... 72,924 29,260 (24,162) All other cash flows................................................... (15,588) 3,933 27,109 --------- --------- --------- Cash Flows from Operating Activities................................... $ 57,336 $ 33,193 $ 2,947 --------- --------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES required cash totaling $72.9 million in 1997 and provided cash totaling $92.9 million in 1996 and $95.0 million in 1995. Changes in notes payable-other provided $371.0 million in 1997, required $22.9 million in 1996 and provided $84.9 million in 1995. The changes reflect primarily increases and decreases in borrowings on TDS's revolving bank line of credit agreements. The TDS Group uses short-term debt to finance its investments in PCS and radio paging operations, for acquisitions and for general corporate purposes. Long-term debt and equity financing from time to time, including sales of debt and equity securities by subsidiaries, have reduced such short-term debt. In 1997, the TDS Group received net proceeds of $144.8 million on the sale of 8.5% Trust Originated Preferred Securities and in 1995 the TDS Group received $39.0 million from TDS's sale of Medium-Term Notes. The proceeds of these transactions were used to reduce short-term debt balances. Changes in notes payable-affiliates required $36.8 million in 1997 and provided $80.2 million in 1996 and $61.6 million in 1995. Notes payable-affiliates represents the TDS Group's liability for the excess cash of the Telecom Group, the Cellular Group and the Aerial Group deposited with the TDS Group in the cash management programs. The decrease in 1997 reflects the decrease in the Cellular Group and the Aerial Group investments in the cash management programs. The increases in 1996 and 1995 reflect the Tracking Groups additional cash deposited with the TDS Group. Changes in notes receivable-affiliates required $467.5 million in 1997, provided $33.8 million in 1996 and required $87.6 million in 1995. Notes receivable-affiliates represent financing provided to the Groups by the TDS Group. The requirements in 1997 and 1995 reflect primarily funds provided to the Aerial Group to finance its PCS construction program and working capital requirements. During 1996, Aerial completed its Initial Public Offering and repaid its intercompany debt. The Telecom Group required financing totaling $18.9 million in 1997, $15.9 million in 1996 and $9.1 million in 1995. Dividends received from affiliates totaled $18.1 million in 1997, $24.8 million in 1996 and $16.8 million in 1995 reflecting dividends received from the Telecom Group. The Cellular Group and the Aerial Group have not paid cash dividends. Aggregate dividends paid by TDS on Common and Preferred Shares, excluding dividends reinvested, totaled $27.4 million in 1997, $26.7 million in 1996 and $24.6 million in 1995. During 1997, TDS repurchased 1.8 million Common Shares for $69.9 million. The Company authorized the repurchase of up to 3.0 million Common Shares over a period of three years in December 1996. The Company also purchased 350,000 shares of U.S. Cellular common stock on the open market for $9.8 million. CASH FLOWS FROM INVESTING ACTIVITIES provided cash totaling $5.1 million in 1997 and required cash totaling $116.8 million in 1996 and $92.5 million in 1995. Cash expenditures for capital additions required $41.4 million in 1997, $44.6 million in 1996 and $36.9 million in 1995. Investments in PCS licenses totaled $6.8 million in 1997 and $26.6 million in 1996 reflecting primarily capitalized interest on qualifying PCS investments and $42.1 million in 1995 reflecting primarily the payment to the FCC for narrowband PCS licenses. Cash required for the acquisition of telephone and cellular interests totaled $2.2 million in 1997, $17.4 million in 1996 and $27.2 million in 1995. These telephone and cellular interests were transferred to the Telecom Group and the Cellular Group, respectively. Changes in temporary investments and marketable securities provided $28.8 million in 1997, required $30.2 million in 1996 and provided $9.9 million in 1995. The TDS Group had excess cash at the end of 1996 which increased the temporary investment and marketable securities balances. This cash was redeployed in 1997 reducing such balances. Proceeds from the sale of investments provided $21.0 million in 1997, reflecting the sale of a cellular minority interest, and $.5 million in 1996 and $4.8 million in 1995 reflecting the sales of miscellaneous investments. V-11 CAPITAL EXPENDITURES Parent capital expenditures, primarily for computer equipment, software and systems development, totaled $21.0 million in 1997, $10.5 million in 1996 and $7.8 million in 1995. American Paging's capital expenditures for pagers, terminals and transmitters, and other fixed assets totaled $18.6 million in 1997, $32.5 million in 1996 and $26.5 million in 1995. The following table summarizes the TDS Group's investment in property and equipment during the past three years.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Parent Computer equipment, software and systems development................. $ 17,780 $ 8,857 $ 6,079 Leasehold improvements............................................... 1,730 554 915 Office equipment and other........................................... 1,447 1,053 769 --------- --------- --------- 20,957 10,464 7,763 --------- --------- --------- American Paging Pagers............................................................... 14,875 12,081 15,582 Terminals and transmitters........................................... 3,603 4,595 6,353 Customer Telecare Center............................................. 98 10,216 -- Other................................................................ 48 5,625 4,592 --------- --------- --------- 18,624 32,517 26,527 --------- --------- --------- Other.................................................................. 1,819 1,579 2,615 --------- --------- --------- $ 41,400 $ 44,560 $ 36,905 --------- --------- --------- --------- --------- ---------
LIQUIDITY The TDS Group has access to a variety of external capital sources. TDS had $644 million of bank lines of credit for general corporate purposes at December 31, 1997. Unused amounts of such lines totaled $118 million. TDS has used short-term debt to finance its investments in PCS and radio paging operations, for acquisitions and for general corporate purposes. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate. Long-term debt and equity financing from time to time have reduced such short-term debt. The TDS Group had cash, temporary investments and marketable securities totaling $19.2 million at December 31, 1997. In February 1998, the TDS Group received net proceeds of $145 million on the sale of 6.0 million 8.04% Trust Originated Preferred Securities at $25 per Preferred Security. The net proceeds were used to repay short-term indebtedness. Subject to the approval of the Tracking Stock Proposal by Telephone and Data Systems, Inc. shareholders, TDS intends to, among other things, offer and sell Telecom Group Shares in a public offering for cash, and allocate the net proceeds to the Telecom Group. Telephone and Data Systems, Inc. intends to file with the SEC a registration statement on Form S-3 relating to the registration of between 10,000,000 and 17,000,000 Telecom Group Shares. This offering is expected to commence promptly after the approval of the Tracking Stock Proposal by Telephone and Data Systems, Inc. shareholders, subject to prevailing market conditions and other factors. TDS management estimates proceeds of approximately $150 million from the offering which the Telecom Group would use to repay indebtedness to the TDS Group, and which the TDS Group would use to repay certain short-term indebtedness. The TDS Group has assessed, and continues to assess, the impact of the Year 2000 Issue on its reporting systems and operations. The TDS Group believes that modifying its reporting systems and operations is not a material event and is taking steps to make its systems Year 2000 compliant. The Year 2000 Issue exists because many computer systems and applications abbreviate dates by eliminating the first two digits of the year, assuming that these two digits would always be "19." Unless corrected, this shortcut is expected to cause problems when the century date occurs. On that date, some computer programs may recognize the date as January 1, 1900 instead of January 1, 2000. This may cause systems to incorrectly process critical financial and operational information, or stop processing altogether. The cost of addressing the Year 2000 Issue to date was not material to the TDS Group's results of operations or financial condition, and management believes that the costs to be incurred in 1998 and 1999 will not be material to future operating results or financial condition. If management's steps are not successful in making its systems Year 2000 compliant, it could have a material adverse effect on its results of operations. V-12 PROPOSED CORPORATE RESTRUCTURING The Board of Directors of Telephone and Data Systems, Inc. (the "Board") has adopted a proposal which, if approved by shareholders and implemented by the Board, would authorize the Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). The Tracking Stocks are intended to result in greater market recognition of the value (individually and collectively) of TDS and of TDS's three principal business groups ("Tracking Groups"), thereby enhancing shareholder value over the long term, while at the same time enabling TDS's businesses to preserve the benefits of being part of a consolidated enterprise. The Tracking Stock Proposal is expected to: - provide TDS with greater flexibility in raising capital and making acquisitions, using equity securities specifically related to the Tracking Groups; - enable TDS to more effectively tailor employee benefit plans to provide incentives to employees of the Tracking Groups; - provide shareholders with the opportunity to invest in separate securities that specifically reflect the underlying businesses, depending upon their investment objectives; - permit shareholders to continue to invest in all of the TDS businesses through the Common Shares and the Series A Common Shares. Pursuant to the Tracking Stock Proposal each issued TDS Preferred Share, no par value, TDS Common Share and Series A Common Share, $1.00 par value per share, would be converted into a new TDS Preferred Share, $. 01 par value per share, a new TDS Common Share and Series A Common Share, $.01 par value per share, of the new TDS Delaware Corporation. In addition, the Tracking Stock Proposal would authorize three new classes of common stock, to be designated as United States Cellular Group Common Shares (the "Cellular Group Shares"), TDS Telecommunications Group Common Shares (the "Telecom Group Shares") and Aerial Communications Group Common Shares (the "Aerial Group Shares"). The Cellular Group Shares, when issued, are intended to reflect the separate performance of the United States Cellular Group (the "Cellular Group"), which consists of TDS's interest in United States Cellular Corporation, a subsidiary of TDS operating and investing in cellular telephone companies and properties ("U.S. Cellular"). The Telecom Group Shares, when issued, are intended to reflect the separate performance of the TDS Telecommunications Group (the "Telecom Group"), which primarily consists of TDS's interest in TDS Telecommunications Corporation, a subsidiary of TDS operating landline telephone companies ("TDS Telecom"). The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Communications Group (the "Aerial Group"), which consists of TDS's interest in Aerial Communications, Inc., a subsidiary of TDS providing broadband personal communications services ("Aerial"). Subject to the approval of the Tracking Stock Proposal by shareholders, TDS intends to: - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group, - issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by TDS, subject to approval by the board of directors and the shareholders of U.S. Cellular, (the "U.S. Cellular Merger"), - issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by TDS, subject to approval by the board of directors and the shareholders of Aerial (the "Aerial Merger"), and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of TDS (the "Distribution"). It is currently expected that the Distribution would take place in July 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, although the Board reserves the right to effect all or any part of the Distribution at any time after the approval of the Tracking Stock Proposal, or not to make the Distribution, regardless of whether or not such other transactions have taken place. The shares of Tracking Stock which would be issued in the Distribution would represent an approximately 75% interest in the common equity value of TDS in each Tracking Group (the "Outstanding Interest"). When considering V-13 the shares of Tracking Stock which would also be issued in the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger, as well as the Distribution, the Outstanding Interest would initially represent in the aggregate an approximately 80% interest in each Tracking Group. Upon completion of all of the Transactions as contemplated, approximately 20% of the common shareholders' value of each Tracking Group would initially be retained (the "Retained Interest") in a residual group (the "TDS Group"), along with all other interests held by TDS. The TDS Series A Common Shares and Common Shares will continue to be outstanding and are intended to reflect the performance of the Cellular Group, the Telecom Group and the Aerial Group to the extent of the Retained Interest in the respective groups, and to reflect the performance of the other assets and businesses attributed to the TDS Group. Following the Distribution, subject to the legal and contractual restrictions on the payment of dividends, the Board currently intends to establish an annual dividend on the TDS Common Shares and Series A Common Shares in an amount equal to $.10 per share. The Board also currently intends to establish an annual dividend on the Telecom Group Shares in an amount equal to $.48 per share. (Based on the expected distribution ratio of two-thirds of a Telecom Group Share for each existing Common Share and Series A Common Share, the dividend on Telecom Group Shares would equate to a per share dividend of $.32 per existing Common Share and Series A Common Share. The total of the dividend on TDS Common Shares and Series A Common Shares of $.10 and the equivalent dividend on Telecom Group Shares of $.32 equals the existing current annual dividend on the existing Common Shares and Series A Common Shares of $.42.) With regard to the Cellular Group Shares and the Aerial Group Shares, the Board currently intends to retain future earnings, if any, for the development of the businesses of the Cellular Group and Aerial Group, respectively, and does not anticipate paying dividends on the Cellular Group Shares or the Aerial Group Shares in the foreseeable future. Future dividends on the shares of common stock will be payable when, as and if declared by the Board out of the lesser of (1) all funds of TDS legally available therefor and (2) the available dividend amount with respect to the relevant Group. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $1,222 million for the Cellular Group, $287 million for the Telecom Group and $144 million for the Aerial Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. With respect to the TDS Group, the Available Dividend Amount (approximately $602 million as of December 31, 1997) is an amount approximately equal to the greater of a) an amount (approximately $313 million) which is approximately equal to the Surplus of TDS less the sum of all Available Dividend Amounts of all Tracking Groups or b) an amount (approximately $602 million) which is approximately equal to the TDS Group Equity and Preferred Stock less the par or stated value of all Common and Series A Common Shares and Preferred Shares outstanding. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the policies between TDS and such subsidiaries would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. V-14 PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AND OTHER SECTIONS OF THIS PROXY STATEMENT/PROSPECTUS MAY 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 TDS'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 THE TDS GROUP 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 AND PCS 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. V-15 THE TDS GROUP STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) RETAINED INTEREST IN NET INCOME OF -- The Cellular Group.................................................................... $ 22,569 $ 26,188 $ 20,174 The Telecom Group..................................................................... 7,597 8,924 8,539 The Aerial Group...................................................................... (51,005) (8,244) (1,617) ---------- ---------- ---------- (20,839) 26,868 27,096 ---------- ---------- ---------- INVESTMENT AND OTHER INCOME (EXPENSE) Interest income--affiliates........................................................... 48,147 24,253 45,980 Interest expense--affiliates.......................................................... (10,446) (17,875) (8,672) Interest expense--other............................................................... (25,057) (6,635) (9,265) Minority interest in income of subsidiary trust....................................... (1,523) -- -- Capitalized interest.................................................................. 6,755 22,688 -- Gain (loss) on sale of investments.................................................... 10,398 3,435 (963) Investment income..................................................................... 3,784 4,188 467 Other, net............................................................................ (2,486) 4,825 101 ---------- ---------- ---------- 29,572 34,879 27,648 ---------- ---------- ---------- NET (LOSS) OF AMERICAN PAGING, INC...................................................... (51,636) (39,159) (12,928) Less: Intra-group interest.............................................................. 16,073 11,797 6,952 ---------- ---------- ---------- (35,563) (27,362) (5,976) ---------- ---------- ---------- INCOME TAX (BENEFIT) EXPENSE............................................................ (79,798) (13,155) 26,077 ---------- ---------- ---------- NET INCOME.............................................................................. 52,968 47,540 22,691 Preferred Dividend Requirement.......................................................... (1,892) (1,957) (2,509) ---------- ---------- ---------- NET INCOME AVAILABLE TO COMMON.......................................................... $ 51,076 $ 45,583 $ 20,182 ---------- ---------- ---------- ---------- ---------- ----------
The accompanying notes to financial statements are an integral part of these statements. V-16 THE TDS GROUP STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ------------ ------------ ---------- (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income......................................................................... $ 52,968 $ 47,540 $ 22,691 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization.................................................... 43,285 46,175 32,481 Deferred taxes................................................................... (11,539) 11,931 4,459 Retained interest in net loss (income) of Cellular, Telecom and Aerial Groups.... 20,839 (26,868) (27,096) Investment income................................................................ (3,784) (4,188) (467) (Gain) loss on sale of investments............................................... (10,398) (3,435) 963 Interest attributed to Telecom Group............................................. (21,766) (21,848) (21,576) Other noncash income............................................................. (1,468) (6,876) (2,376) Change in accounts receivable.................................................... 159 13,806 8,667 Change in accounts payable....................................................... 934 (5,207) (1,294) Change in accrued taxes.......................................................... (10,025) (16,788) (16,127) Change in other assets and liabilities........................................... (1,869) (1,049) 2,622 ------------ ------------ ---------- 57,336 33,193 2,947 ------------ ------------ ---------- CASH FLOWS FROM FINANCING ACTIVITIES Change in notes payable-other...................................................... 371,013 (22,899) 84,901 Change in notes payable-affiliates................................................. (36,798) 80,161 61,555 Trust preferred securities......................................................... 144,788 -- -- Change in notes receivable-affiliates.............................................. (467,487) 33,844 (87,604) Dividends received from affiliates................................................. 18,100 24,824 16,828 Dividends paid..................................................................... (27,396) (26,704) (24,602) Repurchase of TDS Common Shares.................................................... (69,942) -- -- Purchase of subsidiary Common Shares............................................... (9,801) -- -- Long-term debt borrowings.......................................................... -- -- 39,000 Other financing activities......................................................... 4,635 3,654 4,890 ------------ ------------ ---------- (72,888) 92,880 94,968 ------------ ------------ ---------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures............................................................... (41,400) (44,560) (36,905) Investments in PCS licenses........................................................ (6,755) (26,550) (42,053) Acquisitions....................................................................... (2,166) (17,425) (27,157) Change in temporary investments and marketable securities.......................... 28,829 (30,158) 9,852 Proceeds from investment sales..................................................... 20,999 500 4,800 Other investments.................................................................. 5,555 1,418 (1,032) ------------ ------------ ---------- 5,062 (116,775) (92,495) ------------ ------------ ---------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS................................. (10,490) 9,298 5,420 CASH AND CASH EQUIVALENTS Beginning of period................................................................ 19,995 10,697 5,277 ------------ ------------ ---------- End of period...................................................................... $ 9,505 $ 19,995 $ 10,697 ------------ ------------ ---------- ------------ ------------ ----------
The accompanying notes to financial statements are an integral part of these statements. V-17 THE TDS GROUP BALANCE SHEETS--ASSETS
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents..................................................................... $ 9,505 $ 19,995 Temporary investments......................................................................... 2,485 23,803 Due from affiliates Notes receivable............................................................................ 28,181 25,039 Accounts receivable......................................................................... 10,271 6,810 Taxes receivable............................................................................ 21,785 13,425 Accounts receivable Customers, less allowance of $2,300 and $1,883, respectively................................ 9,913 13,237 Other....................................................................................... 3,557 3,965 Prepaid income taxes.......................................................................... 23,504 21,532 Inventory..................................................................................... 7,278 9,010 Other......................................................................................... 5,420 3,642 ------------- ------------- 121,899 140,458 ------------- ------------- INVESTMENTS Notes receivable-affiliates................................................................... 703,535 239,538 Investment in affiliated groups United States Cellular Group................................................................ 330,306 297,592 TDS Telecommunications Group................................................................ 95,677 85,565 Aerial Communications Group................................................................. 39,684 90,472 Investment in Narrowband PCS license costs.................................................... 60,901 60,901 Investment in Broadband PCS license costs..................................................... 22,875 18,066 Investment in minority interests.............................................................. 28,354 26,856 Marketable securities......................................................................... 7,259 14,770 Other investments............................................................................. 776 788 ------------- ------------- 1,289,367 834,548 ------------- ------------- PROPERTY AND EQUIPMENT Radio Paging In service and under construction........................................................... 118,275 113,000 Less accumulated depreciation............................................................... 75,045 61,528 ------------- ------------- 43,230 51,472 ------------- ------------- Other In service and under construction........................................................... 96,809 82,781 Less accumulated depreciation............................................................... 49,511 48,202 ------------- ------------- 47,298 34,579 ------------- ------------- Net Property and Equipment.............................................................. 90,528 86,051 ------------- ------------- OTHER ASSETS AND DEFERRED CHARGES............................................................... 18,035 18,918 ------------- ------------- TOTAL ASSETS.................................................................................... $ 1,519,829 $ 1,079,975 ------------- ------------- ------------- -------------
The accompanying notes to financial statements are an integral part of these statements. V-18 THE TDS GROUP BALANCE SHEETS--LIABILITIES AND GROUP EQUITY
DECEMBER 31, ---------------------------- 1997 1996 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Notes payable................................................................................. $ 530,175 $ 159,162 Due to affiliates Notes payable............................................................................... 165,686 201,641 Accounts payable............................................................................ 1,555 1,166 Accrued interest............................................................................ -- 996 Accounts payable.............................................................................. 6,192 5,005 Unearned revenue and deposits................................................................. 7,121 10,815 Accrued interest.............................................................................. 10,888 10,750 Accrued taxes................................................................................. 999 653 Other current liabilities..................................................................... 10,879 6,319 ------------- ------------- 733,495 396,507 ------------- ------------- DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability............................................................. 27,626 35,769 Other......................................................................................... 6,237 5,694 ------------- ------------- 33,863 41,463 ------------- ------------- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (a)........................................................... 150,000 -- ------------- ------------- TDS GROUP EQUITY................................................................................ 602,471 642,005 ------------- ------------- TOTAL LIABILITIES AND GROUP EQUITY.............................................................. $ 1,519,829 $ 1,079,975 ------------- ------------- ------------- -------------
- --------- (a) As described in Note 8, the sole asset of TDS Capital I is $154.6 million principal amount of 8.5% subordinated debentures due 2037 from TDS. The accompanying notes to financial statements are an integral part of these statements. V-19 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS NOTE 1--PROPOSED RESTRUCTURING The Board of Directors of Telephone and Data Systems, Inc. (the "Board") has adopted a proposal which, if approved by shareholders and implemented by the Board, would authorize the Board to issue three new classes of common stock and change the state of incorporation of TDS from Iowa to Delaware (the "Tracking Stock Proposal"). The three new classes of stock are intended to separately reflect the performance of TDS's cellular telephone, landline telephone and personal communications services businesses ("Tracking Stocks"). The Tracking Stocks are intended to result in greater market recognition of the value (individually and collectively) of TDS and of TDS's three principal business groups ("Tracking Groups"), thereby enhancing shareholder value over the long term, while at the same time enabling TDS's businesses to preserve the benefits of being part of a consolidated enterprise. The Tracking Stock Proposal is expected to: - provide TDS with greater flexibility in raising capital and making acquisitions, using equity securities specifically related to the Tracking Groups; - enable TDS to more effectively tailor employee benefit plans to provide incentives to employees of the Tracking Groups; - provide shareholders with the opportunity to invest in separate securities that specifically reflect the underlying businesses, depending upon their investment objectives; - permit shareholders to continue to invest in all of the TDS businesses through the Common Shares and the Series A Common Shares. The Cellular Group Shares, when issued, are intended to reflect the separate performance of the Cellular Group, which consists of TDS's interest in United States Cellular Corporation, a subsidiary of TDS. The Telecom Group Shares, when issued, are intended to reflect the separate performance of the Telecom Group, which primarily consists of TDS's interest in TDS Telecommunications Corporation, a subsidiary of TDS. The Aerial Group Shares, when issued, are intended to reflect the separate performance of the Aerial Group, which consists of TDS's interest in Aerial Communications, Inc., a subsidiary of TDS. Subject to the approval of the Tracking Stock Proposal by shareholders, TDS intends to: - offer and sell Telecom Group Shares in a public offering for cash, subject to prevailing market and other conditions (the "Telecom Public Offering"), and allocate the net proceeds thereof to the Telecom Group, - issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular which are not owned by TDS, subject to approval by the board of directors and the shareholders of U.S. Cellular, (the "U.S. Cellular Merger"), - issue Aerial Group Shares in exchange for all of the Common Shares of Aerial which are not owned by TDS, subject to approval by the board of directors and the shareholders of Aerial (the "Aerial Merger"), and - distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of TDS (the "Distribution"). It is currently expected that the Distribution would take place in July 1998 or later, after the completion of the Telecom Public Offering, the U.S. Cellular Merger and the Aerial Merger. The TDS Series A Common Shares and Common Shares will continue to be outstanding and are intended to reflect the performance of the Cellular Group, the Telecom Group and the Aerial Group to the extent of the Retained Interest in the respective groups, and to reflect the performance of the assets and businesses attributed to the TDS Group. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, TDS intends to terminate certain intercompany agreements between TDS and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the policies between TDS and such subsidiaries would be determined solely by methods that management of TDS V-20 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 1--PROPOSED RESTRUCTURING (CONTINUED) believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission, consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. For additional information regarding the Tracking Stock Proposal, see "Proposed Corporate Restructuring" in Management's Discussion and Analysis of Results of Operations and Financial Condition. NOTE 2--DESCRIPTION OF THE TDS GROUP The TDS Group is a residual group which is primarily intended to reflect (i) retained interests (the "Retained Interests") in the Company's common equity interest in each of the United States Cellular Group (the "Cellular Group"), the TDS Telecommunications Group (the "Telecom Group") and the Aerial Communications Group (the "Aerial Group") (collectively, the "Tracking Groups"); (ii) the effects of certain corporate management, intercompany financing, cash management and intercompany income tax allocation activities (the "Corporate Operations"); and (iii) the operations of American Paging, Inc., currently an 82%-owned subsidiary of TDS ("American Paging") and all other businesses and investments of the Company not attributed to a Tracking Group. Capitalized terms used herein are used as defined elsewhere in this Proxy Statement/Prospectus. See "Exhibit G--Index of Certain Defined Terms." In structuring the terms of the Tracking Stock Proposal, the Board determined that the retention by the TDS Group of Retained Interests in the Cellular Group, the Telecom Group and the Aerial Group was appropriate. In making this determination, the Board concluded that it would be desirable for shareholders to have the opportunity of continuing to maintain a common equity investment in all of the businesses of the Company and its subsidiaries by retaining ownership of the Common Shares and Series A Common Shares. Accordingly, the Tracking Stock Proposal contemplates that, upon the completion of all of the Transactions as contemplated, the Series A Common Shares and the Common Shares of TDS Delaware would represent a common equity interest in the TDS Group. Following such Transactions, the Series A Common Shares and Common Shares of TDS Delaware are intended to reflect the interest of the TDS Group in the performance of each of the Tracking Groups of TDS, the effects of the Corporate Operations and the performance of APP and all other interests held by the Company which are not attributed to a Tracking Group. Holders of Common Shares and Series A Common Shares will continue to be subject to all of the risks associated with an investment in the Company and all of its businesses, assets and liabilities. There is no assurance as to the degree to which the market value of the Common Shares will reflect the separate performance of the TDS Group or its Retained Interests in the Tracking Groups. The TDS Group would also include such other assets and liabilities of the Company as the Board may in the future determine to attribute to the TDS Group and such other businesses, assets and liabilities as the Company or any of its subsidiaries may in the future acquire for the TDS Group, as determined by the Board. The Board intends to adopt a policy providing that the TDS Group may own, invest or otherwise have an interest in, lease, operate or manage any business other than a Cellular Business, a Telecom Business or a PCS Business. At the present time, the TDS Group owns interests in businesses which may be considered to include such other businesses. The TDS Group will continue to be permitted to operate these existing businesses. Except with respect to such existing businesses, the TDS Group will generally not engage in the Cellular Business, the Telecom Business or the PCS Business, except through the Retained Interests, unless the Board determines to permit the TDS Group to pursue such opportunities. This will be done on a case-by-case basis. It is currently the V-21 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 2--DESCRIPTION OF THE TDS GROUP (CONTINUED) intention of the Board that any businesses, opportunities, assets and liabilities attributed to the TDS Group in the future would not include assets and liabilities of the Cellular Group, the Telecom Group or the Aerial Group. The Board also determined that it would be desirable for the Company to have a Group such as the TDS Group which could enter into new ventures and possibly create additional tracking stocks for such ventures by designating series of Undesignated Shares. For example, such new shares of tracking stock could be distributed to the holders of Common Shares and Series A Common Shares upon the creation or separation of a business, sold for cash in a public or private offering to finance a new business for the benefit of the TDS Group or delivered in connection with the acquisition of a business by the TDS Group. The Company has no current plans to create any additional tracking stocks or to make any material investments in any new businesses. RETAINED INTERESTS Upon completion of all of the Transactions as described in this Proxy Statement/Prospectus, the outstanding shares of each class of Tracking Stock would initially represent in the aggregate an approximately 80% interest in the related Tracking Group. Approximately 20% of the common shareholders' value of the Company in each Tracking Group would initially be retained as Retained Interests of the TDS Group. The following briefly describes each of the Tracking Groups of TDS. THE CELLULAR GROUP. The Cellular Group consists of the Company's interest in U.S. Cellular, currently an 81%-owned subsidiary of the Company which operates and invests in cellular telephone companies and properties. TDS has made an offer to acquire all of the outstanding shares of common stock of U.S. Cellular which it does not own in exchange for Cellular Group Shares, in which case U.S. Cellular would become a wholly-owned subsidiary of TDS. The U.S. Cellular Restated Certificate of Incorporation currently provides that U.S. Cellular may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of cellular telephone systems (the "Cellular Business"), unless it first obtains the written consent of the Company. If U.S. Cellular becomes a wholly-owned subsidiary of the Company as contemplated, this provision is expected to be eliminated from the U.S. Cellular Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Cellular Group. Accordingly, the Cellular Group will generally only engage in the Cellular Business, unless the Board determines to permit the Cellular Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Cellular Group in the future would not include assets and liabilities of the TDS Group, the Telecom Group or the Aerial Group. A more complete description of the Cellular Group is included in Annex II of this Proxy Statement/Prospectus. THE TELECOM GROUP. The Telecom Group consists of the Company's interest in TDS Telecom, a wholly-owned subsidiary of the Company which operates landline telephone companies, and includes the allocation of certain corporate debt. The Board intends to adopt a policy providing that the Telecom Group may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of landline telephone systems (the "Telecom Business"), unless it first obtains the consent of the Board. At the present time, the Telecom Group operates certain businesses which are not considered Telecom Business. The Telecom Group will initially be permitted to continue to operate these existing businesses. Except with respect to such existing businesses, the Telecom Group will generally only engage in the Telecom Business, unless the Board determines to permit the Telecom Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Telecom Group in the future would not include assets and liabilities of the TDS Group, the Cellular Group or the Aerial Group. A more complete description of the Telecom Group is included in Annex III of this Proxy Statement/Prospectus. THE AERIAL GROUP. The Aerial Group consists of the Company's interest in Aerial, currently an 82%-owned subsidiary of the Company which is developing broadband personal communications services. TDS has made an V-22 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 2--DESCRIPTION OF THE TDS GROUP (CONTINUED) offer to acquire all of the outstanding shares of common stock of Aerial which it does not own in exchange for Aerial Group Shares, in which case Aerial would become a wholly-owned subsidiary of TDS. The Aerial Restated Certificate of Incorporation currently provides that Aerial may not own, invest or otherwise have an interest in, lease, operate or manage any business other than a business engaged solely in the construction of, the ownership of interests in and/or the management of personal communications services (the "PCS Business"), unless it first obtains the written consent of the Company. If Aerial becomes a wholly-owned subsidiary of the Company as contemplated, this provision is expected to be eliminated from the Aerial Restated Certificate of Incorporation. However, the Board intends to continue this provision as a policy with respect to the Aerial Group. Accordingly, the Aerial Group will generally only engage in the PCS Business, unless the Board determines to permit the Aerial Group to pursue other opportunities. This will be done on a case-by-case basis. It is currently the intention of the Board that any businesses, opportunities, assets and liabilities attributed to the Aerial Group in the future would not include assets and liabilities of the TDS Group, the Cellular Group or the Telecom Group. A more complete description of the Aerial Group is included in Annex IV of this Proxy Statement/Prospectus. Upon completion of all the Transactions as described in the Proxy Statement/Prospectus, approximately 20% of the common shareholders' value of the Company in each Tracking Stock would be retained as Retained Interest by the TDS Group. Although the TDS Group is not a legal entity, it will represent a legal interest. The TDS Group will be defined in the Restated Certificate of Incorporation of TDS Delaware (see below) and assets and liabilities will be attributed to that Group. Shareholders of TDS will have legal rights with respect to the TDS Group to the extent provided in the Restated Certificate of Incorporation and, thus, the Group will involve a legal interest. The TDS Group financial statements have been prepared reflecting the TDS Group's equity interest in the Cellular Group, the Telecom Group and the Aerial Group through the Retained Interests attributed to the TDS Group. The Restated Certificate of Incorporation of the Company provides that the "TDS GROUP" means, as of any date that any shares of any class or series of Tracking Stock have been issued and continue to be outstanding: a. the interest of the Company and all of its subsidiaries, (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets) and their respective properties and assets, other than (except as provided in clause (e) of this definition) the interest of the Company and its subsidiaries in Aerial and its subsidiaries, TDS Telecom and its subsidiaries, U.S. Cellular and its subsidiaries, and any other subsidiaries attributed by the Board to a Group other than the TDS Group (including any successors thereto by merger, consolidation or sale of all or substantially all of its assets, whether or not in connection with Related Business Transactions) and their respective businesses, assets and liabilities; b. all businesses, assets and liabilities of the Company or any of its subsidiaries to the extent attributed to the TDS Group by the Board, whether or not such businesses, assets or liabilities are businesses, assets and liabilities of the TDS Group or any of its subsidiaries (or a successor as described in clause (a) of this definition); c. all businesses, assets and liabilities contributed or otherwise transferred to the TDS Group from any of the Tracking Groups; d. the interest of the Company or any of its subsidiaries in the business, assets and liabilities acquired by the Company or any of its subsidiaries for the TDS Group, as determined by the Board; e. a proportionate undivided interest in each and every business, asset and liability attributed to a Tracking Group equal to the Retained Interest Fraction of the TDS Group in such other Tracking Group; and f. such other businesses, assets and liabilities and such adjustments to the foregoing as may be contemplated hereby or which may be determined in good faith by the Board. If a Retained Interest in any Tracking Group is then existing and if the Company shall pay a dividend or make any other distribution with respect to holders of Tracking Stock of such Tracking Group payable in cash, securities or other property of the Company attributed to such Tracking Group, other than shares of Tracking Stock, the TDS V-23 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 2--DESCRIPTION OF THE TDS GROUP (CONTINUED) Group shall be deemed to hold an amount or fair value thereof (as determined in good faith by the Board) of such cash, securities or other property equal to the amount or fair value so distributed multiplied by a fraction the numerator of which is such Tracking Group's Retained Interest Fraction and the denominator of which is such Tracking Group's Outstanding Interest Fraction in effect immediately prior to the record date for such dividend or other distribution and, to the extent interest or dividends are paid or other distributions are made on any securities other than shares of Tracking Stock so distributed to the holders of such shares of Tracking Stock, such Tracking Group shall no longer include a corresponding ratable amount of fair value of the kind of assets paid as such interest or dividends or other distributions in respect of such securities deemed to be held by the TDS Group. From and after any transfer of cash, securities or other property from a Tracking Group to the TDS Group, such Tracking Group shall no longer include the cash, securities or other property so transferred and the TDS Group shall include such cash, securities or other property and from and after any transfer of cash, securities or other property from the TDS Group to a Tracking Group, the TDS Group shall no longer include the cash, securities or property so transferred and such Tracking Group shall include such cash, securities or other property. AMERICAN PAGING, INC. In December 1997, TDS announced an agreement with TSR Paging, Inc. ("TSR") to combine their respective paging businesses. On February 10, 1998, the board of directors of American Paging approved a merger agreement providing for the acquisition by TDS of all of the issued and outstanding shares of American Paging not owned by TDS for cash in an amount equal to $2.50 per share, approximately $9.1 million in total. Upon consummation of the merger, TDS will contribute substantially all of the assets and certain, limited liabilities of American Paging, and TSR will contribute all of its assets and liabilities to a new limited liability company. The asset contribution agreement provides that, subject to adjustment, TDS will have a 30% interest and TSR will have a 70% interest in the new company. The formation of the new company, while subject to a number of conditions, including consummation of the merger and regulatory approvals, is expected to occur in the first half of 1998. TDS will adopt the equity method of accounting for its investment in the new company. TDS will not have any funding requirements once the combination is completed. The following table summarizes the assets and liabilities which TDS would contribute to the new company as of December 31, 1997.
DECEMBER 31, 1997 ------------------ (DOLLARS IN THOUSANDS) Current Assets Cash................................................................................ $ 3,058 Temporary investments............................................................... 61 Accounts receivable................................................................. 9,051 Inventory........................................................................... 6,851 Other............................................................................... 1,076 Property, plant and equipment, net.................................................... 41,762 Narrowband PCS license................................................................ 60,901 Other Investments..................................................................... 429 Deferred assets....................................................................... 10,959 Current Liabilities Accounts payable.................................................................... (942) Advance billings and customer deposits.............................................. (6,827) Other............................................................................... (42) ---------- $ 126,337 ---------- ----------
V-24 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The TDS Group is a residual group which is primarily intended to reflect (i) retained interests (the "Retained Interests") in the Company's common equity interest in each of the United States Cellular Group (the "Cellular Group"), the TDS Telecommunications Group (the "Telecom Group") and the Aerial Communications Group (the "Aerial Group") (collectively, the "Tracking Groups"); (ii) the effects of certain corporate management, intercompany financing, cash management and intercompany income tax allocation activities (the "Corporate Operations"); and (iii) the operations of American Paging, Inc., currently an 82%-owned subsidiary of TDS ("American Paging") and all other businesses and investments of the Company not attributed to a Tracking Group. Capitalized terms used herein are used as defined elsewhere in this Proxy Statement/Prospectus. See "Exhibit G--Index of Certain Defined Terms." BASIS OF PRESENTATION The financial statements of the Groups comprise all of the accounts included in the corresponding consolidated financial statements of Telephone and Data Systems, Inc. The separate Cellular Group, Telecom Group, Aerial Group and TDS Group financial statements give effect to the management and accounting policies that would be applicable upon implementation of the Tracking Stock Proposal. Subject to the completion of the U.S. Cellular Merger and the Aerial Merger, TDS intends to terminate certain intercompany agreements between the Company and U.S. Cellular and Aerial, respectively. Thereafter, some or all of the relationships between the Company and such subsidiaries would be determined solely by methods that management of TDS believes to be reasonable. Many of such policies would continue the arrangements which presently exist between TDS and U.S. Cellular or Aerial pursuant to the intercompany agreements, but TDS would have no contractual obligation to continue such policies after the intercompany agreements have been terminated. The separate Group financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (1) the historical financial position, results of operations and cash flows of the businesses that comprise each of the Groups, (2) any assets and liabilities (including contingent liabilities) which have been attributed to any Group from any other Group, and (3) with respect to the TDS Group, the Retained Interest in each of the Tracking Groups. The effects of the issuance of the Tracking Stocks have not been reflected in these historical financial statements. Financial effects arising from the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group that affect the consolidated results of operations or financial condition of the Company could affect the results of operations or financial condition of the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, or could affect the market price of any or all classes of Common Stock. In addition, any net losses of the Company or the Cellular Group, the Telecom Group, the Aerial Group or the TDS Group, and dividends or distributions on, or repurchases of, any class of Common Stock will reduce the assets of TDS legally available for payment of dividends on any class of Common Stock. Accordingly, TDS's consolidated financial statements should be read in conjunction with the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group financial information. The management and accounting policies applicable to the preparation of the financial statements of the TDS Group could be modified or rescinded by the Board, in its sole discretion and without the approval of shareholders, although there is no present intention to do so. The Board could also adopt additional policies depending upon the circumstances. Any determination by the Board to modify or rescind such policies, or to adopt additional policies, including any such decision that could have disparate effects upon the holders of different series of common stock, would be made by the Board in good faith and in the honest belief that such decision is in the best interests of Telephone and Data Systems, Inc. In addition, generally accepted accounting principles require that changes in accounting policy must be preferable (in accordance with such principles) to the policy previously in place. Following completion of the Tracking Stock Proposal, it is currently anticipated that the TDS Group would have an approximately 20% Retained Interest in each of the Tracking Groups. For purposes of the TDS Group financial statements, the TDS Group's Retained Interest in the equity value of the Groups has been reflected as "Investment In Affiliated Groups" on the balance sheet. Similarly, the net income or loss of the Groups attributable to the TDS V-25 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Group Retained Interest is reflected as "Retained Interest in the Net Income of the Cellular Group, the Telecom Group and the Aerial Group" in the Statements of Operations. Funds of TDS legally available for the payment of dividends ("Surplus") (approximately $1,966 million as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Total Common and Preferred Equity of TDS less the par or stated value of all shares of common and preferred stock outstanding (204,922,000 shares as of December 31, 1997 after the Distribution). With respect to any Tracking Group, the Available Dividend Amount (approximately $1,222 million for the Cellular Group, $287 million for the Telecom Group and $144 million for the Aerial Group as of December 31, 1997, based on the financial statements) is an amount approximately equal to the Outstanding Interest Fraction of such Tracking Group (approximately 75% after the Distribution) times the respective Tracking Group Equity less the par value of the respective outstanding Tracking Group Shares. With respect to the TDS Group, the Available Dividend Amount (approximately $602 million as of December 31, 1997) is an amount approximately equal to the greater of a) an amount (approximately $313 million) which is approximately equal to the Surplus of TDS less the sum of all Available Dividend Amounts of all Tracking Groups or b) an amount (approximately $602 million) which is approximately equal to the TDS Group Equity and Preferred Stock less the par or stated value of all Common and Series A Common Shares and Preferred Shares outstanding. If the Tracking Stock Proposal is approved by shareholders and implemented by the Board, following the issuance of the Tracking Stocks, TDS will prepare and file with the Securities and Exchange Commission consolidated financial statements of TDS and financial statements of the Cellular Group, the Telecom Group and the Aerial Group for so long as the respective Tracking Stock is outstanding, and the TDS Group for as long as any Tracking Stock is outstanding. Although the financial statements of the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group will separately report the assets, liabilities (including contingent liabilities) and shareholders' equity of TDS attributed to the Cellular Group, the Telecom Group, the Aerial Group and the TDS Group, such attribution will not affect the legal title to such assets or responsibility for such liabilities. Holders of the Cellular Group, the Telecom Group and the Aerial Group Common Shares will be, and holders of TDS Common Shares and Series A Common Shares will continue to be, shareholders of TDS. TDS and its subsidiaries will each continue to be responsible for their respective liabilities. PRINCIPLES APPLIED IN THE FINANCIAL STATEMENTS The accounting policies of the TDS Group conform to generally accepted accounting principles. The financial statements include the accounts of the TDS Group and its majority-owned subsidiaries since acquisition. All material transactions between companies within the TDS Group have been eliminated. The TDS Group 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. Effective January 1, 1996, the TDS Group implemented the provisions of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed Of." Under SFAS No. 121, the TDS Group is required to review long-lived assets and certain identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the book value of a long-lived asset is not recoverable. An impairment loss would be recognized whenever the review demonstrates that the book value of a long-lived asset is not recoverable. The implementation of SFAS No. 121 did not have an impact on the TDS Group's financial position or results of operations. V-26 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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. The carrying amounts of Cash and Cash Equivalents and Temporary Investments approximate fair value due to the short-term nature of these instruments. INVENTORY Inventory consists primarily of paging subscriber devices on hand. Subscriber device cost is determined by the average cost method. NOTES RECEIVABLE-AFFILIATES The TDS Group currently lends funds to the Cellular Group and the Aerial Group pursuant to Revolving Credit Agreements at interest rates of prime plus .75% and prime plus 1.5%, respectively (the prime rate was 8.5% at December 31, 1997). The TDS Group also currently lends funds to the Telecom Group at an interest rate of prime plus .5%. No principal will be payable until maturity, January 4, 1999. Certain notes which mature within a year are classified as current assets. INVESTMENT IN AFFILIATED GROUPS Investment in affiliated groups represents the TDS Group's Retained Interest in the equity value of the Cellular Group, the Telecom Group and the Aerial Group. INVESTMENT IN PCS LICENSES Broadband PCS license costs consists of capitalized interest on the investment in the licenses. These costs are being amortized over 40 years. Narrowband PCS licenses consist of costs incurred in acquiring the licenses ($55.3 million) and capitalized interest ($5.6 million). These licenses are to be contributed to the new combined paging company as a part of the merger agreement with TSR. INVESTMENT IN MINORITY INTERESTS Investments in minority interests consist of investments in entities or joint ventures in which the TDS Group holds a minority interest. The equity method of accounting is followed for minority interests in which the TDS Group holds common stock ownership of at least 20% or can influence the policies of the affiliated company ($28.1 million and $26.6 million at December 31, 1997 and 1996, respectively). Income and losses from these entities are reflected in the statements of operations on a pretax basis. At December 31, 1997, the cumulative share of income from minority investments accounted for under the equity method was $9.0 million, of which $6.6 million was undistributed. The cost method of accounting is followed for certain minority interests managed by others ($236,000 and $277,000 at December 31, 1997 and 1996, respectively). UNEARNED REVENUE AND DEPOSITS Unearned revenue and deposits primarily represent monthly charges to customers for paging subscriber device rental and dispatch services billed in advance. Such revenue is recognized in the following months when service is provided and deposits are applied against the customer's final bill. V-27 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EARNINGS PER COMMON SHARE Earnings per Common Share were omitted from the historical statements of operations since the recapitalization in connection with the Tracking Stock Proposal has not been completed and the TDS articles of incorporation did not provide for the TDS Group at such time. SUPPLEMENTAL CASH FLOW DISCLOSURES Following are supplemental cash flow disclosures for interest and income taxes paid, acquisitions and certain noncash transactions.
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Interest paid....................................................... $ 59,486 $ 47,389 $ 37,363 Income taxes (received) from Tracking Groups........................ (76,282) (84,640) (27,939) Income taxes paid to taxing authorities............................. 3,358 55,380 52,101 Common Shares issued by Telephone and Data Systems, Inc. for conversion of Preferred Shares.................. 1,487 4,602 948 Additions to property, plant and equipment financed through accounts payable and accrued expenses...................................... $ 642 $ 3,522 $ (1,743)
Telephone and Data Systems, Inc. has acquired operating cellular and telephone companies and certain cellular licenses since January 1, 1995. The cellular and telephone properties were acquired for the benefit of the Cellular Group and the Telecom Group and were recorded as an increase in the investment in these groups. In conjunction with these acquisitions, the following assets were acquired and liabilities assumed, and Common and Preferred Shares issued:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ---------- ------------ ------------ (DOLLARS IN THOUSANDS) Investment in subsidiaries....................................... $ 47,851 $ 84,737 $ 133,292 Notes receivable-other........................................... -- 4,100 -- Notes receivable-affiliates...................................... -- -- 16,371 Other assets and liabilities, excluding cash and cash equivalents.................................................... -- (5,245) 5,330 Notes payable-affiliates......................................... -- 102,791 -- TDS Group Equity................................................. (45,685) (168,958) (127,836) ---------- ------------ ------------ Decrease in cash due to acquisitions............................. $ 2,166 $ 17,425 $ 27,157 ---------- ------------ ------------ ---------- ------------ ------------
NOTE 4--INCOME TAXES TDS has Tax Allocation Agreements with U.S. Cellular and Aerial. The Agreements provide that U.S. Cellular and Aerial and their respective subsidiaries are included in a consolidated federal income tax return and in state income or franchise tax returns in certain situations with the TDS affiliated group. U.S. Cellular and Aerial and their respective subsidiaries calculate their losses and credits as if they comprised separate affiliated groups. Under the Agreements, TDS does not reimburse U.S. Cellular and Aerial on a current basis for their respective losses and credits, if any, used by the affiliated group. U.S. Cellular and Aerial are able to carry forward their losses and credits, if any, and use them to offset any future income tax liabilities to TDS. After all loss and credit carryforwards have either been utilized or expired, U.S. Cellular and Aerial compute income taxes as defined in the agreements and pay to TDS the required income tax due. V-28 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 5--NOTES PAYABLE-AFFILIATE The TDS Group provides cash management services to the Cellular Group, the Telecom Group and the Aerial Group. Amounts invested by the Groups are available upon demand and bear interest each month at the 30-day Commercial Paper Rate as reported in the Wall Street Journal, plus .25%, or such higher rate as the TDS Group may at its discretion offer on such deposits. NOTE 6--PROPERTY AND EQUIPMENT RADIO PAGING Radio Paging property and equipment is stated at original cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property and equipment was 24.6%, 27.9% and 22.1% in 1997, 1996 and 1995, respectively. Radio Paging property and equipment in service and under construction consists of:
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Subscriber devices......................................................... $ 41,059 $ 39,714 Terminals and transmitters................................................. 48,181 44,251 Computer equipment......................................................... 16,402 16,595 Furniture and fixtures..................................................... 10,515 10,314 Other...................................................................... 2,118 2,126 ----------- ----------- $ 118,275 $ 113,000 ----------- ----------- ----------- -----------
OTHER Other property and equipment is stated at original cost. Depreciation is provided using the straight-line method over the estimated useful lives of assets. The provision for depreciation as a percentage of depreciable property and equipment was 12.3%, 15.9% and 10.0% in 1997, 1996 and 1995, respectively. Other property and equipment in service and under construction consists of:
DECEMBER 31, -------------------- 1997 1996 --------- --------- (DOLLARS IN THOUSANDS) Computer equipment............................................................ $ 54,062 $ 42,682 Furniture and fixtures........................................................ 18,710 15,772 Cable, printing and other equipment........................................... 12,138 11,737 Work in process............................................................... 11,899 5,055 Capital leases................................................................ -- 7,535 --------- --------- $ 96,809 $ 82,781 --------- --------- --------- ---------
Certain costs relating to the development of computer software for internal use are capitalized and are amortized over the estimated five-year life of the software. NOTE 7--NOTES PAYABLE The TDS Group has used short-term debt to finance its investments in PCS and radio paging operations, for acquisitions, and for general corporate purposes. Long-term debt and equity financing from time to time, including sales of debt and equity securities by TDS's subsidiaries, have reduced such short-term debt. Proceeds from the issuance of long-term debt and equity securities reduced short-tem debt by $241.4 million, $131.2 million and $131.4 million in 1997, 1996 and 1995, respectively. Proceeds from the sales of non-strategic cellular and other investments from time to time in 1997, 1996 and 1995 have also been used to reduce short-term debt. V-29 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 7--NOTES PAYABLE (CONTINUED) TDS had $644.2 million of bank lines of credit for general corporate purposes at December 31, 1997, all of which were committed. Unused amounts of such lines totaled $117.9 million, all of which were committed. These line-of-credit agreements provide for borrowings at negotiated rates up to the prime rate. The carrying amounts of short-term debt approximate fair value due to the short-term nature of these instruments. Information concerning notes payable for the TDS Group is shown in the table below:
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Balance at end of period........................................... $ 530,175 $ 159,162 $ 182,625 Weighted average interest rate at end of period.................... 6.1% 6.0% 6.3% Maximum amount outstanding during the period....................... $ 586,308 $ 202,765 $ 182,625 Average amount outstanding during the period(1).................... $ 406,596 $ 111,072 $ 139,527 Weighted average interest rate during the period(1)................ 6.0% 5.7% 6.4%
- --------- (1) The average was computed based on month-end balances. NOTE 8-- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES In November 1997, TDS Capital I, a subsidiary trust ("the Trust") of TDS, issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities (the "Preferred Securities") at $25 per Preferred Security. Net proceeds from the issuance totaled $144.8 million and were used to reduce short-term debt. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due December 31, 2037. There is a full and unconditional guarantee by TDS of the Trust's obligations under the Preferred Securities issued by the Trust. However, TDS's obligations are subordinate and junior in right of payment to certain other indebtedness of TDS. TDS has the right to defer payments of interest on the Subordinated Debentures by extending the interest payment period, at any time, for up to 20 consecutive quarters. If interest payments on the Subordinated Debentures are so deferred, distributions on the Preferred Securities will also be deferred. During any deferral, distributions will continue to accrue with interest thereon. In addition, during any such deferral, TDS may not declare or pay any dividend or other distribution on, or redeem or purchase, any of its common stock. The Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after November 18, 2002, or, in whole but not in part, at any time in the event of certain income tax circumstances. If the Subordinated Debentures are redeemed, the Trust must redeem Preferred Securities on a pro rata basis having an aggregate liquidation amount equal to the aggregate principal amount of the Subordinated Debentures so redeemed. In the event of the dissolution, winding up or termination of the Trust, the holders of Preferred Securities will be entitled to receive, for each Preferred Security, a liquidation amount of $25 plus accrued and unpaid distributions thereon to the date of payment, unless, in connection with the dissolution, winding up or termination, Subordinated Debentures are distributed to the holders of the preferred securities. V-30 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9--TDS GROUP EQUITY The changes in the TDS Group equity for the periods presented is as follows:
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 ----------- ----------- ------------ (DOLLARS IN THOUSANDS) Balance at beginning of period.................................... $ 642,005 $ 509,421 $ 683,783 Net income........................................................ 52,968 47,540 22,691 Dividends......................................................... (27,396) (26,426) (24,602) Repurchase of Common Shares....................................... (69,942) -- -- Issuance of stock by Aerial....................................... -- 114,056 -- Recapitalization of Aerial........................................ -- -- (216,896) All other changes................................................. 4,836 (2,586) 44,445 ----------- ----------- ------------ Balance at end of period.......................................... $ 602,471 $ 642,005 $ 509,421 ----------- ----------- ------------ ----------- ----------- ------------
PREFERRED STOCK Telephone and Data Systems, Inc. Cumulative Voting Preferred Shares have a stated value of $100 per share. The authorized Preferred Shares were issuable in series by the TDS Board of Directors who establish the terms of the issue. At December 31, 1997, TDS had 324,667 shares of Preferred Stock outstanding. COMMON AND SERIES A SHARES COMMON SHARE REPURCHASE PROGRAM In December 1996, Telephone and Data Systems, Inc. authorized the repurchase of up to 3.0 million Telephone and Data Systems, Inc. Common Shares over a period of three years. Telephone and Data Systems, Inc. plans to finance the repurchase program using internally generated funds and borrowings under short-term lines of credit. Telephone and Data Systems, Inc. may use repurchased shares to fund acquisitions and for other corporate purposes. Subject to prevailing market conditions, purchases may be made from time to time through open market purchases or at negotiated prices in private transactions. The actual number of Telephone and Data Systems, Inc. Common Shares which may be repurchased will be subject to the trading price of the Common Shares, Telephone and Data Systems, Inc.'s financial position and other factors. Through December 31, 1997, Telephone and Data Systems, Inc. purchased 1,798,100 Common Shares for $69.9 million. Telephone and Data Systems, Inc. reissued 1,003,524 Common Shares primarily for acquisitions. SALE OF STOCK BY SUBSIDIARIES Aerial Communications, Inc. 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 Telephone and Data Systems, Inc.'s ownership percentage from 100% to 82.8%. The Aerial Communications, Inc. Common Shares offering was recorded at fair market value which was more than Telephone and Data Systems, Inc.'s book value investment in Aerial Communications, Inc. The TDS Group adjusted its book value investment as a result of this issue and increased TDS Group Equity $114.1 million in 1996. On December 31, 1995, prior to the initial public offering, TDS converted certain Notes Receivable-Affiliate from Aerial to equity, decreasing the TDS Group equity $216.9 million. COMMON STOCK ACQUISITIONS During 1997, 1996 and 1995, Telephone and Data Systems, Inc. issued 998,783, 2,634,408 and 2,947,777 Telephone and Data Systems, Inc. Common Shares, respectively, for the acquisition of cellular and telephone interests. The 1997 Common Shares issued for acquisitions are reissued Treasury Shares (See Common Share Repurchase Program). V-31 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9--TDS GROUP EQUITY (CONTINUED) COMMON SHARES ISSUABLE A certain acquisition agreement requires Telephone and Data Systems, Inc. to deliver 10,480 Telephone and Data Systems, Inc. Common Shares in 1998. DIVIDEND REINVESTMENT, INCENTIVE AND BENEFIT PLANS The following table summarizes Telephone and Data Systems, Inc. Common and Series A Common Shares issued for the employee stock ownership plans and dividend reinvestment plans described below.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Common Shares Tax-deferred savings plan............................................ 32,354 36,269 40,624 Dividend reinvestment plan........................................... 25,273 28,827 105,001 Employee stock options, awards, stock appreciation rights and employee stock purchase plan....................................... 64,367 35,273 40,025 --------- --------- --------- 121,994 100,369 185,650 --------- --------- --------- --------- --------- --------- Series A Common Shares Dividend reinvestment plan........................................... 19,731 26,445 17,855 --------- --------- --------- --------- --------- ---------
TAX-DEFERRED SAVINGS PLAN. Telephone and Data Systems, Inc. had reserved 78,558 Common Shares for issue under the Telephone and Data Systems, Inc. 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 Telephone and Data Systems, Inc. Common Shares, United States Cellular Common Shares, Aerial Communications Common Shares, American Paging Common Shares or five nonaffiliated funds. DIVIDEND REINVESTMENT PLANS. Telephone and Data Systems, Inc. had reserved 460,742 Common Shares for issue under the Automatic Dividend Reinvestment and Stock Purchase Plan and 172,523 Series A Common Shares for issue under the Series A Common Share Automatic Dividend Reinvestment Plan. These plans enable holders of Telephone and Data Systems, Inc.'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 Telephone and Data Systems, Inc.'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 Telephone and Data Systems, Inc. had reserved 1,291,107 Common Shares for options granted and to be granted to key employees. Telephone and Data Systems, Inc. has established certain plans that provide for the grant of stock options to officers and employees. The options are exercisable over a specified period not in excess of ten years. The options expire from 1998 to 2006 or the date of the employee's termination of employment, if earlier. Telephone and Data Systems, Inc. accounts for stock options, stock appreciation rights ("SARs") and employee stock purchase plans under Accounting Principles Board ("APB") Opinion No. 25. No compensation costs have been recognized for the stock option and employee stock purchase plans. Compensation expense for SARs, measured on the difference between the year-end market price of the Common Shares and SAR prices, was $91,000, $263,000 and $408,000 in 1997, 1996 and 1995, respectively. Had compensation cost for all plans been V-32 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9--TDS GROUP EQUITY (CONTINUED) determined consistent with SFAS No. 123, the TDS Group's net income would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- (DOLLARS IN THOUSANDS) Net Income As Reported.......................................................... $ 52,968 $ 47,540 $ 22,691 Pro Forma............................................................ $ 47,511 $ 46,198 $ 22,132 --------- --------- --------- --------- --------- ---------
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 Telephone and Data Systems, Inc.'s stock option plans at December 31, 1997, 1996 and 1995 and changes during the years ended is presented in the table and narrative below:
WEIGHTED AVERAGE WEIGHTED NUMBER OF OPTION AVERAGE SHARES PRICES FAIR VALUES --------- ----------- ----------- Stock Options: Outstanding January 1, 1995 (172,689 exercisable)....................... 485,597 $ 30.25 Granted............................................................... 59,995 $ 38.67 $ 14.84 Exercised............................................................. (26,101) $ 5.52 Cancelled............................................................. (3,046) $ 43.32 --------- Outstanding December 31, 1995 (240,160 exercisable)..................... 516,445 $ 32.47 Granted............................................................... 89,228 $ 41.00 $ 13.30 Exercised............................................................. (11,025) $ 13.10 Cancelled............................................................. (3,210) $ 39.89 --------- Outstanding December 31, 1996 (405,996 exercisable)..................... 591,438 $ 34.08 Granted 68,137 $ 43.90 $ 10.61 Exercised............................................................. (43,824) $ 19.51 Cancelled............................................................. (41,243) $ 40.78 --------- Outstanding December 31, 1997 (492,917 exercisable) 574,508 $ 35.87 --------- ---------
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.1%, 5.6% and 6.6%; expected dividend yields of 1.0%, 1.0% and 1.0%; expected lives of 5.0 years, 5.1 years and 6.9 years and expected volatility of 19.2%, 20.5% and 25.0%. Stock appreciation rights allowed the grantee to receive an amount in cash or Telephone and Data Systems, Inc. Common Shares, or a combination thereof, equivalent to the difference between the exercise price and the fair market value of the Common Shares on the exercise date. The following table summarizes the SARs outstanding at $4.43 to $36.60 per share. These rights expired March 1997. The fair value of each stock appreciation right grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of V-33 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 9--TDS GROUP EQUITY (CONTINUED) 4.9%, 5.2% and 5.5%; expected dividend yields of 1.0%, 1.0% and 1.0%; expected lives of 0.1 year, 0.2 year and 0.7 year; and expected volatility of 20.5%, 18.4% and 20.2%.
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1996 1995 --------- --------- --------- Outstanding beginning of period.......................................... 10,070 16,034 12,096 Granted................................................................ 630 5,923 8,174 Exercised.............................................................. (10,700) (11,887) (4,236) --------- --------- --------- Outstanding end of period................................................ -- 10,070 16,034 --------- --------- --------- --------- --------- ---------
EMPLOYEE STOCK PURCHASE PLAN. Telephone and Data Systems, Inc. had reserved 159,816 Common Shares for sale to the employees of Telephone and Data Systems, Inc. The fair value of the employees' purchase rights was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants rights in 1997 and 1996: risk-free interest rate of 5.6% and 5.6%; expected dividend yield of 1.0% and 1.0%; expected lives of 1.2 years and 0.5 year; and expected volatility of 16.9% and 15.3%. CONVERTIBLE PREFERRED SHARES Telephone and Data Systems, Inc. convertible Preferred Shares are convertible into 932,011 Common Shares. Telephone and Data Systems, Inc. issued 56,365, 347,707 and 40,734 Common Shares in 1997, 1996 and 1995, respectively, for Telephone and Data Systems, Inc. preferred shares converted and 11,345 and 3,781 Common Shares in 1997 and 1996, respectively, for subsidiary preferred stock converted. SERIES A COMMON SHARES The holders of Telephone and Data Systems, Inc. Common Shares and the outstanding Preferred Shares are entitled to one vote per share. The holders of Telephone and Data Systems, Inc. Series A Common Shares are entitled to ten votes per share. Series A Common Shares are convertible, on a share-for-share basis, into Telephone and Data Systems, Inc. Common Shares. Telephone and Data Systems, Inc. has reserved 6,936,277 Common Shares for possible issuance upon such conversion. NOTE 10--COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The TDS Group has leases for certain plant facilities, office space and data processing equipment, most of which are classified as operating leases. For the years 1997, 1996 and 1995, rent expense for noncancelable, long-term leases was $8.2 million, $4.1 million and $2.6 million, respectively, and rent expense under cancelable, short-term leases was $4.3 million, $5.2 million and $4.5 million, respectively. At December 31, 1997, the aggregate minimum rental commitments under noncancelable, long-term operating leases were as follows:
MINIMUM FUTURE RENTAL PAYMENTS --------------------- (DOLLARS IN THOUSANDS) 1998............................................................................... $ 7,055 1999............................................................................... 6,280 2000............................................................................... 5,600 2001............................................................................... 5,061 2002............................................................................... 4,669 Thereafter......................................................................... $ 45,755
V-34 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED) LEGAL PROCEEDINGS Telephone and Data Systems, Inc. is involved in legal proceedings before the FCC and various state and federal courts from time to time. Management does not believe that any of such proceedings should have a material adverse impact on the financial position or results of operations of the TDS Group. NOTE 11--INVESTMENTS IN ENTITIES ACCOUNTED FOR BY THE EQUITY METHOD The following summarizes the unaudited combined assets, liabilities and equity, and the unaudited results of operations of the interests in which the TDS Group's investments are accounted for by the equity method.
DECEMBER 31, ------------------------ 1997 1996 ----------- ----------- (DOLLARS IN THOUSANDS) Assets Current assets........................................................... $ 56,581 $ 58,143 Due from affiliates...................................................... -- 67 Property and other....................................................... 75,666 66,534 ----------- ----------- $ 132,247 $ 124,744 ----------- ----------- ----------- ----------- Liabilities and Equity Current liabilities...................................................... $ 34,671 $ 38,891 Due to affiliates........................................................ -- 406 Deferred credits......................................................... 2,666 2,589 Long-term debt........................................................... 34,386 25,070 Partners' capital and stockholders' equity............................... 60,524 57,788 ----------- ----------- $ 132,247 $ 124,744 ----------- ----------- ----------- -----------
YEAR ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Results of Operations Revenues.......................................................... $ 58,586 $ 52,954 $ 47,956 Costs and expenses................................................ (49,765) (46,342) (38,835) Other income...................................................... 1,481 1,098 927 Interest expense.................................................. (2,266) (1,683) (2,004) Income taxes...................................................... (2,760) (1,680) (3,079) Extraordinary item................................................ -- (2,211) -- ---------- ---------- ---------- Net income........................................................ $ 5,276 $ 2,136 $ 4,965 ---------- ---------- ---------- ---------- ---------- ----------
V-35 THE TDS GROUP NOTES TO FINANCIAL STATEMENTS (CONTINUED) NOTE 12--AMERICAN PAGING, INC. OPERATIONS The table below details the TDS Group's (loss) resulting from American Paging, Inc.'s results of operations for each of the years in the three year period ended December 31, 1997.
YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Operating Revenues Service revenue.................................................. $ 85,937 $ 93,841 $ 93,034 Equipment sales revenue.......................................... 8,476 10,346 14,116 ----------- ----------- ----------- 94,413 104,187 107,150 ----------- ----------- ----------- Operating Expense Cost of services................................................. 27,822 26,712 22,294 Selling, general and administrative.............................. 62,089 70,441 55,064 Depreciation and amortization.................................... 32,040 33,777 24,692 Cost of equipment sold........................................... 7,769 9,883 14,097 ----------- ----------- ----------- 129,720 140,813 116,147 ----------- ----------- ----------- Operating (Loss)................................................... (35,307) (36,626) (8,997) ----------- ----------- ----------- Investment and Other Income (Expense) Investment (loss) in joint venture............................... (459) (1,201) (1,151) Interest income.................................................. 128 259 175 Other, net....................................................... 75 33 121 ----------- ----------- ----------- (256) (909) (855) ----------- ----------- ----------- (Loss) Before Interest and Income Taxes............................ (35,563) (37,535) (9,852) ----------- ----------- ----------- Interest expense-affiliates........................................ 16,073 11,797 6,953 Capitalized interest............................................... -- (4,147) (1,420) ----------- ----------- ----------- 16,073 7,650 5,533 ----------- ----------- ----------- (Loss) Before Income Taxes......................................... (51,636) (45,185) (15,385) Income tax expense................................................. -- 342 325 ----------- ----------- ----------- Net (Loss) to Shareholders......................................... (51,636) (45,527) (15,710) Net (Loss) to Minority Shareholders................................ -- 6,368 2,782 ----------- ----------- ----------- Net (Loss) to Telephone and Data Systems, Inc. Shareholders..................................................... $ (51,636) $ (39,159) $ (12,928) ----------- ----------- ----------- ----------- ----------- -----------
NOTE 13--SUBSEQUENT EVENT COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES In February 1998, TDS Capital II, a subsidiary trust of TDS, issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable Preferred Securities at $25 per Preferred Security. Net proceeds from the issuance totaled $145.0 million and were used to reduce short-term debt. The sole asset of TDS Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated Debentures due March 31, 2038 or such date to which the maturity is extended by TDS, but in no event later than March 31, 2047. The Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after March 31, 2003, or, in whole but not in part, at any time in the event of certain income tax circumstances. All other terms and conditions are identical to those of TDS Capital I. (See Note 8--Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Company Subordinated Debentures) V-36 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Telephone and Data Systems, Inc.: We have audited, the accompanying balance sheets of the TDS Group (representing a business unit of Telephone and Data Systems, Inc.) as of December 31, 1997 and 1996, and the related statements of operations and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the management of Telephone and Data Systems, Inc. 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 the TDS Group as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Chicago, Illinois January 28, 1998 (except with respect to the matters discussed in Note 2, "American Paging, Inc."; and in Note 13 as to which the date is February 18, 1998) V-37 PART II INFORMATION NOT REQUIRED IN PROXY STATEMENT-PROSPECTUS ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the Delaware General Corporation Law (the "DGCL") permits the Registrant's board of directors to indemnify any person against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with any threatened, pending or completed action, suit or proceeding in which such person is made a party by reason of his being or having been a director, officer, employee or agent of the Registrant, in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act of 1933, as amended (the "Securities Act"). The statute provides that indemnification pursuant to its provisions is not exclusive of other rights of indemnification to which a person may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors, or otherwise. The Registrant's Certificate of Incorporation and Bylaws provide for indemnification of its directors and officers to the fullest extent permitted by law. As permitted by Sections 102 and 145 of the DGCL, the Registrant's Certificate of Incorporation eliminates a director's personal liability for monetary damages to the Registrant and its stockholders arising from a breach or alleged breach of a director's fiduciary duty except for liability under Section 174 of the DGCL, for liability for any breach of the director's duty of loyalty to the Registrant or its stockholders, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law or for any transaction from which the director derived an improper personal benefit. The directors and officers of the Registrant are covered by insurance policies indemnifying against certain liabilities, including certain liabilities arising under the Securities Act which might be incurred by them in such capacities and against which they cannot be indemnified by the Registrant. The Registrant has directors' and officers' liability insurance which provides, subject to certain policy limits, deductible amounts and exclusions, coverage for all persons who have been, are or may in the future be, directors or officers of the Registrant, against amounts which such persons must pay resulting from claims against them by reason of their being such directors or officers during the policy period for certain breaches of duty, omissions or other acts done or wrongfully attempted or alleged. Insofar as indemnification for liabilities arising under the 1933 Act may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final adjudication of such issue. II-1 ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits
EXHIBIT NO. DESCRIPTION OF DOCUMENT - ----------- --------------------------------------------------------------------------------- 2 Agreement and Plan of Merger, dated as of March 6, 1998, between Telephone and Data Systems, Inc., a Delaware corporation, and Telephone and Data Systems, Inc., an Iowa corporation (included herein as Exhibit A to the Proxy Statement and Prospectus included as part of this Registration Statement). 4.1 Restated Certificate of Incorporation of Telephone and Data Systems, Inc., a Delaware Corporation (included herein as Exhibit B to the Proxy Statement and Prospectus included as part of this Registration Statement) 4.2 * Restated By-laws of Telephone and Data Systems, Inc., a Delaware corporation 5 * Opinion of Sidley & Austin 8 * Tax Opinion of Sidley & Austin 9.1 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. 9.2 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. 9.3 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. 23.1 Consent of independent public accountants 23.2 Consent of Sidley & Austin (included in Exhibits 5 and 8) 24 Powers of Attorney (included on signature page of original filing of this Registration Statement) 99.1 * Telephone and Data Systems, Inc.'s Offer Letter to the Board of Directors of United States Cellular Corporation 99.2 * Telephone and Data Systems, Inc.'s Offer Letter to the Board of Directors of Aerial Communications, Inc. 99.3 * Form of Proxy Cards 99.4 * Consent of C.S. First Boston 99.5 * Consent of Salomon Smith Barney 99.6 * Consent of Kevin A. Mundt
- --------- * Previously filed ITEM 22. UNDERTAKINGS (a) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling the registrant pursuant to the foregoing provisions, the registrant has been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and therefore unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful II-2 ITEM 22. UNDERTAKINGS (CONTINUED) defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (b) The undersigned registrant hereby undertakes that, for purposes of determining any liability under the Securities Act, each filing of the registrant's annual report pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the registration statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (c) The undersigned registrant undertakes that every Proxy Statement-Prospectus (i) that is filed pursuant to the immediately preceding paragraph or (ii) that purports to meet the requirements of Section 10(a)(3) of the Securities Act and is used in connection with the offering of securities subject to Rule 415, except to the extent permitted to be filed as a Proxy Statement-Prospectus supplement, will be filed as a part of an amendment to the registration statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the bona fide offering thereof. (d) The undersigned registrant hereby undertakes to respond to requests for information that is incorporated by reference into the Proxy Statement-Prospectus pursuant to Items 4, 10(b), 11, or 13 of this Form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the registration statement through the date of responding to the request. (e) The undersigned registrant hereby undertakes to supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the registration statement when it became effective, except where the transaction in which the securities being offered pursuant to this registration statement would itself qualify for an exemption from Section 5 of the Securities Act, absent the existence of other similar (prior or subsequent) transactions. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-4 and has duly caused this Registration Statement or Amendment to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Chicago, State of Illinois on this 9th day of March, 1998. TELEPHONE AND DATA SYSTEMS, INC. By: /s/ LEROY T. CARLSON ----------------------------------------- LeRoy T. Carlson CHAIRMAN
POWER OF ATTORNEY Each person whose signature appears below constitutes and appoints LeRoy T. Carlson and LeRoy T. Carlson, Jr., and each of them individually, as his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, and to take such actions in, and file with the appropriate applications, statements, consents and other documents as may be necessary or expedient to register securities of the Registrant for sale, granting unto said attorney-in-fact and agent full power and authority to do so and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all the said attorney-in-fact and agent or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof and the registrant hereby confers like authority on its behalf. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement or Amendment has been signed below by the following persons on behalf of the registrant on this 9th day of March, 1998 in the capacities indicated:
SIGNATURE TITLE - ------------------------------ -------------------------- /s/ LEROY T. CARLSON - ------------------------------ Chairman and Director LeRoy T. Carlson /s/ LEROY T. CARLSON, JR.* President and Director - ------------------------------ (chief executive LeRoy T. Carlson, Jr. officer) Executive Vice /s/ MURRAY L. SWANSON* President-Finance and - ------------------------------ Director (principal Murray L. Swanson financial officer)
II-4
SIGNATURE TITLE - ------------------------------ -------------------------- /s/ LETITIA G.C. CARLSON* - ------------------------------ Director Letitia G.C. Carlson /s/ RUDOLPH E. HORNACEK* - ------------------------------ Director Rudolph E. Hornacek /s/ JAMES BARR III* - ------------------------------ Director James Barr III /s/ DONALD C. NEBERGALL* - ------------------------------ Director Donald C. Nebergall /s/ HERBERT S. WANDER* - ------------------------------ Director Herbert S. Wander /s/ WALTER C.D. CARLSON* - ------------------------------ Director Walter C.D. Carlson /s/ DONALD R. BROWN* - ------------------------------ Director Donald R. Brown /s/ GEORGE W. OFF* - ------------------------------ Director George W. Off /s/ MARTIN L. SOLOMON* - ------------------------------ Director Martin L. Solomon /s/ GREGORY J. WILKINSON* Vice President and - ------------------------------ Controller (principal Gregory J. Wilkinson accounting officer)
*By: /s/ LEROY T. CARLSON Attorney-in-Fact ------------------------------ LeRoy T. Carlson
II-5 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF DOCUMENT - ----------- --------------------------------------------------------------------------------- (a) Exhibits 23.1 Consent of independent public accountants
EX-23.1 2 CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference in this Proxy Statement/Prospectus 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 incorporated by reference in the Telephone and Data Systems, Inc. Form 10-K for the year ended December 31, 1996, to the incorporation by reference in this Proxy Statement/Prospectus 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 Telephone and Data Systems, Inc., included in the Telephone and Data Systems, Inc. Form 10-K for the year ended December 31, 1996. We also consent to all references to our Firm included in this Proxy Statement/Prospectus. ARTHUR ANDERSEN LLP Chicago, Illinois March 6, 1998 -----END PRIVACY-ENHANCED MESSAGE-----