-----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, UylN659anb0a4Aj9lnbCaazZf8CKbjfN8cmMLuoOvy+JIcureN2bOr2stpnKfMul vPRRUGr83BHDnTl/mzYeXg== 0001047469-99-012604.txt : 19990402 0001047469-99-012604.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-012604 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TELEPHONE & DATA SYSTEMS INC /DE/ CENTRAL INDEX KEY: 0001051512 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 362669023 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-14157 FILM NUMBER: 99579988 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 10-K405 1 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 001-14157 --------------------- TELEPHONE AND DATA SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 36-2669023 (State or other jurisdiction (IRS Employer Identification No.) of incorporation or organization) 30 NORTH LASALLE STREET, CHICAGO, 60602 ILLINOIS (Zip code) (Address of principal executive offices) REGISTRANT'S TELEPHONE NUMBER: (312) 630-1900 Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED - ---------------------------------------- ------------------------------------------- Common Shares, $.01 par value American Stock Exchange 8.5% TDS-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust American Stock Exchange 8.04% TDS-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None --------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. _X_ As of February 26, 1999, the aggregate market values of the registrant's Common Shares, Series A Common Shares and Preferred Shares held by non-affiliates were approximately $2.7 billion, $26.1 million and $33.3 million, respectively. The closing price of the Common Shares on February 26, 1999, was $50.25, as reported by the American Stock Exchange. Because no market exists for the Series A Common Shares and Preferred Shares, the registrant has assumed for purposes hereof that (i) each Series A Common Share has a market value equal to one Common Share because the Series A Common Shares were initially issued by the registrant in exchange for Common Shares on a one-for-one basis and are convertible on a share-for-share basis into Common Shares, (ii) each nonconvertible Preferred Share has a market value of $100 because each of such shares had a stated value of $100 when issued, and (iii) each convertible Preferred Share has a value of $50.25 times the number of Common Shares into which it was convertible on February 26, 1999. The number of shares outstanding of each of the registrant's classes of common stock, as of February 26, 1999, is 54,391,873 Common Shares, $.01 par value, and 6,949,904 Series A Common Shares, $.01 par value. DOCUMENTS INCORPORATED BY REFERENCE Those sections or portions of the registrant's 1998 Annual Report to Shareholders and of the registrant's Notice of Annual Meeting of Shareholders and Proxy Statement for its Annual Meeting of Shareholders to be held May 14, 1999, described in the cross reference sheet and table of contents attached hereto are incorporated by reference into Part II and III of this report. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CROSS REFERENCE SHEET AND TABLE OF CONTENTS
PAGE NUMBER OR REFERENCE(1) -------------------- Item 1. Business........................................................................... 3 Item 2. Properties......................................................................... 42 Item 3. Legal Proceedings.................................................................. 42 Item 4. Submission of Matters to a Vote of Security Holders................................ 42 Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............. 43(2) Item 6. Selected Financial Data............................................................ 43(3) Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................... 43(4) Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................... 43(4) Item 8. Financial Statements and Supplementary Data........................................ 43(5) Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................................................................... 43 Item 10. Directors and Executive Officers of the Registrant................................. 44(6) Item 11. Executive Compensation............................................................. 44(7) Item 12. Security Ownership of Certain Beneficial Owners and Management..................... 44(8) Item 13. Certain Relationships and Related Transactions..................................... 44(9) Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................... 45
- ------------------------ (1) Parenthetical references are to information incorporated by reference from the registrant's Exhibit 13, which includes portions of its Annual Report to Shareholders for the year ended December 31, 1998 ("Annual Report") and from the registrant's Notice of Annual Meeting of Shareholders and Proxy Statement for its Annual Meeting of Shareholders to be held on May 14, 1999 ("Proxy Statement"). (2) Annual Report sections entitled "TDS Stock and Dividend Information" and "Market Price per Common Share by Quarter." (3) Annual Report section entitled "Selected Consolidated Financial Data." (4) Annual Report section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition." (5) Annual Report sections entitled "Consolidated Statements of Operations," "Consolidated Statements of Cash Flows," "Consolidated Balance Sheets," "Consolidated Statements of Common Stockholders' Equity," "Notes to Consolidated Financial Statements," "Consolidated Quarterly Income Information (Unaudited)" and "Report of Independent Public Accountants." (6) Proxy Statement sections entitled "Election of Directors" and "Executive Officers." (7) Proxy Statement section entitled "Executive Compensation," except for the information specified in Item 402(a)(8) of Regulation S-K under the Securities Exchange Act of 1934, as amended. (8) Proxy Statement section entitled "Security Ownership of Certain Beneficial Owners and Management." (9) Proxy Statement section entitled "Certain Relationships and Related Transactions." 2 TELEPHONE AND DATA SYSTEMS, INC. 30 NORTH LASALLE STREET, CHICAGO, ILLINOIS 60602 TELEPHONE (312) 630-1900 [LOGO] - -------------------------------------------------------------------------------- PART I - -------------------------------------------------------------------------------- ITEM 1. BUSINESS Telephone and Data Systems, Inc. (the "Company" or "TDS"), is a diversified telecommunications service company with cellular telephone, telephone and personal communications services ("PCS") operations. At December 31, 1998, the Company served approximately 3.0 million customer units in 35 states, including 2,183,000 cellular telephones, 547,500 telephone access lines and 311,900 PCS telephones. For the year ended December 31, 1998, cellular operations provided 64% of the Company's consolidated revenues; telephone operations provided 27%; and PCS operations provided 9%. The Company's long-term business development strategy is to expand its existing operations through internal growth and acquisitions and to explore and develop other telecommunications businesses that management believes will utilize the Company's expertise in customer-based telecommunications. The Company conducts substantially all of its cellular operations through its 81.0%-owned subsidiary, United States Cellular Corporation [AMEX: USM]. At December 31, 1998, U.S. Cellular provided cellular telephone service to 2,183,000 customers through 138 majority-owned and managed ("consolidated") cellular systems serving approximately 17% of the geography and approximately 9% of the population of the United States. Since 1985, when U.S. Cellular began providing cellular service in Knoxville, Tennessee, U.S. Cellular has expanded its cellular networks and customer service operations to cover 145 managed markets in 26 states as of December 31, 1998. In total, the Company operated eight market clusters, of which four had a total population of more than two million, and each of which had a total population of more than one million. Overall, 90% of the Company's 26.2 million population equivalents were in markets which were consolidated, 2% were in managed but not consolidated markets and 8% were in markets in which the Company holds an investment interest. The Company conducts substantially all of its telephone operations through its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom"). At December 31, 1998, TDS Telecom operated 105 telephone companies serving 547,500 access lines in 28 states. TDS Telecom is expanding by offering additional lines of telecommunications products and services to existing customers and through the selective acquisition of local exchange telephone companies serving rural and suburban areas. TDS Telecom has acquired 16 telephone companies and divested one telephone company since the beginning of 1994. These net acquisitions added 76,000 access lines during this five-year period, while internal growth added 115,300 lines. TDS Telecom also began offering services as a Competitive Local Exchange Carrier ("CLEC") in 1998 in certain markets in Wisconsin and Minnesota. At December 31, 1998, TDS Telecom's CLECs served 38,800 access lines. The Company conducts substantially all of its broadband PCS operations through its 82.3%-owned subsidiary, Aerial Communications, Inc. [NASDAQ: AERL]. Aerial provides PCS service in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major 3 Trading Areas ("MTAs") (collectively, the "PCS Markets"). The PCS Markets include approximately 27.7 million population equivalents. Aerial has commenced service in all its markets and provided service to 311,900 PCS telephones as of December 31, 1998. The Company was incorporated in 1968 and changed its corporate domicile from Iowa to Delaware in 1998. The Company's executive offices are located at 30 North LaSalle Street, Chicago, Illinois 60602. Its telephone number is 312-630-1900. Unless the context indicates otherwise: (i) references to "TDS" or the "Company" refer to Telephone and Data Systems, Inc., and its subsidiaries; (ii) references to "USM" or "U.S. Cellular" refer to United States Cellular Corporation and its subsidiaries; (iii) references to "TDS Telecom" refer to TDS Telecommunications Corporation and its subsidiaries; (iv) references to "AERL" or "Aerial" refer to Aerial Communications, Inc. and its subsidiaries; (v) references to "MSA" or to a particular city refer to the Metropolitan Statistical Area, as designated by the U.S. Office of Management and Budget and used by the Federal Communications Commission ("FCC") in designating metropolitan cellular market areas; (vi) references to "RSA" refer to the Rural Service Area, as used by the FCC in designating non-MSA cellular market areas; (vii) references to cellular "markets" or "systems" refer to MSAs, RSAs or both; (viii) references to "MTA" refer to Major Trading Areas, as used by the FCC in designating PCS markets; (ix) references to "population equivalents" mean the population of a market, based on 1998 Claritas estimates, multiplied by the percentage interests that the Company owns or has the right to acquire in an entity licensed, designated to receive a license or expected to receive a construction permit ("licensee") by the FCC to construct or operate a cellular or a PCS system in such market. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT This Annual Report on Form 10-K, including exhibits, contains "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on current expectations, estimates and projections. Statements that are not historical facts, including statements about the Company's beliefs and expectations are forward-looking statements. These statements contain potential risks and uncertainties and, therefore, actual results may differ materially. TDS undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Important factors that may affect these projections or expectations include, but are not limited to: changes in the overall economy; changes in competition in markets in which TDS operates; advances in telecommunications technology; changes in the telecommunications regulatory environment; pending and future litigation; availability of future financing; unanticipated changes in growth in cellular and PCS customers, penetration rates, churn rates; the mix of products and services offered in the Company's markets; and unanticipated problems with the Year 2000 Issue. Readers should evaluate any statements in light of these important factors. PROPOSED CORPORATE RESTRUCTURING In December 1997, the Board of Directors of Telephone and Data Systems, Inc. adopted a proposal, which was approved by the shareholders in April 1998, to authorize three new classes of common stock and to change the state of incorporation of TDS from Iowa to Delaware. The three new classes of stock were intended to separately reflect the performance of the Company's cellular telephone, telephone and personal communications services businesses ("Tracking Stocks"). The reincorporation was completed May 1998. The Company intended to: a) offer and sell Telecom Group Shares in a public offering for cash, b) issue Cellular Group Shares in exchange for all of the Common Shares of U.S. Cellular not owned by the Company, c) issue Aerial Group Shares in exchange for all of the Common Shares of Aerial not owned by the Company, and d) distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of the Company. 4 In December 1998, TDS announced the withdrawal of its offers to exchange tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial which it did not own. An integral part of the tracking stock plan was the offering of shares in the Telecom Group, which TDS was not able to complete at a reasonable offering price. In addition, TDS was unable to reach mutually acceptable agreements with the special committees representing the minority shareholders of U.S. Cellular and Aerial. At the same time TDS announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. There are a number of conditions that must be met for a spin-off to occur, including the receipt of a favorable Internal Revenue Service ruling on the tax free status of such a spin-off, final approval by the TDS Board of Directors, certain government and third party approvals and review by the Securities and Exchange Commission ("SEC") of appropriate SEC filings. Prior to any spin-off, it is expected that Aerial will seek additional financing so that Aerial would have the appropriate capitalization to operate as a stand-alone entity. In connection with such financing, it is anticipated that a substantial amount of Aerial's debt to TDS may be converted into equity. TDS intends to seek shareholder approval of a proposal to distribute Aerial Series A Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and Aerial Common Shares, on a pro-rata basis, to holders of TDS Common Shares. There can be no assurance that a spin-off will be consummated or that other alternatives will not be pursued. In September 1998, pursuant to a purchase agreement between TDS, Aerial, Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4 million shares of common stock of AOC representing a 19.423% equity interest in AOC, subject to adjustment under certain circumstances, for an aggregate purchase price of $200 million. Sonera has the right, subject to adjustment under certain circumstances, to exchange each share of AOC, common stock which it owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent Purchase Price"). Following the announcement by TDS in December 1998, that it intended to distribute to its shareholders all of the capital stock of Aerial that it owns, and that Aerial would seek additional financing from sources other than TDS in connection therewith, Sonera contacted TDS to express certain concerns about the announcement. Sonera has asserted that the TDS announcement reflects a change in circumstances that warrant the renegotiation of certain matters related to its investment in AOC, including an adjustment in the Equivalent Purchase Price, and has raised the possibility of litigation in connection therewith. TDS and Aerial intend to attempt to reach a mutually acceptable resolution of the concerns raised by Sonera. There can be no assurance that this matter will not lead to litigation, or that it will not have a material adverse effect on TDS or Aerial or on the plans relating to the refinancing and spin-off of Aerial. CELLULAR TELEPHONE OPERATIONS The Company's cellular operations are conducted through U.S. Cellular and its subsidiaries. U.S. Cellular is the eleventh largest wireless company in the United States, based on the aggregate number of customers in its consolidated markets. U.S. Cellular's corporate development strategy is to operate controlling interests in cellular market licensees in areas adjacent to or in proximity to its other markets, thereby building clusters of operating markets. Customers benefit from larger service areas such as these, which provide longer uninterrupted service and the ability to make outgoing calls and receive incoming calls within the designated area without special roaming arrangements. In addition, U.S. Cellular anticipates that clustering will continue to provide it certain economies in its capital and operating costs. As the number of opportunities for outright acquisitions has decreased in recent years, and as U.S. Cellular's clusters have grown, U.S. Cellular's focus has shifted toward exchanges and divestitures of managed and investment interests which are considered less essential to U.S. Cellular's clustering strategy. 5 The following table summarizes the status of U.S. Cellular's interests in cellular markets at December 31, 1998. Owns Majority Interest and Manages.................................. 138 Owns Minority Interest and Manages.................................. 7 --------- Total Markets Managed by the Company................................ 145 Markets Managed by Others (1)....................................... 38 --------- Total Markets....................................................... 183 --------- ---------
- ------------------------ (1) Represents markets in which U.S. Cellular owns a minority or other noncontrolling interest and which are managed by third parties; as of December 31, 1998, U.S. Cellular accounted for its interests in 31 of these markets using the equity method and accounted for the remaining seven markets using the cost method. Cellular systems in U.S. Cellular's 138 majority-owned and managed markets served 2,183,000 customers at December 31, 1998, and contained 2,065 cell sites. The average penetration rate in U.S. Cellular's consolidated markets was 8.84% at December 31, 1998, and the churn rate in all consolidated markets averaged 1.9% per month for the twelve months ended December 31, 1998. THE CELLULAR TELEPHONE INDUSTRY Cellular telephone technology provides high-quality, high-capacity communications services to in-vehicle and hand-held portable cellular telephones. Cellular technology is a major improvement over earlier mobile telephone technologies. Cellular telephone systems are designed for maximum mobility of the customer. Access is provided through system interconnections to local, regional, national and world-wide telecommunications networks. Cellular telephone systems also offer a full range of ancillary services such as conference calling, call-waiting, call-forwarding, voice mail, facsimile and data transmission. Cellular telephone systems divide each service area into smaller geographic areas or "cells." Each cell is served by radio transmitters and receivers operating on discrete radio frequencies licensed by the FCC. All of the cells in a system are connected to a computer-controlled Mobile Telephone Switching Office ("MTSO"). The MTSO is connected to the conventional ("landline") telephone network and potentially other MTSOs. Each conversation on a cellular phone involves a transmission over a specific set of radio frequencies from the cellular phone to a transmitter/receiver at a cell site. The transmission is forwarded from the cell site to the MTSO and from there may be forwarded to the landline telephone network to complete the call. As the cellular telephone moves from one cell to another, the MTSO determines radio signal strength and transfers ("hands off") the call from one cell to the next. This hand-off is not noticeable to either party on the phone call. The FCC currently grants only two licenses to provide cellular telephone service in each market. However, competition for customers includes competing communications technologies such as conventional landline and mobile telephone, Specialized Mobile Radio ("SMR") systems, radio paging and PCS. PCS has become available in many areas of the United States, including U.S. Cellular's markets, and U.S. Cellular expects PCS operators to continue deployment of PCS in portions of all of U.S. Cellular's clusters through 1999. Additionally, technologies such as Enhanced Specialized Mobile Radio ("ESMR") and mobile satellite communication systems may prove to be competitive with cellular service in the future in some or all of U.S. Cellular's markets. The services available to cellular customers and the sources of revenue available to cellular system operators are similar to those provided by conventional landline telephone companies. Customers may be charged a separate fee for system access, airtime, long-distance calls and ancillary services. Cellular system operators often provide service to customers of other operators' cellular systems while the customers are temporarily located within the operators' service areas. Customers using service away from their home system are called "roamers." Roaming is not limited to cellular customers and systems; 6 PCS customers and systems have this roaming capability as well. In all cases, the system that provides the service to roamers will generate usage revenue. Many operators, including U.S. Cellular, charge premium rates for this roaming service. There have been a number of technical developments in the cellular industry since its inception. Currently, while most companies' MTSOs process information digitally, on certain cellular systems the radio transmission is done on an analog basis. During 1992, a new transmission technique was approved for implementation by the cellular industry. Time Division Multiple Access ("TDMA") technology was selected as one industry standard by the cellular industry and has been deployed in several markets, including U.S. Cellular's operations in portions of several clusters. Another digital technology, Code Division Multiple Access ("CDMA"), is also being deployed by U.S. Cellular in portions of several clusters. Digital radio technology offers several advantages, including greater privacy, less transmission noise, greater system capacity and potentially lower incremental costs to accommodate additional system usage. The conversion from analog to digital radio technology is continuing on an industry-wide basis; however, this process is expected to take a number of years. PCS operators have deployed TDMA, CDMA and a third digital technology, Global System for Mobile Communication ("GSM"), in the markets where they have begun operations. The cellular telephone industry is characterized by high initial fixed costs. Accordingly, if and when revenues less variable costs exceed fixed costs, incremental revenues should yield an operating profit. The amount of profit, if any, under such circumstances is dependent on, among other things, prices and variable marketing costs which in turn are affected by the amount and extent of competition. Until technological limitations on total capacity are approached, additional cellular system capacity can normally be added in increments that closely match demand and at less than the proportionate cost of the initial capacity. CELLULAR OPERATIONS From its inception in 1983 until 1993, U.S. Cellular was principally in a start-up phase. Until 1993, U.S. Cellular's activities had been concentrated significantly on the acquisition of interests in cellular licensees and on the construction and initial operation of cellular systems. The development of a cellular system is capital-intensive and requires substantial investment prior to and subsequent to initial operation. U.S. Cellular experienced operating losses and net losses from its inception until 1993. During the past five years, U.S. Cellular generated operations-driven net income and has significantly increased its operating cash flows during that time. Management anticipates further growth in cellular units in service and revenues as U.S. Cellular continues to expand through internal growth. Marketing and system operations expenses associated with this expansion may reduce the rate of growth in operating cash flows and operating income during the period of additional growth. In addition, U.S. Cellular anticipates that the seasonality of revenue streams and operating expenses may cause U.S. Cellular's operating income to vary from quarter to quarter. While U.S. Cellular produced operating income and net income during the last five years, changes in any of several factors may reduce U.S. Cellular's growth in operating income and net income over the next few years. These factors include: (i) the growth rate in U.S. Cellular's customer base; (ii) the usage and pricing of cellular services; (iii) the churn rate; (iv) the cost of providing cellular services, including the cost of attracting new customers; (v) continued competition from PCS and other technologies; and (vi) continuing technological advances which may provide additional competitive alternatives to cellular service. U.S. Cellular is building a substantial presence in selected geographic areas throughout the United States where it can efficiently integrate and manage cellular telephone systems. Its cellular interests include regional market clusters in the following areas: Wisconsin/Illinois, Iowa/Missouri/Illinois/Indiana, Eastern North Carolina/South Carolina, West Virginia/Maryland/Pennsylvania/Ohio, Virginia/North Carolina, Washington/Oregon/Idaho, Oregon/California, Maine/New Hampshire/Vermont, Florida/Georgia, 7 Oklahoma/Missouri/Kansas, Texas/Oklahoma, Eastern Tennessee/Western North Carolina and Southern Texas. See "U.S. Cellular's Cellular Interests." U.S. Cellular has acquired its cellular interests through the wireline application process (16%), including settlements and exchanges with other applicants, and through acquisitions (84%), including acquisitions from TDS and third parties. CELLULAR SYSTEMS DEVELOPMENT ACQUISITIONS, DIVESTITURES AND EXCHANGES. U.S. Cellular assesses its cellular holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. As U.S. Cellular's clusters have grown, its focus has shifted toward exchanges and divestitures of managed and investment interests, with outright acquisitions becoming a decreasing portion of U.S. Cellular's overall acquisition strategy. As a result, U.S. Cellular has not substantially increased its population equivalents during the past five years, but has shifted the balance of its holdings between investment and operating interests so that currently over 90% of U.S. Cellular's interests are in markets where it is the operator. This shift has resulted primarily because of U.S. Cellular's recent focus on exchanges and divestitures of investment interests and the acquisitions of interests in markets where it will become the operator. U.S. Cellular has only increased its population equivalents by 5% in the last five years, from approximately 24.8 million at December 31, 1993, to approximately 26.1 million at December 31, 1998. However, during that period U.S. Cellular has increased the percentage of those population equivalents which are in markets U.S. Cellular operates. As of December 31, 1998, 92% of U.S. Cellular's population equivalents represented interests in markets U.S. Cellular operates compared to 81% at December 31, 1993. Also, the number of markets operated by U.S. Cellular have increased to 145 markets at December 31, 1998 from 136 markets at December 31, 1993. Recently, the pace of acquisitions, exchanges and divestitures has slowed as industry-wide consolidation has reduced the number of markets available for acquisition. U.S. Cellular may continue to make opportunistic acquisitions or exchanges in markets that further strengthen its market clusters and in other attractive markets. U.S. Cellular also seeks to acquire minority interests in markets where it already owns the majority interest and/or operates the market. There can be no assurance that U.S. Cellular, or TDS for the benefit of U.S. Cellular, will be able to negotiate additional acquisitions or exchanges on terms acceptable to it or that regulatory approvals, where required, will be received. U.S. Cellular plans to retain minority interests in certain cellular markets which it believes will earn a favorable return on investment. Other minority interests may be exchanged for interests in markets which enhance U.S. Cellular's market clusters or may be sold for cash or other consideration. U.S. Cellular also continues to evaluate the disposition of certain managed interests which are not essential to its corporate development strategy. COMPLETED ACQUISITIONS. During 1998, U.S. Cellular, or TDS for the benefit of U.S. Cellular, purchased majority interests in six markets and several additional minority interests, representing approximately 1.3 million population equivalents. The total consideration paid for these purchases, primarily in the form of cash and U.S. Cellular Common Shares issued to TDS to reimburse TDS for the value of TDS Common Shares issued to third parties, totaled $168.3 million. COMPLETED DIVESTITURES. During 1998, U.S. Cellular and TDS sold a majority interest in one market and several minority interests, representing approximately 1.2 million population equivalents. In exchange, U.S. Cellular and TDS received approximately 5.2 million AirTouch Communications, Inc. ("AirTouch") common shares and cash totaling $119.7 million. PENDING ACQUISITIONS AND DIVESTITURE. At December 31, 1998, U.S. Cellular had agreements pending to acquire minority interests in two markets in which U.S. Cellular currently owns majority interests, representing 74,000 population equivalents, for $8.1 million in cash. Also at December 31, 1998 U.S. Cellular had an agreement pending to divest a majority interest in one market, representing 264,000 population equivalents, for a total consideration of $35.2 million. U.S. Cellular expects all of the pending transactions to be completed during the first half of 1999. TDS and U.S. Cellular maintain shelf registrations of Common Shares and Preferred Stock under the Securities Act of 1933 for issuance specifically in connection with acquisitions. 8 U.S. Cellular is a majority-owned subsidiary of TDS. At December 31, 1998, TDS owned 81.0% of the combined total of the outstanding Common Shares and Series A Common Shares of U.S. Cellular and controlled 95.7% of the combined voting power of both classes of common stock. CELLULAR INTERESTS AND CLUSTERS U.S. Cellular operates clusters of adjacent cellular systems in nearly all of its markets, enabling its customers to benefit from larger service areas than otherwise possible. Where U.S. Cellular offers wide-area coverage, its customers enjoy uninterrupted service within the designated area. Customers may also make outgoing calls and receive incoming calls within this area without special roaming arrangements. In addition to benefits to customers, clustering also has provided to U.S. Cellular certain economies in its capital and operating costs. These economies are made possible through increased sharing of facilities, personnel and other costs and have resulted in a reduction of U.S. Cellular's per customer cost of service. The extent to which U.S. Cellular benefits from these revenue enhancements and economies of operation is dependent on market conditions, population size of each cluster and engineering considerations. U.S. Cellular may continue to make opportunistic acquisitions and exchanges which will complement its established market clusters. From time to time, U.S. Cellular may also consider exchanging or selling its interests in markets which do not fit well with its long-term strategies. U.S. Cellular owned interests in cellular telephone systems in 183 markets at December 31, 1998, representing 26.4 million population equivalents. Including the minority interests to be purchased and the majority interest to be sold during 1999, U.S. Cellular owned or had the right to acquire 182 markets, representing 26.2 million population equivalents, at December 31, 1998. The following table summarizes the growth in U.S. Cellular's population equivalents in recent years and the development status of these population equivalents.
DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (THOUSANDS OF POPULATION EQUIVALENTS)(1) Operational Markets: Majority-Owned and Managed.................................. 23,661 22,929 20,539 20,230 18,812 Minority-Owned and Managed (2).............................. 354 401 401 512 1,213 Majority-Owned Markets to be Managed, Net of Markets to be Divested: (2)(3)............................................ -- -- 218 274 2,228 --------- --------- --------- --------- --------- Total Markets Managed and to be Managed................... 24,015 23,330 21,158 21,016 22,253 Minority Interests in Markets Managed by Others............... 2,150 2,143 4,569 4,070 3,821 --------- --------- --------- --------- --------- Total..................................................... 26,165 25,473 25,727 25,086 26,074 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
- ------------------------ (1) Based on 1998 Claritas estimates for all years. (2) Includes markets where the Company has the right to acquire an interest but does not currently own an interest. (3) Includes markets which are operational but which are currently managed by third parties. The following section details U.S. Cellular's cellular interests, including those it owned or had the right to acquire as of December 31, 1998. The table presented therein lists clusters of markets that U.S. Cellular manages. U.S. Cellular's market clusters show the areas in which U.S. Cellular is currently focusing its development efforts. These clusters have been devised with a long-term goal of allowing delivery of cellular service to areas of economic interest and along corridors of economic activity. The number of population equivalents represented by U.S. Cellular's cellular interests may have no direct relationship to the number of potential cellular customers or the revenues that may be realized from the operation of the related cellular systems. 9 U.S. CELLULAR'S CELLULAR INTERESTS The table below sets forth certain information with respect to the interests in cellular markets which U.S. Cellular owned or had the right to acquire pursuant to definitive agreements as of December 31, 1998.
TOTAL CURRENT AND ACQUIRABLE 1998 POPULATION CLUSTER/MAJOR SERVICE AREA POPULATION EQUIVALENTS - ------------------------------------------------------------------------------------ ------------- ------------- MIDWEST REGIONAL MARKET CLUSTER: Wisconsin/Illinois................................................................ 4,874,000 4,792,000 Iowa/Missouri/Illinois/Indiana.................................................... 4,666,000 4,240,000 ------------- ------------- Total Midwest Regional Market Cluster........................................... 9,540,000 9,032,000 ------------- ------------- MID-ATLANTIC REGIONAL MARKET CLUSTER: Eastern North Carolina/South Carolina............................................. 2,602,000 2,557,000 West Virginia/Maryland/Pennsylvania/Ohio.......................................... 1,379,000 1,251,000 Virginia/North Carolina........................................................... 1,320,000 1,313,000 ------------- ------------- Total Mid-Atlantic Regional Market Cluster...................................... 5,301,000 5,121,000 ------------- ------------- NORTHWEST REGIONAL MARKET CLUSTER: Washington/Oregon/Idaho........................................................... 1,506,000 1,406,000 Oregon/California................................................................. 1,046,000 1,046,000 ------------- ------------- Total Northwest Regional Market Cluster......................................... 2,552,000 2,452,000 ------------- ------------- MAINE/NEW HAMPSHIRE/VERMONT MARKET CLUSTER:......................................... 1,690,000 1,636,000 ------------- ------------- FLORIDA/GEORGIA MARKET CLUSTER:..................................................... 1,562,000 1,562,000 ------------- ------------- TEXAS/OKLAHOMA/MISSOURI/KANSAS REGIONAL MARKET CLUSTER: Oklahoma/Missouri/Kansas.......................................................... 1,428,000 882,000 Texas/Oklahoma.................................................................... 694,000 575,000 ------------- ------------- Total Texas/Oklahoma/Missouri/Kansas Regional Market Cluster:................... 2,122,000 1,457,000 ------------- ------------- EASTERN TENNESSEE/WESTERN NORTH CAROLINA MARKET CLUSTER:............................ 1,636,000 1,319,000 ------------- ------------- SOUTHERN TEXAS MARKET CLUSTER:...................................................... 1,306,000 1,295,000 ------------- ------------- Other Operations:................................................................... 141,000 141,000 ------------- ------------- Total Managed Markets............................................................... 25,850,000 24,015,000 Markets Managed by Others........................................................... 2,150,000 ------------- Total Population Equivalents........................................................ 26,165,000 ------------- -------------
SYSTEM DESIGN AND CONSTRUCTION. U.S. Cellular designs and constructs its systems in a manner it believes will permit it to provide high-quality service to mobile, transportable and portable cellular telephones, based on market and engineering studies which relate to specific markets. Engineering studies are performed by U.S. Cellular personnel or independent engineering firms. U.S. Cellular's switching equipment is digital, which reduces noise and crosstalk and is capable of interconnecting in a manner which reduces costs of operation. While digital microwave interconnections are typically made between the MTSO and cell sites, both analog and digital radio transmissions are made between cell sites and the cellular telephones themselves. Network reliability is given careful consideration and extensive redundancy is employed in virtually all aspects of U.S. Cellular's network design. Route diversity, ring topology and extensive use of emergency standby power are also utilized to enhance network reliability and minimize service disruption from any particular network failure. 10 In accordance with its strategy of building and strengthening market clusters, U.S. Cellular has selected high capacity digital cellular switching systems that are capable of serving multiple markets through a single MTSO. U.S. Cellular's cellular systems are designed to facilitate the installation of equipment which will permit microwave interconnection between the MTSO and the cell site. U.S. Cellular has implemented such microwave interconnection in most of the cellular systems it manages. In other systems in which U.S. Cellular owns a majority interest and where it is believed to be cost-efficient, such microwave technology will also be implemented. Otherwise, such systems will rely upon landline telephone connections to link cell sites with the MTSO. Although the installation of microwave network interconnection equipment requires a greater initial capital investment, a microwave network enables a system operator to avoid the current and future charges associated with leasing telephone lines from the landline telephone company, while generally improving system reliability. In addition, microwave facilities can be used to connect separate cellular systems to allow shared switching, which reduces the aggregate cost of the equipment necessary to operate multiple systems. Microwave facilities can also be used to carry long-distance calls, which reduces the costs of interconnecting to the landline network. U.S. Cellular has continued to expand its Wide Area Network to accommodate various business functions, including: automatic call delivery, intersystem handoff, credit validation, fraud prevention, network management, long-distance traffic, SS7 signaling and virtually all internal data communications between various U.S. Cellular office locations and a significant number of U.S. Cellular's retail locations. Management believes that currently available technologies will allow sufficient capacity on U.S. Cellular's networks to meet anticipated demand over the next few years. COSTS OF SYSTEM CONSTRUCTION AND FINANCING Construction of cellular systems is capital-intensive, requiring substantial investment for land and improvements, buildings, towers, MTSOs, cell site equipment, microwave equipment, engineering and installation. U.S. Cellular, consistent with FCC control requirements, uses primarily its own personnel to engineer and oversee construction of each cellular system it owns and operates. In so doing, U.S. Cellular expects to improve the overall quality of its systems and to reduce the expense and time required to make them operational. The costs (exclusive of license costs) of the systems in which U.S. Cellular owns an interest have historically been financed through capital contributions or intercompany loans from U.S. Cellular to the entities owning the systems, and through certain vendor financing. In recent years, these funding requirements have been met with cash generated from operations, proceeds from debt and equity offerings and proceeds from the sales of cellular interests. MARKETING U.S. Cellular's marketing plan is centered around rapid penetration of its market clusters, increasing customer awareness of cellular service and reducing churn through both the building of brand awareness and the implementation of marketing programs. The marketing plan stresses the value of U.S. Cellular's service offerings and incorporates combinations of rate plans and cellular telephone equipment which are designed to meet the needs of a variety of customer segments and their usage patterns. U.S. Cellular's distribution channels include direct sales personnel, agents and retail service centers in the vast majority of its markets. U.S. Cellular-owned and managed locations are designed to market cellular service to the consumer segment in a familiar setting. In late 1997, U.S. Cellular expanded its e-commerce site to offer three rate plans across the country aimed at each of U.S. Cellular's three major segments. Sales are relatively light at this time, but U.S. Cellular anticipates that as customers become more comfortable with on-line purchasing the Internet will become more of a robust marketing channel. U.S. Cellular manages each cluster of markets with a local staff, including sales, customer service, engineering and in some cases installation personnel. Direct sales consultants market cellular service to business customers throughout each cluster. Retail associates work out of the retail locations and market cellular service primarily to the consumer and small business segment. U.S. Cellular maintains 11 an ongoing training program to improve the effectiveness of sales consultants and retail associates by focusing their efforts on obtaining customers and maximizing the sale of high-user packages. These packages provide for customers to obtain a minimum amount of usage at discounted rates per minute, at fixed prices which are charged even if usage falls below a defined monthly minimum amount. U.S. Cellular continues to expand its relationships with agents, dealers and non-U.S. Cellular retailers to obtain customers. Agents and dealers are independent business people who obtain customers for U.S. Cellular on a commission basis. U.S. Cellular's agents are generally in the business of selling cellular telephones, cellular service packages and other related products. U.S. Cellular's dealers include car stereo companies and other companies whose customers are also potential cellular customers. The non-U.S. Cellular retailers include car dealers, major appliance dealers, office supply dealers and mass merchants. U.S. Cellular opened its first retail locations in late 1993, expanding to over 280 stand-alone retail stores by the end of 1998. These U.S. Cellular-owned and operated businesses utilize rental facilities in high-traffic areas, primarily in strip malls. U.S. Cellular has implemented a uniform appearance in these stores, with all having similar displays and layouts. The retail centers' hours of business match those of the retail trade in the local marketplace, often staying open on weekends and later in the evening than a typical business supplier. To fully serve customer needs, these stores sell accessories to complement the phones and services U.S. Cellular has traditionally provided. During 1998, U.S. Cellular further expanded its retail presence by opening smaller retail kiosks within other larger merchandisers, called "stores within a store," and had several of these locations in place at year-end. Additionally, U.S. Cellular operates small kiosks within stores such as Wal-Mart and staffs those kiosks with U.S. Cellular personnel. At December 31, 1998, U.S. Cellular managed nearly 170 of these kiosks. U.S. Cellular actively pursues national retail accounts, as agents of U.S. Cellular, which yield new customer additions in multiple markets. Agreements have been entered into with such national distributors as Ford Motor Company, General Motors, Radio Shack, Best Buy, Circuit City, Staples, Office Depot, Sears, TDS Telecom, TSR Wireless and Onstar in certain of U.S. Cellular's markets. Upon the sale of a cellular telephone by one of these national distributors, U.S. Cellular receives, often exclusively within the territories served, the resulting cellular customer. U.S. Cellular created a new class of agent during 1998, the Value Added Distributor agent channel. This channel's initial focus was on the sale of U.S. Cellular's prepaid service product, TalkTracker, to selected market segments, and complements U.S. Cellular's own distribution channels. U.S. Cellular uses a variety of direct mail, billboard, radio, television and newspaper advertising to stimulate interest by prospective customers in purchasing U.S. Cellular's cellular service and to establish familiarity with U.S. Cellular's name. In 1998, U.S. Cellular increased its focus on brand advertising, including the addition of several new television commercials, using the tag line "The Way People Talk Around Here"-SM- to promote the United States Cellular-Registered Trademark- brand. Additionally, U.S. Cellular began actively advertising its digital service offerings through both television and radio advertising during the year. Advertising is directed at gaining customers, improving customers' awareness of the United States Cellular-Registered Trademark- brand, increasing existing customers' usage and increasing the public awareness and understanding of the cellular services offered by U.S. Cellular. U.S. Cellular attempts to select the advertising and promotion media that are most appealing to the targeted groups of potential customers in each local market. U.S. Cellular utilizes local advertising media and public relations activities and establishes programs such as its CommunityCare programs to enhance public awareness of U.S. Cellular. These programs are aimed at supporting the communities in which U.S. Cellular serves. The programs range from loaning phones to support public service operations in emergencies to assisting victims of domestic abuse. 12 The following table summarizes, by operating cluster, the total population, U.S. Cellular's customer units and penetration for U.S. Cellular's majority-owned and managed markets that were operational as of December 31, 1998.
OPERATING CLUSTERS POPULATION CUSTOMERS PENETRATION - --------------------------------------------- ------------ ------------ --------------- Wisconsin/Illinois........................... 4,874,000 498,000 10.22 % Iowa/Missouri/Illinois/Indiana............... 4,096,000 426,000 10.40 Eastern North Carolina/South Carolina........ 2,602,000 168,000 6.46 West Virginia/Maryland/Pennsylvania/Ohio..... 1,129,000 90,000 7.97 Virginia/North Carolina...................... 1,320,000 107,000 8.11 Washington/Oregon/Idaho...................... 1,506,000 124,000 8.23 Oregon/California............................ 1,046,000 86,000 8.22 Maine/New Hampshire/Vermont.................. 1,690,000 129,000 7.63 Florida/Georgia.............................. 1,562,000 136,000 8.71 Oklahoma/Missouri/Kansas..................... 1,428,000 133,000 9.31 Texas/Oklahoma............................... 694,000 59,000 8.50 Eastern Tennessee/Western North Carolina..... 1,289,000 137,000 10.63 Southern Texas............................... 1,306,000 70,000 5.36 Other Operations............................. 141,000 20,000 14.18 ------------ ------------ ----- 24,683,000 2,183,000 8.84 % ------------ ------------ ----- ------------ ------------ -----
CUSTOMERS AND SYSTEM USAGE Cellular customers come from a wide range of demographic segments. Business users typically include a large proportion of individuals who work outside of their offices such as people in the construction, real estate, wholesale and retail distribution businesses and professionals. Increasingly, U.S. Cellular is providing cellular service to consumers and to customers who use their cellular telephones for mixed business and personal use as well as for security purposes. A major portion of U.S. Cellular's recent customer growth is from these lower revenue segments. Although some of U.S. Cellular's customers still use in-vehicle cellular telephones, most new customers are selecting portable cellular telephones. These units have become more compact and fully featured as well as more attractively priced, and they appeal to newer segments of the customer population. U.S. Cellular's cellular systems are used most extensively during normal business hours between 7:00 AM and 6:00 PM. On average, the local retail customers in U.S. Cellular's consolidated markets used their cellular systems approximately 105 minutes per unit each month and generated retail revenue of approximately $33 per month during 1998, compared to 103 minutes and $36 per month in 1997. Revenue generated by roamers using U.S. Cellular's systems ("inbound roaming"), together with local retail, toll and other revenues, brought U.S. Cellular's total average monthly service revenue per customer unit in consolidated markets to $49 during 1998. Average monthly service revenue per customer unit decreased approximately 10% during 1998. This decrease resulted from decreases in average revenue per minute of use from both local retail customers and inbound roamers. Competitive pressures and U.S. Cellular's increasing use of pricing and other incentive programs that encourage weekend and off-peak usage at reduced rates, in order to stimulate overall usage, resulted in a decrease in average local retail revenue per minute of use in 1998. Although the introduction of "one rate" pricing plans by other wireless companies has helped increase inbound roaming minutes of use on U.S. Cellular's systems during 1998, the inbound roaming revenue per minute has decreased during the year. The decrease is partially a result of the ongoing trend toward reduced per minute prices for roaming negotiated between U.S. Cellular and other cellular operators and also due to the additional minutes generated by customers with "one rate" pricing plans, which are at lower than average rates. U.S. Cellular anticipates that average monthly service revenue per customer unit will continue to decline in the future. However, this effect is more than offset by U.S. Cellular's increasing number of customers; therefore, U.S. Cellular expects total revenues to continue to grow for the next few years. 13 U.S. Cellular's main sources of revenue are from its own customers and from inbound roaming customers. U.S. Cellular's roaming service allows a customer to place or receive a call in a cellular service area away from the customer's home service area. U.S. Cellular has entered into "roaming agreements" with operators of other cellular systems covering virtually all systems in the United States, Canada and Mexico. U.S. Cellular also has roaming agreements with several PCS operators. The charge for this service is typically at premium rates and is billed by U.S. Cellular to the customer's home system, which then bills the customer. U.S. Cellular has entered into agreements with other cellular carriers to transfer roaming usage at agreed-upon rates. In some instances, based on competitive factors, U.S. Cellular may charge a lower amount to its customers than the amount actually charged to U.S. Cellular by another cellular carrier for roaming. The following table summarizes certain information about customers and market penetration in U.S. Cellular's consolidated operations.
YEAR ENDED OR AT DECEMBER 31, ---------------------------------------------------------- 1998 1997 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Majority-owned and managed markets: Cellular markets in operation (1)............... 138 134 131 137 130 Total population of markets in service (000s)... 24,683 24,034 21,712 22,309 21,314 Customer Units: (2) at beginning of period........................ 1,710,000 1,073,000 710,000 421,000 261,000 additions during period....................... 915,000 941,000 561,000 426,000 250,000 disconnects during period..................... 442,000 304,000 198,000 137,000 90,000 at end of period.............................. 2,183,000 1,710,000 1,073,000 710,000 421,000 Market penetration at end of period (3)......... 8.84% 7.11% 4.94% 3.18% 1.98% Consolidated revenues............................. $1,162,467 $ 876,965 $ 680,068 $ 480,316 $ 327,630 Depreciation expense.............................. 167,150 97,591 74,631 57,302 39,520 Amortization expense.............................. 39,629 34,788 34,208 32,156 25,934 Operating Income.................................. 176,075 129,543 87,366 42,755 17,385 Capital expenditures.............................. 320,417 318,748 248,123 210,878 167,164 Identifiable Assets............................... $3,010,651 $2,548,909 $2,116,592 $1,890,621 $1,584,142
- ------------------------------ (1) Represents the number of markets in which U.S. Cellular owned at least a 50% interest and which it managed. The revenues and expenses of these cellular markets are included in U.S. Cellular's consolidated revenues and expenses. (2) Represents the approximate number of revenue-generating cellular telephones served by the cellular markets referred to in footnote (1). The revenue generated by such cellular telephones is included in consolidated revenues. (3) Computed by dividing the number of customer units at the end of the period by the total population of markets in service as estimated by Claritas (1997-1998) or Donnelley Marketing Service (1994-1996) for the respective years. PRODUCTS AND SERVICES CELLULAR TELEPHONES AND INSTALLATION. There are a number of different types of cellular telephones, all of which are currently compatible with cellular systems nationwide. U.S. Cellular offers a full range of vehicle-mounted, transportable and portable cellular telephones. Features offered in some of the cellular telephones include hands-free calling, repeat dialing, horn alert and others. In the systems where U.S. Cellular offers digital service, additional features such as caller ID and short messaging services are available on those cellular telephones. U.S. Cellular negotiates volume discounts from its cellular telephone suppliers. U.S. Cellular discounts cellular telephones to meet competition or to stimulate sales by reducing the cost of becoming a cellular customer. In these instances, where permitted by law, customers are generally required to sign a service contract with U.S. Cellular. U.S. Cellular also cooperates with cellular equipment manufacturers in local advertising and promotion of cellular equipment. U.S. Cellular has established service and/or installation facilities in many of its local markets to ensure quality installation and service of the cellular telephones it sells. These facilities allow U.S. Cellular to improve its service by promptly assisting customers who experience equipment problems. Additionally, U.S. Cellular maintains a repair facility in Tulsa, Oklahoma, which handles more complex service and repair issues. 14 CELLULAR SERVICES. U.S. Cellular's customers are able to choose from a variety of packaged pricing plans which are designed to fit different calling patterns. The ability to help a customer find the right technology and the right pricing plan is central to U.S. Cellular's brand positioning. During 1998, U.S. Cellular focused its efforts on new products with the continued introduction of its digital service offering, called Digital PCS, and its prepaid offering, TalkTracker-Registered Trademark-. Both offerings were very successful, as many higher revenue customers purchased U.S. Cellular's digital offering and new market segments such as individuals with credit difficulties, were able to purchase cellular service through U.S. Cellular's prepaid offering. U.S. Cellular's customer bills typically show separate charges for custom-calling features, airtime in excess of the packaged amount, and toll calls. Custom-calling features provided by U.S. Cellular include wide-area call delivery, call forwarding, call waiting, three-way calling and no-answer transfer. U.S. Cellular also offers a voice message service in many of its markets. This service, which functions like a sophisticated answering machine, allows customers to receive messages from callers when they are not available to take calls. Additional services, such as short messaging services, are available in U.S. Cellular's markets where digital service is offered. REGULATION REGULATORY ENVIRONMENT. The operations of U.S. Cellular are subject to FCC and state regulation. The cellular telephone licenses held by U.S. Cellular are granted by the FCC for the use of radio frequencies and are an important component of the overall value of the assets of U.S. Cellular. The construction, operation and transfer of cellular systems in the United States are regulated to varying degrees by the FCC pursuant to the Communications Act of 1934 (the "Communications Act"). In 1996, Congress enacted the Telecommunications Act of 1996 (the "1996 Act"), which amended the Communications Act. The 1996 Act mandates significant changes in existing telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops. The FCC has promulgated regulations governing construction and operation of cellular systems, licensing (including renewal of licenses) and technical standards for the provision of cellular telephone service under the Communications Act, and is implementing the legislative objectives of the 1996 Act, as discussed below. LICENSING. For cellular telephone licensing purposes, the FCC has divided the United States into separate geographic markets (MSAs and RSAs). In each market, the allocated cellular frequencies are divided into two equal blocks. During the application process, the FCC reserved one block of frequencies for non-wireline applicants and another block for wireline applicants. Subject to FCC approval, a cellular system may be sold to either a wireline or non-wireline entity, but no entity which controls a cellular system may own an interest in another cellular system in the same MSA or RSA. The completion of acquisitions involving the transfer of control of a cellular system requires prior FCC approval. Acquisitions of minority interests generally do not require FCC approval. Whenever FCC approval is required, any interested party may file a petition to dismiss or deny the application for approval of the proposed transfer. The FCC must be notified each time an additional cell is constructed which enlarges the service area of a given market. The FCC's rules also generally require persons or entities holding cellular construction permits or licenses to coordinate their proposed frequency usage with neighboring cellular licensees in order to avoid electrical interference between adjacent systems. The height and power of base stations in the cellular system are regulated by FCC rules, as are the types of signals emitted by these stations. In addition to regulation by the FCC, cellular systems are subject to certain Federal Aviation Administration ("FAA") regulations with respect to the siting and construction of cellular transmitter towers and antennas as well as local zoning requirements. Beginning in 1996, the FCC has also imposed a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. All new towers must be registered at the time of construction and existing towers were required to be registered on a staggered state-by-state basis, by May 1998. U.S. Cellular has completed the registration of its existing towers. 15 Beginning in October 1997, cellular systems, which previously were "categorically excluded" from having to evaluate their facilities to ensure their compliance with federal "radio frequency" (RF) radiation requirements, were made subject to those requirements (all cellular towers of less than 10 meters in height, building mounted antennas and cellular telephones must comply with RF radiation guidelines). After October 1997, all new cellular facilities must be in compliance when they are brought into service. Existing facilities must be brought into compliance with the requirements when their licenses are renewed. U.S. Cellular believes that the great majority of its existing facilities already comply with the requirements, the remainder will be brought into compliance as required and that the cellular telephones it sells comply with the standards. Initial cellular telephone licenses were granted for ten-year periods. The FCC has established standards for conducting comparative renewal proceedings between a cellular licensee seeking renewal of its license and challengers filing competing applications. The FCC has: (i) established criteria for comparing the renewal applicant to challengers, including the standards under which a renewal expectancy will be granted to the applicant seeking license renewal; (ii) established basic qualifications standards for challengers; and (iii) provided procedures for preventing possible abuses in the comparative renewal process. The FCC has concluded that it will award a renewal expectancy if the licensee has (i) provided "substantial" performance, which is defined as "sound, favorable and substantially above a level of mediocre service just minimally justifying renewal," and (ii) complied with FCC rules, policies and the Communications Act. If a renewal expectancy is awarded to an existing licensee, its license is renewed and competing applications are not considered. All of U.S. Cellular's licenses which it applied to have renewed in 1995, 1996, 1997, and 1998 were renewed. U.S. Cellular conducts and plans to conduct its operations in accordance with all relevant FCC rules and regulations and anticipates being able to qualify for a renewal expectancy in its upcoming renewal filings. Accordingly, U.S. Cellular believes that current regulations will have no significant effect on its operations and financial condition. However, changes in the regulation of cellular operators or their activities and of other mobile service providers could have a material adverse effect on U.S. Cellular's operations. The FCC has also provided that five years after the initial licenses are granted, unserved areas within markets previously granted to licensees may be applied for by both wireline and non-wireline entities and by third parties. Accordingly, many unserved area applications have been filed by U.S. Cellular and others and have generally been routinely granted. U.S. Cellular's strategy with respect to system construction in its markets has been to build cells covering areas within such markets that U.S. Cellular considers economically feasible to serve or might conceivably wish to serve and to do so within the five-year period following issuance of the license. In cases where applications for unserved areas are filed which are mutually exclusive and would result in overlapping service areas, the FCC decides between the competing applicants by an auction process. Pursuant to 1993 amendments to the Communications Act, cellular service is classified as a Commercial Mobile Radio Service ("CMRS"), in that it is service offered to the public, for a fee, which is interconnected to the public switched telephone network. The FCC has determined that it will forebear from requiring CMRS carriers to comply with a number of statutory provisions otherwise applicable to common carriers, such as the filing of tariffs. RECENT EVENTS. There are certain regulatory proceedings currently pending before the FCC which are of particular importance to the cellular industry. In one proceeding, the FCC has imposed new "enhanced 911" regulations on cellular carriers. Enhanced 911 capabilities will enable cellular systems to determine the precise location of persons making emergency calls. The new rules will require cellular carriers to work with local public safety officials to process 911 calls, including those made from mobile telephones not registered with the cellular system. Since April 1998, cellular carriers have had to be able to identify the cell from which the call has been made. The rules will require cellular systems to improve their ability to locate wireless 911 callers by 2001. The FCC has adopted a limited expansion of the obligation of cellular carriers to serve the roaming subscribers of broadband PCS providers, among others, even though the subscribers involved have no pre-existing service relationship with that carrier. Under these new policies, broadband PCS providers 16 may offer their subscribers handsets which are capable of operating over broadband PCS and cellular networks so that when their subscribers are out of range of broadband PCS networks, they will be able to obtain non-automatic access to cellular networks. The FCC expects that implementation of these roaming capabilities will promote competition between broadband PCS and cellular service providers. The FCC has adopted requirements which will make it possible for subscribers to retain, subject to certain geographic and other limitations, their existing telephone numbers when they switch from one service provider to another. This numbering portability will include switching between Local Exchange Carriers ("LECs") and other wireline providers, between wireless service providers and between LEC/ wireline and wireless providers. LECs, in the 100 largest MSAs, had implementation deadlines by the end of 1998 at those switches which received specific requests for numbering portability. The FCC recently extended the compliance date for cellular, broadband PCS, and certain other wireless providers to November 2002. In another proceeding, the FCC in 1996 adopted rules regarding the method by which cellular carriers and LECs shall compensate each other for interconnecting cellular and local exchange facilities. The FCC rules provided for symmetrical and reciprocal compensation between LECs and cellular carriers, and also prescribed interim interconnection proxy rates, which are much lower than the rates formerly paid by cellular carriers to LECs. Symmetrical and reciprocal compensation means they must pay each other at the same rate. Interconnection rate issues will be decided by the states. Cellular carriers are now paying and in the future can be expected to pay lower rates to LECs than they previously paid. This result is expected to be favorable to the wireless industry and somewhat unfavorable to LECs. The FCC is also proceeding to implement other parts of the 1996 Act. The 1996 Act provides that implementing its legislative objectives will be the task of the FCC, the state public utilities commissions and a Federal-state Joint Board. Much of this implementation is proceeding in numerous, concurrent proceedings with aggressive deadlines. The Company cannot predict the full extent of, nature of and interrelationships among state and federal implementation and other responses to the 1996 Act. The primary purpose and effect of the new law is to open all telecommunications markets to competition. The 1996 Act makes most direct or indirect state and local barriers to competition unlawful. It directs the FCC to preempt all inconsistent state and local laws and regulations, after notice and comment proceedings. It also enables electric and other utilities to engage in telecommunications service through qualifying subsidiaries. Only narrow powers over competitive entry are left to state and local authorities. Each state retains the power to impose competitively neutral requirements that are consistent with the 1996 Act's universal service provisions and necessary for universal services, public safety and welfare, continued service quality and consumer rights. The 1996 Act establishes principles and a process for implementing a modified "universal service" policy. This policy seeks nationwide, affordable service and access to advanced telecommunications and information services. It calls for reasonably comparable urban and rural rates and services. The 1996 Act also requires universal service to schools, libraries and rural health facilities at discounted rates. Cellular carriers must provide such discounted rates in accordance with federal regulations. The FCC has implemented the mandate of the 1996 Act to create a new universal service support mechanism "to ensure that all Americans have access to telecommunications services." The 1996 Act requires all interstate telecommunications providers, including wireless service providers, to "make an equitable and non-discriminatory contribution" to support the cost of providing universal service, unless their contribution would be de minimis. At present, the provision of landline telephone service in high cost areas is subsidized by access charges and other payments by interexchange carriers to LECs. The obligation to make payments to support universal service has been expanded to include other telecommunications service providers, including cellular carriers. Such payments, based on a percentage of the total "billed revenue" of carriers for a given previous half year and began in the first quarter of 1998. Carriers are free to pass such charges on to their customers. Cellular carriers are also eligible to receive universal service support payments in certain circumstances under the new systems if they provide specified services in "high cost" areas. U.S. Cellular has sought designation as an "eligible telecommunications carrier" qualified to receive universal service support in certain states. 17 Under a 1994 federal law, the Communications Assistance to Law Enforcement Act, all telecommunications carriers, including U.S. Cellular and other wireless licensees, were to have implemented, by October 1998, certain equipment changes necessary to assist law enforcement authorities in achieving an enhanced ability to conduct electronic surveillance of those suspected of criminal activity. However, owing to disputes between the Federal Bureau of Investigation and the relevant industry groups about the law's requirements, the FCC has not yet adopted the necessary technical standards to enable carriers to meet those requirements. Questions also exist regarding reimbursement by a federal fund of certain of the costs involved. U.S. Cellular supported the efforts of industry groups to obtain from the FCC a postponement of the October 1998 deadline on the grounds that compliance with the originally proposed schedule was impossible. In September 1998, the FCC postponed the compliance deadline until June 2000. The FCC also has pending proceedings: (1) to ensure that the customers of wireless providers, among others, receive complete, accurate, and understandable bills; (2) to establish safeguards to protect against authorized access to customer information; (3) to retain, relax or repeal its 45 megahertz ("MHz") cap on the amount of spectrum which entities under common ownership and control may hold in a single market and its related cellular cross-interest restrictions; and (4) to implement requirements for wireless providers to set interstate interexchange rates in each state at levels no higher than the rates charged to subscribers in any other state. The FCC has also allocated a total of 140 MHz to broadband PCS, 20 MHz to unlicensed operations and 120 MHz to licensed operations, consisting of two 30 MHz blocks in each of the 51 Major Trading Areas ("MTAs") and one 30 MHz block and three 10 MHz blocks in each of 493 Basic Trading Areas ("BTAs"). Cellular operators and those entities under common ownership with them are permitted to participate in the ownership of PCS licenses, except for those PCS licenses reserved for small businesses, and licenses for PCS service areas in which the cellular operator owns a 20% or greater interest in a cellular licensee, the service area of which covers 10% or more of the population of the PCS service area. In the latter case, the cellular license is limited to two 10 MHz PCS channel blocks. As noted previously, the FCC is now reconsidering these ownership limits. PCS technology is similar in some respects to cellular technology. Where it has become commercially available, this technology is capable of offering increased capacity for wireless two-way and one-way voice, data and multimedia communications services and has resulted in increased competition with U.S. Cellular's operations in the markets where PCS systems have begun operations. The ability of these PCS licensees to complement or compete with existing cellular licensees will be affected by future FCC rule-makings. These and other future technological and regulatory developments in the wireless telecommunications industry and the enhancement of current technologies will likely create new products and services that are competitive with the services currently offered by U.S. Cellular. There can be no assurance that U.S. Cellular will not be adversely affected by such technological and regulatory developments. STATE AND LOCAL REGULATION. U.S. Cellular is also subject to state and local regulation in some instances. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure. In 1993, Congress preempted states from regulating the entry of cellular systems into service and the rates charged by cellular systems to customers. The siting and construction of the cellular facilities, including transmitter towers, antennas and equipment shelters are still subject to state or local zoning and land use regulations. However, in 1996, Congress amended the Communications Act to provide that states could not discriminate against wireless carriers in tower zoning proceedings and had to decide on zoning requests with reasonable speed. In addition, states may still regulate other terms and conditions of cellular service. The FCC is required to forbear from applying any statutory or regulatory provision that is not necessary to keep telecommunications rates and terms reasonable or to protect consumers. A state may not apply a statutory or regulatory provision that the FCC decides to forbear from applying. In addition, the FCC must review its telecommunications regulations every two years and change any that are no longer necessary. Further, the FCC is empowered under certain circumstances to preempt state regulatory authorities if a state is obstructing the Communications Act's basic purposes. 18 U.S. Cellular and its subsidiaries have been and intend to remain active participants in proceedings before the FCC and state regulatory authorities. Proceedings with respect to the foregoing policy issues before the FCC and state regulatory authorities could have a significant impact on the competitive market structure among wireless providers and the relationships between wireless providers and other carriers. U.S. Cellular is unable to predict the scope, pace or financial impact of policy changes which could be adopted in these proceedings. COMPETITION U.S. Cellular's principal competitor for cellular telephone service in each market is the licensee of the second cellular system in that market. Since each competitor operates its cellular system on a 25 MHz frequency block licensed by the FCC using comparable technology and facilities, competition for customers between the two systems in each market is principally on the basis of quality of service, price, size of area covered, services offered, and responsiveness of customer service. The competing entities in many of the markets in which U.S. Cellular has an interest have financial resources which are substantially greater than those of U.S. Cellular and its partners in such markets. The FCC's rules require all operational cellular systems to provide, on a nondiscriminatory basis, cellular service to resellers which purchase blocks of mobile telephone numbers from an operational system and then resell them to the public. In addition to competition from the other cellular licensee in each market, there is also competition from PCS providers and ESMR system providers, both of which are able to connect with the landline telephone network. PCS providers have initiated service in many markets across the United States, including markets where U.S. Cellular has operations. PCS providers offer digital, wireless communications services to their customers. U.S. Cellular expects PCS operators to continue deployment of PCS in portions of all of U.S. Cellular's clusters throughout 1999. ESMR, an enhanced SMR system, has cells and frequency reuse like other wireless services, thereby eliminating any technological limitation. In recent years, ESMR providers have initiated service in several of U.S. Cellular's markets. Although less directly a substitute for cellular service, wireless data services and paging services may be adequate for those who do not need full two-way voice service. Similar technological advances or regulatory changes in the future may make available other alternatives to cellular service, thereby creating additional sources of competition. Continuing technological advances in the communications field make it difficult to predict the extent of additional future competition for cellular systems. For example, the FCC has allocated radio channels to a mobile satellite system in which transmissions from mobile units to satellites would augment or replace transmissions to cell sites, and several consortia to provide such service have been formed. Such a system is designed primarily to serve the communications needs of remote locations and a mobile satellite system could provide viable competition for land-based cellular systems in such areas. It is also possible that the FCC may in the future assign additional frequencies to cellular telephone service to provide for more than two cellular telephone systems per market. 19 TELEPHONE OPERATIONS OVERVIEW The Company's telephone operations are conducted through TDS Telecom and its subsidiaries. TDS Telecom is a full-service local exchange carrier providing high-quality telecommunication services, including local and long-distance telephone service and Internet access, to rural and suburban communities through TDS Telecom's 105 telephone company subsidiaries. Each of these telephone companies, ranging in size from less than 500 to more than 60,000 access lines, is an Incumbent Local Exchange Carrier ("ILEC"). TDS Telecom served approximately 547,500 access lines through its ILEC subsidiaries at December 31, 1998, in 28 states. The table below sets forth, as of December 31, 1998, (i) the nine largest states of operations of TDS Telecom based on the number of access lines and (ii) the total number of access lines operated by all of the telephone subsidiaries of TDS Telecom.
NUMBER OF ACCESS LINES STATE AT DECEMBER 31, 1998 % OF TOTAL - ---------------------------------------------------------------------------- ------------------------ ----------- Tennessee................................................................... 94,102 17.2% Wisconsin................................................................... 90,099 16.5 Georgia..................................................................... 41,224 7.5 Minnesota................................................................... 31,463 5.7 Indiana..................................................................... 28,575 5.2 Alabama..................................................................... 26,735 4.9 Michigan.................................................................... 24,721 4.5 Maine....................................................................... 24,037 4.4 New York.................................................................... 23,959 4.4 -------- ----- Total for 9 Largest States.............................................. 384,915 70.3 Other States................................................................ 162,585 29.7 -------- ----- Total................................................................. 547,500 100.0% -------- ----- -------- -----
TDS Telecom provides consumers and businesses with landline local telephone service through its switching and intra-city network. Long-distance or toll service is provided through connections with long-distance carriers, primarily AT&T and the Regional Bell Operating Companies ("RBOCs"), which purchase network access from TDS Telecom. In 1998, TDS Telecom began providing telecommunications services as a Competitive Local Exchange Carrier ("CLEC") in Madison, Appleton, Green Bay, Menasha and Neenah, Wisconsin under the TDS METROCOM brand name and in Minnesota markets including Brainerd, Duluth and St. Cloud under the USLink brand name. TDS Telecom served approximately 38,800 customers through its CLEC subsidiaries at December 31, 1998. Future growth in telephone operations is expected to be derived from providing service to new or presently unserved establishments, from business expansion in the areas served by TDS Telecom and others, from upgrading existing customers to higher grades of service, from increased usage of the network through both local and long-distance calling, from providing additional services made possible by advances in technology and from the acquisition of additional telephone companies. TDS Telecom is committed to offering its customers a full complement of telecommunications services, and is bundling those services in customer friendly packages in order to become a single source for their telecommunications needs. TDS Telecom intends to provide its customers with an ever-growing range of communications products and services covering their local, long distance, data, video and wireless needs. In 1998, TDS Telecom grew its competitive market offerings with products and services such as cellular telephone service (in partnership with U.S. Cellular), Personal Number Services, Prepaid Calling Cards, and a Commercial DISH Network (digital broadcast satellite) product. 20 The following table summarizes certain information regarding TDS Telecom's telephone operations:
YEAR ENDED OR AT DECEMBER 31, ----------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------- ------------- ------------- ------------- ----------- (DOLLARS IN THOUSANDS) ILEC Access lines(1).................... 547,500 515,500 484,500 425,900 392,500 % Residential......................... 78.1% 78.3% 79.9% 80.6% 81.3% % Business (nonresidential)........... 21.9% 21.7% 20.1% 19.4% 18.7% CLEC Access lines....................... 38,800 -- -- -- -- Total Revenues.......................... $ 488,104 $ 437,624 $ 395,059 $ 354,841 $ 306,341 % Local service....................... 28.0% 28.1% 28.0% 26.8% 26.8% % Network access and long-distance.... 52.5% 53.9% 53.9% 55.1% 56.9% % Miscellaneous and other............. 19.5% 18.0% 18.1% 18.1% 16.3% Depreciation and amortization expense... $ 111,402 $ 98,021 $ 88,459 $ 77,354 $ 68,878 Operating income........................ 94,412 100,143 102,649 98,240 91,606 Construction expenditures............... 143,125 151,460 144,440 104,372 115,483 Total identifiable assets............... $ 1,341,856 $ 1,221,463 $ 1,181,084 $ 1,058,241 $ 984,563
- ------------------------ (1) An "access line" is a single or multi-party circuit between the customer's establishment and the central switching office. TDS Telecom is a wholly-owned business unit of TDS, founded in 1968. TDS Telecom's corporate headquarters are located in Madison, Wisconsin. BUSINESS STRATEGY TDS Telecom has historically produced revenue growth in its ILEC markets by providing its customers with state-of-the-art telecommunications solutions, maintaining a high quality of on-going service and selectively acquiring local telephone companies. Management believes that TDS Telecom has a number of advantages as an ILEC, including (i) a modern network substantially upgraded to provide a variety of Advanced Calling Services ("ACS"), (ii) a strong local presence and established brand name, (iii) economies of scale not available to smaller independent operators and (iv) attractive, growing markets. However, the competitive environment in the telecommunications industry has changed significantly as a result of technological advances, increasing customer requirements and regulatory changes, including the Telecommunications Act of 1996 ("the 1996 Act"). In response to this changing competitive environment, TDS Telecom's business plan is designed to leverage TDS Telecom's strength as an ILEC into a full-service telecommunications company. The business plan provides for TDS Telecom to meet these challenges in three areas: (i) by growing and protecting TDS Telecom's core ILEC business, (ii) by leveraging its strengths into attractive new markets, and (iii) by creating a robust line of data products and services, and selling them in existing and new markets. GROW AND PROTECT CORE ILEC BUSINESS Management of TDS Telecom believes that the key to growing and protecting its existing ILEC markets is to continue to build customer loyalty by providing superior customer service, offering a suite of standardized products and services, including bundled service offerings, and rapidly developing new products and services. Management of TDS Telecom believes that its community-based business offices offering full face-to-face customer service are a fundamental competitive advantage. That advantage was further enhanced in 1998 when TDS Telecom rolled out its Virtual Business Office ("VBO") initiative, which links multiple business offices electronically, permitting TDS Telecom to maintain its local presence while expanding hours and achieving certain efficiencies of a consolidated call center. With respect to products and services, TDS Telecom markets itself to consumers as a single telecommunications provider offering bundled packages of advanced telecommunications services including local, long distance, Internet and data services. These service packages are all offered under the TDS Telecom 21 brand name in order to benefit from the brand equity in this name. In addition, management of TDS Telecom believes it can achieve cost economies by refining its acquisition strategy to focus on certain acquisitions which will increase the geographic clustering of TDS Telecom's ILEC markets. See "--ILEC Telephone Markets". LEVERAGE STRENGTHS INTO CLEC MARKETS TDS Telecom has begun its controlled entry into certain targeted midsized communities, geographically proximate to existing TDS Telecom facilities and service areas, for facilities-based entry as a CLEC (a term which depicts companies that enter the operating areas of traditional telephone companies). Management of TDS Telecom believes that the smaller size of these markets reduces the likelihood of facing significant competition and it can offer a significantly improved service level over that of the ILEC. Because it can utilize the infrastructure (e.g. billing systems, network control center, operating systems, financial and control accounting, technology planners, etc.) built for the ILEC business, management believes that TDS Telecom can become profitable in markets too small for start-ups and become profitable faster than start-ups at the high end of its targeted range (about 200,000 population). As in its ILEC markets, TDS Telecom intends to be the single source for customers' telecommunications needs in its CLEC markets. The geographic focus of TDS Telecom's CLEC strategy is designed to leverage TDS Telecom's existing infrastructure to facilitate early entry into new CLEC markets and to complement TDS Telecom's ILEC clustering strategy. Consistent with this strategy, TDS Telecom initiated service as a CLEC in Madison, Wisconsin, and in Brainerd, Duluth and St. Cloud, Minnesota, in January 1998 and initiated service as a CLEC in Appleton, Green Bay, Menasha and Neenah, Wisconsin, in June 1998. In Minnesota, TDS Telecom has adopted a slightly different strategy by entering as a CLEC through its long-distance subsidiary, USLink. USLink is able to build on its relationship developed as a long distance reseller and now offers local and Internet access services to its long distance customers in a number of locations in Minnesota. During 1999, USLink will be converting customers in Brainerd, Duluth and St. Cloud to its facilities as part of its long-term strategy. TDS Telecom plans to expand its CLEC operations to additional markets if the results of operations in the aforementioned markets prove successful. See "--CLEC Telephone Markets". PURSUE EMERGING DATA MARKETS Data communications is one of the fastest growing segments of the telecommunications services industry. In light of the growth of Internet use and rapid introduction of new telecommunications technology, TDS Telecom intends to offer a suite of data products in all of its markets, thereby positioning itself as a full-service data networking service provider. TDS Telecom currently provides Internet access service to its ILEC and CLEC customers. Most of TDS Telecom's data products are in the early stages of development. See "--Data Initiatives". ILEC TELEPHONE MARKETS TDS Telecom's goal is to be a leading provider of electronically deliverable products in its ILEC markets. According to published sources, at December 31, 1998 TDS Telecom was the 9th largest non-Bell local exchange telephone company in the United States, based on the number of telephone access lines served. At December 31, 1998, the telephone subsidiaries of TDS Telecom served approximately 547,500 access lines in 28 states. TDS Telecom currently operates over 435 central office and remote switching centers in its telephone operating areas. Substantially all of TDS Telecom's access lines are served by digital switching technology, which, in conjunction with other technologies, allows TDS Telecom to offer additional premium services to its customers, including call forwarding, conference calling, caller identification, selective call ringing and call waiting. At December 31, 1998, TDS Telecom's telephone subsidiaries also provided Internet services to approximately 4,000 customers. As one of the major independent telephone companies in the United States, TDS Telecom's ILECs provide both local telephone service and access to the long distance network for customers in their respective service areas. The ILECs also provide directory advertising through a contract with another 22 company and billing and collection services to interexchange carriers ("IXCs"). TDS Telecom provides centralized administrative and support services to field operations from its corporate offices in Madison, Wisconsin. RETAIL MARKETS TDS Telecom's ILEC presence includes a Retail Markets Group and Wholesale Markets Group. The Retail Markets Group is the customer-facing organization for all retail sales with residential and commercial customers. The Retail Markets Group includes 119 sales and service offices located in 28 states. The retail customer base is a mix of rural and suburban customers, with significant concentrations in the Upper Midwest and in the Southeast. Approximately 78% of TDS Telecom's retail access lines serve residential customers and approximately 22% serve business customers. Most business customers could be described as small business or small office/home office type customers. The Retail Markets Group has three primary goals to support its grow and protect strategy: (i) build customer loyalty, (ii) grow revenues, and (iii) control costs. Management of TDS Telecom believes it can achieve these goals by offering a continually updated flow of new products and services through value- added packages and bundles, by building brand equity in the TDS Telecom brand name, and by providing superior customer service to its retail customers. VALUE ADDED PRODUCT BUNDLES AND PACKAGES. Management of TDS Telecom believes that its consumer and business customers have a strong preference to purchase all of their telecommunications services from a single provider. TDS Telecom believes that by offering a full complement of telecommunication services and bundling those services in customer-friendly packages it can build customer loyalty and reduce customer churn. TDS Telecom added several new services in 1998 by combining the services of its network with the services of carefully selected strategic partners. These products include: cellular telephone service (in partnership with U.S. Cellular), Personal Number Services, Prepaid Calling Cards, and a Commercial DISH Network (digital broadcast satellite) product. These products were sold both as stand-alone items and as part of value-added product bundles and packages. TDS Telecom will continue to pursue relationships with strategic partners to further develop the long distance, video and wireless components of its product mix. BRAND EQUITY. TDS Telecom continued the branding process started in 1996. This process adopted the TDS Telecom name as a unified brand name across its ILEC markets to build its brand image. TDS Telecom has continued its customer awareness campaign to build awareness of the TDS Telecom name. TDS Telecom continues to build name awareness through existing customer-facing vehicles such as bill statements, and vehicle and company signage. Centralized media purchasing has enabled higher reach and frequency at a lower cost. In 1998, TDS Telecom focused on building a positive share of mind with current and prospective customers. This was done by increasing the volume of public relations messages and through linkage of company image with sales and marketing messages. The strategy will continue through 1999. Management of TDS Telecom believes that branding will increase the loyalty of its customers and also reduce expenses through more cost-effective marketing. CUSTOMER SERVICE. TDS Telecom makes a unique customer service offer to its retail customers. TDS Telecom is a large national company with a local sales and service office in each of its ILEC markets. This combination provides TDS Telecom's retail customers with the economies of scale and product offers generally associated with large companies. It also provides the high levels of personal customer service generally associated with small companies, through community-based professional service representatives and field representatives who both live and work in the communities served. TDS Telecom's strength in two key areas--product/price and customer service-- provides a fundamental competitive advantage for TDS Telecom. TDS Telecom began deploying a Virtual Business Office ("VBO") initiative in 1998. This initiative enables multiple local sales and service offices to function as a single office. Management of TDS Telecom believes that VBO will facilitate enhanced customer service at a lower cost. Cost savings are expected to come through standardization of training and procedures and improved voice and customer service application technology. Enhanced customer service will come through expanded hours of 23 operation, improved product, service and sales training for all customer sales and service representatives, and through improved customer access to company personnel on the first call. Initial customer surveys show that customer satisfaction with transactions in the VBO environment is equal to or better than satisfaction with transactions in the prior environment. TDS Telecom plans to complete deployment of VBO in 1999. WHOLESALE MARKETS The Wholesale Markets Group focuses on TDS Telecom's wholesale customers and has traditionally provided a majority of TDS Telecom's revenues. TDS Telecom receives much of its ILEC revenue from the sale of traditional wholesale services, such as access service charges and billing and collections services to the IXCs. As a result, TDS Telecom continues to provide a high level of service to traditional IXC wholesale customers such as AT&T, MCI, Sprint and the RBOCs. ACCESS REVENUES. TDS Telecom's operating telephone subsidiaries receive access revenue as compensation for carrying interstate and intrastate long-distance traffic on its network. The interstate and intrastate access rates charged include the cost of providing service plus a fair rate of return. Access revenues account for approximately 56% of the revenue generated by TDS Telecom's ILEC subsidiaries. TDS Telecom participates in the National Exchange Carrier Association ("NECA") interstate common line and traffic sensitive tariffs for all but one of its ILEC subsidiaries. These operating companies participate in the access revenue pools administered by NECA, which collect and distribute revenue from interstate access services. The FCC created NECA and it is subject to FCC rules and oversight. The FCC regulates interstate toll rates and other matters relating to interstate telephone service. On June 4, 1998, the FCC released a Notice of Proposed Rulemaking (NPRM) on access reform for local exchange carriers subject to rate of return regulation. In the NPRM, the FCC proposed changes similar to those which were ordered for price cap local exchange carriers ("LECs") in 1997. The proposed changes could negatively affect rural LECs' ability to recover costs from the interstate jurisdiction. The FCC also released an NPRM on jurisdictional separations reform on October 7, 1997. In the NPRM, the FCC reviewed the current procedures for separating LECs' service costs between state and federal jurisdictions. Many of the proposals in the NPRM seek to limit costs assigned to the interstate jurisdiction and seek to assign greater costs to the intrastate jurisdiction. To the extent that the costs are not made up in the federal and state universal service mechanisms, TDS Telecom may seek rate increases to offset any reductions in interstate revenues. The FCC has not yet issued a final order on either of these two NPRMs. TDS Telecom is also monitoring the effects of increasing volumes of Internet traffic on the operating telephone subsidiaries' ability to appropriately recover the network-related costs associated with this traffic. Unless changes to the access charge methodology and/or to the separations process are made, increasing costs will continue to be shifted to the intrastate jurisdiction for recovery and TDS Telecom may need to seek rate increases to recover these costs. Where applicable and subject to state regulatory approval, TDS Telecom's ILEC subsidiaries utilize intrastate access tariffs and participate in intrastate revenue pools. However, many intrastate toll revenue pooling arrangements, a source of substantial revenues to TDS Telecom's ILECs, have been replaced with access-charge-based arrangements. In these cases, access charges are typically set to generate revenue flows similar to those realized in the pooling process. To the extent that state-ordered access charge revisions reduce revenues, TDS Telecom may seek adjustments in other rates. Some states are utilizing a state high cost fund to offset access charge reductions. FEDERAL FINANCING TDS Telecom's primary sources of long-term financing for additions to telephone plant and equipment have been the Rural Utilities Service ("RUS"), the Rural Telephone Bank ("RTB") and the Federal Financing Bank ("FFB"), agencies of the United States of America. The RUS has made primarily 35-year loans to telephone companies since 1949, at interest rates of 2% and 5%, for the purpose of improving telephone service in rural areas. Currently, the RUS is authorized to issue hardship loans at a 5% interest 24 rate and other loans at an interest rate approximating the government's rate for instruments of comparable maturity. The RTB, established in 1971, makes loans at interest rates based on its average cost of money (5.71% for its fiscal year ended September 30, 1998), and in some cases makes loans concurrently with RUS loans. In addition, the RUS guarantees loans made to telephone companies by the FFB at the federal cost of money. All such loans have a maturity date based on the life of the assets being financed. Substantially all of TDS Telecom's telephone plant is pledged under, or is otherwise subject to, mortgages securing obligations of the operating telephone companies to the RUS, RTB and FFB. The amount of dividends on common stock that may be paid by the operating telephone companies is limited by certain financial requirements set forth in the mortgages. In any calendar year, companies with greater than 40% net worth to total assets can distribute the entire amount above 40%. The majority of TDS Telecom's telephone subsidiaries exceed this percentage. Approximately $400.9 million may be paid as dividends from the operating subsidiaries to TDS Telecom and TDS. At December 31, 1998, TDS Telecom's operating telephone companies had unadvanced loan commitments under the RUS, RTB and FFB loan programs aggregating approximately $116.4 million, at a weighted average annual interest rate of 5.10%, to finance specific construction activities in 1999 and future years. These loan commitments are generally issued for five-year periods and may be extended under certain circumstances. TDS Telecom's operating telephone companies intend to make further applications for additional loans from the RUS, RTB and FFB as their needs arise. There is no assurance that these applications will be accepted or what the terms or interest rates of any future loan commitments will be. FEDERAL SUPPORT REVENUES To promote universal service, the FCC developed a number of federal support mechanisms to keep telephone rates affordable for both high-cost rural areas and low-income customers. Many of TDS Telecom's ILEC subsidiaries provide telephone service in rural areas and all of them offer service to low-income customers. The 1996 Act codified universal service; set forth principles for ensuring affordable access to modern telephone service nationwide; established discounts for schools, libraries and rural health care facilities; and established a federal-state joint board to make recommendations to the FCC regarding implementation of the universal service provisions of the 1996 Act. On May 8, 1997, the FCC released its Order on universal service, adopting many of the joint board's recommendations. The FCC adopted the use of forward-looking proxy cost models to determine costs rather than relying on actual costs. However, rural LECs will continue to receive support based on their actual costs through at least December 31, 2000. Rural LECs will then transition to another method of receiving support if it can be shown that the method will be sufficient to meet the universal service needs of customers in the areas they serve. Proceedings to resolve additional universal service issues, including what ILEC or CLEC lines can receive support, petitions for reconsideration and judicial appeals of portions of the FCC's universal service rules and policies remain pending. The FCC's Order also mandated that all telecommunications providers contribute to the universal service fund beginning January 1, 1998. However, the Order allows LECs to recover these contributions through their interstate access rates. The final rules to implement the universal service provisions of the 1996 Act will involve development of new support mechanisms and changes in the eligibility criteria. In addition, some of TDS Telecom's LEC subsidiaries operate in states where support and rate structures are either being re-evaluated or have already been changed. Full recovery of universal service costs in the future through interstate and intrastate mechanisms is uncertain. If interstate or intrastate support decreases, TDS Telecom's LEC subsidiaries may pursue local service rate increases to recover the difference. Historically, telephone company acquisition and investment decisions assumed the ability to recover the cost and a reasonable rate of return through local service, access and support revenues. Significant changes in the universal service funding system could affect TDS's and TDS Telecom's acquisition and investment strategy. 25 TELEPHONE ACQUISITIONS TDS and TDS Telecom continually review attractive opportunities to acquire operating telephone companies. Since January 1, 1994, TDS has acquired 16 telephone companies serving a total of 77,100 net access lines for an aggregate consideration totaling $238.1 million, all of which were transferred to TDS Telecom. The consideration paid by TDS consisted of $27.3 million in cash and notes, 155,000 TDS Preferred Shares and 4.4 million TDS Common Shares. TDS sold one telephone company serving 1,100 access lines in 1995. Telephone holding companies and others actively compete for the acquisition of telephone companies and such acquisitions are subject to the consent or approval of regulatory agencies in most states and, in some cases, to federal waivers that may affect the form of regulation or amount of interstate cost recovery of acquired telephone exchanges. The Company has modified its acquisition strategy to focus on geographic clustering of telephone companies to achieve cost economies and to complement TDS Telecom's growth strategy. While management believes that it will be successful in making additional acquisitions, there can be no assurance that TDS or TDS Telecom will be able to negotiate additional acquisitions on terms acceptable to it or that regulatory approvals, where required, will be received. It is TDS Telecom's policy to preserve, in so far as possible, the local management of each telephone company it acquires. TDS Telecom provides the telephone subsidiaries with centralized purchasing and general management and other services, at cost plus a reasonable rate of return on invested capital. These services afford the subsidiaries expertise in finance, accounting and treasury services; marketing; customer service; traffic; network management; engineering and construction; customer billing; rate administration; credit and collection; and the development of administrative and procedural practices. CLEC TELEPHONE MARKETS The 1996 Act facilitates entry of TDS Telecom into new markets by requiring non-exempted ILECs (e.g., RBOCs and GTE) to provide reasonable and non-discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. TDS Telecom, through TDS METROCOM and USLink, wholly owned subsidiaries of TDS Telecom, has targeted certain midsized communities, geographically proximate to existing TDS Telecom facilities and service areas for facilities-based entry as a CLEC. Management of TDS Telecom believes that the size of the target markets will sustain one or two facilities-based competitors in addition to the ILEC. While additional competitors may enter such markets as resellers, TDS Telecom believes only facility-based CLECs will be profitable over the long term because facilities will provide a long-run cost advantage, discourage further competitors from entry and enable an alternative wholesale strategy for growth. To this end, TDS Telecom plans to build switching and other network facilities in its targeted CLEC markets. TDS Telecom plans to follow a "clustering" approach to building its CLECs which will allow it to seek regional long distance traffic, share service and repair resources, and realize marketing efficiencies. As in its ILEC markets, TDS Telecom intends to become an Integrated Communications Provider ("ICP") in its chosen CLEC markets. It will provide local, long distance, Internet access and other services through its own facilities and via resale. TDS Telecom intends to resell mobile services in many markets. TDS Telecom's CLEC strategy is currently focused on third-tier cities in Wisconsin and Minnesota. TDS Telecom's first CLEC in Madison, Wisconsin, became operational in January 1998. The Madison CLEC is a facilities-based, full-service alternative to Ameritech and Mid-Plains Telephone Companies, providing both voice and data services to commercial and consumer accounts, as well as wholesale services to IXCs and other carriers. TDS Telecom also began CLEC operations in Appleton, Green Bay, Menasha and Neenah, Wisconsin. USLink began offering local service (in addition to its long distance and Internet products) on a resale basis in 1998 in Minnesota, with a focus on the Brainerd, St. Cloud and Duluth markets. USLink plans to deploy local facilities in these markets during 1999 to enhance the operating margins. TDS Telecom will consider expanding into other markets if the results of operations in the aforementioned markets prove successful. 26 The CLEC strategy will place primary emphasis on the small and medium-sized commercial and wholesale customers such as Internet Service Providers ("ISP's"), cellular, paging and PCS companies. Consumer markets will be pursued approximately six months after the CLEC enters the commercial market. Wholesale customers purchase transmission capacity and access services from CLECs. These services will be available to wholesale customers shortly after network completion. TDS Telecom believes that these customers are generally more sophisticated and are more likely to switch providers to obtain network reliability, redundancy and more flexible pricing. Medium-sized commercial prospects are characterized by above-average access line to employee ratios, heavier utilization of data services, and a focus on using telecommunications for business improvement rather than on cost reduction concerns. The companies are generally growth-oriented and may be underserved by the ILEC or major IXCs. TDS Telecom will pursue a personal selling approach for its primary target markets. This approach builds on customer preference for integrated communication services and the customer's perception that the quality of the product is in the personalized service. While the CLEC is positioning itself as a high-quality provider, it expects price competition from the ILECs as they attempt to retain and regain their customers. The CLEC will seek to maintain an efficient cost structure to ensure it can match price-based initiatives from competitors. The ILEC is likely to be constrained in the short term by the existing regulatory environment; as a result, TDS Telecom expects to be more flexible in responding to customer needs. To effectively compete in this new environment, TDS Telecom will enhance its efforts at product development to provide high-quality, cutting-edge services to its customers. TDS Telecom believes the targeted third-tier markets present a significant opportunity to market data services, as the major carriers serving these locations have typically underinvested in these markets despite the growing demand. Switched data communications represents one of the fastest growing segments of the telecommunications services market. Computer proliferation, connectivity via local and wide area networks, the Internet and the emergence of multimedia applications are all driving demand. As a result, the domestic network infrastructure is strained at both the local and national levels. TDS Telecom's CLEC initiative will add local capacity in its selected cities designed to accommodate this growth. DATA INITIATIVES TDS Telecom is also seeking to recognize additional revenue opportunities in adjacent areas of the telecommunications industry. In 1998, TDS Telecom continued to expand its investments into data communications to offer a suite of data products in its CLEC and in many of its ILEC markets. TDSNET, TDS Telecom's Internet service provider, expanded its operation in 1998 to serve approximately 43,000 customers at December 31, 1998. As of December 31, 1998, TDS Telecom integrated its Internet and developing data services into existing products and services offered by its ILEC and CLEC business units. Alignment of the company's growing Internet product line into its core business units, coupled with sales and marketing strategies focused on in-territory and nearby markets, will allow TDS Telecom to continue its Internet sales growth while benefiting from operational and financial synergies. The FCC has proposed to reduce the dominant carrier regulation on an ILEC's advanced network capabilities, but only if the ILEC's basic telephone services and advanced operations follow strict standards for structural and operational separation. During 1998, management determined that the TDS Datacom structured wiring business did not fit well with the Company's other lines of business and subsequently TDS Datacom was disposed of through a combination of sales and market closings. In furtherance of TDS Telecom's strategy to position itself as a full-service, networking service provider, it plans to make high-speed Digital Subscriber Loop ("DSL") based services available to customers in several of its ILEC markets. TDS Telecom believes DSL technology will form the foundation for new, high-speed data services and applications and has conducted trials of DSL modems manufactured by several vendors. The first commercial offering of DSL began in Wisconsin in 1998. This technology will be employed to offer high-speed Internet access as well as high-speed LAN connectivity to remote users. In addition, TDS Telecom plans to offer Frame Relay and asynchronous transfer mode ("ATM") services in select markets. TDS Telecom is expanding its business offerings to include web hosting services and customized web content development for various sized market segments. TDS 27 Telecom also plans to attract new Internet customers by offering Internet access appliances. TDS Telecom is a provider of enterprise network management center ("ENMC") services to large businesses and government through expanded use of its own network management facilities, and its knowledgeable personnel. Such services would consist of centralized network monitoring as well as network management. In 1997, the State of Wisconsin awarded TDS Telecom the "BadgerNet" ENMC multi-year contract. The BadgerNet ENMC has been designed to provide a focal point for the operational management of over 72 state agency and university networks, services and equipment and began operations in 1998. TDS Telecom believes it has developed substantial expertise in developing its ENMC and has the capacity through existing facilities (and personnel) to provide ENMC services to additional third parties. Although TDS Telecom currently operates these businesses, they are in an early stage of development. There can be no assurance that TDS Telecom will expand these businesses. SALES AND MARKETING TDS Telecom seeks to leverage its networks through sales and marketing activities targeted at two separate customer groups: retail and wholesale. Retail customers are composed primarily of residential customers, businesses, government and institutional telecommunications users. Wholesale customers consist of IXCs and information service providers such as commercial data processing service providers and ISPs. RETAIL MARKETS COMMERCIAL MARKETS. Businesses account for approximately 22% of TDS Telecom's access lines. TDS Telecom focuses its marketing on information-intensive industries such as financial services, health services, realty, hotels and motels, education and government. TDS Telecom uses its direct sales force, targeted mailings, and telemarketing to sell products and services to the commercial markets, which are segmented into tiers based on size and strategic importance. Different sales and distribution channels are employed for each segment. Account executives focus on the most profitable customers by staying in contact with them on a regular basis. TDS Telecom employs an aggressive compensation plan for its account executives targeted at revenue and customer satisfaction results. CONSUMER MARKETS. TDS Telecom's promotional and sales strategy consists of two major initiatives: building brand equity by creating awareness of the TDS Telecom brand name; and using direct marketing to sell specific products and product groupings. Approximately 78% of TDS Telecom's total access lines are residential. Approximately 25% of TDS Telecom's residential customers live in rural areas, while the other 75% are located in suburban settings. The nature of TDS Telecom's markets has historically made direct marketing more effective than mass media such as radio and television. In addressing its consumer markets, TDS Telecom has made extensive and aggressive use of direct mail. It has been more selective, though still active, in the use of telemarketing as a means of generating awareness, qualified leads, and actual sales. Newspaper is used as well. Uniform branding has made the use of mass media more attractive, and TDS Telecom has increasingly incorporated these elements into its media mix. In nearly all of its markets, TDS Telecom offers the complete family of custom calling services including call waiting, call forwarding, three-way calling, and speed dialing. In 1998, TDS Telecom sold 10,200 residential second lines, an increase of 37% over 1997. TDS Telecom's advanced calling services ("ACS") family of products is centered around Caller ID service. In 1998, the ACS family of services were available to 89% of the lines in service compared to 78% in 1997. Penetration of Caller ID increased from 16% to 19% of lines equipped, and aggregate penetration of ACS increased from 30% to 35% of lines equipped. WHOLESALE MARKETS Access charges, billing and collection services and other primarily traditional wholesale offerings generated $275 million, or approximately 60%, of TDS Telecom's revenue for the year ended December 31, 1998. Wholesale customers are currently serviced by account teams in Madison, Wisconsin, and 28 Knoxville, Tennessee. These teams manage and coordinate the purchasing of access services by the major IXC's and RBOCs on a national basis. TDS Telecom also provides new wholesale offerings to non-traditional customers. TDS Telecom has targeted wireline and wireless telecommunications service providers and select vertical markets. COMPETITION ILEC MARKETS The 1996 Act has helped to introduce a new wave of competition in the telecommunications industry. The 1996 Act embraced competition in telecommunications as a national policy and also started the process of deregulation. The 1996 Act requires ILECs to provide reasonable and non- discriminatory interconnection services and access to unbundled network elements to any CLEC that seeks to enter the markets in which the ILEC already offers services. The 1996 Act also allows CLECs to co-locate network equipment on the ILEC's premises and prevents ILECs and CLECs from unduly restricting each other from use of facilities or information that would allow other organizations to effectively compete with them. The FCC has proposed adding further interconnection requirements to spur competitive broadband development. All 105 TDS Telecom ILEC companies are exempt from many of the provisions of the 1996 Act. Specifically, they are exempt from the requirements imposed on the ILECs until they receive a bona fide request for interconnection and the state commission lifts the exemption. This, coupled with the economics of competing in lower population density markets, may delay certain forms of competition occurring in TDS Telecom ILEC service areas while additional regulatory issues are resolved. However, some TDS Telecom ILECs already face interconnection requests, filed by potential competitors, and TDS Telecom believes there will eventually be open entry into nearly every aspect of the telephone industry, including local service, interstate and intrastate toll, switched and special access services and customer premises equipment. TDS Telecom expects competition in the telephone business to be dynamic and intense as a result of the entrance of new competitors and the development of new technologies, products and services. Increased competition is expected from competitive access providers, IXCs, out-of-territory RBOCs and independent telephone companies, niche entrepreneurs, cable and utility companies, and wireless and satellite providers. To face this increasing competition, TDS Telecom's strategy is to build customer loyalty by providing superior customer service, offering a suite of standardized products and services bundled in response to customer preferences, and rapidly developing new data products and services. In the long-run, TDS Telecom believes that the wireless companies pose the most significant threat to the local exchange industry. Wireless providers are also seeking universal service support in various rural markets. Although traditional analog cellular radio service currently cannot match the features or the clarity of communications provided via wireline networks, and as a result of high error rates and speed limitations is not suitable for data transmission, advances in digital cellular and PCS technology may permit wireless companies to match the functionality and clarity of wireline communication and still allow customers the mobility of traditional wireless service. As the emerging PCS companies compete directly with established cellular radio companies, flat-rate pricing alternatives may drive wireless rates towards or below wireline rates. In order to minimize the impact of wireless competition, TDS Telecom is pursuing wholesale service agreements with wireless companies to provide services to them and expects to provide wireless services through resale in many of its markets. CLEC MARKETS In Wisconsin and Minnesota and in each location in which TDS Telecom expands as a CLEC, TDS Telecom faces, and expects to continue to face, significant competition from the ILECs which currently dominate their local telecommunications markets. TDS Telecom will compete with the ILECs on the basis of price, reliability, state-of-the-art technology, product offerings, route diversity, ease of ordering and customer service. However, the ILECs have long-standing relationships with their customers, may have the potential to subsidize competitive services from monopoly service revenues, and benefit from 29 some favorable state and federal regulations. TDS Telecom will seek to achieve parity with the ILECs to be able to provide a full range of local telecommunications services. Although the ILECs generally are subject to greater pricing and regulatory constraints than CLECs, ILECs are achieving increased pricing flexibility for their services as a result of, among other things, the 1996 Act. Existing competition for private line, special access and local exchange services is based primarily on quality, capacity and reliability of network facilities, customer service, response to customer needs, service features and price, and is not based on any proprietary technology. As a result of the technology used in its networks, TDS Telecom may have cost and service quality advantages over some currently available ILEC networks. In addition, TDS Telecom believes that, in general, it will provide more attention and responsiveness to its customers than will its ILEC competitors. TDS Telecom may face competition from other CLECs and other potential competitors in certain of the cities in which TDS Telecom plans to offers its services. Many of TDS Telecom's existing and potential competitors have financial, personnel and other resources significantly greater than those of TDS Telecom. However, TDS Telecom believes that its strategy of targeting third-tier cities (midsized communities), and its capital, technical and management resources will enable it to achieve its strategic objectives. In addition to the ILECs and other CLECs, potential competitors capable of offering private line, special access and local exchange services include long distance carriers, cable television companies, electric utilities, microwave carriers, wireless telephone system operators, and private networks built by large end users. Previous impediments to certain utility companies entering telecommunications markets under the Public Utility Holding Company Act of 1935 were removed by the 1996 Act. CONSTRUCTION AND DEVELOPMENT PROGRAM In 1998, TDS Telecom continued its program of enhancing and expanding its service providing network. TDS Telecom intends to meet competition by providing its customers with high-quality telecommunications services and building its network to take full advantage of advanced telecommunications technologies such as Signaling System 7 ("SS7"), fiber optic fed Digital Serving Areas ("DSAs"), Integrated Services Digital Network ("ISDN"), and ACS. The following table shows that TDS Telecom continues to make these advanced features available to a large majority of its customers:
AS OF DECEMBER 31, 1998 --------------------------------------------- # OF EQUIPPED LINES % OF EQUIPPED LINES -------------------- ----------------------- Signaling System 7................................................... 509,331 96% Advanced Calling Services............................................ 509,331 96% Integrated Services Digital Network.................................. 400,715 76%
As TDS Telecom upgrades and expands its network, it is also standardizing equipment and processes to increase efficiency and has centralized the monitoring and management of its network to reduce costs and improve service reliability. TDS Telecom formed strategic alliances with Lucent Technologies and Siemens Telecom Networks to modernize and standardize TDS Telecom's switching platform with the Lucent 5ESS-2000 and Siemens EWSD switches. This standardized switching platform assisted TDS Telecom in implementing its 24-hour-a-day/7-day-per-week Network Management Center. The Network Management Center continuously monitors the network in an effort to proactively identify and correct network faults prior to any customer impact. The Network Management Center is proactively monitoring 100% of TDS Telecom's network. TDS Telecom's total 1999 capital budget is $120 million compared to actual capital expenditures of $143.1 million in 1998 and $151.5 million in 1997. The telephone capital additions budget for 1999 includes approximately $12 million for current CLEC markets, $45 million for outside plant facilities and $35 million for switching facilities in the ILEC markets. Financing for the 1999 capital additions will be primarily provided by internally generated funds and supplemented by federal long-term financing. 30 REGULATION TDS Telecom's ILEC subsidiaries are regulated by state regulatory agencies and TDS Telecom seeks to maintain positive relationships with these regulators. Rate setting, including local rates, intrastate toll rates and intrastate access charges, are subject to state commission approval in most states. The state regulators also establish and oversee any state universal service funds. TDS Telecom will continue to pursue necessary changes in rate structures to ensure affordable rates and reasonable earnings. State regulators can approve service areas, service standards, and accounting methods. In some states, construction plans, borrowing, depreciation rates, affiliated charge transactions and certain other financial transactions are also subject to regulatory approval. States have traditionally regulated entry into local markets by designating a single carrier to be the universal service provider. However, the 1996 Act has almost completely pre-empted state authority over market entry. Each state retains the power to impose competitively neutral requirements that are consistent with the 1996 Act's universal service provision and necessary for universal services, public safety, and welfare, continued service quality and consumer rights. While a state may not impose requirements that effectively function as barriers to entry, and the FCC must pre-empt challenged state requirements if they impose such barriers to entry, a state retains limited authority to regulate certain competitive practices in rural telephone company service areas. Proceedings to pre-empt laws and policies in several states are pending before the FCC. The 1996 Act establishes a general duty for all telecommunications carriers, including wireless providers, to interconnect with other carriers. Congress prescribed a more specific list of interconnection requirements for all LECs including resale, number portability, dialing parity, access to rights-of-way and reciprocal compensation. The FCC recently ruled that Internet access traffic is primarily interstate, but left in place negotiated contracts and state arbitrated arrangements for local reciprocal compensation between ILECs and CLECs that provide interconnecting links between ISPs and their customers, as well as the existing exemption from interstate access charges applicable to ISPs. Challenges to these non-interstate arrangements for interstate traffic will now continue at the federal appellate court level. Unless exempted, or granted suspension or modification, ILECs have additional obligations: (a) to negotiate in good faith terms of interconnection; (b) to comply with more detailed interconnection terms, including non-discrimination and unbundling their network and service components so competitors may use only those elements they choose for providing their services; (c) to offer their retail services at wholesale rates to facilitate resale by their competitors; and (d) to allow other carriers to place equipment necessary for interconnection or access on their premises. The FCC has adopted or is considering rules and policies implementing the provisions of the 1996 Act. Many of the FCC determinations made to implement the 1996 Act and to facilitate competition in local service and other telephone services involve investment and upgrades to TDS Telecom LEC networks, and impose greater costs and obligations on ILECs than on their competitors. These investments and upgrades include requirements to implement local number portability so subscribers may change to competitors' services without changing their telephone numbers, network signaling information that must be provided to certain other carriers and pay phone providers, requirements for preventing unauthorized use of customer information gained from providing telephone service for other purposes, and other changes that require additional investments and expenses. TDS Telecom is seeking to comply with these requirements or to obtain the necessary suspensions or modifications where appropriate, while at the same time also pursuing policies that provide a fair opportunity to recover its costs. A new law also requires LECs to provide certain communications for law enforcement purposes. The full cost and the adequacy of the government compensation are not yet known, but the LEC industry is pursuing regulatory policies that cover any shortfall in available government compensation. The FCC is also exploring how to comply with the requirement in the 1996 Act for federal and state authorities to encourage nationwide advanced broadband infrastructure development that could require extensive additional investment. As defined in the 1996 Act, all of TDS Telecom's ILEC subsidiaries qualify as rural telephone companies. Therefore, they are exempted from the ILEC interconnection requirements until they receive a bona fide request for interconnection and the state commission lifts the exemption. The FCC has also adopted extensive rules for state commissions to follow in mediating and arbitrating interconnection negotiations between incumbent LECs and carriers requesting interconnection, services or network 31 elements. The 1996 Act establishes deadlines, standards for state commission approval of interconnection agreements and recourse to the FCC if a state commission fails to act. A federal appellate decision striking down FCC pricing regulations for interconnection and several rules that limited TDS Telecom telephone companies' ability to obtain regulatory relief from stricter interconnection requirements for incumbent telephone companies was taken to the U.S. Supreme Court in petitions for certiorari. On January 25, 1999, the Supreme Court overturned most of the Eighth Circuit Court of Appeals decision that the FCC's interconnection rules unlawfully infringed upon state regulatory jurisdiction. Among the rulings the Supreme Court struck down were decisions that the FCC had unlawfully increased the showings and changed the burden of proof for retaining a rural ILEC's interconnection exemption and had misread the 1996 Act to allow an ILEC's competitors to demand piece parts of interconnection agreements negotiated by other competitors with ILECs without agreeing to the overall terms of the agreement. TDS Telecom seeks to maintain and enhance existing revenue streams despite heightened earnings review activity by state regulators and the advent of local exchange competition sparked by the 1996 Act. TDS Telecom is preparing for competition even though its operating subsidiaries remain governed by state regulators. For example, TDS Telecom is seeking the necessary pricing flexibility to adjust its rate structures to a more competitive model. TDS Telecom is also participating in state regulatory and legislative processes to urge that any telecommunications reform measures treat rural areas fairly and continue to provide sufficient contributions to high cost rural service areas to keep TDS Telecom ILECs' rates affordable and allow for the continued development of rural infrastructure. The ongoing changes in public policy due to numerous court proceedings and the introduction of competition may affect the earnings of the operating subsidiaries, and TDS Telecom is not able to predict the impact of these changes. While the majority of TDS Telecom's ILEC subsidiaries continue to operate in a rate-of-return environment, a number of state commissions are negotiating, or have agreed to, alternative regulation plans with LECs. Price regulation, the most common form of alternative regulation, focuses on the price of telecommunication services. TDS Telecom's ILEC subsidiaries in Alabama, Arkansas, Michigan and Pennsylvania are currently operating in a price-regulated environment, whereby the commissions in those states no longer review earnings. For several years, the RBOCs and some of the nation's larger LECs have operated under an FCC "price cap" plan, modified in 1997, where earnings can be increased only through productivity improvements. For 1998, TDS Telecom's telephone subsidiaries did not elect either price caps or an alternative FCC plan, which was designed for smaller LECs. Instead, the operating subsidiaries plan to continue to abide by traditional rate-of-return regulation for interstate purposes, unless those regulatory requirements are changed. Since approximately one-third of TDS Telecom's telephone subsidiaries serve high-cost areas, important averaging mechanisms associated with the NECA pooling process would be lost if TDS Telecom elected either of the alternatives to traditional rate-of-return regulation. However, the FCC periodically considers whether to initiate a proceeding to lower the allowed rate-of-return for rate-of-return LECs. On October 5, 1998, the FCC released a Public Notice initiating a proceeding to represcribe the authorized rate of return for interstate services provided by ILECs. Currently, this rate is set at 11.25%. Reduction of the interstate rate of return would have detrimental effects on ILECs and may impact the ability of ILECs to continue to invest in infrastructure and economic development. TDS Telecom, along with the rural industry associations, believes that it is inappropriate for the FCC to represcribe the rate of return at this time, and that represcription should not occur until after the FCC resolves other pending issues including universal service, access reform, and separations reform. If the FCC proceeds with the represcription, TDS Telecom may potentially be faced with a lower allowed interstate rate of return, a reduction in universal service funds, and potentially higher local rates. Access to affordable long-distance service in rural areas was achieved because the FCC ordered AT&T to provide nationwide average rates. As a result of increasing competition, the FCC lifted all regulations relating to AT&T's interstate services in 1996. However, the 1996 Act preserves interstate toll rate averaging and endorses a nationwide policy that interstate and intrastate long-distance rates of all long-distance carriers should not be higher in rural areas than in urban areas they serve. TDS Telecom will continue to monitor regulatory activities at both the federal and state levels to ensure continued affordable long-distance and local rates for even its most remote exchanges. 32 BROADBAND PCS OPERATIONS The Company's broadband PCS operations are conducted through Aerial and its subsidiaries. Aerial is a provider of Personal Communications Services in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major Trading Areas (collectively, the "PCS Markets"). The PCS Markets include approximately 27.7 million population equivalents. Aerial has constructed networks for its PCS Markets using Global System for Mobile Communication ("GSM") technology. Aerial served 311,900 PCS telephones at December 31, 1998. At December 31, 1998, Aerial had expanded its system coverage to total more than 80% of the six MTAs' total population. PCS is the term used to describe the wireless telecommunications services that are offered by those companies that acquired licenses for radio spectrum (frequency range 1850-1990 MHz) in the Federal Communications Commission ("FCC") auctions and are the newest entrants in the wireless telecommunications market. PCS competes directly with existing cellular telephone, paging and specialized mobile radio services. PCS providers were the first in most markets to offer mass market all-digital mobile networks. In addition, Aerial believes PCS providers may be among the first to be able to offer mass market wireless local loop applications, in competition with switched and direct access local telecommunications services. Aerial's strategic goal is to take full advantage of the potential of wireless telecommunications. Aerial sees an opportunity for significant growth in the wireless telecommunications market through the shift of existing wireless usage patterns from applications focused on business use, special occasions and emergencies to much broader applications for everyday use. Aerial is structured to meet the increasingly competitive challenges of the wireless telecommunications marketplace, and has a marketing-oriented approach focused on serving its customers and their needs. Since 1983, the demand for wireless telecommunications services has grown dramatically as cellular, paging and other emerging wireless personal communications services have become widely available and increasingly affordable. During 1996 and early 1997, Aerial contracted for network equipment, billing systems, support software and the equipment and services necessary to launch service. Additionally during this period, Aerial completed the design for its PCS networks, acquired and built out the switching centers serving each market, leased and built out a National Operations Center, leased or purchased the cell sites required to launch service and commenced zoning and building the sites. The Columbus MTA launched service on March 27, 1997. Aerial's five remaining MTAs launched service during the second quarter of 1997. Across all six markets, Aerial launched with approximately 600 cell sites in service. Aerial had 1,180 cell sites in service by the end of 1998. The coverage of Aerial's PCS networks includes the major metropolitan areas within the PCS Markets, as well as portions of the major highway corridors extending out from those areas. In November 1996, the Company entered into a Member Control Agreement ("Agreement") forming a joint venture with Rural Cellular Corporation ("RCC"), called the Wireless Alliance, LLC ("WALLC"), to build out certain rural areas covering approximately 925,000 population equivalents in the Minneapolis MTA. Aerial has contributed 20 MHz of its Minneapolis MTA license covering certain territories as defined in the Agreement in return for a 49% equity interest in the joint venture. RCC built the network and is responsible for the ongoing operations. The WALLC launched service on in 1998. The joint venture purchases services such as network switching from Aerial. The network uses GSM technology. On September 8, 1998, pursuant to the terms of a Purchase Agreement dated June 1, 1998, Sonera Ltd. ("Sonera"), formerly Telecom Finland Ltd., made a $200 million investment in Aerial Operating Company, Inc. ("AOC"), a then wholly-owned subsidiary of Aerial. Sonera purchased approximately 2.4 million shares of common stock of AOC at a price of approximately $83 per share representing a 19.4% equity interest in AOC. Sonera's equity ownership amount in AOC is subject to adjustment based on Aerial's 20-day average stock price during the three years commencing September 8, 1998. Depending on the level of increase in the stock price, Sonera's ownership amount in AOC could decline to approximately 15%. In addition, after five years Sonera's equity in AOC becomes incrementally 33 exchangeable for equity in Aerial Communications, Inc. or, in certain circumstances, incrementally exchangeable for equity in TDS or cash. See "--Proposed Corporate Restructuring". The following table summarizes certain information regarding Aerial's initial years of operations:
YEAR ENDED OR AT DECEMBER 31, ---------------------------- 1998 1997 ------------- ------------- (DOLLARS IN THOUSANDS) MTAs in operation........................................................... 6 6 Total MTA population (in millions).......................................... 27.7 27.6 Customers................................................................... 311,900 125,000 Market penetration.......................................................... 1.13% .45% Consolidated revenues....................................................... $ 155,154 $ 55,952 Depreciation expense........................................................ 75,846 36,045 Amortization expense........................................................ 7,555 4,509 Operating (loss)............................................................ (279,985) (218,165) Capital expenditures........................................................ 74,580 274,709 Identifiable assets......................................................... $ 961,347 $ 960,648
WIRELESS TELECOMMUNICATIONS INDUSTRY OVERVIEW. Wireless service is currently available using analog or digital technology. Traditionally wireless services transmitted voice and data signals over analog-based networks by varying the amplitude or frequency of one continuous electronic signal transmitted over a single radio channel. Analog technology currently has several limitations, including inconsistent service quality, lack of privacy, limited capacity and less reliability in transferring data without errors. Aerial has chosen GSM, which utilizes a digital technology, for use in the PCS Markets. Digital systems convert voice or data signals into a stream of digits that is compressed before transmission, enabling a single radio channel to carry multiple simultaneous signal transmissions. This additional capacity, along with improvements in digital protocols, allows digital-based wireless technologies to offer new and enhanced services, such as greater call privacy and more robust data transmission features, such as "mobile office" applications (including facsimile, electronic mail and wireless connections to computer/data networks, including the Internet). PCS spectrum differs from existing cellular and specialized mobile radio ("SMR") spectrum in three basic ways: frequency, spectrum and geographic division. PCS networks will operate in a higher frequency range (1850-1990 MHz) compared to the cellular and SMR frequency (800-900 MHz). PCS is comprised of 30 or 10 MHz spectrum versus 25 MHz spectrum for cellular networks. As a result of the improved capacity of the infrastructure and large allocation of spectrum in the A, B and C PCS frequency Blocks, PCS will have more capacity for new wireless services such as data and video transmission. Finally, the geographic areas for PCS licenses are divided differently than for cellular licenses. PCS is segmented among 51 MTAs and 493 Basic Trading Areas ("BTAs") as opposed to cellular's 306 MSAs and 428 RSAs. An MTA license generally covers a much larger geographic area than a BTA, MSA or RSA license. OPERATION OF WIRELESS NETWORKS. Wireless service areas are divided into smaller geographic areas called "cells", each of which contains an antenna and a base transceiver station ("BTS") consisting of a low-power transmitter, a receiver and signaling equipment. The cells are typically configured on a grid in a honeycomb-like pattern, although terrain factors (including natural and man-made obstructions) and signal coverage patterns may result in irregularly shaped cells and overlaps or gaps in coverage. The BTS in each cell is connected by microwave, fiber optic cable or telephone wires to a switching office ("mobile switching center" or "MSC"). The MSC controls the operation of the wireless telephone network for its entire service area, performing inter-BTS hand-offs, managing call delivery to handsets, allocating calls among the cells within the network and connecting calls to local landline telephone systems or to long-distance telephone carriers. Wireless service providers have interconnection agreements with various local exchange carriers and interexchange carriers, thereby integrating the wireless telephone network with landline telecommunications systems. Because two-way wireless networks are 34 fully interconnected with landline telephone networks and long-distance networks, customers can receive and originate both local and long-distance calls from their wireless telephones. The signal strength of a transmission between a handset and a BTS antenna declines as the handset moves away from the BTS antenna. The MSC and the BTSs monitor the signal strength of calls in process. When the signal strength of a call declines to a predetermined level, the MSC may "hand off" the call to another BTS that can establish a stronger signal with the handset. If a handset leaves the service area of the wireless service provider, the call is disconnected unless an appropriate technical interface is established to hand off the call to an adjacent service provider's system. Operators of wireless networks frequently agree to provide service to customers from other compatible networks who are temporarily located or traveling through the operator's service area. Such customers are called "roamers." Agreements among network operators allocate revenues received from roamers. With automatic roaming, wireless customers are preregistered in certain networks outside their home service area and receive service automatically while they are roaming. Other roaming features permit calls to a customer to follow the customer into different networks, so that the customer will continue to receive calls in a different network just as if the customer were within his or her service area. Wireless customers generally are charged separately for monthly access, air time, long-distance calls and custom-calling features (although custom-calling features may be included in monthly access charges in certain pricing plans). Wireless network operators pay fees to local exchange and long-distance telephone companies for access to their networks and toll charges based on standard or negotiated rates. When wireless operators provide service to roamers from other networks, they generally charge roamer air-time usage rates, which usually are higher than standard air-time usage rates for their own customers, and additionally may charge daily access fees. Special, discounted rate roaming arrangements, often between neighboring operators who wish to stimulate usage in their respective territories, provide for reduced roaming fees and no daily access fees. TECHNOLOGY With GSM technology, Aerial offers easy-to-use, interactive menu-driven phones, and advanced features such as caller identification and a smart card, as well as more complex features such as text messaging, which allows the GSM handset to function as a two-way messaging device. In the future, Aerial intends to increasingly emphasize services which are expected to increase the size and scope of the wireless market, such as wireless data and information services as well as wireless local loop services. Aerial anticipates that PCS will ultimately offer a competitive alternative to wireline telephone service as PCS networks are constructed and PCS operators form strategic alliances. GSM is not compatible with other PCS or cellular technologies. However, compatibility can be achieved through the use of handsets that support multiple technologies. Aerial expects that compatibility between GSM and the existing analog cellular systems will be achieved with the use of dual-mode handsets. Aerial expects to launch its dual-mode service in 1999. To date, seventeen North American PCS companies are providing commercial GSM service. GSM systems are currently in commercial operation in over 2,400 North American cities with more than 3 million customers. Aerial anticipates that its customers will be able to roam substantially throughout the United States, either on other GSM-based PCS networks or by using dual-mode handsets that can also be used on existing cellular networks. Aerial is a member of the North American GSM Alliance LLC ("GSM Alliance"), an all-digital wireless PCS network of U.S. and Canadian carriers. The GSM Alliance was established to create a national network and develop seamless wireless communications for customers, whether at home, away or abroad. The GSM Alliance's collaborative efforts focus on serving the wireless customer efficiently by addressing the areas of roaming, customer care, national distribution and data communications. Aerial is also a member of the GSM Capital Limited Partnership. The partnership was formed to make investments in companies mainly engaged in the wireless communications industry using the GSM platform, that are in a development or expansion stage, or whose securities trade in an organized market. Aerial is also a part of the GSM North America consortium, which is the North American interest 35 group for the GSM Association. Formed in 1995, GSM North America brings together service providers and equipment manufacturers to identify and resolve issues related to making GSM the premier PCS digital technology. SOURCES OF EQUIPMENT Aerial does not manufacture any of the GSM network equipment, handsets or accessories ("equipment") used or anticipated to be used in its operations. The equipment Aerial uses or anticipates to use is available from multiple sources, and Aerial anticipates such equipment will continue to be available to Aerial in the foreseeable future, consistent with normal manufacturing and delivery lead times. As GSM uses an open system architecture, and due to the fact that GSM has well-developed features, software systems and equipment that are available "off the shelf", Aerial is able to design its GSM networks and systems without being dependent upon any single manufacturing source. Nokia Telecommunications Inc. has been Aerial's sole supplier of digital radio channel and switching infrastructure equipment during the initial build-out of its PCS networks. Aerial's current handset vendors are Nokia Mobile Phones, Inc., Motorola Inc., and Mitsubishi Wireless Communications, Inc. PRODUCTS AND SERVICES Aerial offers coverage in those areas of the PCS Markets where most of the population lives and works. Subsequent construction of its PCS networks will provide coverage which, in combination with roaming services as described above, is competitive with that of current cellular operators. Aerial provides roaming capabilities through agreements with other GSM and cellular operators. Aerial's two primary sources of revenues are similar to those available to other cellular system providers. Service revenue primarily consists of charges for access, airtime and value-added services provided to Aerial's retail customers who use the network operated by Aerial, and charges for long-distance calls made on Aerial's systems. Service revenue also consists of charges to customers of other wireless carriers who use Aerial's PCS network when roaming (outcollect roaming revenue). Equipment sales revenue consists of the sale of handsets and related accessories to retailers, independent agents and end user customers. At December 31, 1998, Aerial had 311,900 customers. Service revenues and equipment sales revenues totaled $123.6 million and $31.5 million, respectively, for the year ended December 31, 1998. Aerial provides the following services and features: THE SMART CARD. GSM technology employs a Smart Card which contains a microchip containing detailed information about a customer's service profile. The Smart Card allows Aerial to initiate services or change a customer's service package from a remote location. The Smart Card also allows customers to roam onto other participating GSM-based networks by using their cards in handsets compatible with the local network. FEATURE-RICH HANDSETS. As part of its basic service package, Aerial provides easy-to-use, interactive menu-driven phones that enable customers to utilize the features available in a GSM network. These handsets primarily use words and easy-to-use menus rather than numeric codes to operate handset functions such as call-forwarding, call-waiting and text messaging. SHORT TEXT MESSAGING. GSM technology allows for the capability to send and receive short text messages, similar to two-way radio paging services. This service allows Aerial to offer a quicker and less expensive form of wireless communication when a full conversation is not necessary. ENHANCED SECURITY. Aerial's service provides greater security from eavesdropping and cloning than analog wireless service. Greater conversation security is provided by the encryption code of the digital GSM signal. Greater fraud protection is provided because GSM handsets require the use of a Smart Card with a sophisticated authentication scheme, the replication of which is virtually impossible. As the market for wireless telecommunications services continues to develop, Aerial expects to offer advanced wireless applications such as mobile data services, wireless private branch exchange applications, wireless local loop services and other individually customized wireless products and services. 36 MARKETING AND DISTRIBUTION Aerial's marketing objective is to create demand for its PCS service by clearly differentiating its service offerings. Aerial believes the strength of its marketing efforts is a key contributor to its success. Aerial has developed overall marketing strategies as well as certain, specific local marketing strategies for each PCS Market. Aerial's mass marketing efforts emphasize the value of Aerial's services and its "fairness" to customers and are supported by heavily promoting the Aerial brand name. This is supported by a substantial advertising program. Aerial offers its services and products through traditional cellular sales channels as well as through new, lower cost channels which increase the quality of the typical sale. Aerial utilizes traditional sales channels which include mass merchandisers and retail outlets, company retail stores, sales agents and a direct sales force. National distributors include Best Buy, Office Depot, Staples and Ritz Camera. Aerial currently also distributes its services and products through over 90 company retail locations (mall stores, strip mall stores and kiosks). Based in part upon the remote activation feature of the GSM Smart Card, Aerial also intends to develop distribution innovations such as simplified retail sales processes and lower-cost channels which include inbound telesales, affinity marketing programs, and via the Internet. COMPETITION The wireless telecommunications industry is experiencing significant technological change, as evidenced by the increasing pace of digital upgrades to existing analog cellular networks, evolving industry standards, ongoing improvements in the capacity and quality of digital technology, shorter development cycles for new products and enhancements, and changes in end-user requirements and preferences. Accordingly, Aerial expects competition in the wireless telecommunications business to be dynamic and intense as a result of the entrance of new competitors and the development of new technologies, products and services. Aerial competes directly with up to five other PCS providers in each of its PCS Markets. The other successful bidders in the FCC's broadband Block A and Block B PCS auction in each of the six PCS Markets were PCS PrimeCo (Houston and Tampa-St. Petersburg-Orlando), Sprint Spectrum (Minneapolis, Pittsburgh and Kansas City) and AT&T Wireless Services, Inc. (Columbus). The existing cellular providers in the PCS Markets, most of which have an infrastructure in place and have been operational for a number of years, have, in most cases, upgraded their networks to provide comparable services in competition with Aerial. Principal cellular providers in the PCS Markets are AT&T Wireless Services, Inc., BellSouth Mobility, Inc., GTE Mobile Communications Corporation, AirTouch Communications, Inc., Southwestern Bell, Bell Atlantic-NYNEX Mobile and Ameritech Cellular. Additionally, the Company competes with SMR provider Nextel Communications, Inc. in each of its six PCS Markets. Aerial also competes with other communications technologies that now exist, such as paging, enhanced specialized mobile radio ("ESMR") and global satellite networks. In the future, cellular service and PCS will also compete more directly with traditional landline telephone service providers and with cable operators who expand into the offering of traditional communications services over their cable systems. All of such competition is intense. There can be no assurance that Aerial will be able to compete successfully in this environment or that new technologies and products that are more commercially effective than Aerial's technologies and products will not be developed. In addition, many of Aerial's competitors have substantially greater financial, technical, marketing, sales and distribution resources than those of Aerial and have significantly greater experience than Aerial in testing new or improved telecommunications products and services and obtaining regulatory approvals. Some competitors are expected to market other services, such as cable television access, with their wireless telecommunications service offerings. Several of Aerial's competitors are operating, or planning to operate, through joint ventures and affiliation arrangements, wireless telecommunications networks that cover most of the United States. 37 Aerial anticipates that market prices for two-way wireless services generally will continue to decline in the future based on increased competition. Aerial will compete to attract and retain customers principally on the basis of services and enhancements, its customer service, the size and location of its service areas and pricing. Aerial's ability to compete successfully will also depend, in part, on its ability to anticipate and respond to various competitive factors affecting the industry, including new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and discount pricing strategies by competitors, which could adversely affect Aerial's operating margins. REGULATION REGULATORY ENVIRONMENT. The FCC regulates the licensing, construction, operation and acquisition of wireless telecommunications systems in the United States pursuant to the Communications Act of 1934, as amended, and the rules, regulations and policies promulgated by the FCC thereunder. Under the Communications Act, the FCC is authorized to allocate, grant and deny licenses for PCS frequencies, establish regulations governing the interconnection of PCS networks with wireline and other wireless carriers, grant or deny license renewals and applications for transfer of control or assignment of PCS licenses, and impose fines and forfeitures for any violations of FCC regulations. In addition, the 1996 Act, which amended the Communications Act, mandates significant changes in existing telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the nation and to streamline regulation of the telecommunications industry to remove regulatory burdens, as competition develops, and makes regulation less necessary. The FCC promulgated and continues to promulgate regulations governing construction and operation of wireless carriers, licensing (including renewal of licenses) and technical standards for the provision of PCS services under the Communications Act, and is implementing the legislative objectives of the 1996 Act, as discussed below. PCS LICENSING. The FCC established PCS service areas in the United States and its possessions and territories based upon Rand McNally's market definition of 51 MTAs comprised of 493 smaller BTAs. Each MTA consists of at least two BTAs. The FCC has allocated 120 MHz of radio spectrum in the 2 GHz band for licensed broadband PCS services. The FCC divided the 120 MHz of spectrum into six individual blocks, each of which is allocated to serve either MTAs or BTAs. The spectrum allocation includes two 30 MHz blocks ("A" and "B" Blocks) licensed for each of the 51 MTAs, one 30 MHz block ("C" Block) licensed for each of the 493 BTAs, and three 10 MHz blocks ("D," "E" and "F" Blocks) licensed for each of the 493 BTAs. A PCS license has been awarded for each MTA and substantially all of the BTAs in every block, for a total of more than 1,500 licenses. This means that in any PCS service area as many as six licensees could be operating separate PCS networks. Under the FCC's rules, a broadband PCS licensee may own combinations of licenses with total aggregate spectrum coverage of up to 45 MHz in a single geographic area. The FCC adopted comprehensive rules that outlined the bidding process, described the bidding application and payment process, established penalties for certain bid withdrawals, default or disqualification and established regulatory safeguards. Several auction winners have filed for bankruptcy. Other winners tendered approximately 450 licenses acquired in auctions to the FCC for cancellation in 1998. These licenses are scheduled to be reauctioned starting in March of 1999. On November 9, 1995, in CINCINNATI BELL TELEPHONE CO. V. FCC (Case No. 94-3701/4113), the United States Court of Appeals for the Sixth Circuit granted two petitions for review of an FCC order that had barred certain common ownership of cellular and PCS interests in the same market, and remanded the case to the FCC for further proceedings. Neither of the two petitioners had been barred by cross interests from applying for any of the authorizations the FCC later granted to Aerial. Aerial is watching the FCC proceedings closely. The grants of licenses to Aerial are conditioned upon timely compliance with the FCC's build-out requirements, I.E., coverage of one-third of the population of a PCS market within five years of initial 38 license grant and coverage of two-thirds of that population within ten years. Aerial has exceeded the buildout requirements for both the five year and ten year stages for each of its MTAs. The FCC also imposes a requirement that all licensees register and obtain FCC registration numbers for all of their antenna towers which require prior FAA clearance. All broadband PCS transmitting facilities of Aerial also must comply with federal "radio frequency" (RF) radiation requirements. Aerial has complied with and continues to comply with the antenna registration and RF radiation requirements. The FCC enhanced 911 ("E911") regulations require broadband PCS operators to "be capable of transmitting 911 calls from individuals with speech or hearing disabilities through the use of Text Telephone Devices ("TTY")." TTY equipment currently, however, is not compatible with digital wireless systems such as Aerial's. Consequently, on December 4, 1998, Aerial filed a petition with the FCC requesting a waiver of the applicability of the TTY connectivity requirement to Aerial's digital system. On December 30, 1998, the FFC granted Aerial, along with over 100 other wireless operators, a temporary waiver of the regulation. Equipment manufacturers are developing hardware and software that will make TTY devices compatible with the digital wireless technologies used by Aerial and other wireless service providers. Aerial is working with manufacturers and other members of the wireless industry in developing solutions for users of TTY devices. The E911 regulations also require broadband PCS operators to determine the approximate location of persons making the emergency calls. On February 5, 1999, Aerial filed a petition requesting a waiver to clarify that handset based location technology will meet the FCC's E911 location requirements. A waiver will enable Aerial to be compliant with the location requirements by introducing new handsets that have the capability of being located rather than installing very expensive upgraded equipment throughout Aerial's entire network. Aerial's waiver and dozens of other wireless operators' waiver requests are pending before the FCC. The FCC licenses granted to Aerial are issued for a ten-year period expiring June 23, 2005 and may be renewed. In the event challengers file competing applications in response to any of Aerial's renewal filings, the FCC has rules and policies providing that the application of the licensee seeking renewal will be granted and the application of the challenger will not be considered in the event that the broadband PCS licensee involved has (i) provided "substantial" service, which is defined as "sound, favorable and substantially above a level of mediocre service just minimally justifying renewal" and (ii) substantially complied with FCC rules, policies and the Communications Act. Although Aerial is unaware of any circumstances which would prevent the approval of any future renewal applications, there can be no assurance that Aerial's licenses will be renewed by the FCC in the future. Moreover, although revocation and involuntary modification of licenses are extraordinary regulatory measures, the FCC has the authority to restrict the operation of licensed facilities or revoke or modify licenses. The FCC has proceedings in process which could open up other frequency bands for wireless telecommunications and PCS-like services. There can be no assurance that such proceedings will not result in additional wireless competition. In addition, there are citizenship requirements, assignment requirements and other federal regulations and requirements which may affect the business of Aerial. RECENT EVENTS. There are certain regulatory proceedings currently pending before the FCC which are of particular importance to the broadband PCS industry. The FCC is expected to give the telecommunications industry guidance as to the implementation of the Communications Assistance for Law Enforcement Act ("CALEA"). Due to a conflict between manufacturing standards and law enforcement requirements, the FCC extended the compliance date to June 30, 2000. The FCC has adopted a limited expansion of the obligation of cellular carriers to serve the subscribers of broadband PCS providers, among others, even though neither the subscribers or the PCS providers involved have a pre-existing service relationship with such cellular carrier. Under these new policies, broadband PCS providers may offer their subscribers handsets which are capable of operating over broadband PCS and cellular networks so that when their subscribers are out of range of broadband 39 PCS networks, they will be able to obtain non-automatic access to cellular networks. The FCC expects that implementation of these roaming capabilities will promote competition between broadband PCS and cellular service providers. The FCC is considering whether cellular, broadband PCS and certain SMR providers instead should be required to provide "automatic" roaming service to other providers (i.e., carrier-to-carrier roaming service) during a five year period commencing after the last group of initial broadband PCS licenses are awarded, which is expected to occur in 1999. The FCC has adopted requirements which will make it possible for subscribers to retain, subject to certain geographic and other limitations, their existing telephone numbers when they switch from one service provider to another. This numbering portability will include switching between LEC and other wireline providers, between wireless service providers and between LEC/wireline and wireless providers. LECs, in the 100 largest MSAs, had implementation deadlines by the end of 1998 at those switches which received specific requests for numbering portability. The FCC recently extended the compliance date for cellular, broadband PCS, and certain other wireless providers to November 2002. The FCC also has pending proceedings (1) to ensure that the customers of wireless providers, among others, receive complete, accurate and understandable bills, (2) to establish effective safeguards to protect against unauthorized access to customer information, (3) to retain, relax or repeal its 45MHz spectrum cap on the amount of broadband PCS and cellular spectrum which entities under common ownership or control may hold in any single market and its related cellular cross-interest restrictions, (4) to devise guidelines for the operation and administration of universal service support mechanisms as applied to wireless providers and (5) to implement requirements for wireless providers to set rates for interstate interexchange services in each state at levels no higher than the rates charged to subscribers in any other state. The FCC is also continuing to implement the 1996 Act. The 1996 Act provides that implementing its legislative objectives will be the task of the FCC, the state public utilities commissions and a Federal-State Joint Board. Much of this implementation has and continues to be proceeding in numerous, concurrent proceedings with aggressive deadlines. Aerial cannot predict the full extent and nature of developments of the 1996 Act, which will depend, in part, upon interrelationships among state and federal regulators. The primary purpose and effect of the 1996 Act is to open all telecommunications markets to competition -- including local telephone service. The 1996 Act makes most direct or indirect state and local barriers to competition unlawful. It directs the FCC to preempt all inconsistent state and local laws and regulations, after notice and comment proceedings. It also enables electric and other utilities to engage in telecommunications service through qualifying subsidiaries. Only narrow powers over competitive entry are left to state and local authorities. Each state retains the power to impose competitively neutral requirements that are consistent with the 1996 Act's universal service provision and necessary for universal services, public safety and welfare, continued service quality and consumer rights. The 1996 Act establishes principles and a process for implementing a modified "universal service" policy. This policy seeks nationwide, affordable service and access to advanced telecommunications and information services. It calls for reasonably comparable urban and rural rates and services. The 1996 Act also requires universal service to schools, libraries and rural health facilities at discounted rates. In a series of orders adopted in 1997, the FCC established universal service support mechanisms which require telecommunications providers, including all wireless carriers, to contribute. Aerial has made the required Universal Service Worksheet filings and makes the required periodic payments. Since enactment, the FCC has adopted orders implementing the local competition provisions of the 1996 Act. The FCC found that broadband PCS and certain other wireless providers that are entitled to reciprocal compensation, may not be charged for LEC-originated traffic or for code opening/per-number fees, and may obtain LEC interconnection subject to the terms of the 1996 Act. Appeals were taken to the United States Supreme Court from these FCC orders by numerous parties alleging that the FCC has exceeded its statutory mandate, among other matters. On January 25, 1999, the U.S. Supreme Court upheld the FCC's general jurisdiction to implement the local competition provisions of the 1996 Act. 40 STATE AND LOCAL REGULATION The scope of state and local regulatory authority covers such matters as the terms and conditions of interconnection between LECs and wireless carriers with respect to intrastate services, customer billing information and practices, billing disputes, other consumer protection matters, facilities construction issues and transfers of control, among other matters. In these areas, particularly the terms and conditions of interconnection between LECs and wireless providers, the FCC and state regulatory authorities share regulatory responsibilities with respect to interstate and intrastate issues, respectively. The FCC has pending numerous petitions for preemption of state and local regulations which allege such regulations prohibit or impair the provision of interstate or intrastate telecommunications services. It has also requested public comment on a petition requesting preemption of moratoria imposed by state and local governments on siting of telecommunications facilities, the imposition of state taxes on the gross receipts of CMRS providers and other proposed state taxes based on the asset value of CMRS licenses awarded by the FCC. The FCC has been actively involved in educating state and local regulatory and zoning authorities as to the prohibitions in the 1996 Act against the creation of unreasonable and discriminatory zoning, taxation or other barriers to new wireless providers. The FCC is required to forbear from applying any statutory or regulatory provision that is not necessary to keep telecommunications rates and terms reasonable or to protect consumers. A state may not apply a statutory or regulatory provision that the FCC decides to forbear from applying. In addition, the FCC must review its telecommunications regulations every two years and change any that are no longer necessary. Aerial and its subsidiaries have been and intend to remain active participants in proceedings before the FCC and before state regulatory and zoning authorities. Proceedings with respect to the foregoing policy issues before the FCC and state regulatory authorities could have significant impacts on the competitive market structure among wireless providers and the relationships between wireless providers and other carriers. Aerial is unable to predict the scope, pace, or financial impact of policy changes which could be adopted in these proceedings. EMPLOYEES The Company enjoys satisfactory employee relations. As of December 31, 1998, 9,907 persons were employed by the Company, 144 of whom are represented by unions. 41 - -------------------------------------------------------------------------------- ITEM 2. PROPERTIES The property of TDS consists principally of switching and cell site equipment related to cellular telephone and broadband PCS operations; telephone lines, central office equipment, telephone instruments and related equipment, and land and buildings related to telephone operations. As of December 31, 1998, TDS's property, plant and equipment, net of accumulated depreciation, totaled approximately $2.7 billion and consisted of the following: Cellular telephone................................................. 42.6% Telephone.......................................................... 33.0 PCS................................................................ 23.2 Other.............................................................. 1.2 ----- 100.0% ----- -----
The plant and equipment of TDS is maintained in good operating condition and is suitable and adequate for the Company's business operations. The properties of the operating telephone subsidiaries are subject to the lien of the mortgages securing the funded debt of such companies. The Company leases most of its offices and transmitter sites used in its cellular and PCS businesses and owns substantially all of its central office buildings, local administrative buildings, warehouses, and storage facilities used in its telephone operations. All of the Company's cell and transmitter sites and telephone lines are located either on private or public property. Locations on private land are by virtue of easements or other arrangements. - -------------------------------------------------------------------------------- ITEM 3. LEGAL PROCEEDINGS The Company is involved in a number of legal proceedings before the FCC and various state and federal courts. Management does not believe that any such proceeding should have a material adverse impact on the financial position or results of operations of the Company. See Item 1. Business-- "Proposed Corporate Restructuring". - -------------------------------------------------------------------------------- ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of 1998. 42 - -------------------------------------------------------------------------------- PART II - -------------------------------------------------------------------------------- ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Incorporated by reference from Exhibit 13, Annual Report sections entitled "TDS Stock and Dividend Information" and "Market Price per Common Share by Quarter." - -------------------------------------------------------------------------------- ITEM 6. SELECTED FINANCIAL DATA Incorporated by reference from Exhibit 13, Annual Report section entitled "Selected Consolidated Financial Data," except for ratios of earnings to fixed charges, which are incorporated herein by reference from Exhibit 12 to this Annual Report on Form 10-K. - -------------------------------------------------------------------------------- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference from Exhibit 13, Annual Report section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition." - -------------------------------------------------------------------------------- ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Incorporated by reference from Exhibit 13, Annual Report section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition" under the caption "Market Risk." - -------------------------------------------------------------------------------- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Incorporated by reference from Exhibit 13, Annual Report sections entitled "Consolidated Statements of Operations," "Consolidated Statements of Cash Flows," "Consolidated Balance Sheets," "Consolidated Statements of Common Stockholders' Equity," "Notes to Consolidated Financial Statements," "Consolidated Quarterly Income Information (Unaudited)," and "Report of Independent Public Accountants." - -------------------------------------------------------------------------------- ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 43 - -------------------------------------------------------------------------------- PART III - -------------------------------------------------------------------------------- ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference from Proxy Statement sections entitled "Election of Directors" and "Executive Officers." - -------------------------------------------------------------------------------- ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference from Proxy Statement section entitled "Executive Compensation" except for the information specified in Item 402(a)(8) of Regulation S-K under the Securities Exchange Act of 1934, as amended. - -------------------------------------------------------------------------------- ITEM 12. BENEFICIAL OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference from Proxy Statement sections entitled "Security Ownership of Management" and "Principal Shareholders." - -------------------------------------------------------------------------------- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference from Proxy Statement section entitled "Certain Relationships and Related Transactions." 44 - -------------------------------------------------------------------------------- PART IV - -------------------------------------------------------------------------------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The following documents are filed as a part of this report: (a) (1) Financial Statements Consolidated Statements of Operations.............................. Annual Report* Consolidated Statements of Cash Flows.............................. Annual Report* Consolidated Balance Sheets........................................ Annual Report* Consolidated Statements of Common Stockholders' Equity............. Annual Report* Notes to Consolidated Financial Statements......................... Annual Report* Consolidated Quarterly Income Information (Unaudited).............. Annual Report* Report of Independent Public Accountants........................... Annual Report*
- ------------------------ * Incorporated by reference from Exhibit 13. (2) Schedules
LOCATION ---------- Report of Independent Public Accountants on Financial Statement Schedules................................... page 48 I. Condensed Financial Information of Registrant-Balance Sheets as of December 31, 1998 and 1997 and Statements of Operations and Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 1998.......................................................................... page 49 II. Valuation and Qualifying Accounts for each of the Three Years in the Period Ended December 31, 1998............................................................................................. page 54
All other schedules have been omitted because they are not applicable or not required because the required information is shown in the financial statements or notes thereto. (3) Exhibits The exhibits set forth in the accompanying Index to Exhibits are filed as a part of this Report. The following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of this Report.
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- 10.1 Salary Continuation Agreement for LeRoy T. Carlson dated May 20, 1977, as amended May 22, 1981 and May 25, 1984 is hereby incorporated by reference to the Company's Registration Statement on Form S-2, No. 2-92307. 10.2(a) Supplemental Benefit Agreement for LeRoy T. Carlson dated March 21, 1980, as amended March 20, 1981 is hereby incorporated by reference to an exhibit to the Company's Registration Statement on Form S-7, No. 2-74615. 10.2(b) Memorandum of Amendment to Supplemental Benefit Agreement dated May 28, 1991 is hereby incorporated by reference to Exhibit 10.2(b) to the Company's Annual Report Form 10-K for the year ended December 31, 1991. 10.3 Description of Terms of Letter Agreement with Sandra L. Helton dated August 7, 1998. 10.4(a) 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby incorporated by reference to Exhibit A to the Company's definitive Notice of Annual Meeting and Proxy Statement dated March 31, 1988.
45
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- 10.4(b) Amendment #1 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby incorporated by reference to Exhibit 10.7(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10.4(c) Amendment #2 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company is hereby incorporated by reference to Exhibit 10.7(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10.5 Telephone and Data Systems, Inc. 1994 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257). 10.6 Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit D to the Company's Proxy Statement/Prospectus dated March 24, 1998 which was part of the Company's Registration Statement on Form S-4 (Registration No. 333-42535). 10.7 Amended and Restated Supplemental Executive Retirement Plan of the Company. 10.11 Supplemental Benefit Agreement between United States Cellular Corporation and H. Donald Nelson is hereby incorporated by reference to an exhibit to United States Cellular Corporation's Registration Statement on Form S-1 (Registration No. 33-16975). 10.12 Deferred Compensation Agreement for H. Donald Nelson dated July 15, 1996, is hereby incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report in Form 10-Q for the quarterly period ended September 30, 1996. 10.13 Stock Option and Stock Appreciation Rights Plan, is hereby incorporated by reference to Exhibit B to United States Cellular Corporation's definitive Notice of Annual Meeting and Proxy Statement dated April 15, 1991, as filed with the Commission on April 16, 1991. 10.14 Summary of 1998 Bonus Program for the Senior Corporate Staff on United States Cellular Corporation is hereby incorporated by reference to Exhibit 10.11 to United States Cellular Corporation's Annual Report on Form 10-K for the year ended December 31, 1998. 10.15 United States Cellular Corporation 1994 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 33-57255). 10.16 United States Cellular Corporation 1996 Senior Executive Stock Bonus and Restricted Stock Award Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-19405). 10.17 United States Cellular Corporation Special Retention Restricted Stock Award Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-23861). 10.18 United States Cellular Corporation 1998 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.4 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-57063). 10.19 Form of 1997 Special Retention Restricted Stock Awards is hereby incorporated by reference to Exhibit 99.2 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-57063). 10.20 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995, is hereby incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 10.21 Aerial Communications, Inc. 1996 Long-Term Incentive Plan, as amended, is hereby incorporated by reference to Exhibit 99.1 to Aerial Communications, Inc.'s Registration Statement on Form S-8 (Registration No. 333-06471)
46
EXHIBIT NUMBER DESCRIPTION - --------- ------------------------------------------------------------------------------------------------------- 10.22 Amendment to the Aerial Communications, Inc. 1996 Long-Term Incentive Plan is hereby incorporated by reference to Aerial Communications, Inc.'s Form S-8 dated April 30, 1998 (Registration No. 333-51561). 10.23 Description of Supplemental Benefit Agreement with Donald W. Warkentin dated August 2, 1996, is hereby incorporated by reference to Exhibit 10.17 to Aerial Communications, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1997. 10.24 TDS Compensation Plan for Non-Employee Directors is hereby incorporated by reference to Exhibit 99.1 of the Company's Registration Statement on Form S-8 (Registration No. 333-23947). 10.25 Executive Deferred Compensation Agreement for James Barr III dated January 1, 1998 is hereby incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10.26 Form of TDS Telecommunications Corporation Phantom Stock Option Incentive Agreement between TDS Telecommunications Corporation and James Barr III is hereby incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10.28 Employment Agreement with Murray L. Swanson dated October 15, 1998.
(b) Reports on Form 8-K filed during the quarter ended December 31, 1998. TDS filed a Current Report on Form 8-K on December 23, 1998 dated December 18, 1998, which included a news release relating to the announcement that TDS had withdrawn its offers to exchange tracking stocks for the outstanding common shares of United States Cellular Corporation and Aerial Communications, Inc. which it did not own. In addition, the Company announced that it is pursuing a tax-free spin-off of its 82.3% interest in Aerial Communications, Inc., as well as other alternatives. 47 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES To the Stockholders and Board of Directors of Telephone and Data Systems, Inc.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Telephone and Data Systems, Inc. and Subsidiaries Annual Report incorporated by reference in this Form 10-K, and have issued our report thereon dated January 27, 1999. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The financial statement schedules listed in Item 14(a)(2) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These financial statement schedules have been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Chicago, Illinois January 27, 1999 48 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT TELEPHONE AND DATA SYSTEMS, INC. (PARENT) BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------------- 1998 1997 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents......................................................... $ 264 $ 271 Temporary investments............................................................. -- 132 Notes receivable from affiliates.................................................. 91,354 42,586 Accounts receivable Due from subsidiaries--Income taxes............................................. -- 17,673 Due from subsidiaries--Other.................................................... 32,552 21,060 Other........................................................................... 3,838 6,407 Prepaid income taxes.............................................................. 5,064 16,975 Other current assets.............................................................. 2,621 4,287 ------------- ------------- 135,693 109,391 ------------- ------------- INVESTMENT IN SUBSIDIARIES.......................................................... 2,629,812 2,396,557 ------------- ------------- OTHER INVESTMENTS Notes receivable from affiliates.................................................. 510,274 376,809 Minority interests and other investments.......................................... 50,151 50,846 ------------- ------------- 560,425 427,655 ------------- ------------- PROPERTY AND EQUIPMENT Property and Equipment, net of accumulated depreciation........................... 19,778 34,216 ------------- ------------- OTHER ASSETS AND DEFERRED CHARGES Net deferred income taxes......................................................... 58,999 -- Debt issuance expenses............................................................ 13,350 6,829 Development and acquisition expenses.............................................. 426 267 Other............................................................................. 483 (28) ------------- ------------- 73,258 7,068 ------------- ------------- $ 3,418,966 $ 2,974,887 ------------- ------------- ------------- -------------
The Notes to Consolidated Financial Statements, included in the Annual Report, are an integral part of these statements. 49 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT TELEPHONE AND DATA SYSTEMS, INC. (PARENT) BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, ---------------------------- 1998 1997 ------------- ------------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Current portion of long-term debt................................................. $ 248 $ 239 Notes payable..................................................................... 170,889 525,885 Notes payable to affiliates....................................................... 179,606 -- Accounts payable Due to subsidiaries--Income Taxes............................................... 12,854 -- Due to subsidiaries--Other...................................................... 3,037 763 Other........................................................................... 7,637 5,032 Accrued interest.................................................................. 16,527 10,892 Other............................................................................. 5,346 4,854 ------------- ------------- 396,144 547,665 ------------- ------------- DEFERRED LIABILITIES AND CREDITS Net deferred income taxes......................................................... -- 22,659 Postretirement benefits obligation other than pensions............................ 779 696 Other............................................................................. 7,717 7,241 ------------- ------------- 8,496 30,596 ------------- ------------- LONG-TERM DEBT, excluding current portion (Note A).................................. 441,153 241,401 LONG-TERM DEBT--due to affiliates (Note B).......................................... 309,280 154,640 ------------- ------------- 750,433 396,041 ------------- ------------- PREFERRED SHARES.................................................................... 25,985 32,466 ------------- ------------- COMMON STOCKHOLDERS' EQUITY Common Shares, par value $.01 and $1 per share, respectively; authorized 100,000,000 shares; issued and outstanding 54,988,498 and 54,443,260 shares, respectively.................................................................... 550 54,443 Series A Common Shares, par value $.01 and $1 per share, respectively; authorized 25,000,000 shares; issued and outstanding 6,949,904 and 6,936,277 shares, respectively.................................................................... 69 6,936 Capital in excess of par value.................................................... 1,882,710 1,664,248 Accumulated other comprehensive income from subsidiaries.......................... 75,609 683 Treasury Shares, at cost, 761,220 and 794,576 shares, respectively................ (29,439) (30,682) Retained earnings................................................................. 308,409 272,491 ------------- ------------- 2,237,908 1,968,119 ------------- ------------- $ 3,418,966 $ 2,974,887 ------------- ------------- ------------- -------------
The Notes to Consolidated Financial Statements, included in the Annual Report, are an integral part of these statements. 50 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT TELEPHONE AND DATA SYSTEMS, INC. (PARENT) STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, --------------------------------------- 1998 1997 1996 ------------ ------------ ----------- (DOLLARS IN THOUSANDS) Operating service revenues............................................... $ 78,269 $ 72,372 $ 61,239 Cost of sales and operating expenses..................................... 76,238 72,249 57,538 ------------ ------------ ----------- Net operations......................................................... 2,031 123 3,701 ------------ ------------ ----------- Other income Interest income received from affiliates............................... 72,455 32,945 7,385 Gain on sale of investments............................................ 7,164 10,307 3,434 Other, net............................................................. (10,631) (4,798) (2,139) ------------ ------------ ----------- 68,988 38,454 8,680 ------------ ------------ ----------- Income before interest and income taxes.................................. 71,019 38,577 12,381 Interest expense......................................................... 78,002 44,482 15,790 Income tax expense (credit).............................................. (157,735) (100,074) (28,522) ------------ ------------ ----------- Corporate operations..................................................... 150,752 94,169 25,113 Equity in net income (loss) of subsidiaries and other investments........ (86,344) (103,718) 103,026 ------------ ------------ ----------- Net income (loss)........................................................ $ 64,408 $ (9,549) $ 128,139 ------------ ------------ ----------- ------------ ------------ -----------
The Notes to Consolidated Financial Statements, included in the Annual Report, are an integral part of these statements. Note A: The annual requirements for principal payments on long-term debt are $248,000, $258,000, $270,000, $283,000 and $32.1 million for the years 1999 through 2003, respectively. Note B: In 1998, TDS Capital II, a subsidiary trust ("Capital II") of TDS, issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable Preferred Securities (the "1998 Preferred Securities") at $25 per Preferred Security. Net proceeds totaled $144.9 million and were used to reduce short-term debt. The sole asset of TDS Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated Debentures due March 31, 2038. In 1997, TDS Capital I, a subsidiary trust ("Capital I") of TDS, issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities (the "1997 Preferred Securities") at $25 per Preferred Security. Net proceeds totaled $144.8 million and were used to reduce short-term debt. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due December 31, 2037. The obligations of TDS Capital I and II under the 1998 Preferred Securities and 1997 Preferred Securities (the "Preferred Securities") issued by TDS Capital I and II are fully and unconditionally guaranteed by TDS. However, TDS's obligations are subordinate and junior in right of payment to certain other indebtedness of TDS. TDS has the right to defer payments of interest on the Subordinated Debentures by extending the interest payment period, at any time, for up to 20 consecutive quarters. If interest payments on the Subordinated Debentures are so deferred, distributions on the Preferred Securities will also be deferred. During any deferral, distributions will continue to accrue with interest thereon. In addition, during any such deferral, TDS may not declare or pay any dividend or other distribution on, or redeem or purchase, any of its common stock. The 8.04% and 8.5% Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after March 31, 2003, and November 18, 2002, respectively, or, in whole 51 but not in part, at any time in the event of certain income tax circumstances. If the Subordinated Debentures are redeemed, TDS Capital I and II must redeem Preferred Securities on a pro rata basis having an aggregate liquidation amount equal to the aggregate principal amount of the Subordinated Debentures so redeemed. In the event of the dissolution, winding up or termination of TDS Capital I and II, the holders of Preferred Securities will be entitled to receive, for each Preferred Security, a liquidation amount of $25 plus accrued and unpaid distributions thereon to the date of payment, unless, in connection with the dissolution, winding up or termination, Subordinated Debentures are distributed to the holders of the Preferred Securities. 52 SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT TELEPHONE AND DATA SYSTEMS, INC. (PARENT) STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------- 1998 1997 1996 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss)....................................................... $ 64,408 $ (9,549) $ 128,139 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization......................................... 10,813 9,508 11,047 Gain on sale of investments........................................... (7,164) (10,307) (3,434) Deferred taxes........................................................ (82,300) (8,918) 5,432 Equity in net loss (income) of subsidiaries and other investments..... 86,344 103,718 (103,026) Other noncash expense................................................. (394) (211) 677 Change in accounts receivable......................................... 19,705 (19,063) 20,795 Change in accounts payable............................................ 6,810 3,598 (39,897) Change in accrued taxes............................................... 9,324 2,151 (12,289) Change in other assets and liabilities................................ 8,340 435 2,849 ----------- ----------- ----------- 115,886 71,362 10,293 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Long-term debt borrowings............................................... 343,127 144,788 -- Repayment of long-term debt............................................. (239) (735) (2,815) Change in notes payable................................................. (354,996) 368,658 (23,533) Change in notes payable to affiliates................................... 183,216 (47,990) 104,843 Change in advances from affiliates...................................... -- -- (2,464) Change in notes receivable from affiliates.............................. (270,349) (451,048) (35,165) Change in advances to affiliates........................................ -- 1,616 200 Common stock issued..................................................... 3,391 5,225 5,114 Redemption of preferred shares.......................................... (367) (359) (605) Dividends from subsidiaries............................................. 38,391 22,022 17,953 Dividends paid.......................................................... (28,488) (27,191) (26,232) Repurchase of Common Shares............................................. -- (69,942) -- Purchase of subsidiary common stock..................................... (9,107) (9,801) -- ----------- ----------- ----------- (95,421) (64,757) 37,296 ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Acquisitions Value of assets acquired.............................................. (14,425) (8,767) (121,053) Common Shares issued.................................................. 10,028 3,601 113,128 Preferred Shares issued............................................... -- 3,000 -- ----------- ----------- ----------- Net cash paid for acquisitions...................................... (4,397) (2,166) (7,925) Capital expenditures.................................................... 6,662 (20,957) (13,362) Payment to subsidiary under contract agreement.......................... (28,696) -- -- Proceeds from sale of investments....................................... 5,382 20,886 500 Investments in subsidiaries............................................. 262 (7,111) (19,533) Other investments....................................................... 183 2,851 (8,941) Change in temporary investments......................................... 132 22 (54) ----------- ----------- ----------- (20,472) (6,475) (49,315) ----------- ----------- ----------- NET DECREASE (INCREASE) IN CASH AND CASH EQUIVALENTS...................... (7) 130 (1,726) CASH AND CASH EQUIVALENTS Beginning of period..................................................... 271 141 1,867 ----------- ----------- ----------- End of period........................................................... $ 264 $ 271 $ 141 ----------- ----------- ----------- ----------- ----------- -----------
The Notes to Consolidated Financial Statements, included in the Annual Report, are an integral part of these statements. 53 TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING OF COSTS AND OTHER END OF DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD - ---------------------------------------------- ------------- ------------ ------------ ----------- ----------- COLUMN A COLUMN B COLUMN C-1 COLUMN C-2 COLUMN D COLUMN E (DOLLARS IN THOUSANDS) FOR THE YEAR ENDED DECEMBER 31, 1998 Deducted from deferred state tax asset: For unrealized net operating losses......... $ (29,001) $ (1,023) $ (24,661) $ -- $ (54,685) Deducted from accounts receivable: For doubtful accounts..................... (15,102) (40,629) -- 43,123 (12,608) FOR THE YEAR ENDED DECEMBER 31, 1997 Deducted from deferred state tax asset: For unrealized net operating losses......... (16,891) 877 (12,987) -- (29,001) Deducted from accounts receivable: For doubtful accounts..................... (6,090) (39,107) -- 30,095 (15,102) FOR THE YEAR ENDED DECEMBER 31, 1996 Deducted from deferred state tax asset: For unrealized net operating losses......... (10,061) 239 (7,069) -- (16,891) Deducted from accounts receivable: For doubtful accounts..................... $ (5,104) $ (22,432) $ -- $ 21,446 $ (6,090)
54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TELEPHONE AND DATA SYSTEMS, INC. By: /s/ LEROY T. CARLSON ----------------------------------------- LeRoy T. Carlson CHAIRMAN By: /s/ LEROY T. CARLSON, JR. ----------------------------------------- LeRoy T. Carlson, Jr. PRESIDENT, (CHIEF EXECUTIVE OFFICER) By: /s/ SANDRA L. HELTON ----------------------------------------- Sandra L. Helton EXECUTIVE VICE PRESIDENT--FINANCE (CHIEF FINANCIAL OFFICER) By: /s/ GREGORY J. WILKINSON ----------------------------------------- Gregory J. Wilkinson VICE PRESIDENT AND CONTROLLER (PRINCIPAL ACCOUNTING OFFICER) Dated March 30, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ------------------------------ -------------------------- ------------------- /s/ LEROY T. CARLSON - ------------------------------ Director March 30, 1999 LeRoy T. Carlson /s/ LEROY T. CARLSON, JR. - ------------------------------ Director March 30, 1999 LeRoy T. Carlson, Jr. /s/ SANDRA L. HELTON - ------------------------------ Director March 30, 1999 Sandra L. Helton /s/ JAMES BARR III - ------------------------------ Director March 30, 1999 James Barr III /s/ WALTER C.D. CARLSON - ------------------------------ Director March 30, 1999 Walter C.D. Carlson
55
SIGNATURE TITLE DATE - ------------------------------ -------------------------- ------------------- /s/ LETITIA G.C. CARLSON - ------------------------------ Director March 30, 1999 Letitia G.C. Carlson /s/ HERBERT S. WANDER - ------------------------------ Director March 30, 1999 Herbert S. Wander /s/ DONALD C. NEBERGALL - ------------------------------ Director March 30, 1999 Donald C. Nebergall /s/ GEORGE W. OFF - ------------------------------ Director March 30, 1999 George W. Off /s/ MARTIN L. SOLOMON - ------------------------------ Director March 30, 1999 Martin L. Solomon /s/ KEVIN A. MUNDT - ------------------------------ Director March 30, 1999 Kevin A. Mundt /s/ MURRAY L. SWANSON - ------------------------------ Director March 30, 1999 Murray L. Swanson
56 INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION OF DOCUMENT - ---------- ----------------------------------------------------------------------------------------------------- 3.1 Restated Certificate of Incorporation, as amended, are hereby incorporated by reference to Exhibit 3.1 to the Company's Report on Form 8-A/A filed on July 10, 1998. 3.2 Restated By-laws, as amended, are hereby incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated May 22, 1998. 4.1 Restated Certificate of Incorporation, as amended, are hereby incorporated by reference to Exhibit 3.1 to the Company's Report on Form 8-A/A filed on July 10, 1998. 4.2 Restated By-laws, as amended, are hereby incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated May 22, 1998. 4.3(a) The Indenture between the Company and Harris Trust and Savings Bank, Trustee, dated February 1, 1991, under which the Company's Medium-Term Notes are issuable, is hereby incorporated by reference to the Company's Current Report on Form 8-K filed on February 19, 1991. 4.3(b) Form of First Supplemental Indenture with Harris Trust and Savings Bank is hereby incorporated by reference to Exhibit 4.1(b) of Post Effective Amendment No. 1 to Form S-3 (Registration No. 33-68456). 4.4 Revolving Credit Agreement, dated as of May 19, 1995, among TDS and the First National Bank of Boston, as agent, is hereby incorporated by reference to the registrant's Form 8-K dated May 19, 1995. 4.5 The Trust Indenture dated as of November 4, 1996 between Aerial Communications, Inc. as issuer, the Company as guarantor, and The First National Bank of Chicago, as trustee for Aerial's Series A Zero Coupon Notes, is hereby incorporated by reference to Exhibit 4.1 to Aerial's Current Report on Form 8-K filed on November 29, 1996. 4.6 The Trust Indenture, dated as of February 5, 1998, between Aerial Communications, Inc. as issuer, the Company as guarantor, and The First National Bank of Chicago, as trustee for Aerial's Series B Zero Coupon Notes, is hereby incorporated by reference to Exhibit 4.1 to Aerial's Current Report on Form 8-K filed on April 29, 1998. 4.7(a) The Amended and Restated Declaration of Trust, dated November 18, 1997, by and among the Company, as Sponsor, the Trust, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware, Inc., as Delaware Trustee and the Regular Trustees named therein, is hereby incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on December 2, 1997, dated November 18, 1997. 4.7(b) The Amended and Restated Declaration of Trust, dated February 10, 1998, by and among the Company, as Sponsor, the Trust, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware, Inc., as Delaware Trustee and the Regular Trustees named therein, is hereby incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on April 28, 1998, dated February 10, 1998. 4.7(c) Form of First Supplemental Indenture to Amended and Restated Declaration of Trust relating to assumption of TDS Delaware is hereby incorporated by reference to Exhibit 4.7 of Post Effective Amendment No. 1 to Form S-3 (Registration No. 333-38355). 4.8(a) The Subordinated Indenture, dated October 15, 1997, by and between the Company and the First National Bank of Chicago, as Trustee under which the Trust Originated Preferred Securities are issuable, is hereby incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed on December 2, 1997, dated November 18, 1997.
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EXHIBIT NO. DESCRIPTION OF DOCUMENT - ---------- ----------------------------------------------------------------------------------------------------- 4.8(b) The Supplemental Indenture dated November 18, 1997, by and between the Company and the First National Bank of Chicago, as Trustee under which the Trust Originated Preferred Securities are issuable, is hereby incorporated by reference to Exhibit 4.4 to the Company's Current Report on Form 8-K filed on December 2, 1997, dated November 18, 1997. 4.8(c) The Second Supplemental Indenture, dated as of February 10, 1998, by and among the Company and The First National Bank of Chicago, as Debt Trustees, is hereby incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed on April 28, 1998, dated February 10, 1998. 4.8(d) Form of Third Supplemental Indenture to Subordinated Indenture relating to assumption by TDS Delaware is hereby incorporated by reference to Exhibit 4.9 of Post Effective Amendment No. 1 to Form S-3 (Registration No. 333-38355). 4.9(a) The Preferred Securities Guarantee Agreement, dated as of November 18, 1997, by and among the Company and The First National Bank of Chicago, as Guarantee Trustee for the benefit of the holders of Trust Preferred Securities of the Trust, is hereby incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed on December 2, 1997, dated November 18, 1997. 4.9(b) The Preferred Securities Guarantee Agreement, dated as of February 10, 1998, by and among the Company and The First National Bank of Chicago, as Guarantee Trustee for the benefit of the holders of Trust Preferred Securities of the Trust, is hereby incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed on April 28, 1998, dated February 10, 1998. 4.9(c) Form of First Supplemental Indenture to Preferred Securities Guarantee Agreement relating to assumption by TDS Delaware is hereby incorporated by reference to Exhibit 4.8 of Post Effective Amendment No. 1 to Form S-3 (Registration No. 333-38355). 9.1(a) Voting Trust Agreement, dated as of June 30, 1989, is hereby incorporated by reference to an exhibit to Post-Effective Amendment No. 3 to the Company's Registration Statement on Form S-1, No. 33-12943. 9.1(b) Amendment dated as of May 9, 1991 to the Voting Trust Agreement dated as of June 30, 1989, is hereby incorporated by reference to Exhibit 9.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991. 9.1(c) Amendment dated as of November 20, 1992, to the Voting Trust Agreement dated as of June 30, 1989, as amended, is hereby incorporated by reference to Exhibit 9.1(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992. 9.1(d) Amendment dated as of May 22, 1998, to the Voting Trust Agreement dated as of June 30, 1989, as amended, is hereby incorporated by reference to Exhibit 99.3 to the Company's Current Report on Form 8-K filed on June 5, 1998. 10.1 Salary Continuation Agreement for LeRoy T. Carlson dated May 20, 1977, as amended May 22, 1981 and May 25, 1984 is hereby incorporated by reference to the Company's Registration Statement on Form S-2, No. 2-92307. 10.2(a) Supplemental Benefit Agreement for LeRoy T. Carlson dated March 21, 1980, as amended March 20, 1981, is hereby incorporated by reference to an exhibit to the Company's Registration Statement on Form S-7, No. 2-74615. 10.2(b) Memorandum of Amendment to Supplemental Benefit Agreement dated as of May 28, 1991, is hereby incorporated by reference to Exhibit 10.2(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991. 10.3 Description of Terms of Letter Agreement with Sandra L. Helton dated August 7, 1998. 10.4(a) 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby incorporated by reference to Exhibit A to the Company's definitive Notice of Annual Meeting and Proxy Statement dated March 31, 1988.
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EXHIBIT NO. DESCRIPTION OF DOCUMENT - ---------- ----------------------------------------------------------------------------------------------------- 10.4(b) Amendment #1 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby incorporated by reference to Exhibit 10.7(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10.4(c) Amendment #2 to 1988 Stock Option and Stock Appreciation Rights Plan of the Company, is hereby incorporated by reference to Exhibit 10.7(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993. 10.5 Telephone and Data Systems, Inc. 1994 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.1 to the Company's Registration Statement on Form S-8 (Registration No. 33-57257). 10.6 Telephone and Data Systems, Inc. 1998 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit D to the Company's Proxy Statement/Prospectus dated March 24, 1998 which was part of the Company's Registration Statement on Form S-4 (Registration No. 333-42535). 10.7 Amended and Restated Supplemental Executive Retirement Plan. 10.8 Securities Loan Agreement, dated June 13, 1995, between TDS and Merrill Lynch & Co. is hereby incorporated by reference to Exhibit 99.1 to the Form 8-K dated June 16, 1995 of United States Cellular Corporation. 10.9 Registration Rights Agreement among TDS, Merrill Lynch & Co. and United States Cellular Corporation is hereby incorporated by reference to Exhibit 99.2 to the Form 8-K dated June 16, 1995 of United States Cellular Corporation. 10.10 Common Share Delivery Arrangement Agreement among TDS, Merrill Lynch & Co. and United States Cellular Corporation is hereby incorporated by reference to Exhibit 99.3 to the Form 8-K dated June 16, 1995 of United States Cellular Corporation. 10.11 Supplemental Benefit Agreement between United States Cellular Corporation and H. Donald Nelson is hereby incorporated by reference to an exhibit to United States Cellular Corporation's Registration Statement on Form S-1 (Registration No. 33-16975). 10.12 Deferred Compensation Agreement for H. Donald Nelson dated July 15, 1996, is hereby incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. 10.13 Stock Option and Stock Appreciation Rights Plan, is hereby incorporated by reference to Exhibit B to United States Cellular Corporation's definitive Notice of Annual Meeting and Proxy Statement dated April 15, 1991, as filed with the Commission on April 16, 1991. 10.14 Summary of 1998 Bonus Program for the Senior Corporate Staff on United States Cellular Corporation is hereby incorporated by reference to Exhibit 10.11 to United States Cellular Corporation's Annual Report on Form 10-K for the year ended December 31, 1998. 10.15 United States Cellular Corporation 1994 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 33-57255). 10.16 United States Cellular Corporation 1996 Senior Executive Stock Bonus and Restricted Stock Award Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-19405). 10.17 United States Cellular Corporation Special Retention Restricted Stock Award Plan is hereby incorporated by reference to Exhibit 99.1 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-23861). 10.18 United States Cellular Corporation 1998 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.4 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-57063).
59
EXHIBIT NO. DESCRIPTION OF DOCUMENT - ---------- ----------------------------------------------------------------------------------------------------- 10.19 Form of 1997 Special Retention Restricted Stock Awards is hereby incorporated by reference to Exhibit 99.2 to United States Cellular Corporation's Registration Statement on Form S-8 (Registration No. 333-57063). 10.20 Description of Terms of Signing Letter with Donald W. Warkentin dated June 7, 1995, is hereby incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996. 10.21 Aerial Communications, Inc. 1996 Long-Term Incentive Plan, as amended, is hereby incorporated by reference to Exhibit 99.1 to Aerial Communications, Inc.'s registration statement on Form S-8 (Registration No. 333-06471). 10.22 Amendment to the Aerial Communications, Inc. 1996 Long-Term Incentive Plan is hereby incorporated by reference to Aerial Communications, Inc.'s Form S-8 dated April 30, 1998 (Registration No. 333-51561). 10.23 Description of Supplemental Benefit Agreement with Donald W. Warkentin dated August 2, 1996, is hereby incorporated by reference to Exhibit 10.17 to Aerial Communications, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1997. 10.24 TDS Compensation Plan for Non-Employee Directors is hereby incorporated by reference to Exhibit 99.1 of the Company's Registration Statement on Form S-8 (Registration No. 333-23947). 10.25 Executive Deferred Compensation Agreement for James Barr III dated January 1, 1998 is hereby incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10.26 Form of TDS Telecommunications Corporation Phantom Stock Option Incentive Agreement between TDS Telecommunications Corporation and James Barr III is hereby incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10.27 Credit Agreement dated June 30, 1998, by and between Nokia Telecommunications Inc. and Aerial Communications, Inc., is hereby incorporated by reference to Exhibit 99.1 of Aerial Communications, Inc.'s Form 8-K dated June 30, 1998 and filed on November 9, 1998. 10.28 Employment Agreement with Murray L. Swanson dated October 15, 1998. 11 Statement regarding computation of per share earnings (included in Footnote 4 to financial statements in Exhibit 13). 12 Statements regarding computation of ratios. 13 Incorporated portions of 1998 Annual Report to Security Holders. 21 List of Subsidiaries of the Company. 23 Consent of independent public accountants. 27 Financial Data Schedules for the year ended December 31, 1998.
60 [LOGO] TELEPHONE AND DATA SYSTEMS, INC. 30 North LaSalle Street Chicago, Illinois 60602 312/630-1900 EX-10.3 2 EXHIBIT 10.3 EXHIBIT 10.3 SANDRA L. HELTON -- LETTER AGREEMENT Ms. Helton was hired as Executive Vice President-Finance and Chief Financial Officer on August 10, 1998. The following describes the material terms of Ms. Helton's employment arrangements pursuant to a letter agreement between TDS and Sandra L. Helton, dated August 7, 1998: - A base salary at the annual rate of $365,000 per year through December 31, 1998, with a partial year performance review following year-end 1998. Annual reviews will then follow on January 1st of each subsequent year. - Assuming a start date of September 1, a guaranteed bonus of $60,000 for 1998, with the possibility of obtaining up to $90,000 if certain key fourth quarter objectives are met. Starting in 1999, a target bonus opportunity of 50% of base salary for the year with bonuses above this level for superior performance. - A signing bonus of 3,000 shares of TDS restricted stock. One third of the shares will vest on each of the first three anniversary dates with TDS. - Participation in the TDS three year 1997-1999 Long-Term Incentive Program. Non-qualified stock options consisting of two parts: (i) an automatic grant of 36,000 stock option shares which will vest in three equal annual installments of 12,000 shares, and (ii) an opportunity to receive performance based non- qualified stock options for 1999. If target level individual performance levels are achieved in 1999, an option to purchase 12,000 shares of TDS stock will be granted. Attached is a schedule which provides more detail about these stock option grants. - Participation in the then current Long-Term Incentive Program. - A seat on the TDS Board of Directors. - A moving expense reimbursement program providing reimbursement for: (i) actual moving expenses (i.e., all reasonable costs of packing, insuring, transporting, storing and unpacking furniture, other household furnishings and personal effects), (ii) legal fees and other reasonable expenses incurred in connection with purchasing a new home (if within the first two years of employment), (iii) reasonable travel expenses to look for housing, 61 (iv) normal living expenses for up to sixty days while waiting to move into a new residence, (v) travel expenses incurred during the actual move to Chicago, and (vi) miscellaneous relocation expenses, up to a maximum of one month's salary. - The same medical insurance and life insurance programs currently offered to other TDS managerial employees. - The same pension program currently offered to other TDS managerial employees. - A company car under the company car policy for senior executives pursuant to which executives may purchase a company car of their choice with TDS paying up to $33,200 of the cost of the vehicle. - A luncheon club membership. - Three weeks vacation per year. 62 Attachment SANDRA L. HELTON STOCK OPTION PROGRAM AWARDS AUTOMATIC STOCK OPTION GRANT OF 36,000 SHARES. - The first one third, or 12,000 shares, will vest on December 15, 1998. - On December 15, 1999, and 2000, an additional 12,000 stock option shares will vest. - The strike price for this 36,000 stock option grant will be the fair market price of a share of TDS stock on August 10, 1998. PERFORMANCE-BASED STOCK OPTION AWARD. - The performance year for this award (i.e. the measurement period) will be 1999. - This award will be made in 2000 and will vest on December 15th of that year. - The strike price of performance-based awards is the fair market value of a share of TDS stock on the date the award is approved. - Our performance-based stock option awards are based on individual performance. At target individual performance, an option to purchase 12,000 shares of TDS stock will be granted. - Performance-based stock option award will be determined by the President's assessment of the extent to which the key performance measures/targets were accomplished or exceeded. - The amount of the annual performance stock option award could vary to a maximum of 24,000 stock option shares for truly exceptional performance. 63 EX-10.7 3 EXHIBIT 10.7 EXHIBIT 10.7 TELEPHONE AND DATA SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (As Amended and Restated, Effective January 1, 1998) TELEPHONE AND DATA SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (AS AMENDED AND RESTATED, EFFECTIVE JANUARY 1, 1998) TABLE OF CONTENTS
PAGE SECTION 1 INTRODUCTION....................................................................................1 1.1 Title and Purpose...............................................................................1 1.2 Definitions.....................................................................................2 1.3 Gender and Number...............................................................................5 SECTION 2 ELIGIBILITY AND BENEFITS........................................................................6 2.1 Eligibility.....................................................................................6 2.2 Benefits........................................................................................6 2.3 Earnings and Other Adjustments..................................................................8 SECTION 3 PAYMENT OF BENEFITS.............................................................................8 3.1 Vesting.........................................................................................8 3.2 Commencement of Payments.......................................................................10 3.3 Schedule of Payments...........................................................................10 3.4 Survivor Benefits..............................................................................11 3.5 Distributions to Minor and Disabled Persons....................................................12 3.6 Small Benefits Paid in Lump Sum................................................................13 SECTION 4 GENERAL PROVISIONS.............................................................................13 4.1 Employment Rights..............................................................................13 4.2 Rights Not Secured.............................................................................13 4.3 Administration.................................................................................14 4.4 Effect on Other Plans..........................................................................14 4.5 Interests Not Transferable.....................................................................14 4.6 Adoption by Employers..........................................................................15 4.7 Tax Liability..................................................................................15 4.8 Controlling Law................................................................................15 SECTION 5 CLAIMS PROCEDURE...............................................................................16 SECTION 6 AMENDMENT AND TERMINATION......................................................................17 6.1 Amendment......................................................................................17 6.2 Termination....................................................................................18
TELEPHONE AND DATA SYSTEMS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN (AS AMENDED AND RESTATED, EFFECTIVE JANUARY 1, 1998) SECTION 1 INTRODUCTION 1.1 TITLE AND PURPOSE. The title of this Plan is the "Telephone and Data Systems, Inc. Supplemental Executive Retirement Plan". This Plan was established by Telephone and Data Systems, Inc. (the "Company"), effective January 1, 1994. This Plan was amended by an Amendment Number 1, effective January 1, 1996. Pursuant to the power reserved by the Company in Section 6.1, this Plan is hereby amended and restated, effective January 1, 1998. The purpose of this Plan has been to supplement the benefits under the Telephone and Data Systems, Inc. Employees' Pension Trust I (the "TDS Target Plan") and the Telephone and Data Systems, Inc. Wireless Companies' Pension Plan (the "TDS Wireless Plan") (both Plans being referred to herein as "TDS Pension Plans"), each of which is intended to operate as a "qualified" plan as defined under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"). Qualified plans must comply with Section 401(a)(17) of the Code, which limits the annual compensation of each employee which can be taken into account under a qualified plan. This Plan was established to offset the Code mandated reduction of benefits caused by the limitation on annual employee compensation to be considered under Section 401(a)(17) of the Code for eligible employees participating in either TDS Pension Plan. Additionally, neither of the TDS Pension Plans includes in its definition of compensation for determining benefits any participant's compensation earned in the Plan Year but deferred under a Nonqualified Deferred Compensation Plan. Effective January 1, 1998, this Plan provides a benefit for Qualifying Employer Officers to replace the reduction in benefits which occurs under the TDS Pension Plans because compensation earned in the Plan Year but deferred under a Nonqualified Deferred Compensation Plan is not included in the definition of compensation under the TDS Pension Plans. This Plan is intended to be unfunded and maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. 1.2 DEFINITIONS. All capitalized terms used herein shall have the meanings set forth below, except as otherwise provided in the preamble to or text of this Plan: (a) "AERIAL" means Aerial Communications, Inc., a Delaware corporation, and any corporation which shall succeed to the business of such corporation and adopts this Plan pursuant to Section 4.6. (b) "BENEFICIARY" means the beneficiary designated by the Participant or otherwise entitled to payment of benefits hereunder. If no separate designation is made by a Participant -2- under this Plan, the Beneficiary shall be his beneficiary under the TDS Pension Plan in which the Participant was most recently participating. (c) "BENEFITS DEPARTMENT" means the employee benefits department of the Company, located at 8401 Greenway Boulevard, Post Office Box 628010, Middleton, Wisconsin 53562-8010. (d) "CAUSE" means (i) the continued failure by a Participant to substantially perform the Participant's duties with the Company or an Employer, or (ii) the willful engaging by the Participant in conduct which is clearly injurious to the Company or any of its respective affiliates, monetarily or otherwise. For purposes of clause (ii) of this definition, no act, or failure to act, on the Participant's part shall be deemed "willful" unless done, or omitted to be done, by the Participant not in good faith or without reasonable belief that such act, or failure to act, was in the best interest of the Company or an Employer. (e) "COMMITTEE" means, unless otherwise appointed by the Board of Directors of the Company, the Investment Management Committee of the TDS Target Plan, which shall administer the Plan. (f) "EMPLOYER" means the Company, Telecom, USCC, Aerial and any other entity that participates in the TDS Target -3- Plan or the TDS Wireless Plan and adopts this Plan pursuant to Section 4.6. (g) "NONQUALIFIED DEFERRED COMPENSATION PLAN" means any plan or agreement, other than the Telephone and Data Systems, Inc. Tax-Deferred Savings Plan, which is sponsored, maintained or entered into by the Company, Telecom, USCC or Aerial and which allows employees of any such Employer to defer compensation. (h) "PARTICIPANT" means any employee who meets the eligibility for participation requirements set forth in Section 2.1. (i) "PLAN" means this Telephone and Data Systems, Inc. Supplemental Executive Retirement Plan, as from time to time amended. (j) "PLAN YEAR" means the calendar year. (k) "QUALIFYING EMPLOYER OFFICER" means the Chief Executive Officer, President and any Vice President of the Company, Telecom, USCC or Aerial. (l) "TDS PENSION PLAN" means the TDS Target Plan with respect to a Participant who participates in the TDS Target Plan and the TDS Wireless Plan with respect to a Participant who participates in the TDS Wireless Plan. -4- (m) "TELECOM" means TDS Telecommunications Corporation, a Delaware corporation, and any corporation which shall succeed to the business of such corporation and adopts this Plan pursuant to Section 4.6. (n) "USCC" means United States Cellular Corporation, a Delaware corporation, and any corporation which shall succeed to the business of such corporation and adopts this Plan pursuant to Section 4.6. (o) "YEAR OF SERVICE" means, with respect to a Participant who participates in the TDS Target Plan, a Year of Vesting Service as defined in Article 2 of the TDS Target Plan, and with respect to a Participant who participates in the TDS Wireless Plan, a Year of Service as defined in Article 2 of the TDS Wireless Plan, including all such Years of Vesting Service and Years of Service completed prior to and after January 1, 1996. 1.3 GENDER AND NUMBER. Where the context permits, words in the masculine shall include the feminine and neutral; words in the plural shall include the singular and the singular shall include the plural. -5- SECTION 2 ELIGIBILITY AND BENEFITS 2.1 ELIGIBILITY. An employee who is a participant in the TDS Target Plan or the TDS Wireless Plan shall commence participation in this Plan as a Participant (i) if his compensation (as defined in the TDS Pension Plan) for the Plan Year exceeds the limit set forth in Section 401(a)(17) of the Code for such Plan Year (adjusted for changes in the cost of living pursuant to Section 401(a)(17)) or (ii) if he is a Qualifying Employer Officer and part of his compensation earned in the Plan Year from an Employer is being deferred under a Nonqualified Deferred Compensation Plan. 2.2 BENEFITS. If Employer contributions that would otherwise have been made on behalf of the Participant under the provisions of the TDS Pension Plan are limited in a Plan Year (A) because of Section 401(a)(17) of the Code or (B) in the case of a Qualifying Employer Officer, because the Participant's compensation considered under the TDS Pension Plan does not include part or all of the Participant's compensation earned in the Plan Year because it is being deferred under a Nonqualified Deferred Compensation Plan, such Employer shall credit to an account for the Participant as of the last day of such Plan Year, for bookkeeping purposes only, an amount equal to the difference between (i) the amount of Employer contributions that would have been allocated to the Participant's account under the TDS Pension -6- Plan without regard to Section 401(a)(17) of the Code for such Plan Year, and in the case of a Qualifying Employer Officer, including as compensation for purposes of the TDS Pension Plan all of the Participant's compensation earned in the Plan Year which was deferred under any Nonqualified Deferred Compensation Plan, and (ii) the amount of Employer contributions actually allocated to the Participant's account under the TDS Pension Plan for that Plan Year. When calculating the amount described in part (i) of the previous sentence with respect to TDS Target Plan benefits based on a Participant's compensation in excess of the limitation under Section 401(a)(17) of the Code, amounts credited to the account for such Participant for prior plan years must be considered. Effective January 1, 1996, when calculating the amount described in part (i) of the first sentence of this Section 2.2 with respect to TDS Target Plan benefits, a Participant's compensation shall mean all wages within the meaning of Section 3401(a) of the Code (for purposes of income tax withholding at the source) paid to such Participant by an Employer while a participant in a TDS Pension Plan during such Plan Year, but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed, reduced by all reimbursements or other expense allowances, fringe benefits (cash and noncash), moving expenses, deferred compensation, and welfare benefits and increased by all elective contributions that are made by an Employer on behalf of such Participant that are not includible in gross income under Sections 125, 402(e)(3), 402(h) and 403(b) of the Code; provided, -7- however, effective January 1, 1998, with respect to any Qualifying Employer Officer who is a Participant all of such Participant's compensation earned in the Plan Year which was deferred under any Nonqualified Deferred Compensation Plan shall be included in compensation for purposes of part (i) of the first sentence of this Section 2.2. For calculating benefits under this Section 2.2 with respect to TDS Target Plan benefits for a plan year, the actuarial assumptions and methods in effect during that plan year from the TDS Target Plan will be applied. 2.3 EARNINGS AND OTHER ADJUSTMENTS. For bookkeeping purposes only, the account established for each Participant pursuant to Section 2.2 shall be adjusted at the end of each Plan Year to reflect (i) an assumed rate of earnings on all items other than the contributions for the current Plan Year equal to the yield on ten year BBB rated industrial bonds for the last trading date of the prior Plan Year as quoted by Standard & Poors and (ii) any payments made pursuant to Section 3. SECTION 3 PAYMENT OF BENEFITS 3.1 VESTING. (a) TERMINATION OF EMPLOYMENT UNDER CIRCUMSTANCES ENTITLING THE PARTICIPANT TO DISTRIBUTION OF HIS FULL ACCOUNT. A Participant shall be entitled to distribution of his entire account balance under the Plan if the Participant's -8- employment is terminated, without Cause, after either of the following events: (i) his attainment of age 65; or (ii) his completion of at least ten Years of Service. (b) TERMINATION OF EMPLOYMENT UNDER CIRCUMSTANCES RESULTING IN COMPLETE OR PARTIAL FORFEITURE OF THE PARTICIPANT'S ACCOUNT. If a Participant terminates employment under circumstances other than those set forth in paragraph (a) above, without Cause, the Participant shall be entitled to distribution of the following percentage of his account balance:
Nonforfeitable Years of Service Percentage - ---------------- -------------- Less than 1 0% At least 1, but less than 2 10% At least 2, but less than 3 20% At least 3, but less than 4 30% At least 4, but less than 5 40% At least 5, but less than 6 50% At least 6, but less than 7 60% At least 7, but less than 8 70% At least 8, but less than 9 80% At least 9, but less than 10 90% 10 years or more 100%
If a Participant's employment is terminated for Cause, such Participant shall be entitled to no portion of his account balance under this Plan. -9- 3.2 COMMENCEMENT OF PAYMENTS. The nonforfeitable portion of the Participant's account determined under Section 3.1, adjusted for the assumed rate of earnings in the manner described in Section 2.3 (including periods after the Participant's termination of employment), shall be payable to the Participant, beginning on the first day of the month next following the later of his termination of employment and his completion of all forms and applications requested by the Committee. 3.3 SCHEDULE OF PAYMENTS. The nonforfeitable portion of the Participant's account determined under Section 3.1, adjusted each Plan Year (including periods after any annual installment payments begin) for the assumed rate of earnings in the manner described in Section 2.3 and reduced for annual installments previously paid under the Plan, shall be payable in one of the forms described in the following sentence selected by the Participant on the date he first becomes a Participant and shall commence being paid on the date determined pursuant to Section 3.2. The forms available for payment hereunder are the following: (a) a single lump sum payment; or (b) annual installments over a period of 5, 10, 15, 20 or 25 years. Notwithstanding the Participant's selection of the payment method on the date he becomes a Participant, the Participant may make a one-time request that payments be made in accordance with a different form provided under this Section, provided that such form results in payments over a shorter period than the period -10- formerly selected by him. This request shall be irrevocable, must be made to the Committee prior to the date of the first payment under Section 3.2 and shall be subject to the approval of the Committee. The approval of the request shall be at the sole discretion of the Committee. If a Participant fails to designate a payment schedule in accordance with this Section, the nonforfeitable portion of his account shall be paid in annual installments for a period of ten years. Notwithstanding anything contained herein to the contrary, in the event that the Participant owes any amount to an Employer (an "Obligation"), the payments due hereunder shall be used to offset any Obligation in accordance with the payment schedule selected by the Participant. Any amounts not used to offset an Obligation shall be paid to the Participant or his Beneficiary. 3.4 SURVIVOR BENEFITS. If a Participant dies before payment of his account balance commences, his Beneficiary shall receive the nonforfeitable portion of his account balance determined under Section 3.1 (after offset of any Obligation as provided in Section 3.3) in the form selected by the Participant for payment of his account. If a Participant dies after payment of his account balance commences, his Beneficiary shall receive the remaining portion of the Participant's account balance to which the Participant would have been entitled had he survived, payable in the same form as payments would have been made to the -11- Participant had he survived. Notwithstanding the preceding two sentences, a Beneficiary entitled to payment under this Section may make a one-time request that payments be made in accordance with a different form provided under Section 3.3, provided that such form results in payments over a shorter period than the period formerly selected by the Participant. This request shall be irrevocable, must be made to the Committee prior to the date of the first payment to the Beneficiary and shall be subject to the approval of the Committee in the same manner as provided in Section 3.3. 3.5 DISTRIBUTIONS TO MINOR AND DISABLED PERSONS. If a distribution is to be made to a minor or to a person who, in the opinion of the Committee, is unable to manage his affairs by reason of illness or mental incompetency, such distribution may be made to or for the benefit of any such person in such of the following ways as the Committee shall direct: (a) directly to any such minor person if, in the opinion of the Committee, he is able to manage his affairs, (b) to the legal representative of any such person, (c) to a custodian under a Uniform Gifts to Minors Act for any such minor person, or (d) to some near relative of any such person to be used for the latter's benefit. Neither the Committee nor the Employer shall be required to see to the application by any third party of any distribution made to or for the benefit of a Participant or Beneficiary pursuant to this Section. -12- 3.6 SMALL BENEFITS PAID IN LUMP SUM. Notwithstanding any provision in the Plan to the contrary, if the amount of a Participant's account balance to be distributed under Article 3 is not more than $10,000, such amount shall be distributed, as soon as administratively feasible on or after the date on which such Participant's termination of service occurs, by payment in a lump sum. SECTION 4 GENERAL PROVISIONS 4.1 EMPLOYMENT RIGHTS. This Plan shall not be construed to give any Participant the right to be retained in the employ of any Employer nor any right to benefits not specifically provided for in this Plan. 4.2 RIGHTS NOT SECURED. All payments to be made pursuant to this Plan shall be an obligation of the general assets of the Employers, and no Employer shall be required to segregate any of its assets in order to provide for the satisfaction of the obligations hereunder or to make any investment of assets. Although the amounts credited to each Participant's account shall be reflected in the Employers' accounting records, this Plan shall not be construed to create a trust, custodial, or escrow account nor shall the Participant have any right, title, or interest in any specific investment reserves, accounts, funds or a trust that any Employer may -13- accumulate or establish to aid it in providing benefits under this Plan. Nothing contained in this Plan shall create a trust or fiduciary relationship between any Employer and any Participant or Beneficiary. Neither a Participant nor his Beneficiary shall acquire any interest greater than that of an unsecured creditor. 4.3 ADMINISTRATION. This Plan shall be administered by the Committee. The Committee shall have the same rights and duties with respect to this Plan as the plan administrator of the TDS Plan has with respect to the TDS Plan. The Committee will apply uniform rules to all Participants similarly situated. The determination of the Committee as to any question arising under this Plan shall be final and binding upon all persons. The expenses of administering the Plan shall be borne by the Employers. 4.4 EFFECT ON OTHER PLANS. Amounts credited or paid under this Plan shall not be considered to be compensation for the purposes of any qualified plan maintained by any Employer. 4.5 INTERESTS NOT TRANSFERABLE. Except as provided in Section 3.3 with respect to an Obligation, the interests of the Participants and their Beneficiaries under the Plan are not subject to the claims of their creditors and may not be voluntarily or involuntarily assigned or encumbered in any way, -14- including any assignment, division or awarding of property under state domestic relations law (including community property law). 4.6 ADOPTION BY EMPLOYERS. Any corporation which is or becomes an "Employer" under the Company Pension Plan may, with the consent of the Company, become an Employer in this Plan by delivery to the Company of a resolution of its board of directors or duly authorized committee to such effect, which resolution shall specify the first Plan Year for which this Plan shall be effective in respect of the employees of such corporation. 4.7 TAX LIABILITY. An Employer may withhold from any payment under this Plan any taxes required to be withheld plus such sums as such Employer may reasonably estimate to be necessary to cover any taxes for which the Employer may be liable and which may be assessed with regard to such payment. 4.8 CONTROLLING LAW. The law of Illinois and, where applicable, the provisions of the Employee Retirement Income Security Act of 1974, as amended, shall be controlling in all matters relating to the Plan. -15- SECTION 5 CLAIMS PROCEDURE If any Participant or Beneficiary believes he is entitled to benefits in an amount greater than those which he is receiving or has received, he may file a claim with the Benefits Department. Such a claim shall be in writing and state the nature of the claim, the facts supporting the claim, the amount claimed and the address of the claimant. The Benefits Department shall review the claim and, unless special circumstances require an extension of time, within 90 days after receipt of the claim, give written notice by registered or certified mail to the claimant of its decision with respect to the claim. If special circumstances require an extension of time, the claimant shall be so advised in writing within the initial 90-day period and in no event shall such an extension exceed 90 days. The notice sent by the Benefits Department shall be written in a manner calculated to be understood by the claimant and, if the claim is wholly or partially denied, set forth the specific reasons for the denial, specific references to the pertinent Plan provisions on which the denial is based, a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary, and an explanation of the claim review procedure under this Plan. The Benefits Department shall also advise the claimant that he or his duly authorized representative may request a review by the Committee of the denial by filing with the Committee within 60 -16- days after notice of the denial has been received by the claimant, a written request for such review. The claimant shall be informed that he may have reasonable access to pertinent documents and submit comments in writing to the Committee within the same 60-day period. If a request is so filed, review of the denial shall be made by the Committee and the claimant shall be given written notice of the Committee's final decision within sixty days after receipt of such request, unless special circumstances require an extension of time. If special circumstances require an extension of time, the claimant shall be so advised in writing within the initial 60-day period and in no event shall such an extension exceed 60 days. The notice of the Committee's final decision shall include specific reasons for the decision and specific references to the pertinent Plan provisions on which the decision is based and shall be written in a manner calculated to be understood by the claimant. SECTION 6 AMENDMENT AND TERMINATION 6.1 AMENDMENT. The Company may amend this Plan at any time by resolution duly adopted by its board of directors. No such amendment shall reduce or otherwise adversely affect the rights of Participants or Beneficiaries with respect to amounts accrued hereunder as of the date of such amendment. -17- 6.2 TERMINATION. Although the Company expects to continue this Plan indefinitely, it must necessarily reserve the right to terminate this Plan at any time by a resolution duly adopted by its board of directors. -18- IN WITNESS WHEREOF, the Company has caused this instrument to be executed on March 1, 1999, by its duly authorized officer to be effective as of January 1, 1998. TELEPHONE AND DATA SYSTEMS, INC. By: /s/ Leroy T. Carlson, Jr. ------------------------- LeRoy T. Carlson, Jr. ATTEST: By: /s/ Michael G. Hron ------------------- Secretary EX-10.28 4 EXHIBIT 10.28 [TDS LETTERHEAD] CONFIDENTIAL EMPLOYMENT AGREEMENT This Confidential Employment Agreement ("Agreement") is entered into by and between Telephone and Data Systems, Inc., a Delaware corporation with its principal place of business located in Chicago, Illinois ("TDS"), and Murray L. Swanson, an individual currently residing at 1118 Sheridan Rd., Evanston, Illinois 60202 ("Swanson"). WHEREAS, TDS and its subsidiaries are in the business of providing local telephone, personal communication, and wireless communication services to their customers; WHEREAS, TDS has employed Swanson since 1981 and Swanson formerly held the position of Executive Vice President - Finance and Chief Financial Officer of TDS; WHEREAS, Swanson is a member of TDS's Board of Directors; WHEREAS, Swanson has acquired extensive knowledge of and experience in TDS's business during his employment at TDS; WHEREAS, Swanson and TDS desire to continue their employment relationship until December 15, 1998, when Swanson will retire from TDS; NOW, THEREFORE, in consideration of the mutual promises contained in this Agreement and for other good and valuable consideration, the adequacy and receipt of which the parties expressly acknowledge, Swanson and TDS agree as follows: 1. EMPLOYMENT PERIOD. TDS will continue to employ Swanson at his current annual salary until December 15, 1998, on which date Swanson will retire from employment with TDS. Swanson will complete all necessary paperwork to establish December 15, 1998 as his official TDS retirement date. Until December 15, 1998, Swanson will make himself available to TDS personnel at reasonable times to respond to questions regarding TDS's financial matters. Nothing in this Agreement shall preclude Swanson from seeking, accepting, or commencing employment with an employer other than TDS prior to December 15, 1998, provided that such employment does not violate Paragraph 11 of this Agreement. 2. EMPLOYMENT BENEFITS. TDS will maintain all of Swanson's current TDS employment benefits until December 15, 1998 when they will cease in accordance with the terms of the respective benefit plans. Thereafter, Swanson may continue his medical and life insurance coverages on the same terms and conditions as any other retiree under TDS's Retiree Insurance Plan. TDS will offer Swanson continued dental and vision insurance coverage in accordance with TDS's Retiree Insurance Plan for 18 months after his December 15, 1998 retirement date. 3. COMPANY CAR. Swanson may keep his current company car after December 15, 1998, provided that he bears the entire cost of all expenditures for the car after that date. 4. COMPUTER EQUIPMENT. Swanson may keep the TDS computer equipment that he now has in his home. Swanson agrees that he will not request, and TDS will not purchase, any additional computer equipment for Swanson's use in his home, or elsewhere. 5. STOCK OPTIONS. On December 15, 1998, Swanson will vest in an automatic award of 3700 stock options pursuant to the 1994 TDS Long Term Incentive Plan. On December 15, 1998, Swanson also will vest in the 1997 performance based award of 12,950 stock options and in an automatic award of 9700 stock options pursuant to the 1998 TDS Long Term Incentive Plan. TDS shall request its Board of Directors to grant Swanson until March 15, 1999, 90 days after his December 15, 1998 retirement date, to exercise his stock options in accordance with terms of those respective Plans. 6. SEPARATION PAYMENT. On Swanson's December 15, 1998 retirement date, TDS will pay Swanson the gross amount of $365,000 less (i) any amounts earned and paid as salary for Swanson's employment at TDS after August 31, 1998, (ii) the $3541.67 cash advance that Swanson received when he joined TDS, and (iii) all authorized and legally required withholding and deductions. TDS will make such payment by check payable to Swanson and will send it to Swanson at his address set forth in Paragraph 19 or to such other address as Swanson subsequently notifies TDS in writing. 7. PENSION, 401(k), AND SERP PAYMENTS. As soon after Swanson's retirement date as feasible and provided that Swanson completes the necessary paperwork, TDS will pay Swanson his Telephone and Data Systems, Inc. Employees' Pension Trust I Plan, 401(k), and SERP balances in accordance with the terms of those Plans. 8. MEMBERSHIP IN TDS, UNITED STATES CELLULAR CORPORATION, AND AERIAL COMMUNICATIONS, INC. BOARDS OF DIRECTORS. On or before the date that Swanson executes this Agreement, Swanson will resign his positions as a member of the Boards of Directors of United States Cellular Corporation and Aerial Communications, Inc. by signing the resignation forms attached to this Agreement and returning them with the signed Agreement to TDS. Nothing in this Agreement is intended to limit or interfere with Swanson's ability to fully discharge his continued responsibilities as a TDS Director. 9. EMPLOYMENT INQUIRIES. TDS will direct to TDS's President and Chief Executive Officer all inquiries regarding Swanson's employment with TDS. 10. NON-DISCLOSURE AND USE OF CONFIDENTIAL AND PROPRIETARY INFORMATION. TDS's employment of Swanson has and will result in his exposure and access to confidential and proprietary information including, but not limited to, TDS and its subsidiaries' customer lists, price lists, manufacturing and supply costs, customer information, business plans, financial information, and business strategies which Swanson did not have access to prior to his employment with TDS and which information is of great value to TDS. Swanson shall not, at any - 2 - time, make available to any competitor or potential competitor of TDS or of its subsidiaries, or divulge, disclose, or communicate to any person, firm, corporation, or other business entity other than TDS authorized personnel, in any manner whatsoever, any such confidential or proprietary information, unless authorized to do so in writing by TDS's President and Chief Executive Officer. Under no circumstance shall Swanson remove any confidential or proprietary information from TDS's premises without the express written consent of TDS's President and Chief Executive Officer. Swanson shall not at any time utilize any of TDS's confidential or proprietary information on behalf of himself or any entity other than TDS or its subsidiaries. 11. RESTRICTIVE COVENANT AND EMPLOYEE NON-SOLICITATION. Until June 15, 1999, Swanson shall not directly, or through any other individual or entity, other than on TDS's behalf: (a) provide services similar to those provided by TDS or its subsidiaries including, but not limited to, local telephone, personal communication, or wireless communication services, to any customer of TDS or of any of its subsidiaries. The term "customer" is defined as any individual or entity for whom TDS or any of its subsidiaries provided services during the one year period from June 15, 1998 to June 15, 1999; (b) solicit for employment any employee of TDS or of its subsidiaries whom TDS or any of its subsidiaries employed at any time during the one year period from June 15, 1998 to June 15, 1999. Nothing in this Paragraph precludes Swanson from seeking, accepting, or commencing employment with Sonera. 12. INJUNCTIVE RELIEF. Swanson acknowledges that the covenants contained in Paragraphs 10 and 11 above are reasonable in scope and duration, do not unduly restrict Swanson's ability to engage in his livelihood, and are necessary to protect TDS's legitimate business interests. Without limiting the rights of TDS to pursue and obtain any other legal and/or equitable remedy available to it for any breach by Swanson of the covenants contained in Paragraphs 10 and 11 above, Swanson further acknowledges that a breach of those covenants would cause a loss to TDS and its subsidiaries which could not reasonably or adequately be compensated in damages in an action at law, that remedies other than injunctive relief could not fully compensate TDS for a breach of those covenants and that, accordingly, TDS shall be entitled to injunctive relief to prevent any breach or continuing breaches of Swanson's covenants set forth in Paragraphs 10 and 11 above. Swanson and TDS intend that if, in any action before any Court empowered to enforce those covenants, the Court finds any term, restriction, covenant or promise to be unenforceable, then such term, restriction, covenant or promise shall be deemed modified to the extent necessary to make it enforceable by such Court. 13. GENERAL RELEASE. Swanson, and anyone claiming through Swanson, agree not to sue and release TDS and any and all parents, divisions, subsidiaries, partnerships, affiliates and/or other related entities of TDS (whether or not such entities are wholly owned) and each of those entities' past, present, and future owners, trustees, fiduciaries, shareholders, directors, officers, administrators, agents, partners, employees, attorneys, and the predecessors, successors, and - 3 - assigns of each of them (collectively, the "Released Parties"), from any and all claims, whether known or unknown, which Swanson now has, has ever had, or may ever have against any of the Released Parties arising from or related to any act, omission, or thing occurring at any time prior to his signing this Agreement including, but not limited to, any and all claims that in any way result from, or relate to, Swanson's employment or cessation of employment with any of the Released Parties. These released claims further include, but are not limited to, any and all claims that Swanson could assert or could have asserted in any federal, state, or local court, commission, department, or agency under any common law theory, or under any fair employment, employment, contract, tort, federal, state, or local law, regulation, ordinance, or executive order including under the following laws as amended from time to time: the Age Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, the Americans With Disabilities Act, the Employee Retirement Income Security Act, the Family and Medical Leave Act, the Illinois Human Rights Act, and the Chicago and Cook County Human Rights Ordinances. TDS agrees not to sue and further releases Swanson from all claims that it now has, has ever had, or may ever have against Swanson arising from or related to any act, omission, or thing occurring at any time prior to his signing this Agreement. 14. ACKNOWLEDGMENT OF SUFFICIENT TIME TO CONSIDER THIS AGREEMENT AND TO CONSULT WITH A LAWYER. Swanson expressly acknowledges that he has been informed that he may consult with a lawyer of his choice, he has consulted with his lawyer, and he has had sufficient time to consult with his lawyer prior to executing this Agreement. Swanson further acknowledges that he has been informed that he is entitled to a period of at least 21 days within which to consider this Agreement, but that he may execute this Agreement at any time prior to the expiration of the 21-day period. 15. REVOCATION RIGHT. Within 7 days following the date of Swanson's execution of this Agreement, Swanson shall have the right to revoke this Agreement by serving within such 7- day period written notice of his revocation upon TDS's President and Chief Executive Officer. If Swanson does not revoke this Agreement during this 7-day period, this Agreement shall become effective on the eighth day after the date of Swanson's execution of this Agreement and Swanson shall have no further right to revoke this Agreement. 16. KNOWING AND VOLUNTARY RELEASE. Swanson acknowledges that in releasing and waiving any claims and rights that he has or may have against the Released Parties, including those under the Age Discrimination in Employment Act, he does so knowingly and voluntarily, in exchange for consideration in addition to anything of value to which he already is entitled. 17. RETURN OF TDS PROPERTY. Immediately upon TDS's request and no later than December 15, 1998, Swanson shall return to TDS all of TDS's property in his possession that does not relate to his TDS Board responsibilities. This property includes, but is not limited to, TDS's financial records, company credit cards, tapes, records, manuals, employee lists, customer lists, brochures, files, catalogs, price lists, cost information, keys, equipment, and all copies thereof. - 4 - 18. CONFIDENTIAL AGREEMENT. The existence and the terms of this Agreement are confidential. Accordingly, Swanson shall not disclose the existence or terms of this Agreement to anyone other than to his attorney, his immediate family, or as required by law. 19. NOTICES. All notices and other communications required or permitted under this Agreement shall be deemed to have been duly given and made if in writing and if served personally on the party for whom intended or by being deposited, postage prepaid, certified or registered mail, return receipt requested, in the United States mail bearing the address shown below for each such party or such other address as that party may designate in writing hereafter: (a) If to TDS: (b) If to Swanson: LeRoy T. Carlson, Jr. Murray L. Swanson President and Chief Executive Officer 1118 Sheridan Rd. Telephone and Data Systems, Inc. Evanston, Illinois 60202-1442 30 North LaSalle Street Suite 4000 Chicago, Illinois 60602-2507
20. WAIVER. TDS's future waiver of a breach by Swanson of any provision of this Agreement or failure to enforce any such provision with respect to him shall not operate or be construed as a waiver of any subsequent breach by Swanson of any such provision or of Swanson's right to enforce any such provision with respect to Swanson. No act or omission of TDS shall constitute a waiver of any of its rights hereunder except for a written waiver signed by TDS's President and Chief Executive Officer. 21. ENTIRE AGREEMENT. This Agreement embodies the entire agreement and understanding of Swanson and TDS with regard to the matters described in this Agreement, and supersedes any and all prior and/or contemporaneous agreements and understandings, oral or written, between Swanson and TDS. 22. GOVERNING LAW. This Agreement shall be governed by the laws of the State of Illinois without regard to its conflicts of laws rules. - 5 - SWANSON AND TDS EXPRESSLY STATE THAT THEY HAVE READ THIS AGREEMENT, THAT THEY UNDERSTAND EACH OF ITS TERMS, AND THAT THEY INTEND TO BE BOUND THEREBY. TELEPHONE AND DATA SYSTEMS, INC. MURRAY L. SWANSON By: /S/ LEROY T. CARLSON, JR. /S/ MURRAY L. SWANSON ------------------------------------- --------------------- LeRoy T. Carlson, Jr. President and Chief Executive Officer Dated: October 15, 1998 Dated: October 15, 1998 - 6 - EX-12 5 EXHIBIT 12 EXHIBIT 12 TELEPHONE AND DATA SYSTEMS, INC. RATIOS OF EARNINGS TO FIXED CHARGES FOR THE YEAR ENDED DECEMBER 31, 1998 (DOLLARS IN THOUSANDS, EXCEPT RATIO AMOUNTS) EARNINGS: Income from Continuing Operations before Income Taxes.......................... $ 133,705 Add (Deduct): Minority Share of Losses..................................................... (76,380) Earnings on Equity Method.................................................... 29,250 Distributions from Minority Subsidiaries..................................... 28,912 Amortization of Capitalized Interest......................................... 1,261 Minority share of income in majority-owned subsidiaries that have fixed charges.................................................................... 41,499 ADD FIXED CHARGES: Consolidated interest expense................................................ 149,864 Interest Portion (1/3) of Consolidated Rent Expense.......................... 20,395 --------- $ 328,506 FIXED CHARGES: Consolidated interest expense.................................................. $ 149,864 Capitalized interest........................................................... 132 Interest Portion (1/3) of Consolidated Rent Expense............................ 20,395 --------- $ 170,391 --------- --------- RATIO OF EARNINGS TO FIXED CHARGES............................................... 1.93 --------- --------- Tax-Effected Redeemable Preferred Dividends.................................... $ 163 Fixed Charges.................................................................. 170,391 --------- Fixed Charges and Redeemable Preferred Dividends............................. $ 170,554 --------- --------- RATIO OF EARNINGS TO FIXED CHARGES AND REDEEMABLE PREFERRED DIVIDENDS............ 1.93 --------- --------- Tax-Effected Preferred Dividends............................................... $ 3,022 Fixed Charges.................................................................. 170,391 --------- Fixed Charges and Preferred Dividends........................................ $ 173,413 --------- --------- RATIO OF EARNINGS TO FIXED CHARGES AND PREFERRED DIVIDENDS....................... 1.89 --------- ---------
EX-13 6 EXHIBIT 13 - -------------------------------------------------------------------------------- Selected Consolidated Financial Data 1 - --------------------------------------------------------------------------------
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Operating Revenues $1,805,725 $1,370,541 $1,075,127 $ 835,157 $ 633,971 Operating (Loss) Income from Ongoing Operations (9,498) 33,135 190,015 140,995 108,991 Gain on Sale of Cellular and Other Investments 262,698 41,438 138,735 86,625 7,457 Net Income (Loss) Available to Common 62,757 (11,441) 126,182 101,469 57,362 From Operations (71,805) (27,355) 61,710 60,819 51,598 From Gains $ 134,562 $ 15,914 $ 64,472 $ 40,650 $ 5,764 Weighted Average Shares Outstanding (000s) 60,982 60,211 60,464 57,456 53,295 Basic Earnings per Share $ 1.03 $ (.19) $ 2.09 $ 1.77 $ 1.08 Diluted Earnings per Share $ 1.03 $ (.19) $ 2.07 $ 1.74 $ 1.06 Pretax Profit on Revenues 7.4% 1.4% 23.4% 22.2% 16.0% Effective Income Tax Rate 51.8% N/M 49.1% 43.8% 40.2% Dividends per Common and Series A Common Share $ .44 $ .42 $ .40 $ .38 $ .36 Cash and Cash Equivalents and Temporary Investments $ 60,424 $ 75,567 $ 119,297 $ 80,851 $ 44,566 Working Capital (217,940) (496,302) (161,619) (153,681) (148,474) Property, Plant and Equipment (Net) 2,672,589 2,543,959 1,873,208 1,315,114 1,077,613 Total Assets 5,527,545 4,971,601 4,200,969 3,469,082 2,790,127 Notes Payable 170,889 527,587 160,537 184,320 98,608 Long-term Debt (including current portion) 1,569,042 1,279,034 1,018,851 894,584 562,165 Common Stockholders' Equity 2,237,908 1,968,119 2,032,941 1,684,365 1,473,038 Capital Expenditures $ 558,332 $ 786,317 $ 550,204 $ 359,996 $ 319,701 Current Ratio .7 .5 .7 .6 .5 Common Equity per Share $ 36.12 $ 32.06 $ 33.23 $ 29.01 $ 26.85 Return on Equity 3.0% (.6%) 6.8% 6.4% 4.3% - ---------------------------------------------------------------------------------------------------------------------------
N/M - NOT MEANINGFUL - -------------------------------------------------------------------------------- 2 Management's Discussion and Analysis of Results of Operations and Financial Condition - -------------------------------------------------------------------------------- TELEPHONE AND DATA SYSTEMS, INC. ("TDS" or the "Company") is a diversified telecommunications company which provided high-quality telecommunications services to approximately 3.0 million cellular telephone, telephone and personal communications services ("PCS") customers in 35 states at December 31, 1998. The Company conducts substantially all of its cellular telephone operations through its 81.0%-owned subsidiary, United States Cellular Corporation ("U.S. Cellular"), its telephone operations through its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom") and its PCS operations through its 82.3%-owned subsidiary, Aerial Communications, Inc.("Aerial"). In December 1998, TDS announced the withdrawal of its offers to exchange tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial which it did not own. TDS also announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. See Liquidity and Note 1--Corporate Restructuring of Notes to Consolidated Financial Statements. RESULTS OF OPERATIONS The TDS results of operations in 1998 and 1997 reflect the rapid growth of U.S. Cellular's operations, the steady growth of TDS Telecom operations, and Aerial's developing operations. Revenues increased 32% in 1998 and 27% in 1997 as customer units grew by 29% and 51%, respectively. Operating expenses increased 36% in 1998 and 51% in 1997 reflecting the growth in operations as well as the start-up of Aerial's operations in 1997. Aerial's operating losses have offset improvements in U.S. Cellular's operations and was the primary factor that caused operating income to decrease by $18.7 million in 1998 and $155.6 million in 1997. The Company has sold various majority and minority cellular interests and certain other investments during the last few years resulting in significant gains, particularly in 1998 and 1996. Investment and other income increased $192.0 million in 1998 primarily as a result of a $221.3 million increase in such gains. Interest expense and trust preferred securities distributions increased $36.6 million and $22.0 million, respectively, in 1998 reflecting the sale of debt and trust preferred securities in 1998, 1997 and 1996. Net income available to common and diluted earnings per share totaled $62.8 million, or $1.03 per share, in 1998 compared to a net loss of $11.4 million, or $.19 per share, in 1997 and net income of $126.2 million, or $2.07 per share, in 1996. Net income available to common was significantly affected by gains from the sale of cellular interests and other investments and losses from the start-up and launch of service in Aerial's markets. Gains increased net income available to common by $134.6 million, or $2.21 per share, in 1998, $15.9 million, or $.26 per share, in 1997 and $64.5 million, or $1.05 per share, in 1996. Aerial losses decreased net income available to common by $181.1 million, or $2.97 per share, in 1998, $129.4 million, or $2.15 per share, in 1997 and $15.3 million, or $.25 per share, in 1996. Net income available to common and diluted earnings per share, excluding gains and Aerial losses, totaled $109.3 million, or $1.79 per share, in 1998 compared to $102.1 million, or $1.70 per share, in 1997 and $77.0 million, or $1.27 per share, in 1996. The table below summarizes the effects of the business segments operations and gains (along with the related impact of income taxes and minority interest) on net income (loss) available to common and diluted earnings per share.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - --------------------------------------------------------------------------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Net Income (Loss) Available to Common U.S. Cellular $ 72.0 $ 77.1 $ 43.2 TDS Telecom 41.7 54.5 62.5 Aerial (181.1) (129.4) (15.3) Parent and Other (4.4) (29.5) (28.7) Gains 134.6 15.9 64.5 -------------------------------- $ 62.8 $(11.4) $ 126.2 -------------------------------- Diluted Earnings Per Share U.S. Cellular $ 1.18 $ 1.28 $ .71 TDS Telecom .68 .91 1.03 Aerial (2.97) (2.15) (.25) Parent and Other (.07) (.49) (.47) Gains 2.21 .26 1.05 -------------------------------- $ 1.03 $ (.19) $ 2.07 - ---------------------------------------------------------------------------
U.S. Cellular's net income to common, excluding gains, decreased in 1998 primarily as a result of decreased investment income and increased interest and income tax expense offset somewhat by increased operating income due to rapid customer growth. The decline in net income to common at TDS Telecom was a result of slower growth in telephone operations and increased losses from new business ventures. The increase in net loss at Aerial in 1998 was primarily a result of efforts to expand the customer base. The increase in net income to common from Parent and Other in 1998 related primarily to income tax benefits. Management expects a significant reduction in gains in 1999 which may cause net income to be lower. However, management expects U.S. Cellular's and TDS Telecom's net income to grow as U.S. Cellular adds more customers and as TDS Telecom's competitive local exchange carrier ("CLEC") operations add more customers. TDS Telecom's net income was reduced in 1998 as a result of the costs to exit the LAN wiring business. 3 OPERATING REVENUES increased 32% ($435.2 million) during 1998 and 27% ($295.4 million) during 1997 reflecting primarily growth in customer units offset somewhat by reductions in average service revenue per customer at U.S. Cellular and Aerial. Customer units increased 29% in 1998 and 51% in 1997.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------------- Customer Units U.S. Cellular 2,183,000 1,710,000 1,073,000 TDS Telecom 547,500 515,500 484,500 Aerial 311,900 125,000 -- --------------------------------------- 3,042,400 2,350,500 1,557,500 - -----------------------------------------------------------------------------
U.S. Cellular revenues increased $285.5 million in 1998 and $196.9 million in 1997 on 28% and 59% increases in customer units and 12% and 13% increases in inbound roaming revenues, respectively. Aerial revenues increased $99.2 million in 1998 and totaled $56.0 million in 1997 reflecting the growth in customer units. TDS Telecom revenues increased $50.5 million in 1998 and $42.6 million in 1997 as a result of recovery of increased costs of providing long-distance services, internal access line growth, increased network usage and growth in new business ventures. U.S. Cellular contributed 64% of consolidated revenue in 1998 compared to 64% in 1997 and 63% in 1996. TDS Telecom contributed 27%, 32% and 37%, respectively, of consolidated revenue in 1998, 1997 and 1996. Aerial contributed 9% and 4% of consolidated revenue in 1998 and 1997, respectively. OPERATING EXPENSES rose 36% ($477.8 million) in 1998 and 51% ($452.3 million) in 1997. U.S. Cellular operating expenses increased $239.0 million during 1998 and $154.7 million during 1997 due to the expansion of the customer base as well as the provision of service to the larger customer base. Aerial's operating expenses increased $182.6 million in 1998 and totaled $252.5 million in 1997 reflecting expenses to develop its markets and add customers. TDS Telecom operating expenses increased $56.2 million during 1998 and $45.1 million during 1997 due to growth in telephone operations and the development and start-up of new business ventures. OPERATING INCOME (LOSS) totaled a loss of $20.9 million in 1998, a loss of $2.2 million in 1997 and income of $153.4 million in 1996 reflecting significant increases in losses at Aerial offset somewhat by strong growth at U.S. Cellular.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Operating Income (Loss) U.S. Cellular $ 176,075 $ 129,543 $ 87,366 TDS Telecom 94,412 100,143 102,649 Aerial (279,985) (196,551) -- ------------------------------------- (9,498) 33,135 190,015 American Paging Operating (Loss) (11,406) (35,307) (36,626) ------------------------------------- $ (20,904) $ (2,172) $ 153,389 - -------------------------------------------------------------------------
U.S. Cellular's operating income increased 36% ($46.5 million) in 1998 and 48% ($42.2 million) in 1997 reflecting the increase in customers and revenues. U.S. Cellular's operating margin, as a percent of service revenues, has increased steadily to 15.7% in 1998 from 15.2% in 1997 and 13.2% in 1996. TDS Telecom's operating income decreased $5.7 million in 1998 and $2.5 million in 1997. The decrease in TDS Telecom's operating income primarily reflects CLEC start-up losses. TDS Telecom's operating margin continued its decline to 19.3% in 1998 from 22.9% in 1997 and 26.0% in 1996 due primarily to the impact of CLEC start-up losses. Continued pressure on revenue streams, slightly higher operating costs, improvements to the telephone network, expenditures to develop programs which are aimed at improving customer satisfaction and resale of lower-margin services also contributed to the decline in operating margin. Aerial's operating loss totaled $280.0 million in 1998 and $196.6 million in 1997, reflecting the costs associated with launching service and developing a customer base in its markets. TDS contributed substantially all of the assets and certain limited liabilities of American Paging Inc. ("American Paging") to TSR Wireless Holdings, LLC ("TSR Wireless") effective March 31, 1998. American Paging's revenues were netted against its expenses for the periods presented with the resulting operating loss reported as American Paging Operating (Loss). American Paging's operating revenues totaled $17.8 million and operating expenses totaled $29.2 million for the three month period ended March 31, 1998. American Paging's operating revenues totaled $94.4 million and $104.2 million in 1997 and 1996, respectively, and operating expenses totaled $129.7 million and $140.8 million, respectively. TDS incurred $8.7 million in expenses related to severance pay, legal expenses, investment banker fees, etc. to exit the paging business in 1998. Beginning April 1, 1998, TDS followed the equity method of accounting for its 30% 4 interest in TSR Wireless and reported these results as a component of Investment income. TDS's portion of TSR Wireless' results of operations and the amortization of costs in excess of the underlying book value decreased income $11.8 million. INVESTMENT AND OTHER INCOME (EXPENSE) totaled $304.5 million in 1998, $112.4 million in 1997 and $141.2 million in 1996. Investment and other income (expense) includes interest and dividend income, investment income, gain on sale of cellular and other investments, PCS development costs, other (expense) income, net and minority share of (loss) income. INVESTMENT INCOME, the Company's share of income from investments in which the Company has a minority interest and follows the equity method of accounting, primarily cellular investments, decreased 50% ($40.5 million) in 1998 and increased 39% ($22.7 million) in 1997. Investment income decreased in 1998 as a result of the sale of certain cellular minority interests to AirTouch Communications, Inc. ("AirTouch") in 1998 and the transfer of certain cellular minority interests to BellSouth Corporation ("BellSouth") in the fourth quarter of 1997. See Financial Resources--Acquisitions, Exchanges and Sales. GAIN ON SALE OF CELLULAR AND OTHER INVESTMENTS totaled $262.7 million in 1998, $41.4 million in 1997 and $138.7 million in 1996. TDS sold various majority and minority cellular interests and other investments in the past few years resulting in the recognition of gains. PCS DEVELOPMENT COSTS totaled $21.6 million in 1997 and $43.9 million in 1996. Expenses incurred by Aerial prior to the launch of operations in March 1997, primarily to recruit an experienced management team, develop and execute a business plan, raise capital and design and construct its PCS networks, were reported in Investment and Other Income (Expense). Revenues and expenses incurred subsequent to the launch of service are included as a component of operating income. OTHER (EXPENSE) INCOME, NET for the year 1998 includes additional expenses relating to the corporate restructuring ($10.6 million), a LAN wiring business and the cost to exit this business ($11.9 million), and costs to exit the paging business ($8.7 million). MINORITY SHARE OF (LOSS) INCOME includes U.S. Cellular's, Aerial's and American Paging's minority public shareholders' share of net income or loss and the minority shareholders' or partners' share of subsidiaries' net income or loss. The change in 1998 and 1997 is primarily related to increased Aerial losses allocated to its minority shareholders. A minority investor paid $200 million in 1998 for approximately a 19% interest in a subsidiary of Aerial. Minority public shareholders of American Paging were not allocated losses since 1996 because American Paging's shareholders' equity was negative.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Minority Share of (Income) Loss U.S. Cellular Minority Public Shareholders' Share $(41,083) $(21,264) $(25,179) Subsidiaries' Minority Shareholders' or Partners' Share (6,039) (12,298) (13,743) --------------------------------- (47,122) (33,562) (38,922) --------------------------------- Aerial Minority Public Shareholders' Share 52,354 43,038 4,944 Subsidiary's Minority Shareholders' Share 23,620 -- -- --------------------------------- 75,974 43,038 4,944 American Paging -- -- 6,368 Telephone Subsidiaries and Other (339) (1,160) 1,294 --------------------------------- $ 28,513 $ 8,316 $(26,316) - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
INTEREST EXPENSE increased 41% ($36.6 million) in 1998 and 113% ($48.4 million) in 1997. Interest expense increased in 1998 due primarily to larger long-term debt balances from U.S. Cellular's sale of debt in 1997, Aerial's vendor financing and issuance of zero coupon notes in 1998, TDS's sale of notes in 1998 ($27.6 million), and smaller amounts of capitalized interest ($10.9 million) offset somewhat by decreased short-term debt balances ($2.2 million). Interest expense increased in 1997 due primarily to additional interest expense from larger short-term debt balances ($19.6 million), a smaller amount of capitalized interest ($16.6 million) and additional interest expense from U.S. Cellular's sale of debt in 1997 and Aerial's zero coupon notes issued in late 1996 ($11.7 million). TDS and Aerial capitalized interest totaling $132,000 in 1998, $11.0 million in 1997 and $27.6 million in 1996 on expenditures for PCS licenses and construction costs. The Company stops capitalizing interest on qualifying assets when those assets are placed in service. MINORITY INTEREST IN INCOME OF SUBSIDIARY TRUST (Trust Preferred Securities Distributions) totaled $23.5 million in 1998 and $1.5 million in 1997. The increase in 1998 reflects a full year of dividends on the securities issued in 1997 as well as dividends on additional securities issued in 1998. In November 1997, a wholly-owned subsidiary trust issued $150,000,000 of 8.5% Trust Originated Preferred Securities. In February 1998, another wholly-owned subsidiary trust issued $150,000,000 of 8.04% Trust Originated Preferred Securities. INCOME TAX EXPENSE was $69.3 million in 1998, $28.6 million in 1997, and $123.6 million in 1996. The period to period change reflects primarily the changes in pretax income. 5 NET INCOME (LOSS) AVAILABLE TO COMMON was $62.8 million in 1998, ($11.4 million) in 1997 and $126.2 million in 1996. DILUTED EARNINGS PER COMMON SHARE was $1.03 in 1998, ($.19) in 1997 and $2.07 in 1996. CELLULAR TELEPHONE OPERATIONS The Company provides cellular telephone service through United States Cellular Corporation ("U.S. Cellular"), an 81.0%-owned subsidiary. U.S. Cellular owns, manages and invests in cellular markets throughout the United States. In December 1998, TDS announced the withdrawal of its offer to exchange tracking stocks for the outstanding Common Shares of U.S. Cellular which it did not own. See Note 1--Corporate Restructuring of Notes to Consolidated Financial Statements. Rapid growth in the customer base is the primary reason for the growth in U.S. Cellular's results of operations in 1998 and 1997. The number of customers increased 28% to 2,183,000 at December 31, 1998, and increased 59% to 1,710,000 at December 31, 1997. U.S. Cellular added 454,000 net new customers from its marketing efforts and 19,000 customers from acquisitions in 1998 compared to 442,000 net new customers from its marketing efforts and 195,000 customers from acquisitions, primarily the exchange with BellSouth which occurred at the end of October 1997.
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER CUSTOMER AMOUNTS) Operating Revenues Local retail $ 772,803 $568,578 $414,815 Inbound roaming 242,605 217,499 193,278 Long-distance and Other 108,046 66,914 54,588 --------------------------------------- Service Revenues 1,123,454 852,991 662,681 Equipment sales 39,013 23,974 17,387 --------------------------------------- 1,162,467 876,965 680,068 --------------------------------------- Operating Expenses System operations 193,625 153,137 117,368 Marketing and selling 228,844 178,984 130,310 Cost of equipment sold 94,378 82,302 74,023 General and administrative 262,766 200,620 162,162 Depreciation and amortization 206,779 132,379 108,839 --------------------------------------- 986,392 747,422 592,702 --------------------------------------- Operating Income $ 176,075 $129,543 $ 87,366 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Consolidated Markets: Markets 138 134 131 Market penetration 8.84% 7.11% 4.94% Cell sites in service 2,065 1,748 1,328 Average monthly service revenue per customer $ 48.61 $ 54.18 $ 63.69 Churn rate per month 1.9% 1.9% 1.9% Marketing cost per gross customer addition $ 317 $ 318 $ 332 Employees 4,800 4,600 3,800 - -------------------------------------------------------------------------------
OPERATING REVENUES increased 33% ($285.5 million) in 1998 and 29% ($196.9 million) in 1997. The revenue increases in 1998 and 1997 were driven by growth in customer units and the 12% and 13% growth in inbound roaming revenues in 1998 and 1997, respectively. Increased promotional activity and improved consumer awareness of wireless communications were key factors contributing to customer growth. Lower negotiated roaming rates among carriers and lower revenue per customer due to competitive pricing pressures, incentive plans and consumer market penetration have partially offset the revenue growth resulting from the increase in the customer base. Average monthly service revenue per customer was $48.61 in 1998, $54.18 in 1997 and $63.69 in 1996. The addition of the markets from the exchange with BellSouth in the fourth quarter of 1997 also contributed to the decline in both local retail revenue per customer and inbound roaming revenue per customer. These markets produced a lower amount of local retail revenue per customer, and the addition of these markets caused the elimination of certain inbound roaming revenues between U.S. Cellular's existing markets and these markets. Management anticipates that average monthly service revenue per customer will continue to decrease as local retail and inbound roaming revenue per minute of use decline. LOCAL RETAIL REVENUES (charges to U.S. Cellular's customers for local system usage) increased 36% ($204.2 million) in 1998 and 37% ($153.8 million) in 1997 due primarily to the growth in customers. Average monthly local retail revenue per customer was $33.44 in 1998, $36.11 in 1997 and $39.87 in 1996. Local minutes of use averaged 105 per month in 1998, 103 per month in 1997 and 107 per month in 1996. Average revenue per minute was $.32 in 1998, $.35 in 1997 6 and $.37 in 1996. Competitive pressures and use of incentive programs that encourage lower-priced weekend and off-peak usage, in order to stimulate overall usage, resulted in the decrease in average monthly local retail revenue per minute of use. The decrease in average monthly retail revenue per customer primarily reflects the increasing level of competition for wireless services and the continued penetration of the consumer market. INBOUND ROAMING REVENUES (charges to other cellular service providers whose customers use U.S. Cellular's cellular systems when roaming) increased 12% ($25.1 million) in 1998 and 13% ($24.2 million) in 1997. Minutes of use increased 48% in 1998 and 27% in 1997. Average revenue per minute of use was $.65 in 1998, $.83 in 1997 and $.92 in 1996, reflecting negotiated reductions in roaming rates. LONG-DISTANCE AND OTHER SERVICE REVENUES increased 61% ($41.1 million) in 1998 and 23% ($12.3 million) in 1997 primarily due to increased long-distance revenue from the growth in the volume of long-distance calls billed by U.S. Cellular. OPERATING EXPENSES increased 32% ($239.0 million) in 1998 and 26% ($154.7 million) in 1997. Operating expenses as a percent of service revenue were 87.8% in 1998, 87.6% in 1997 and 89.4% in 1996. The overall increase in operating expenses is primarily due to increased general and administrative expenses ($62.1 million in 1998 and $39.7 million in 1997); the costs to expand the customer base ($61.9 million in 1998 and $57.0 million in 1997); the cost of providing service to the expanding customer base ($40.5 million in 1998 and $35.8 million in 1997); and additional depreciation and amortization on the increased investment in cell sites and equipment ($74.4 million in 1998 and $23.5 million in 1997). General and administrative expenses (costs of local business offices and corporate expenses) as a percent of service revenues were 23.4% in 1998, 23.5% in 1997 and 24.5% in 1996. The overall increases in administrative expenses include the effects of an increase in expenses required to serve the growing customer base and an expansion of both local administrative office and corporate staff, resulting from growth in U.S. Cellular's business. Costs to expand the customer base represent marketing and selling expenses and the cost of equipment sold. These expenses less equipment sales revenue represent the cost to acquire a new customer. The cost to acquire a new cellular customer was $317 in 1998, $318 in 1997 and $332 in 1996. The decrease in cost per gross customer activation has been slowed somewhat by additional advertising expenses incurred to promote U.S. Cellular and to distinguish U.S. Cellular's service offerings from those of competitors. Gross customer activations (excluding acquisitions) rose 20% in 1998 to 896,000 and 33% in 1997 to 746,000 from 563,000 in 1996. Costs of providing service (system operations expenses) as a percent of service revenues were 17.2% in 1998, 18.0% in 1997 and 17.7% in 1996. Systems operations expenses include customer usage expenses (charges from other service providers for landline connection, toll and roaming costs incurred by customers' use of systems other than their local systems), and maintenance, utility and cell site expenses. Customer usage expenses were 11.6% of service revenues in 1998, 11.7% in 1997 and 11.4% in 1996. The overall increase in customer service expenses was due primarily to roaming usage and increased minutes of use. Net outbound roaming usage expense is a result of offering U.S. Cellular's customers increasingly larger service footprints in which their calls are billed at local rates. In certain cases these service footprints include other operators' service areas. U.S. Cellular pays roaming rates to the other carriers for calls its customers make in these areas, while charging these customers a local rate which is usually lower than the roaming rate. Maintenance, utility and cell site expenses were 5.7% of service revenues in 1998, 6.3% in 1997 and 6.3% in 1996. The number of cell sites operated increased to 2,065 in 1998 from 1,748 in 1997 and 1,328 in 1996. Depreciation expense as a percent of service revenues was 14.9% in 1998, 11.4% in 1997 and 11.3% in 1996. Depreciation expense increased 71% ($69.6 million) in 1998 and 31% ($23.0 million) in 1997, reflecting increases in average fixed asset balances of 27% and 35%, respectively. Increased fixed asset balances in both years resulted from the addition 7 of new cell sites built to improve coverage and capacity, from upgrades to provide digital service and from the acquisition of markets from BellSouth in late 1997. The increase in 1998 also reflects a reduction in useful lives of certain assets beginning in 1998 which increased depreciation expense by $23.2 million. Depreciation expense is expected to increase by approximately the same percentage as the increase in average fixed assets in 1999. OPERATING INCOME increased 36% ($46.5 million) to $176.1 million in 1998 from $129.5 million in 1997 and $87.4 million in 1996. The improvement was primarily driven by the substantial growth in customers and revenue. Operating margin, as a percent of service revenue, improved to 15.7% in 1998 from 15.2% in 1997 and 13.2% in 1996. Management believes U.S. Cellular's operating results reflect seasonality in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth. This seasonality may cause operating income to vary from quarter to quarter. Competitors licensed to provide PCS services have initiated service in certain U.S. Cellular markets in the past two and one-half years. U.S. Cellular expects PCS operators to continue deployment of PCS in portions of all its market clusters through 1999. U.S. Cellular has increased its advertising, particularly brand advertising, to promote the United States Cellular brand and distinguish its service from other wireless communications providers. U.S. Cellular's management continues to monitor other wireless communications providers' strategies to determine how this additional competition is affecting U.S. Cellular's results. While the effects of additional wireless competition have slowed customer growth in certain of U.S. Cellular's markets, the overall effect on total customer growth to date has not been material. However, management anticipates that customer growth may be lower in the future, primarily as a result of the increase in the number of competitors in its markets. TELEPHONE OPERATIONS The Company operates its landline telephone business through TDS Telecommunications Corporation ("TDS Telecom"), a wholly-owned subsidiary. TDS Telecom's incumbent local exchange carrier ("ILEC") subsidiaries served 547,500 access lines at the end of 1998 compared to 515,500 at the end of 1997 and 484,500 at the end of 1996 ("ILEC operations"). In late 1997, TDS Telecom began preparations to enter into competition with incumbent local exchange carriers in certain markets in Wisconsin, not served by TDS Telecom, by setting up TDS Metrocom, a competitive local exchange company ("CLEC"). TDS Metrocom began operations in early 1998. TDS Telecom also entered into certain markets in Minnesota as a CLEC through USLink. USLink was primarily a long-distance provider prior to beginning CLEC operations in 1998. TDS Metrocom and USLink are reported as CLEC operations.
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER ACCESS LINE AMOUNTS) Operating Revenues ILEC Revenues Local service $ 136,656 $ 122,826 $ 110,501 Network access and Long-distance 256,272 235,725 213,113 Miscellaneous 68,432 57,759 49,400 ----------------------------------- Total ILEC Revenues 461,360 416,310 373,014 CLEC Revenues 29,743 23,007 23,103 Intercompany Revenues (2,999) (1,693) (1,058) ----------------------------------- Total Operating Revenues 488,104 437,624 395,059 ----------------------------------- Operating Expenses ILEC Expenses Network operations 94,684 81,798 67,930 Depreciation and amortization 108,173 96,488 86,025 Customer operations 72,949 67,877 55,682 Corporate operations 81,679 69,776 62,878 ----------------------------------- Total ILEC Expense 357,485 315,939 272,515 CLEC Expenses 39,206 23,235 20,953 Intercompany Expenses (2,999) (1,693) (1,058) ----------------------------------- Total Operating Expenses 393,692 337,481 292,410 ----------------------------------- Operating Income $ 94,412 $ 100,143 $ 102,649 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- Access lines (ILEC) 547,500 515,500 484,500 Access lines (CLEC) 38,800 -- -- Growth in ILEC access lines from prior year-end: Acquisitions 6,500 3,200 33,100 Internal growth 25,500 27,800 25,500 Average monthly revenue per ILEC access line $ 71.85 $ 69.43 $ 67.30 Employees 2,500 2,400 2,200 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
8 OPERATING REVENUES totaled $488.1 million in 1998, up 12% ($50.5 million) from 1997 which totaled $437.6 million and was up 11% ($42.6 million) from 1996. The increase was due to the growth in ILEC operations ($45.0 million in 1998 and $43.3 million in 1997) and the start-up of CLEC activities ($6.8 million in 1998). Average monthly revenue per ILEC access line was $71.85 in 1998, $69.43 in 1997 and $67.30 in 1996 reflecting primarily growth in miscellaneous and local service revenues. LOCAL SERVICE REVENUES (provision of local telephone exchange service within the franchise serving area of TDS Telecom's ILECs) increased 11% ($13.8 million) in 1998 and 11% ($12.3 million) in 1997. Average monthly local service revenue per customer was $21.28 in 1998, $20.49 in 1997 and $19.94 in 1996. Access line growth, excluding acquisitions, of 4.9% in 1998 and 5.7% in 1997 resulted in increases in revenues of $6.0 million and $5.7 million, respectively. The sale of custom-calling and advanced features increased revenues by $4.4 million in 1998 and $3.1 million in 1997. Acquisitions increased revenues by $1.9 million in 1998 and $2.7 million in 1997. NETWORK ACCESS AND LONG-DISTANCE REVENUES (compensation for carrying interstate and intrastate long-distance traffic on TDS Telecom's ILEC networks) increased 9% ($20.5 million) in 1998 and 11% ($22.6 million) in 1997. Average monthly network access and long-distance revenue per customer was $39.91 in 1998, $39.31 in 1997 and $38.45 in 1996. Revenue generated from access minute growth due to increased network usage increased $8.2 million in 1998 and $5.7 million in 1997. Recovery of increased costs of providing long-distance services resulted in increases in revenue of $5.9 million in 1998 and $12.1 million in 1997. An additional $2.2 million of additional cost recovery was recorded in late 1998 as a result of the ice storm damage in the Northeast earlier in the year. Acquisitions increased revenues by $5.5 million in 1998 and $4.5 million in 1997. MISCELLANEOUS REVENUES (charges for (i) leasing, selling, installing and maintaining customer premise equipment, (ii) providing billing and collection services, (iii) providing Internet services and (iv) selling of digital broadcast satellites) increased 18% ($10.7 million) in 1998 and 17% ($8.4 million) in 1997. Average monthly miscellaneous revenue per customer was $10.66 in 1998, $9.63 in 1997 and $8.91 in 1996. Increased sales of customer premise equipment, including digital broadcast satellites, increased revenues by $5.8 million in 1998 and $6.1 million in 1997. Revenues from providing Internet service increased by $3.6 million in 1998 and $2.8 million in 1997. Acquisitions increased revenues by $1.6 million in 1998 and $1.0 million in 1997. CLEC operating revenues increased 29% ($6.7 million) to $29.7 million in 1998 and declined $100,000 to $23.0 million in 1997. TDS Metrocom generated $3.6 million of revenue in 1998 as it began operations while USLink increased revenues by $3.1 million as it also began CLEC operations. Revenues in 1997 and 1996 were primarily from USLink long-distance services. OPERATING EXPENSES totaled $393.7 million in 1998, up 17% ($56.2 million) from 1997 and totaled $337.5 million in 1997, up 15% ($45.1 million) from 1996. The increase in operating expenses is primarily due to increased costs to provide advanced telecommunications services to customers ($12.9 million in 1998 and $13.9 million in 1997), corporate expenses ($11.9 million in 1998 and $6.9 million in 1997), costs to serve customers ($5.1 million in 1998 and $12.2 million in 1997), and additional depreciation and amortization on the increased investment in equipment ($11.7 million in 1998 and $10.5 million in 1997). Network operations expenses include network maintenance, costs of providing advanced services, costs of customer premise equipment and costs of digital satellites sold. Network operations expenses as a percent of revenue were 20.5% in 1998, 19.6% in 1997 and 18.2% in 1996. Cost of goods sold for customer premise equipment, including digital broadcast satellites, increased expenses by $4.2 million in 1998 and $5.2 million in 1997. The costs to develop and maintain the Network Management Center to provide more effective network monitoring and maintenance increased expenses by $2.6 million in 1998 and $1.8 million in 1997. Support payments made to the Federal high cost pool in 1998 increased expense by $3.0 million. Emergency work related to the ice 9 storm damage in the Northeast increased expenses by $2.4 million in 1998. Acquisitions increased network operations expenses by $3.0 million in 1998 and $1.5 million in 1997. Corporate expenses as a percent of revenue were 17.7% in 1998, 16.8% in 1997 and 16.9% in 1996. Information systems expenses increased by $5.8 million in 1998 and $3.8 million in 1997. Acquisitions increased corporate expenses by $2.0 million in 1998 and $1.3 million in 1997. Costs to serve customers, including costs for marketing, sales and product management, as a percent of revenues were 15.8% in 1998, 16.3% in 1997 and 14.9% in 1996. Information systems support increased expenses by $1.1 million in 1998 and $3.8 million in 1997. Additional product management increased expenses by $1.1 million in 1998 and product advertising for digital broadcast satellites and advanced calling features increased expenses by $4.7 million in 1997. Acquisitions increased customer expenses by $1.3 million in 1998 and $1.4 million in 1997. Depreciation and amortization expenses as a percent of revenues were 23.4% in 1998, 23.2% in 1997 and 23.1% in 1996. CLEC operating expenses increased 69% ($16.0 million) in 1998 and 11% ($2.3 million) in 1997. TDS Metrocom increased expenses by $10.9 million in 1998 and $2.3 million in 1997 as it started operations in 1998. USLink expenses increased by $5.1 million in 1998 reflecting costs of providing CLEC services. OPERATING INCOME decreased 6% ($5.7 million) in 1998 and 2% ($2.5 million) in 1997 reflecting the CLEC start-up losses. Operating loss from CLEC operations was $9.5 million in 1998, an increase of $9.3 million from $200,000 in 1997. The 1997 CLEC operations loss of $200,000 represented a decline of $2.4 million from an operating income of $2.2 million in 1996. The decline in CLEC operating income reflects the expenses associated with the development of the CLEC businesses in 1997 and the start-up of operations in early 1998. Operating income from ILEC operations increased $3.5 million to $103.9 million in 1998 from $100.4 million in 1997 and decreased $100,000 in 1997 from $100.5 million in 1996. The effects of acquisitions increased operating income 1% ($1.2 million) in 1998 and 2% ($1.9 million) in 1997. The ILEC operating margin was 22.5% in 1998, 24.1% in 1997 and 26.9% in 1996. The reduction in operating margin was caused by continued pressure on revenue streams, slightly higher operating costs, improvements to the telephone network, expenditures to develop programs which are aimed at improving customer satisfaction and resale of lower-margin services. TDS Telecom is subject to the provisions of Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation." The Company periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. The Company believes that such criteria are still being met and therefore has no current plans to change its method of accounting. In analyzing the effects of discontinuing the application of SFAS No. 71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally accepted accounting principles and therefore, any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. PCS OPERATIONS The Company provides PCS telephone services through Aerial Communications, Inc. ("Aerial"), an 82.3%-owned subsidiary. Aerial provides service in the Major Trading Areas ("MTAs") of Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus. Aerial served 311,900 customers at the end of 1998 and 125,000 customers at the end of 1997. In December 1998, TDS announced the withdrawal of its offer to exchange tracking stocks for the outstanding Common Shares of Aerial which it did not own. TDS also announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. See Liquidity and Note 1 -- Corporate Restructuring of Notes to Consolidated Financial Statements. Operating results reflect the revenues and expenses of Aerial since the initiation of service on March 27, 1997, when Aerial ceased to be a development stage enterprise. Expenses for the periods prior to March 27, 1997, are 10 reported as PCS development costs included in the "Investment and Other Income (Expense)" section of the Consolidated Statements of Operations.
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER CUSTOMER AMOUNTS) Operating Revenues Service $ 123,640 $ 32,307 $ -- Equipment sales 31,514 23,645 -- --------------------------------- 155,154 55,952 -- --------------------------------- Operating Expenses System operations 69,066 30,655 -- Marketing and selling 79,704 45,974 -- Cost of equipment sold 87,715 71,454 -- General and administrative 61,737 44,467 -- Customer service 53,516 20,882 -- Depreciation and amortization 83,401 39,071 -- --------------------------------- 435,139 252,503 -- --------------------------------- Operating (Loss) $(279,985) $(196,551) $ -- - ----------------------------------------------------------------------- - ----------------------------------------------------------------------- Market penetration 1.13% .45% -- Cell sites in service 1,180 1,044 -- Average monthly service revenue per customer $ 50.96 $ N/M $ -- Churn rate per month 5.5% 4.5% -- Employees 1,900 1,400 400 - -----------------------------------------------------------------------
N/M - NOT MEANINGFUL OPERATING REVENUES totaled $155.2 million in 1998 and $56.0 million in 1997. SERVICE REVENUES (charges for access, airtime and value-added services provided to Aerial's customers who use its network, charges to customers of other wireless carriers who use Aerial's PCS network when roaming, and charges for long-distance calls made on its systems) totaled $123.6 million in 1998 and $32.3 million in 1997. The increase in 1998 is due to the increase in customers served to 311,900 at the end of 1998 from 125,000 customers at the end of 1997 as well as the markets being in service for a full year in 1998 versus a partial year in 1997. The average monthly service revenue per customer was $50.96 in 1998. The average monthly service revenue per customer in 1997 does not provide a meaningful comparison as the initial users and usage patterns are not comparable to the current users and usage patterns. EQUIPMENT SALES REVENUES consisting of units sold to retailers, independent agents and customers totaled $31.5 million in 1998 and $23.6 million in 1997. The average revenue per unit sold was $95 in 1998 and $124 in 1997. OPERATING EXPENSES totaled $435.1 million in 1998 and $252.5 million in 1997 reflecting the costs to build the customer base ($167.4 million in 1998 and $117.3 million in 1997), costs to provide service to the customer base ($69.1 million in 1998 and $30.7 million in 1997), general and administrative expenses ($61.7 million in 1998 and $44.5 million in 1997), customer service expenses ($53.5 million in 1998 and $20.9 million in 1997) and depreciation and amortization expenses ($83.4 million in 1998 and $39.1 million in 1997). Expenses in 1997 reflect the initiation of service in Aerial's markets by mid-1997. The cost to build the customer base represents marketing and selling expenses and the cost of equipment sold. These expenses less equipment sales revenue represent the cost to acquire a new customer. The cost to acquire a new customer was $431 in 1998 and $661 in 1997. The decrease in the cost to acquire a new customer reflects the increase in gross customer activations as well as declining handset prices. Gross customer activations rose 122% in 1998 to 315,100 from 141,900 in 1997. The average cost per handset sold was $265 in 1998 and $374 in 1997. Aerial's costs to build its customer base reflect expenses for salaries and benefits of sales and marketing personnel, sales commissions, the cost of promotions, the cost of print, radio and television advertising and retail store rental costs. The costs to provide service to the customer base consist primarily of cell site expenses, landline interconnection and toll charges, and employee costs. System operations expenses increased due to the increasing size of Aerial's network and its fully operational status during all of 1998 as compared to only a portion of 1997. General and administrative expenses reflect the expenses associated with the management and operating teams as well as overhead expenses. Aerial has experienced increases in these areas in 1998 due to increased staffing to support its growing PCS business. Customer service expenses consist of salaries and benefits of customer service employees, bad debt expense and costs of operating call centers. Customer service expenses increased and have been higher than anticipated due to the effects of higher than planned customer churn and related bad debt costs as well as additional consulting and temporary service expenses directed at reducing churn and bad debt. The churn rate increased to 5.5% in 1998 from 4.5% in 1997 primarily as a result of the initiation of a prepaid program and an increased emphasis on collections. Prepaid programs typically have a higher churn rate. Depreciation expense increased due to rising fixed asset balances as a result of Aerial's network buildout and the amount of time that network assets have been in service in 1998 as compared to 1997. Amortization expense increased reflecting the operational status of the markets in all of 1998 as compared to only a portion of 1997. OPERATING LOSS totaled $280.0 million in 1998 and $196.6 million in 1997. Management expects Aerial to generate significant losses at least through 1999 as it continues to build its customer base. 11 INFLATION Management believes that inflation affects TDS's business to no greater extent than the general economy. ACCOUNTING FOR COMPUTER SOFTWARE DEVELOPED FOR OR OBTAINED FOR INTERNAL USE The American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1 "Accounting for Computer Software Developed for or Obtained for Internal Use" which became effective January 1999. To eliminate the diversity in practice in accounting and improve financial reporting, SOP 98-1 provides guidance for accounting for software developed for internal use. Management is currently analyzing the impact of this statement, but does not anticipate that the effect on results of operations and financial position will be material. REPORTING ON COSTS OF START-UP ACTIVITIES The AICPA issued SOP 98-5 "Reporting on the Costs of Start-up Activities" which became effective January 1999. SOP 98-5 requires that costs of start-up activities, including organizational costs, be charged to operations as incurred. Management believes SOP 98-5 will have an immaterial effect on results of operations and financial position. FINANCIAL RESOURCES TDS and its subsidiaries operate relatively capital-intensive businesses. Rapid growth has caused expenditures for construction, expansion and acquisition programs to exceed internally generated cash flow. Accordingly, in recent years, TDS and its subsidiaries have obtained substantial funds from external sources to finance Aerial's operations and construction activities, to fund acquisitions and for general corporate purposes. Although U.S. Cellular's increasing internal cash flow and TDS Telecom's steady internal cash flow have reduced the overall need for external financing, Aerial's working capital, operating expenses and construction activities have nevertheless required substantial additional funds from external sources. CASH FLOWS FROM OPERATING ACTIVITIES. TDS is generating substantial internal funds from the rapid growth in U.S. Cellular's customer units and revenues and TDS Telecom's steady growth. The launch of Aerial's operations, however, required substantial funds, thereby reducing the effect of increases in cash flows from U.S. Cellular and TDS Telecom on operating activities in 1998 and 1997. Cash flows from operating activities totaled $356.2 million in 1998, $208.8 million in 1997 and $295.0 million in 1996. Operating cash flow (operating income plus depreciation and amortization) increased 30% to $388.6 million in 1998 from $299.3 million in 1997 and $384.4 million in 1996. U.S. Cellular's operating cash flow increased 46% ($120.9 million) to $382.9 million in 1998, and 33% ($65.7 million) to $261.9 million in 1997 while TDS Telecom's operating cash flow increased 4% ($7.7 million) to $205.8 million in 1998, and 4% ($7.2 million) to $198.2 million in 1997. Aerial's operations reduced operating cash flow by $196.6 million in 1998 and $157.5 million in 1997. Cash flows for other operating activities (investment and other income, interest and income tax expense, and changes in working capital and other assets and liabilities) required $32.4 million in 1998, $90.6 million in 1997, and $89.4 million in 1996.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Operating cash flow U.S. Cellular $382,854 $261,922 $196,205 TDS Telecom 205,814 198,164 190,995 Aerial (196,584) (157,480) -- American Paging (3,511) (3,267) (2,849) ---------------------------------- 388,573 299,339 384,351 Other operating activities (32,410) (90,587) (89,357) ---------------------------------- $356,163 $208,752 $294,994 - ------------------------------------------------------------------------ - ------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES. TDS's long-term strategy is to maintain a strong, yet flexible, financial foundation. Consolidated equity capital (common equity, preferred stock, trust originated preferred securities and minority interest) was 63% of total capitalization at December 31, 1998, compared to 59% and 68% at December 31, 1997 and 1996, respectively. 12 Cash flows from financing activities totaled $137.2 million in 1998, $547.6 million in 1997 and $124.9 million in 1996. TDS used short-term debt to finance Aerial's construction, start-up and development activities and operations, for acquisitions and for general corporate purposes in recent years. TDS has taken advantage of attractive opportunities to reduce short-term debt with proceeds from the sale of long-term debt and equity securities, including sales of debt and equity securities by subsidiaries. Proceeds from the sale of these debt and equity securities totaled $543.1 million, $391.8 million and $195.3 million in 1998, 1997 and 1996, respectively. Proceeds from the sales of non-strategic cellular and other investments from time to time in 1998, 1997 and 1996 have also been used to reduce short-term debt. TDS has cash management arrangements with its subsidiaries under which the subsidiaries may from time to time deposit excess cash with TDS for investment under TDS's cash management program. In 1998, the Company received net proceeds of $144.9 million on the sale of 8.04% Trust Originated Preferred Securities, $198.2 million on the sale of eight-year 7% notes, and $200.0 million from the sale of a 19% interest in a subsidiary of Aerial. In 1997, TDS received net proceeds of $144.8 million on the sale of 8.5% Trust Originated Preferred Securities, and U.S. Cellular received $247.0 million on the sale of 10-year 7.25% notes. U.S. Cellular used the proceeds to repay existing balances on its vendor financing arrangements, to finance the cash requirements for the BellSouth exchange and for general corporate purposes. In 1996, Aerial received $195.3 million from an initial public offering of Common Shares. Aerial and TDS Telecom have also used long-term debt to finance their construction and development activities. Aerial has financed $200 million of digital radio channel and switching equipment purchases through the issuance of 10-year 8.05% zero coupon notes in 1998 and 10-year 8.34% zero coupon notes in 1996. Aerial has also financed $45.5 million of network infrastructure equipment and services with a vendor in 1998. TDS Telecom's telephone subsidiaries borrowed $4.1 million in 1998, $15.0 million in 1997 and $12.2 million in 1996 under the Rural Utility Service and the Rural Telephone Bank long-term federal government loan programs to finance their telephone construction programs. In December 1996, TDS authorized the repurchase of up to 3.0 million TDS Common Shares over a period of three years. In 1997, TDS purchased 1.8 million TDS Common Shares for $69.9 million. A total of 1.0 million shares have been subsequently reissued, primarily for acquisitions in 1997. TDS has paid dividends of $.44, $.42 and $.40 per Common and Series A Common Share in 1998, 1997 and 1996, respectively. Aggregate dividends paid on Common and Preferred Shares, excluding dividends reinvested, totaled $28.5 million in 1998, $27.2 million in 1997 and $26.2 million in 1996. CASH FLOWS FROM INVESTING ACTIVITIES. TDS makes substantial investments each year to acquire, construct, operate and maintain modern high-quality communications networks and facilities as a basis for creating long-term value for shareowners. In recent years, rapid changes in technology and new opportunities have required substantial investments in revenue enhancing and cost reducing upgrades of the Company's networks. In addition, the Company has made substantial investments to enter the PCS business. Cash flows used for investing activities totaled $494.3 million in 1998, $763.0 million in 1997 and $417.4 million in 1996 primarily for capital expenditures and acquisitions. Cash expenditures for capital additions totaled $558.3 million in 1998, $786.3 million in 1997 and $550.2 million in 1996. Cash used for acquisitions, excluding cash acquired, totaled $117.8 million in 1998, $129.0 million in 1997 and $31.0 million in 1996. The sale of non-strategic cellular assets and other investments provided $131.0 million in 1998, $84.2 million in 1997 and $221.5 million in 1996. Distributions from partnerships provided $28.9 million in 1998, $56.4 million in 1997 and $25.5 million in 1996 and changes in temporary investments and marketable securities provided $35.7 million in 1998 and $36.4 million in 1997 and required $30.8 million in 1996. 13 CAPITAL EXPENDITURES The primary purpose of TDS's construction and expansion program is to provide for significant customer growth, to upgrade service, to expand into new communication areas, and to take advantage of service-enhancing and cost-reducing technological developments. The following table summarizes the Company's investments in its communications networks and related facilities during the past three years.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) U.S. Cellular Cell sites and equipment $184,032 $238,797 $133,832 Switching equipment 21,220 5,457 5,713 Systems development 46,042 40,949 28,753 Other 69,123 33,545 79,825 ------------------------------------- 320,417 318,748 248,123 ------------------------------------- TDS Telecom Central office 58,332 52,479 47,208 Outside plant 51,409 60,974 53,130 Systems development 20,497 9,127 20,497 Other 12,887 28,880 23,605 ------------------------------------- 143,125 151,460 144,440 ------------------------------------- Aerial Cell sites and equipment 43,790 291,922 150,386 Switching equipment 23,010 38,428 53,170 Systems development 27,533 55,553 26,277 Other 2,617 1,815 12,436 Prepaid network infrastructure -- (70,300) 70,300 ------------------------------------- 96,950 317,418 312,569 Less noncash items (22,370) (42,709) (199,630) ------------------------------------- 74,580 274,709 112,939 ------------------------------------- Other 20,210 41,400 44,702 ------------------------------------- $558,332 $786,317 $550,204 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
U.S. Cellular's capital additions include expenditures to build additional cell sites and add radio channels to expand coverage and add capacity. U.S. Cellular constructed 281 cell sites in 1998, 331 in 1997 and 242 in 1996. The increase in other capital additions for U.S. Cellular in 1998 was a result of the change over to centralized communications centers. TDS Telecom's capital additions include expenditures for switch modernization and outside plant facilities to maintain and enhance the quality of service and offer new revenue opportunities. Aerial completed the initial build out of its systems in 1997. The 1997 and 1996 expenditures included the construction of five switching centers, the central Network Operations Center and over 1,000 cell sites. Aerial continued to expand coverage and add capacity in its markets in 1998 by adding cell sites in its markets. ACQUISITIONS, EXCHANGES AND SALES TDS continually reviews attractive opportunities for the acquisition of additional telecommunications companies which add value to the organization. TDS and U.S. Cellular continue to assess the makeup of cellular holdings in order to maximize the benefits derived from clustering U.S. Cellular's markets. As the number of opportunities for outright acquisitions of cellular interests has decreased and as U.S. Cellular's clusters have grown to realize greater economies of scale, U.S. Cellular's focus has shifted toward exchanges and sales of non-strategic interests. Cash expenditures (excluding cash acquired) for acquisitions totaled $117.8 million in 1998, $129.0 million in 1997 and $31.0 million in 1996. TDS completed the acquisition of controlling interests in five cellular markets and two telephone companies in 1998, completed an exchange with BellSouth in 1997, completed the acquisition of controlling interests in two cellular markets and one telephone company in 1997 and two cellular markets and five telephone companies in 1996, and increased its ownership of certain cellular interests during the last three years for an aggregate consideration (consisting of cash, TDS Common Shares, TDS Preferred Shares, and U.S. Cellular Common Shares) totaling $131.3 million, $174.7 million and $144.1 million, respectively. In October 1997, U.S. Cellular completed an exchange with BellSouth. Pursuant to the exchange, U.S. Cellular received majority interests representing 4.0 million population equivalents ("pops") in exchange for majority interests representing 2.0 million pops, minority interests representing 1.2 million pops and a net amount of $86.7 million in cash. The majority interests U.S. Cellular received are in 12 markets adjacent to its Iowa/Missouri/Illinois/Indiana and Wisconsin/Illinois clusters. In 1998, U.S. Cellular and TDS Telecom sold a majority interest in one market and minority interests in certain markets for 5.2 million AirTouch common shares and cash. In 1997, U.S. Cellular sold its majority interests in one market and one market partition, minority interests in two other markets and received cash from the settlement of a legal matter. In 1996, U.S. Cellular sold its majority interests in eight markets and minority interests in two other markets, received cash from the settlement of two separate legal matters and received cash in an exchange of markets with another cellular operator. Aerial sold two markets in 1996. LIQUIDITY The Company anticipates that the aggregate resources required in 1999 will include approximately $300 million for cellular capital additions and $120 million for telephone capital additions. The Company intends to spin-off its PCS operations in 1999. The aggregate resources required in 1999 for Aerial include approximately $130 million for PCS capital additions, $125 million for working capital and operating expenses and $80 million for interest expense. TDS and its subsidiaries had cash and temporary investments totaling $60.4 million and longer-term investments totaling $9.5 million at December 31, 1998. These investments are primarily the result of telephone operations' internally generated cash. While certain regulated telephone subsidiaries' debt agreements place limits on intercompany dividend payments, these restrictions are not expected to affect the Company's ability to meet its cash obligations. TDS had $598 million of bank lines of credit for general corporate purposes at December 31, 1998, of which $427 million was unused. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate. U.S. Cellular's capital additions budget totals approximately $300 million to expand and enhance coverage, including adding digital service capabilities to its systems and to enhance office systems. U.S. Cellular plans to finance its construction program primarily with internally generated cash supplemented by short-term financing. U.S. Cellular's operating cash flow totaled $382.9 million in 1998 up 46% ($120.9 million) from 1997. U.S. Cellular also received $27.7 million in distributions from minority partnership interests and $148.3 million from the proceeds of investment sales to supplement operating cash flow. At December 31, 1998, U.S. Cellular had $500 million of bank lines of credit for general corporate purposes, all of which was available. TDS Telecom's capital additions budget totals approximately $120 million, including approximately $45 million for outside plant facilities and $35 million for switching facilities in the ILEC markets and $12 million for current CLEC markets. TDS Telecom plans to finance its construction program using internally generated cash supplemented by long-term financing from federal government programs. Operating cash flow totaled $205.8 million in 1998 up 4% ($7.7 million) from 1997. At December 31, 1998, TDS Telecom's telephone subsidiaries had $116.4 million in unadvanced loan funds from federal government programs to finance the telephone construction program. These loan commitments have a weighted average annual interest rate of 5.1%. Management believes that internal cash flows and funds available from cash and cash equivalents, lines of credit, and longer-term financing commitments provide sufficient financial flexibility. However, the timing and amounts of capital expenditures and acquisitions as well as working capital requirements and amounts needed for general corporate purposes may vary throughout the year. There can be no assurance that sufficient funds will be available to the Company on terms or at prices acceptable to the Company. If sufficient funding is not made available to the Company on terms and prices acceptable to the Company, the Company would have to reduce its construction, development and acquisition programs. TDS and its subsidiaries anticipate accessing public and private capital markets to issue debt and equity securities only when and if capital requirements, financial market conditions and other factors warrant. 15 CORPORATE RESTRUCTURING In December 1997, the Board of Directors of TDS adopted a proposal, which was approved by the shareholders in April 1998, to authorize three new classes of common stock and to change the state of incorporation of TDS from Iowa to Delaware. The three new classes of stock were intended to separately reflect the performance of the Company's cellular telephone, telephone and personal communications services businesses ("Tracking Stocks"). The reincorporation was completed in May 1998. In December 1998, TDS announced the withdrawal of its offers to exchange tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial which it did not own. An integral part of the tracking stock plan was the offering of shares in the TDS Telecom Group, which TDS was not able to complete at a reasonable offering price. In addition, TDS was unable to reach mutually acceptable agreements with the special committees representing the minority shareholders of U.S. Cellular and Aerial. At the same time, TDS announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. There are a number of conditions that must be met for a spin-off to occur, including the receipt of a favorable Internal Revenue Service ruling on the tax-free status of such a spin-off, final approval by the TDS Board of Directors, certain government and third party approvals and review by the Securities and Exchange Commission ("SEC") of appropriate SEC filings. Prior to any spin-off, it is expected that Aerial will seek additional financing so that Aerial would have the appropriate capitalization to operate as a stand-alone entity. In connection with such financing, it is anticipated that a substantial amount of Aerial's debt to TDS may be converted into equity. TDS intends to seek shareholder approval of a proposal to distribute Aerial Series A Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and to distribute Aerial Common Shares, on a pro-rata basis, to holders of TDS Common Shares. There can be no assurance that a spin-off will be consummated or that other alternatives will not be pursued. See Note 1--Corporate Restructuring of Notes to Consolidated Financial Statements. In September 1998, pursuant to a purchase agreement between TDS, Aerial, Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4 million shares of common stock of AOC representing a 19.423% equity interest in AOC, subject to adjustment under certain circumstances, for an aggregate purchase price of $200 million. Sonera has the right, subject to adjustment under certain circumstances, to exchange each share of AOC common stock which it owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent Purchase Price"). Following the announcement by TDS in December 1998, that it intended to distribute to its shareholders all of the capital stock of Aerial that it owns, and that Aerial would seek additional financing from sources other than TDS in connection therewith, Sonera contacted TDS to express certain concerns about the announcement. Sonera has asserted that the TDS announcement reflects a change in circumstances that warrant the renegotiation of certain matters related to its investment in AOC, including an adjustment in the Equivalent Purchase Price, and has raised the possibility of litigation in connection therewith. TDS and Aerial intend to attempt to reach a mutually acceptable resolution of the concerns raised by Sonera. There can be no assurance that this matter will not lead to litigation, or that it will not have a material adverse effect on TDS or Aerial or on the plans relating to the refinancing and spin-off of Aerial. Aerial's capital additions budget totals approximately $130 million, including approximately $100 million for cell sites and switching equipment and $27 million for systems development. In addition, Aerial will require an estimated $125 million for working capital and operating expenses and $80 million for interest expense. Aerial plans to finance its construction expenditures and working capital requirements through external financing and vendor financing. As part of the potential tax-free spin-off of Aerial, TDS and Aerial are seeking short- and long-term financing so that Aerial would have the appropriate capitalization to operate as a stand-alone entity. In 1998, a vendor agreed to provide up to $150 million in financing to Aerial for the purchase of network infrastructure equipment and services. Aerial may borrow up to $75 million prior to June 30, 1999 and an additional $75 million between June 30, 1999 and June 30, 2000. At December 31, 1998, Aerial had $104.5 million available under the agreement. 16 In March 1999, TDS agreed to pay Aerial $114.5 million as a settlement for tax losses incurred by Aerial and utilized by the TDS consolidated tax group. Aerial used the funds to repay a portion of the existing indebtedness to TDS thereby increasing the amount available under the revolving credit agreement. Accordingly, available funding under Aerial's revolving credit agreement with TDS is expected to last through June 1999. TDS has not committed to any further financing of Aerial's operations. It is management's intent for Aerial to obtain the necessary level of financial support from sources other than TDS to enable Aerial to pay its debts as they become due. Management believes Aerial has the ability to obtain that financial support. Sources of additional capital may include vendor financing and public and private equity and debt financings by Aerial or its subsidiaries. If sufficient future funding is not available on terms and prices acceptable to Aerial, Aerial would have to reduce its construction and operating activities, which could have a material adverse impact on Aerial's financial condition and results of operations. MARKET RISK The Company is subject to market rate risks due to fluctuations in interest rates and equity markets. The majority of the Company's debt is in the form of long-term fixed-rate notes, debentures and trust securities with original maturities ranging from 1 to 40 years. Accordingly, fluctuations in interest rates can lead to significant fluctuations in the fair value of such instruments. TDS does not enter into financial derivatives to reduce its exposure to interest rate risks. The table below provides the fair value and average interest, or average dividend rate, of TDS's outstanding debt and trust securities instruments at December 31, 1998. The fair value was estimated using discounted cash flow analysis.
EXPECTED MATURITY DATE (DOLLARS IN THOUSANDS) FAIR VALUE AS TDS AND SUBSIDIARIES 1999 2000 2001 2002 2003 THEREAFTER TOTAL OF 12-31-98 - ----------------------------------------------------------------------------------------------------------------------------------- Long-Term Debt $15,058 $60,432 $15,508 $15,253 $47,380 $2,087,525 $2,241,155 $1,606,333 Average Interest Rate 7.32% 5.81% 7.33% 7.30% 8.45% 7.15% 7.14% Trust Securities -- -- -- -- -- $ 300,000 $ 300,000 $ 297,750 Average Dividend Rate -- -- -- -- -- 8.27% 8.27% - -----------------------------------------------------------------------------------------------------------------------------------
TDS maintains a portfolio of available for sale marketable equity securities which resulted from strategic acquisitions. The market value of these investments, principally AirTouch common shares, amounted to $378.8 million at December 31, 1998. A hypothetical 10% decrease in the share prices of these investments would result in a $37.9 million decline in the market value of the investments. YEAR 2000 ISSUE The Year 2000 Issue exists because many computer systems and applications abbreviate dates using only two digits rather than four digits, e.g., "98" rather than "1998." Unless corrected, this shortcut may cause problems when the century date "2000" occurs. On that date, some computer operating systems and applications and embedded technology may recognize the date as January 1, 1900 instead of January 1, 2000. If the Company fails to correct any critical Year 2000 processing problems prior to January 1, 2000, the affected systems may either cease to function or produce erroneous data, which could have material adverse operational and financial consequences. The Company's management has established a project team to address Year 2000 issues. The Company's plan to address the Year 2000 Issue consists of five general phases: (i) Awareness, (ii) Assessment, (iii) Renovation, (iv) Validation and (v) Implementation. The awareness phase consisted of establishing Year 2000 project teams at each business unit and developing an overall strategy. A Year 2000 Program Office has been established at the TDS corporate level to coordinate activities of the Year 2000 project teams, to monitor the current status of individual projects, to report periodically to the TDS Audit Committee, and to promote the exchange of information between all business units to share knowledge and solution techniques. Management of each business unit has made the Year 2000 Issue a top priority. The Year 2000 effort covers the network and supporting infrastructure for the provision of cellular, local switched and data telecommunications and PCS services; the operational and financial information technology ("IT") systems and applications, such as computer systems that support key business functions such as billing, finance, customer service, procurement and supply; and a review of the Year 2000 compliance efforts of the Company's critical vendors. The assessment phase includes the identification of core business areas and processes, analysis of systems and hardware supporting the core business areas and the prioritization of renovation or replacement of systems and hardware that are not Year 2000 compliant. Included in the assessment phase is 17 an analysis of risk management factors such as contingency plans and legal matters. The assessment phase was largely complete early in the first quarter of 1999. Certain critical systems and hardware components have been identified and are in the renovation phase. The renovation phase consists of the conversion or replacement of selected platforms, applications, databases and utilities. The renovation of critical hardware, systems and applications is scheduled to be substantially completed by the third quarter of 1999. The validation phase includes testing, verifying and validating the renovated or replaced platforms, applications, databases and utilities. The validation phase consists of independent verification testing of key hardware, systems and applications as well as network and system component upgrades received from suppliers. In addition, selected Year 2000 upgrades are slated to undergo testing in a controlled environment that replicates the current environment and is equipped to simulate the turn of the century and leap year dates. The Cellular Telecommunications Industry Association ("CTIA") has formed a working group to coordinate efforts of various carriers and manufacturers to facilitate inter-network Year 2000 testing. Validation of critical hardware, systems and applications is scheduled to be completed in the third quarter of 1999. The implementation phase involves switching over to the converted and renovated systems and applications. This phase is expected to be completed during the fourth quarter of 1999. Management cannot provide assurance that its plan to achieve Year 2000 compliance will be successful as it is subject to various risks and uncertainties. The Company's current schedule is subject to change depending on developments that may arise through unforeseen circumstances in the renovation, validation and implementation phases of the Company's compliance efforts. The Company, like most other telecommunications operators, is highly dependent on the telecommunications network vendors to provide compliant hardware, systems and applications and on other third parties, including vendors, other telecommunications service providers, government agencies and financial institutions, to deliver reliable services. The Company is dependent on the development of compliant hardware, systems and applications and upgrades by experts, both internal and external, and the availability of critical resources with the requisite skill sets. The Company's ability to meet its target dates is dependent upon the timely provision of necessary upgrades and modifications by its suppliers and internal resources. In addition, the Company cannot guarantee that third parties on whom it depends for essential services (such as electric utilities, financial institutions, interconnected telecommunications operators, etc.) will convert their critical systems and processes in a timely manner. Failure or delay by any of these parties could significantly disrupt the Company's business, including the provision of cellular, local switched and PCS services, billing and collection processes and other areas of the business, and cause a material adverse effect on the Company's results of operations, financial positions and cash flow. The Company's Year 2000 worst case scenario may involve interruption of telecommunications services and data processing services and/or interruption of customer billing, operating and other information systems. As part of its Year 2000 initiative, the Company is evaluating a variety of adverse scenarios and is in the process of developing contingency and business continuity plans tailored for adverse Year 2000-related occurrences. The contingency and business continuity plans are expected to assess the potential for business disruption in various scenarios, and to provide key operational back-up, recovery and restorational alternatives. The Company's contingency plan initiatives will include the following: reviewing, assessing and updating existing 18 business recovery plans; identifying teams who will be on call during the millennium change to monitor the network, critical systems, operations centers and business processes to react immediately to facilitate repairs; re-prioritization of mission critical work processes and associated resources; developing alternate processes to support critical customer functions in the event information systems or mechanized processes experience Year 2000 disruptions; establishing replacement/repair parallel paths to provide for repair and readiness of existing systems and components that are scheduled for replacement by the year 2000, in the event the replacement schedules are not met; developing alternate plans for critical suppliers of products/services that fail to meet Year 2000 compliance commitment schedules; developing data retention and recovery procedures to be in place for customer and critical business data to provide pre-millennium backups with on-site as well as off-site data copies. The Company anticipates having these contingency plans in place before December 31, 1999. The Company estimates that the total costs related to the Year 2000 project will be approximately $30 million. Through December 31, 1998, the total costs associated with the Year 2000 Issue were $8 million. In recent years, the Company has made capital expenditures, primarily related to upgrades of the cellular network to provide digital capabilities as well as certain financial systems, which are by design Year 2000 compliant but will be tested. These costs are not considered to be directly related to the Year 2000 project because they were incurred as part of the Company's overall operating strategies to add digital capabilities for competitive purposes, and to improve financial systems and customer service. The timing of expenditures may vary and is not necessarily indicative of readiness efforts or progress to date. Though Year 2000 project costs will directly impact the reported level of future net income, the Company intends to manage its total cost structure, including deferral of non-critical projects, in an effort to mitigate the impact of Year 2000 project costs. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION AND OTHER SECTIONS OF THIS ANNUAL REPORT CONTAIN "FORWARD-LOOKING" STATEMENTS, AS DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, THAT ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS. STATEMENTS THAT ARE NOT HISTORICAL FACTS, INCLUDING STATEMENTS ABOUT THE COMPANY'S BELIEFS AND EXPECTATIONS ARE FORWARD-LOOKING STATEMENTS. THESE STATEMENTS CONTAIN POTENTIAL RISKS AND UNCERTAINTIES AND THEREFORE, ACTUAL RESULTS MAY DIFFER MATERIALLY. TDS UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. IMPORTANT FACTORS THAT MAY AFFECT THESE PROJECTIONS OR EXPECTATIONS INCLUDE, BUT ARE NOT LIMITED TO: CHANGES IN THE OVERALL ECONOMY; CHANGES IN COMPETITION IN MARKETS IN WHICH TDS OPERATES; ADVANCES IN TELECOMMUNICATIONS TECHNOLOGY; CHANGES IN THE TELECOMMUNICATIONS REGULATORY ENVIRONMENT; PENDING AND FUTURE LITIGATION; AVAILABILITY OF FUTURE FINANCING; UNANTICIPATED CHANGES IN GROWTH IN CELLULAR AND PCS CUSTOMERS, PENETRATION RATES, CHURN RATES AND THE MIX OF PRODUCTS AND SERVICES OFFERED IN OUR MARKETS; AND UNANTICIPATED PROBLEMS WITH THE YEAR 2000 ISSUE. READERS SHOULD EVALUATE ANY STATEMENTS IN LIGHT OF THESE IMPORTANT FACTORS. - -------------------------------------------------------------------------------- Consolidated Statements of Operations 19 - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) OPERATING REVENUES U.S. Cellular $ 1,162,467 $ 876,965 $ 680,068 TDS Telecom 488,104 437,624 395,059 Aerial 155,154 55,952 -- ----------------------------------------- 1,805,725 1,370,541 1,075,127 ----------------------------------------- OPERATING EXPENSES U.S. Cellular 986,392 747,422 592,702 TDS Telecom 393,692 337,481 292,410 Aerial 435,139 252,503 -- ----------------------------------------- 1,815,223 1,337,406 885,112 ----------------------------------------- OPERATING INCOME (LOSS) FROM ONGOING OPERATIONS (9,498) 33,135 190,015 American Paging Operating (Loss) (11,406) (35,307) (36,626) ------------------------------------------ OPERATING INCOME (LOSS) (20,904) (2,172) 153,389 ------------------------------------------ INVESTMENT AND OTHER INCOME (EXPENSE) Interest and dividend income 10,952 13,660 15,569 Investment income 40,646 81,150 58,455 Amortization of costs related to minority investments (11,395) (6,450) (4,431) Gain on sale of cellular and other investments 262,698 41,438 138,735 PCS development costs -- (21,614) (43,950) Other (expense) income, net (26,941) (4,051) 3,187 Minority share of loss (income) 28,513 8,316 (26,316) ------------------------------------------- 304,473 112,449 141,249 ------------------------------------------- INCOME BEFORE INTEREST AND INCOME TAXES 283,569 110,277 294,638 Interest expense 126,360 89,744 42,853 Minority interest in income of subsidiary trust 23,504 1,523 -- ------------------------------------------ INCOME BEFORE INCOME TAXES 133,705 19,010 251,785 Income tax expense 69,297 28,559 123,646 ----------------------------------------- NET INCOME (LOSS) 64,408 (9,549) 128,139 Preferred Dividend Requirement (1,651) (1,892) (1,957) ------------------------------------------ NET INCOME (LOSS) AVAILABLE TO COMMON $ 62,757 $ (11,441) $ 126,182 - ------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE SHARES OUTSTANDING (000S) 60,982 60,211 60,464 BASIC EARNINGS PER SHARE $ 1.03 $ (.19) $ 2.09 - ------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------- DILUTED EARNINGS PER SHARE $ 1.03 $ (.19) $ 2.07 - ------------------------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------- DIVIDENDS PER SHARE $ .44 $ .42 $ .40 - ------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. - -------------------------------------------------------------------------------- 20 Consolidated Statements of Cash Flows - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 64,408 $ (9,549) $ 128,139 Add (Deduct) adjustments to reconcile net income (loss) to net cash provided by operating activities Depreciation and amortization 409,477 301,511 230,962 Deferred income taxes and investment tax credit, net 49,349 17,236 75,015 Investment income (40,646) (81,150) (58,455) Minority share of income (loss) (28,513) (8,316) 26,316 Gain on sale of cellular and other investments (262,698) (41,438) (138,735) Noncash interest expense 36,399 24,289 17,042 Other noncash expense 33,781 18,109 25,017 Change in accounts receivable (41,383) (41,900) (28,687) Change in materials and supplies 10,674 (25,827) (2,395) Change in accounts payable 82,619 32,498 23,531 Change in accrued taxes 24,030 7,612 (8,249) Change in other assets and liabilities 18,666 15,677 5,493 ------------------------------------------ 356,163 208,752 294,994 ------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES Issuance of long-term debt 202,277 260,099 15,846 Repayments of long-term debt (16,454) (121,958) (34,200) Change in notes payable (356,698) 368,858 (27,133) Trust preferred securities 144,880 144,788 -- Dividends paid (28,490) (27,193) (26,232) Proceeds from issuance of subsidiaries' stock 200,000 -- 195,265 Repurchase of Common Shares -- (69,942) -- Other financing activities (8,283) (7,064) 1,350 ----------------------------------------- 137,232 547,588 124,896 ------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (558,332) (786,317) (550,204) Investments in and advances to investment entities and license costs (2,823) (20,084) (23,134) Distributions from investments 28,912 56,413 25,453 Investments in PCS licenses -- (5,034) (26,548) Proceeds from investment sales 130,957 84,230 221,542 Acquisitions, net of cash acquired (117,817) (128,979) (31,019) Change in temporary investments and marketable securities 35,690 36,422 (30,797) Other investing activities (10,907) 384 (2,666) ------------------------------------------ (494,320) (762,965) (417,373) ------------------------------------------ NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (925) (6,625) 2,517 CASH AND CASH EQUIVALENTS BEGINNING OF PERIOD 51,008 57,633 55,116 ------------------------------------------ END OF PERIOD $ 50,083 $ 51,008 $ 57,633 - --------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. - -------------------------------------------------------------------------------- Consolidated Balance Sheets -- Assets 21 - --------------------------------------------------------------------------------
DECEMBER 31, 1998 1997 - -------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) CURRENT ASSETS Cash and cash equivalents $ 50,083 $ 51,008 Temporary investments 10,341 24,559 Accounts receivable Due from customers, less allowance of $12,608 and $15,102, respectively 163,910 148,811 Other, principally connecting companies 120,700 98,487 Materials and supplies, at average cost 36,621 55,127 Other current assets 23,784 30,292 ------------------------- 405,439 408,284 ------------------------- INVESTMENTS Intangible Assets Cellular license costs, net of amortization 1,200,653 1,079,080 Broadband PCS license costs, net of amortization 311,915 319,918 Franchise and other costs in excess of the underlying book value of subsidiaries, net of amortization 181,517 180,669 Investments in unconsolidated entities 307,258 275,462 Marketable equity securities 378,812 1,621 Other investments 33,870 115,834 ------------------------- 2,414,025 1,972,584 ------------------------- PROPERTY, PLANT AND EQUIPMENT, NET U.S. Cellular 1,138,585 1,018,559 TDS Telecom 881,507 830,767 Aerial 621,281 604,104 Other 31,216 90,529 ------------------------- 2,672,589 2,543,959 ------------------------- OTHER ASSETS AND DEFERRED CHARGES 35,492 46,774 ------------------------- $ 5,527,545 $ 4,971,601 - ------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. - -------------------------------------------------------------------------------- 22 Consolidated Balance Sheets -- Liabilities and Stockholders' Equity - --------------------------------------------------------------------------------
DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) CURRENT LIABILITIES Current portion of long-term debt $ 15,946 $ 14,816 Notes payable 170,889 527,587 Accounts payable 288,417 239,783 Advance billings and customer deposits 37,473 33,640 Accrued interest 24,290 18,284 Accrued taxes 30,449 6,961 Accrued compensation 29,584 23,386 Other current liabilities 26,331 40,129 ------------------------- 623,379 904,586 ------------------------- DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability 314,858 202,680 Postretirement benefits obligation other than pensions 9,463 11,364 Other 22,668 21,602 ------------------------- 346,989 235,646 ------------------------- LONG-TERM DEBT, excluding current portion 1,553,096 1,264,218 ------------------------- MINORITY INTEREST in subsidiaries 440,188 416,566 ------------------------- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES (a) 300,000 150,000 ------------------------- PREFERRED SHARES 25,985 32,466 ------------------------- COMMON STOCKHOLDERS' EQUITY Common Shares, par value $.01 and $1 per share, respectively; authorized 100,000,000 shares; issued and outstanding 54,988,498 and 54,443,260 shares, respectively 550 54,443 Series A Common Shares, par value $.01 and $1 per share, respectively; authorized 25,000,000 shares; issued and outstanding 6,949,904 and 6,936,277 shares, respectively 69 6,936 Capital in excess of par value 1,882,710 1,664,248 Treasury Shares, at cost, 761,220 and 794,576 shares, respectively (29,439) (30,682) Accumulated other comprehensive income 75,609 683 Retained earnings 308,409 272,491 ------------------------- 2,237,908 1,968,119 ------------------------- $ 5,527,545 $ 4,971,601 - ------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. (a) AS DESCRIBED IN NOTE 14, THE SOLE ASSET OF TDS CAPITAL I IS $154.6 MILLION PRINCIPAL AMOUNT OF 8.5% SUBORDINATED DEBENTURES DUE 2037 FROM TDS, AND THE SOLE ASSET OF TDS CAPITAL II IS $154.6 MILLION PRINCIPAL AMOUNT OF 8.04% SUBORDINATED DEBENTURES DUE 2038 FROM TDS. - -------------------------------------------------------------------------------- Consolidated Statements of Common Stockholders' Equity 23 - --------------------------------------------------------------------------------
Accumulated Series A Capital in Compre- Other Com- Common Common Excess of Treasury hensive prehensive Retained Shares Shares Par Value Shares Income Income Earnings - ----------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) BALANCE, DECEMBER 31, 1995 $ 51,137 $ 6,893 $ 1,419,002 $ -- $ 7 $ 207,326 Comprehensive Income Net Income -- -- -- -- $ 128,139 -- 128,139 Net unrealized gains on securities -- -- -- -- 506 506 -- ---------- Comprehensive Income $ 128,645 ---------- ---------- Dividends Common and Series A Common Shares -- -- -- -- -- (24,274) Preferred Shares -- -- -- -- -- (1,958) Acquisitions 2,645 -- 111,103 -- -- -- Dividend reinvestment, incentive and compensation plans 100 27 4,487 -- -- -- Conversion of Preferred Shares 352 -- 4,422 -- -- -- Conversion of Series A Common Shares 3 (3) -- -- -- -- Gain on sale of subsidiary stock -- -- 114,056 -- -- -- Other -- -- 8,971 -- -- -- ------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1996 54,237 6,917 1,662,041 -- 513 309,233 Comprehensive Income Net (Loss) -- -- -- -- $ (9,549) -- (9,549) Net unrealized gains on securities -- -- -- -- 170 170 -- ---------- Comprehensive (Loss) $ (9,379) ---------- ---------- Dividends Common and Series A Common Shares -- -- -- -- -- (25,300) Preferred Shares -- -- -- -- -- (1,893) Acquisitions 16 -- 3,585 39,084 -- -- Repurchase Common Shares -- -- -- (69,942) -- -- Dividend reinvestment, incentive and compensation plans 122 19 4,707 176 -- -- Conversion of Preferred Shares 68 -- 1,419 -- -- -- Other -- -- (7,504) -- -- -- ------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1997 54,443 6,936 1,664,248 (30,682) 683 272,491 Comprehensive Income Net Income -- -- -- -- $ 64,408 -- 64,408 Net unrealized gains on securities -- -- -- -- 74,926 74,926 -- ---------- Comprehensive Income $ 139,334 ---------- ---------- Dividends Common and Series A Common Shares -- -- -- -- -- (26,850) Preferred Shares -- -- -- -- -- (1,640) Recapitalization (53,899) (6,867) 60,766 -- -- -- Acquisitions 2 -- 10,025 -- -- -- Dividend reinvestment, incentive and compensation plans 1 -- 2,029 1,243 -- -- Conversion of Preferred Shares 3 -- 6,284 -- -- -- Gain on sale of subsidiary stock -- -- 148,357 -- -- -- Other -- -- (8,999) -- -- -- ------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1998 $ 550 $ 69 $ 1,882,710 $ (29,439) $ 75,609 $ 308,409 - ------------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------------
THE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ARE AN INTEGRAL PART OF THESE STATEMENTS. - ------------------------------------------------------------------------------- 24 Notes to Consolidated Financial Statements - ------------------------------------------------------------------------------- NOTE 1 CORPORATE RESTRUCTURING In December 1997, the Board of Directors of Telephone and Data Systems, Inc. adopted a proposal, which was approved by the shareholders in April 1998, to authorize three new classes of common stock and to change the state of incorporation of Telephone and Data Systems, Inc. ("TDS" or "the Company") from Iowa to Delaware. The three new classes of stock were intended to separately reflect the performance of the Company's cellular telephone, telephone and personal communications services businesses ("Tracking Stocks"). The reincorporation was completed in May 1998. The Company intended to: a) offer and sell Telecom Group Shares in a public offering for cash, b) issue Cellular Group Shares in exchange for all of the Common Shares of United States Cellular Corporation ("U.S. Cellular") not owned by the Company, c) issue Aerial Group Shares in exchange for all of the Common Shares of Aerial Communications, Inc. ("Aerial") not owned by the Company, and d) distribute one Cellular Group Share, two-thirds of a Telecom Group Share and two-thirds of an Aerial Group Share in the form of a stock dividend with respect to each outstanding Series A Common Share and Common Share of the Company. In December 1998, TDS announced the withdrawal of its offers to exchange tracking stocks for the outstanding Common Shares of U.S. Cellular and Aerial which it did not own. An integral part of the tracking stock plan was the offering of shares in the TDS Telecom Group, which TDS was not able to complete at a reasonable offering price. In addition, TDS was unable to reach mutually acceptable agreements with the special committees representing the minority shareholders of U.S. Cellular and Aerial. At the same time, TDS announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. There are a number of conditions that must be met for a spin-off to occur, including the receipt of a favorable Internal Revenue Service ruling on the tax-free status of such a spin-off, final approval by the TDS Board of Directors, certain government and third party approvals and review by the Securities and Exchange Commission ("SEC") of appropriate SEC filings. Prior to any spin-off, it is expected that Aerial will seek additional financing so that Aerial would have the appropriate capitalization to operate as a stand-alone entity. In connection with such financing, it is anticipated that a substantial amount of Aerial's debt to TDS may be converted into equity. TDS intends to seek shareholder approval of a proposal to distribute Aerial Series A Common Shares, on a pro-rata basis, to holders of TDS Series A Common Shares and Aerial Common Shares, on a pro-rata basis, to holders of TDS Common Shares. There can be no assurance that a spin-off will be consummated or that other alternatives will not be pursued. NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS TDS is a diversified telecommunications company which provided high-quality telecommunications services to approximately 3.0 million cellular telephone, telephone and personal communications services ("PCS") customers in 35 states at December 31, 1998. The Company conducts substantially all of its cellular telephone operations through its 81.0%-owned subsidiary, United States Cellular Corporation ("U.S. Cellular"), its telephone operations through its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom"), and its PCS operations through its 82.3%-owned subsidiary, Aerial Communications, Inc. ("Aerial"). In December 1998, TDS announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. See Note 1 --Corporate Restructuring. TDS contributed substantially all of the assets and certain, limited liabilities of American Paging, Inc. ("American Paging") to TSR Wireless Holdings, LLC ("TSR Wireless") for a 30% interest in TSR Wireless effective March 31, 1998. American Paging's revenues are netted against its expenses in the Consolidated Statements of Operations with the resulting operating loss reported as American Paging Operating (Loss). American Paging's revenues totaled $17.8 million and operating expenses totaled $29.2 million for the three month period ended March 31, 1998. American Paging's revenues totaled $94.4 million and $104.2 million in 1997 and 1996, respectively, and operating expenses totaled $129.7 million and $140.8 million, respectively. Beginning April 1, 1998, TDS followed the equity method of accounting for its 30% interest in TSR Wireless and reported these results as a component of Investment income. 25 The following table summarizes the assets and liabilities which American Paging contributed to TSR Wireless.
MARCH 31, 1998 - ------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Current assets Cash $ 3,969 Accounts receivable 8,259 Materials and supplies 5,898 Other 1,494 Property, plant and equipment, net 37,899 Other investments - Narrowband PCS license 60,901 Deferred assets 10,108 Current liabilities Advance billings and customer deposits (9,958) Accrued taxes (541) Other (1,128) --------- $116,901 - ----------------------------------------------------------------------- - -----------------------------------------------------------------------
See Note 20 -- Business Segment Information for summary financial information on each business segment. PRINCIPLES OF CONSOLIDATION The accounting policies of TDS conform to generally accepted accounting principles. The consolidated financial statements include the accounts of TDS, its majority-owned subsidiaries since acquisition and the cellular partnerships in which TDS has a majority general partnership interest. All material intercompany items have been eliminated. TDS includes as investments in subsidiaries the value of the consideration given and all direct and incremental costs relating to acquisitions accounted for as purchases. All costs relating to unsuccessful negotiations for acquisitions are expensed. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Certain amounts reported in prior years have been reclassified to conform to current period presentation. CASH AND CASH EQUIVALENTS AND TEMPORARY INVESTMENTS Cash and cash equivalents include cash and those short-term, highly-liquid investments with original maturities of three months or less. Those investments with original maturities of more than three months to 12 months are classified as temporary investments. Temporary investments are stated at cost. Those investments with original maturities of more than 12 months are classified as marketable non-equity securities (included in Other investments in the Consolidated Balance Sheets) and are stated at amortized cost. As part of its cash management program, the Company utilizes controlled disbursement banking arrangements. Outstanding checks in excess of cash balances totaled $28.7 million at December 31, 1998 and are classified as Accounts payable in the Consolidated Balance Sheets. Sufficient funds were available to fund these outstanding checks when presented for payment. TDS has cash management arrangements with its subsidiaries under which the subsidiaries may from time to time deposit excess cash with TDS for investment under TDS's cash management program. The carrying amounts of Cash and cash equivalents and Temporary investments approximate fair value due to the short-term nature of these investments. REVENUE RECOGNITION Revenues from cellular and PCS operations primarily consist of charges to customers for monthly access, airtime, data usage, vertical services, roaming charges, long-distance charges and equipment sales. Revenues are recognized as services are rendered. Unbilled revenues, resulting from service provided from the billing cycle date to the end of each month and from other cellular and PCS carriers' customers using the Company's cellular and PCS systems for the last half of each month, are estimated and recorded. Equipment sales are recognized upon delivery to the customer or upon the shipment of goods to retailers and independent agents. TDS's telephone subsidiaries participate in revenue pools with other telephone companies for interstate revenue and for certain intrastate revenue. Such pools are funded by toll revenue and/or access charges within state jurisdiction and by access charges in the interstate market. Revenues earned through the various pooling processes are initially recorded based on the Company's estimates. ADVERTISING COSTS The Company expenses advertising costs as incurred.Advertising expense totaled $83.7 million, $66.9 million and $29.9 million in 1998, 1997 and 1996, respectively. ACCOUNTING FOR COMPUTER SOFTWARE DEVELOPED FOR OR OBTAINED FOR INTERNAL USE The American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-1 "Accounting for Computer Software Developed for or Obtained for Internal Use" which became effective January 1999. To eliminate the diversity in practice in accounting and improve financial reporting, SOP 98-1 provides guidance for accounting for software developed for internal use. Management is currently analyzing the impact of this statement, but does not anticipate that the effect on results of operations and financial position will be material. 26 REPORTING ON THE COSTS OF START-UP ACTIVITIES The AICPA issued SOP 98-5 "Reporting on the Costs of Start-up Activities" which became effective January 1999. SOP 98-5 requires that costs of start-up activities, including organizational costs, be charged to operations as incurred. Management believes SOP 98-5 will have an immaterial effect on results of operations and financial position. NOTE 3 INCOME TAXES TDS files a consolidated federal income tax return. Income tax provisions charged to net income are summarized as follows:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Current: Federal $ 9,873 $ 4,533 $ 31,356 State 10,075 6,790 17,275 Deferred: Federal 36,827 13,302 67,040 State 13,372 4,453 10,072 Amortization of deferred investment tax credits (850) (519) (2,097) ----------------------------------- Total income tax expense $ 69,297 $ 28,559 $123,646 - ------------------------------------------------------------------------- - -------------------------------------------------------------------------
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, 1998 1997 1996 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Statutory federal income tax rate $46,797 $ 6,653 $ 88,125 State income taxes, net of federal benefit 14,582 6,958 17,358 Amortization of license acquisition costs and costs in excess of book value 3,925 5,276 4,280 Dividend exclusion and other permanent items 130 752 377 Amortization of deferred investment tax credits (850) (519) (2,097) Effects of corporations not included in consolidated federal tax return 1,855 1,409 2,351 Sale of cellular interests 2,580 5,549 12,337 Rate difference of federal net operating loss -- 1,246 -- Resolution of prior period tax issues 167 -- -- Other differences, net 111 1,235 915 -------------------------------- Income tax expense $69,297 $28,559 $123,646 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
Deferred income taxes are provided for the temporary differences between the amount of the Company's assets and liabilities for financial reporting purposes and their tax bases. The Company's current net deferred tax assets totaled $1.2 million and $3.7 million as of December 31, 1998 and 1997, respectively. The net current deferred tax asset primarily represents the deferred tax effects of unearned revenues. The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities are as follows:
DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Deferred Tax Asset: Net operating loss carryforwards $156,633 $ 55,363 Alternative minimum tax credit carryforward 28,830 21,205 Taxes on acquisitions 27,066 54,134 Partnership investments 7,300 -- Postretirement benefits 3,673 4,819 Amortization of deferred charges -- 1,614 Other 78 3,511 ------------------------- 223,580 140,646 Less valuation allowance (54,685) (29,001) ------------------------- Net Deferred Tax Asset 168,895 111,645 Deferred Tax Liability: ------------------------- Property, plant and equipment 174,292 134,672 Marketable equity securities 133,333 462 Equity investments 78,179 64,141 Licenses 62,673 55,756 Minority share of income 18,416 1,549 Partnership investments -- 25,687 Capitalized interest 15,678 18,721 Other 1,182 13,337 ------------------------ Total Deferred Tax Liability 483,753 314,325 ------------------------ Net Deferred Income Tax Liability $314,858 $202,680 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
TDS had $274.7 million of federal net operating loss carryforward (generating a $90.7 million deferred tax asset) at December 31, 1998, expiring between 2012 and 2013 which is available to offset future consolidated taxable income. In addition, TDS had $965.3 million of state net operating loss carryforward (generating a $65.9 million deferred tax asset) at December 31, 1998, expiring between 1999 and 2013 which is available to offset future taxable income primarily of the individual subsidiaries which generated the loss. A valuation allowance was established for the state operating loss carryforwards since it is more likely than not that a portion will expire before such carryforwards can be utilized. At December 31, 1998, TDS had $28.8 million of federal alternative minimum tax credit carryforward available to offset regular income tax payable in future years. The financial reporting basis of the marketable equity securities was greater than the tax basis at the date of acquisition, generating $73.6 million of deferred taxes. Additionally, the value of the marketable equity securities has appreciated since acquisition, generating $59.7 million of deferred taxes. 27 NOTE 4 EARNINGS PER SHARE The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share," effective December 31, 1997. Earnings per Share amounts for 1996 have been restated to conform to current period presentation. The amounts used in computing Earnings per Share and the effect on income and the weighted average number of Common and Series A Common Shares of dilutive potential common stock are as follows:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (DOLLARS AND SHARES IN THOUSANDS) Net Income (Loss) $64,408 $ (9,549) $128,139 Preferred Dividend Requirement (1,651) (1,892) (1,957) --------------------------------- Net Income (Loss) Available to Common used in Basic Earnings per Share 62,757 (11,441) 126,182 Reduction in preferred dividends if Preferred Shares converted into Common Shares 125 -- 671 Minority income adjustment (92) (100) (152) --------------------------------- Net Income (Loss) Available to Common used in Diluted Earnings per Share $62,790 $(11,541) $126,701 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ Weighted Average Number of Common Shares used in Basic Earnings per Share 60,982 60,211 60,464 Effect of Dilutive Securities: Common Shares outstanding if Preferred Shares converted 117 -- 543 Stock options and stock appreciation rights 122 -- 165 Common Shares issuable 13 -- 28 --------------------------------- Weighted Average Number of Common Shares used in Diluted Earnings per Share 61,234 60,211 61,200 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
The following future issuances of Common Shares were not included in computing Diluted Earnings per Share because their effects were antidilutive.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (SHARES IN THOUSANDS) Common Shares issuable upon conversion of Preferred Shares 702 917 428 Stock options and stock appreciation rights -- 130 -- Common Shares issuable in future -- 15 -- - ------------------------------------------------------------------------------
The minority income adjustment reflects the additional minority share of U.S. Cellular's income computed as if all of U.S. Cellular's issuable securities were outstanding. NOTE 5 INTANGIBLE ASSETS Cellular license costs consist of costs incurred in acquiring Federal Communications Commission ("FCC") licenses to provide cellular service. These costs include amounts paid to license applicants and owners of interests in cellular entities awarded licenses and all direct and incremental costs relating to acquiring the licenses. These costs are capitalized and amortized through charges to expense over 40 years upon commencement of operations. Amortization amounted to $32.7 million, $27.2 million and $25.9 million in 1998, 1997 and 1996, respectively. Accumulated amortization of cellular license costs was $153.9 million and $121.2 million at December 31, 1998 and 1997, respectively. Included in cellular license costs is approximately $242 million and $281 million at December 31, 1998 and 1997, respectively, of goodwill related to various acquisitions structured to be tax-free. No deferred taxes have been provided on this goodwill. Broadband PCS license costs consist of costs incurred in acquiring PCS licenses ($284.9 million) and capitalized interest ($39.7 million). These costs are amortized over 40 years upon commencement of operations. Amortization amounted to $8.0 million and $4.7 million in 1998 and 1997, respectively. Accumulated amortization of Broadband PCS license costs was $12.7 million and $4.7 million at December 31, 1998 and 1997, respectively. Interest capitalized totaled $5.0 million and $22.7 million in 1997 and 1996, respectively. Franchise and other costs include the costs in excess of the underlying book value of acquired telephone companies. Costs aggregating $215.3 million and $209.1 million at December 31, 1998 and 1997, respectively, relating to acquisitions since November 1, 1970, are being amortized on a straight-line basis over a 40-year period. Amortization amounted to $5.3 million, $5.2 million and $4.9 million in 1998, 1997 and 1996, respectively. Accumulated amortization of excess cost was $40.2 million and $34.9 million at December 31, 1998 and 1997, respectively. Costs in excess of the underlying book value relating to acquisitions initiated before November 1, 1970, aggregating $6.5 million, are not being amortized. Included in franchise and other costs is approximately $141 million and $135 million at December 31, 1998 and 1997, respectively, of goodwill related to various acquisitions structured to be tax-free. No deferred taxes have been provided on this goodwill. 28 NOTE 6 INVESTMENTS IN UNCONSOLIDATED ENTITIES Investments in unconsolidated entities consists of investments in which the Company holds a minority interest. The Company follows the equity method of accounting, which recognizes TDS's proportionate share of the income and losses accruing to it under the terms of its partnership or shareholder agreements, where the Company's ownership interest equals or exceeds 20% for corporations and 3% for partnerships ($291.5 million and $266.0 million at December 31, 1998 and 1997, respectively). Income and losses from these entities are reflected in the Consolidated Statements of Operations on a pretax basis as Investment income. Investment income totaled $40.6 million, $81.2 million and $58.5 million in 1998, 1997 and 1996, respectively. At December 31, 1998, the cumulative share of income from minority investments accounted for under the equity method was $185.7 million, of which $52.2 million was undistributed. The cost method of accounting is followed for certain minority interests where the Company's ownership interest is less than 20% for corporations and 3% for partnerships ($15.8 million and $9.5 million at December 31, 1998 and 1997, respectively). Investments in unconsolidated entities includes cellular license costs and costs in excess of the underlying book value of certain non-cellular minority investments. These costs are being amortized from 10 to 40 years. Amortization amounted to $9.7 million, $3.0 million and $3.0 million in 1998, 1997 and 1996, respectively. The Company's more significant investments in unconsolidated entities consist of the following:
PERCENTAGE OWNERSHIP DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------- Cellular Los Angeles SMSA Limited Partnership 5.5% 5.5% Oklahoma City SMSA Limited Partnership 14.6% 14.6% Raleigh-Durham MSA Limited Partnership 8.0% 8.0% Midwest Wireless Communication, LLC 14.7% 14.7% Northeast Cellular Telephone Co., L.P. 49.0% 49.0% Saco River Cellular Telephone Co. 40.0% 40.0% Allentown SMSA Limited Partnership 8.1% 8.1% Eau Claire Cellular Telephone Limited Partnership 44.5% 44.5% Ohio RSA #9 49.0% 49.0% Other TSR Wireless Holdings, LLC 30.0% -- - -------------------------------------------------------------------------
The following summarizes the unaudited combined assets, liabilities and equity, and the unaudited combined results of operations of the entities for which TDS's investments are accounted for by the equity method.
DECEMBER 31, 1998 1997 - -------------------------------------------------------------------------- (UNAUDITED, DOLLARS IN MILLIONS) Assets Current assets $ 620 $ 425 Due from affiliates 7 3 Property and other 1,156 1,159 -------------------- $1,783 $1,587 - -------------------------------------------------------------------------- - -------------------------------------------------------------------------- Liabilities and Equity Current liabilities $ 397 $ 287 Due to affiliates 26 38 Deferred credits 3 9 Long-term debt 359 70 Partners' capital and stockholders' equity 998 1,183 -------------------- $1,783 $1,587 - -------------------------------------------------------------------------- - --------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (UNAUDITED, DOLLARS IN MILLIONS) Results of Operations Revenues $1,581 $1,740 $1,395 Costs and expenses 1,091 1,256 958 -------------------------------- Operating Income 490 484 437 -------------------------------- Other income (expense) (13) 5 7 Interest expense (5) (10) (6) Income taxes (4) (6) (3) Extraordinary item -- -- (2) -------------------------------- Net income $ 468 $ 473 $ 433 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
NOTE 7 MARKETABLE EQUITY SECURITIES Marketable equity securities include the Company's investments in equity securities, primarily AirTouch Communications, Inc. ("AirTouch") common shares. These securities are classified as available-for-sale and stated at fair market value. Information regarding the Company's marketable equity securities is summarized below.
DECEMBER 31, 1998 1997 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Available-for-sale Equity Securities Aggregate Fair Value $378,812 $1,621 Original Cost 230,344 473 ---------------------- Gross Unrealized Holding Gains 148,468 1,148 Tax Effect 59,661 465 ---------------------- Unrealized Holding Gains, net of tax 88,807 $ 683 Minority Share of Unrealized Holding Gains 13,198 -- ---------------------- Net Unrealized Holding Gains $ 75,609 $ 683 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
The Company's net unrealized holding gains are included as an increase to Common Stockholders' Equity. Realized gains and losses are determined on the basis of specific identification. During 1998, proceeds from the sale of available- for-sale securities totaled $613,000 and gross realized gains 29 totaled $300,000. During 1997, proceeds from the sale of available-for-sale securities totaled $1.5 million and gross realized gains totaled $154,000. NOTE 8 PROPERTY, PLANT AND EQUIPMENT U.S. CELLULAR U.S. Cellular property, plant and equipment is stated at cost and consists of:
DECEMBER 31, 1998 1997 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Cell site-related equipment $ 790,292 $ 725,544 Switching-related equipment 116,198 105,955 Office furniture and equipment 127,397 89,987 Land, buildings and leasehold improvements 237,361 199,108 System development 134,225 96,423 Work in process 70,197 44,000 Other operating equipment 59,152 47,981 ---------------------------- 1,534,822 1,308,998 Accumulated depreciation 396,237 290,439 ---------------------------- $1,138,585 $1,018,559 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
Renewals and betterments of units of property are recorded as additions to plant in service. The original cost of depreciable property retired is removed from plant in service and, together with removal cost less any salvage realized, is charged to depreciation expense. Repairs and renewals of minor units of property are charged to system operations expense. TDS TELECOM TDS Telecom property, plant and equipment is stated at the original cost of construction including the capitalized costs of certain taxes, payroll-related expenses, and an allowance for funds used during construction ("AFUDC") and consists of:
DECEMBER 31, 1998 1997 - --------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Cable and wire $ 772,749 $ 719,945 Central office equipment 460,323 399,016 Office furniture and equipment 145,851 112,921 Land and buildings 68,274 67,203 Other equipment 67,338 69,128 Work in process 28,696 52,677 ------------------------ 1,543,231 1,420,890 Accumulated depreciation 661,724 590,123 ------------------------ $ 881,507 $ 830,767 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
Renewals and betterments of units of property are added to telephone plant in service. The original cost of depreciable property retired is removed from plant in service and, together with removal cost less any salvage realized, is charged to accumulated depreciation. Repairs and renewals of minor items of property are included in plant operations expense. No gain or loss is recognized on ordinary retirements of depreciable telephone property. AFUDC, a noncash item of non-operating income, totaled $403,000, $686,000 and $825,000 in 1998, 1997 and 1996, respectively. The composite weighted average rates were 5.9%, 5.5% and 7.3% in 1998, 1997 and 1996, respectively. The amount of such allowance has varied principally as a result of changes in the level of construction work in process and in the cost of capital. The Company's telephone operations follow accounting for regulated enterprises prescribed by SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." Management periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. Management believes that such criteria are still being met and therefore has no current plans to change its method of accounting. In analyzing the effects of discontinuing the application of SFAS No. 71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally accepted accounting principles and therefore, any adjustments to telecommunications plant would be immaterial, as would be the write-off of regulatory assets and liabilities. AERIAL Aerial property, plant and equipment is stated at original cost and consists of:
DECEMBER 31, 1998 1997 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Cell site-related equipment $467,654 $422,927 Switching-related equipment 113,169 91,598 Information systems 89,422 83,950 Office equipment, leasehold improvements and other 26,269 24,266 Work in process 37,444 19,381 ------------------------- 733,958 642,122 Accumulated depreciation 112,677 38,018 ------------------------- $621,281 $604,104 - ---------------------------------------------------------------------------- - ----------------------------------------------------------------------------
Renewals and betterments of units of property are recorded as additions to plant in service. The original cost of depreciable property retired is removed from plant in service and, together with removal cost less any salvage realized, is charged to operating expense. Repairs and renewals of minor units of property are charged to system operations expense. PCS work in process includes expenditures for the design, construction and testing of Aerial's PCS networks, costs of developing information systems and costs to relocate dedicated private microwave links currently operating in Aerial's spectrum in its markets. Aerial capitalized interest on certain of its work in process expenditures totaling $132,000, $6.0 million and $1.2 million in 1998, 1997 and 1996, respectively. 30 OTHER Other property, plant and equipment is stated at original cost and consists of:
DECEMBER 31, 1998 1997 - --------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Computer equipment $33,016 $ 34,602 System development 22,992 30,713 Other equipment 12,919 11,806 Land and buildings 7,840 12,947 Furniture and fixtures 6,649 6,741 Radio paging property and equipment -- 118,275 --------------------- 83,416 215,084 Accumulated depreciation 52,200 124,555 --------------------- $31,216 $ 90,529 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
The investment in radio paging property and equipment was contributed to TSR Wireless along with certain other assets of American Paging. See Note 2 -- Summary of Significant Accounting Policies -- Nature of Operations. DEPRECIATION Depreciation is provided using the straight-line method over the estimated useful lives of the assets. The provision for depreciation as a percentage of depreciable property was as follows:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------------- U.S. Cellular 13.0% 10.3% 10.8% TDS Telecom 7.5 7.4 7.2 Aerial 11.5 10.9 20.2 Other 17.6% 19.5% 22.9% - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
Cellular depreciation as a percentage of depreciable property increased in 1998 due to the reduction in useful lives of certain assets in 1998, increasing the provision for depreciation. NOTE 9 SUPPLEMENTAL CASH FLOW DISCLOSURES Following are supplemental cash flow disclosures for interest and income taxes paid, acquisitions and certain noncash transactions.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (Dollars in thousands) Interest paid $83,567 $70,741 $ 52,835 Income taxes paid 7,404 10,743 67,967 Common Shares issued for conversion of Preferred Shares 6,114 1,031 4,602 Increase in PCS network equipment and prepaid infrastructure costs through the issuance of long-term debt and interim financing 65,423 84,355 100,000 Additions to property, plant and equipment financed through accounts payable and accrued expenses $33,874 $69,916 $108,167 - ------------------------------------------------------------------------------
TDS has acquired certain cellular licenses and operating companies, operating telephone companies and certain other assets since January 1, 1996. In conjunction with these acquisitions, the following assets were acquired and liabilities assumed, and Common Shares and Preferred Shares issued:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - --------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Property, plant and equipment $ 26,560 $120,365 $ 55,692 Cellular licenses 94,590 137,409 95,447 Decrease in investment in cellular minority-owned entities (2,317) (89,205) (3,641) Franchise and other costs 5,983 2,452 17,679 Long-term debt (4,450) (4,857) (22,979) Deferred credits (3,905) 1,104 (6,205) Other assets and liabilities, excluding cash and cash equivalents 10,835 7,396 8,154 Common Shares issued and issuable (9,479) (42,685) (113,128) Preferred Shares issued -- (3,000) -- ---------------------------------- Decrease in cash due to acquisitions $117,817 $128,979 $ 31,019 - --------------------------------------------------------------------------- - ---------------------------------------------------------------------------
NOTE 10 ACQUISITIONS, EXCHANGES AND SALES During 1998, 1997 and 1996, TDS and its subsidiaries completed the following business combinations:
Consideration -------------------------------- TDS and U.S. Cellular Common Stock, and TDS Cash Preferred Shares - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Acquisitions During 1998 Cellular interests (1,264,000 population equivalents) $117,319 $ 4,750 Telephone interests (6,500 access lines) 498 8,725 Acquisitions During 1997 Cellular interests (534,000 population equivalents) $128,828 $32,486 Telephone interests (3,200 access lines) 151 13,200 Acquisitions During 1996 Cellular interests (446,000 population equivalents) $ 13,596 $42,499 Telephone interests (33,100 access lines) 17,423 70,663 - ----------------------------------------------------------------------------
Assuming that these acquisitions, accounted for as purchases, had taken place on January 1, 1997, unaudited pro forma results of operations from continuing operations would have been as follows:
YEAR ENDED DECEMBER 31, 1998 1997 - ---------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Operating Revenues $1,828,240 $1,408,352 Net Income (Loss) 65,402 (10,704) Basic Earnings per Share 1.04 (.21) Diluted Earnings per Share $1.04 $ (.21) - ----------------------------------------------------------------------------
31 EXCHANGE OF MARKETS WITH BELLSOUTH In October 1997, U.S. Cellular completed an exchange with BellSouth Corporation. Pursuant to the exchange, U.S. Cellular received majority interests representing 4.0 million population equivalents in exchange for majority interests representing 2.0 million population equivalents, minority interests representing 1.2 million population equivalents and a net amount of $86.7 million in cash. The majority interests U.S. Cellular received are in 12 markets adjacent to its Iowa/Missouri/Illinois/Indiana and Wisconsin/Illinois clusters. SALES OF CELLULAR AND OTHER INVESTMENTS The gains recorded in 1998, 1997 and 1996 reflect the sales of non-strategic cellular and certain other investments. In 1998, U.S. Cellular and TDS Telecom sold their minority interests in certain cellular markets to AirTouch for 5.2 million AirTouch common shares and cash. U.S. Cellular also sold its majority interest in one market for cash. In 1997, U.S. Cellular sold its majority interests in one market and one market partition, minority interests in two other markets and received cash from the settlement of a legal matter. In 1996, U.S. Cellular sold its majority interests in eight markets and minority interests in two other markets, received cash from the settlement of two separate legal matters and received cash in an exchange of markets with another cellular operator. Aerial sold its majority interests in two markets. These transactions, along with the sales of certain other investments by TDS, generated net cash proceeds of $131.0 million, $84.2 million and $221.5 million in 1998, 1997 and 1996, respectively. AMERICAN PAGING MERGER TDS contributed substantially all of the assets and certain, limited liabilities of American Paging to TSR Wireless for a 30% interest in TSR Wireless effective March 31, 1998. See Note 2--Summary of Significant Accounting Policies--Nature of Operations. NOTE 11 NOTES PAYABLE TDS has used short-term debt to acquire PCS licenses, to finance Aerial's construction, start-up and development activities and operations, for acquisitions and for general corporate purposes. Proceeds from the sale of long-term debt and equity securities from time to time, including the sale of debt and equity securities by subsidiaries, have been used to reduce such short-term debt. Proceeds from the sale of non-strategic cellular and other investments from time to time have also been used to reduce short-term debt. TDS had $598 million of committed bank lines of credit for general corporate purposes at December 31, 1998. Unused amounts of such lines totaled $427 million. These lines of credit consist of a $500 million TDS revolving credit facility and $98 million in direct bank lines of credit. TDS has a six-year $500 million revolving credit facility with a group of banks ("TDS Revolving Credit Facility"). As of December 31, 1998, $384 million was unused. The terms of the credit facility provide for borrowings with interest, at the London InterBank Offered Rate ("LIBOR") plus 22.5 basis points. Interest and principal are due the last day of the borrowing period, as selected by the borrower, of either seven days or one, two, three or six months. The credit facility expires in June 2002. TDS also has $98 million in direct bank lines of credit. As of December 31, 1998, $43 million was unused. The terms of the direct bank lines of credit provide for borrowings at negotiated rates up to the prime rate. U.S. Cellular has a seven-year $500 million revolving credit facility with a group of banks ("U.S. Cellular Revolving Credit Facility"). As of December 31, 1998, $500 million was unused. The terms of the credit facility provide for borrowings with interest, at the LIBOR plus 26.5 basis points. Interest and principal are due the last day of the borrowing period, as selected by the borrower, of either seven days or one, two, three or six months. The credit facility expires in August 2004. The carrying amount of short-term debt approximates fair value due to the short-term nature of these instruments. Information concerning notes payable is shown in the table below:
DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Balance at end of year $170,889 $527,587 $160,537 Weighted average interest rate at end of year 6.0% 6.3% 6.0% Maximum amount outstanding during the year $572,405 $587,683 $204,140 Average amount outstanding during the year (1) $360,375 $407,965 $112,341 Weighted average interest rate during the year (1) 5.7% 6.1% 5.8% - ----------------------------------------------------------------------------- (1)THE AVERAGE WAS COMPUTED BASED ON MONTH-END BALANCES.
32 NOTE 12 LONG-TERM DEBT Long-term debt is as follows:
DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Telephone and Data Systems, Inc. (Parent) Medium-term notes, 8% to 10%, (averaging 9%) due through 2025 $ 239,200 $ 239,200 7% Notes, maturing in 2006 200,000 -- Purchase contracts and other long-term notes, 9% to 14%, (averaging 10%) due through 2003 2,201 2,440 ------------------------- Total Parent 441,401 241,640 ------------------------- Subsidiaries U.S. Cellular 6% zero coupon convertible redeemable debentures, maturing in 2015 744,975 744,975 Unamortized discount (463,488) (479,645) ------------------------- 281,487 265,330 ------------------------- 7.25% notes, maturing in 2007 250,000 250,000 TDS Telecom RUS, RTB and FFB Mortgage Notes, due through 2031, various rates averaging 5.5% in 1998, 5.5% in 1997 and 5.4% in 1996 308,494 313,012 Other long-term notes, 0% to 12.6% (averaging 7.2%), due through 2009 5,676 8,723 Aerial 8.34% zero coupon notes, maturing in 2006 226,245 226,245 8.05% zero coupon notes, maturing in 2008 219,975 -- Unamortized discount (213,682) (114,161) ------------------------- 232,538 112,084 ------------------------- Vendor credit agreement, 5.31% due in 2000 45,472 84,355 Other Long-term notes, 7.92% to 8.23%, due through 2002 3,974 3,890 ------------------------- Total Subsidiaries 1,127,641 1,037,394 ------------------------- Total long-term debt 1,569,042 1,279,034 Less current portion 15,946 14,816 ------------------------- Total long-term debt, excluding current portion $1,553,096 $1,264,218 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
The Medium-Term Notes ("MTNs") carry original maturities of 12 to 30 years, maturing at various times from 2003 to 2025. Interest is payable semi-annually. The MTNs may be redeemed by the Company at par value beginning at various times in 1999 to 2006. The Company sold $200 million principal amount of 7% unsecured notes in 1998 with proceeds to the Company of $198.4 million. The notes are due August 2006 and interest is payable semi-annually. The notes are redeemable at any time at the option of the Company, at a redemption price equal to the greater of (a) 100% of the principal amount of such notes, plus accrued but unpaid interest, or (b) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the redemption date on a semi-annual basis at the Treasury Rate plus .25%. The 6% yield to maturity zero coupon convertible redeemable unsecured notes are due in 2015 and there is no periodic payment of interest. The notes are convertible at any time into 9.475 U.S. Cellular Common Shares per $1,000 of notes. Beginning in 2000, U.S. Cellular may redeem, or the holder may call, the notes at the issue price plus accreted interest. U.S. Cellular sold $250 million principal amount of 7.25% unsecured senior notes in 1997 with proceeds of $247.0 million. The notes are due 2007 and interest is payable semi-annually. U.S. Cellular may redeem the notes beginning 2004 at principal amount plus accrued interest. The RUS, RTB and FFB Mortgage Notes issued under certain loan agreements with the Rural Utilities Service ("RUS"), Rural Telephone Bank ("RTB") and Federal Financing Bank ("FFB"), agencies of the United States of America, are to be repaid in equal monthly or quarterly installments covering principal and interest beginning six months to three years after dates of issue and expiring through 2031. Substantially all telephone plant is pledged under RUS and RTB mortgage notes and various other obligations of the telephone subsidiaries. Aerial sold $220 million principal amount at maturity, 10-year zero coupon 8.05% yield to maturity debt in 1998 and $226 million principal amount at maturity, 10-year zero coupon 8.34% yield to maturity debt in 1996. The unsecured notes are due in 2008 and 2006, respectively, and there is no periodic payment of interest. The proceeds were paid to Aerial's equipment vendor in satisfaction of $200 million of obligations. The notes are fully and unconditionally guaranteed by TDS. The notes are subject to optional redemption beginning in 2003 and 2001, respectively, at redemption prices which reflect original issue discount accreted since issuance. In 1998, Nokia Telecommunications Inc. ("Nokia") agreed to provide up to an aggregate of $150 million in financing to Aerial for the purchase of network infrastructure equipment and services from Nokia. Aerial may borrow up to $75 million until June 30, 1999. These loans mature on June 30, 1999, however, the maturity date may be extended to June 30, 2000, upon written notice and payment of an extension fee by Aerial to Nokia. A second $75 million becomes available commencing on June 30, 1999. All loans mature on June 30, 2000. Interest under the agreement is payable monthly at a per annum rate equal to the 30-day LIBOR plus .25%. The obligations of Aerial under the agreement are fully and unconditionally guaranteed by TDS. 33 The annual requirements for principal payments on long-term debt are approximately $15.9 million, $61.2 million, $15.6 million, $15.4 million and $47.4 million for the years 1999 through 2003, respectively. The carrying value and estimated fair value of the Company's Long-term Debt were $1,569 million and $1,606 million at December 31, 1998 and $1,279 million and $1,270 million at December 31, 1997, respectively. The fair value of the Company's long-term debt was estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. NOTE 13 MINORIITY INTEREST IN SUBSIDIARIES The following table summarizes the minority shareholders' and partners' interests in the equity of consolidated subsidiaries.
DECEMBER 31, 1998 1997 - ----------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) U.S. Cellular Public shareholders $362,224 $305,478 Subsidiaries' partners and shareholders 43,609 53,908 ---------------------------- 405,833 359,386 Aerial Public shareholders 3,527 33,692 Subsidiary's shareholders 5,835 -- ---------------------------- 9,362 33,692 TDS Telecom telephone subsidiaries 24,701 23,293 Other 292 195 ---------------------------- $440,188 $416,566 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
SALE OF STOCK BY SUBSIDIARIES In 1998, Sonera, Ltd. ("Sonera"), formerly Telecom Finland Ltd., purchased approximately 2.4 million shares of common stock, representing a 19.423% interest, of Aerial Operating Co., Inc. ("AOC") for $200 million. Prior to this investment, AOC was a wholly-owned subsidiary of Aerial Communications, Inc. ("Aerial"). (AOC owns a 100% interest in each of Aerial's six operating markets.) The Sonera investment was recorded at a fair market value which was more than TDS's book value investment in Aerial. TDS adjusted its book value investment as a result of this investment and increased capital in excess of par value $148.4 million in 1998. Sonera's equity ownership amount in AOC is subject to adjustment based on Aerial's 20-day average stock price during the three years commencing September 8, 1998. Depending on the stock price, Sonera's ownership amount in AOC could decline to approximately 15%. Aerial issued 12.3 million Common Shares in 1996 in an initial public offering (at a price of $17 per share). The initial public offering reduced TDS's ownership percentage from 100% to 82.8%. The Aerial Common Share offering was recorded at a fair market value which was more than TDS's book value investment in Aerial. TDS adjusted its book value investment as a result of this issue and increased capital in excess of par value $114.1 million in 1996. NOTE 14 COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY COMPANY SUBORDINATED DEBENTURES In 1998, TDS Capital II, a subsidiary trust ("Capital II") of TDS, issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable Preferred Securities (the "1998 Preferred Securities") at $25 per Preferred Security. Net proceeds totaled $144.9 million and were used to reduce short-term debt. The sole asset of TDS Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated Debentures due March 31, 2038. In 1997, TDS Capital I, a subsidiary trust ("Capital I") of TDS, issued 6,000,000 of its 8.5% Company-Obligated Mandatorily Redeemable Preferred Securities (the "1997 Preferred Securities") at $25 per Preferred Security. Net proceeds totaled $144.8 million and were used to reduce short-term debt. The sole asset of TDS Capital I is $154.6 million principal amount of TDS's 8.5% Subordinated Debentures due December 31, 2037. The obligations of TDS Capital I and II under 1998 Preferred Securities and 1997 Preferred Securities (the "Preferred Securities") issued by TDS Capital I and II are fully and unconditionally guaranteed by TDS. However, TDS's obligations are subordinate and junior in right of payment to certain other indebtedness of TDS. TDS has the right to defer payments of interest on the Subordinated Debentures by extending the interest payment period, at any time, for up to 20 consecutive quarters. If interest payments on the Subordinated Debentures are so deferred, distributions on the Preferred Securities will also be deferred. During any deferral, distributions will continue to accrue with interest thereon. In addition, during any such deferral, TDS may not declare or pay any dividend or other distribution on, or redeem or purchase, any of its common stock. The 8.04% and 8.5% Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after March 31, 2003, and November 18, 2002, respectively, or, in whole but not in part, at any time in the event of certain income tax circumstances. If the Subordinated Debentures are redeemed, TDS Capital I and II must redeem Preferred Securities on a pro rata basis having an aggregate liquidation amount equal to the aggregate principal amount of the Subordinated Debentures so redeemed. In the event of 34 the dissolution, winding up or termination of TDS Capital I and II, the holders of Preferred Securities will be entitled to receive, for each Preferred Security, a liquidation amount of $25 plus accrued and unpaid distributions thereon to the date of payment, unless, in connection with the dissolution, winding up or termination, Subordinated Debentures are distributed to the holders of the Preferred Securities. The carrying value and estimated fair value of the Company's Preferred Securities were $300.0 million and $297.8 million at December 31, 1998 and $150.0 million and $153.4 million at December 31, 1997, respectively. The fair value of the Company's Preferred Securities was estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of arrangements. NOTE 15 PREFERRED SHARES At December 31, 1998, 259,847 Preferred Shares were authorized, issued and outstanding. Certain series of Preferred Shares are redeemable at the option of TDS at $100 per share, plus accrued and unpaid dividends. The average dividend rate is $5.76 per share. At December 31, 1998, certain series of Preferred Shares are convertible into TDS Common Shares. See Note 16 -- Common Stockholders' Equity -- Convertible Preferred Shares. In connection with the reincorporation of TDS into Delaware, each issued Iowa Preferred Share, no par value, stated value of $100 per share, was converted into a Delaware Preferred Share, $.01 par value. All Preferred Shares have a liquidation value of $100 per share plus accrued and unpaid dividends. Accordingly, Preferred Shares are stated on the balance sheet at $100 per share. The following is a schedule of Preferred Shares activity.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Balance, beginning of year $32,466 $30,858 $44,803 Add: Acquisition -- 3,000 -- Stock Dividends -- -- 113 Less: Conversion of preferred (6,114) (1,031) (4,602) Redemption of preferred (367) (361) (9,456) ----------------------------------- Balance, end of year $25,985 $32,466 $30,858 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
The carrying value and estimated fair value of the Company's Preferred Shares were $26.0 million and $17.8 million at December 31, 1998 and $32.5 million and $23.6 million at December 31, 1997, respectively. The fair value of the Company's Preferred Shares was estimated using discounted cash flow analysis based on the Company's current incremental borrowing rates for similar types of arrangements. NOTE 16 COMMON STOCKHOLDER'S EQUITY COMMON STOCK The following table summarizes the number of Common and Series A Common Shares outstanding:
Series A Common Common Treasury Shares Shares Shares ----------------------------------------------------------------------------- (SHARES IN THOUSANDS) Balance December 31, 1995 51,137 6,893 -- Acquisitions of cellular and telephone interests 2,645 -- -- Dividend reinvestment, incentive and compensation plans 100 27 -- Conversion of Preferred Shares 352 -- -- Conversion of Series A Common Shares 3 (3) -- -------------------------------- Balance December 31, 1996 54,237 6,917 -- Repurchase Common Shares -- -- (1,798) Acquisitions of cellular and telephone interests 16 -- 999 Dividend reinvestment, incentive and compensation plans 122 19 4 Conversion of Preferred Shares 68 -- -- -------------------------------- Balance December 31, 1997 54,443 6,936 (795) Acquisitions of cellular and telephone interests 228 -- -- Dividend reinvestment, incentive and compensation plans 39 14 34 Conversion of Preferred Shares 278 -- -- -------------------------------- Balance December 31, 1998 54,988 6,950 (761) - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
In connection with the reincorporation of TDS into Delaware, each issued, Iowa Common and Series A Common Share, $1 par value, was converted into a Delaware Common and Series A Common Share, $.01 par value. The December 31, 1998 amounts for Common Shares, Series A Common Shares and Capital in Excess of Par Value have been adjusted to reflect the change in par value. CONVERTIBLE PREFERRED SHARES TDS convertible Preferred Shares are convertible into 688,977 Common Shares. See Note 15 -- Preferred Shares. TDS issued 274,634 Common Shares in 1998, 56,365 in 1997 and 347,707 in 1996 for TDS Preferred Shares converted. TDS also issued 3,780 Common Shares in 1998, 11,345 in 1997 and 3,781 in 1996 for subsidiary preferred stock converted. SERIES A COMMON SHARES The holders of Common Shares and outstanding Preferred Shares are entitled to one vote per share. The holders of Series A Common Shares are entitled to ten votes per share. Series A Common Shares are convertible, on a share-for-share basis, into Common Shares. TDS has reserved 6,949,904 Common Shares for possible issuance upon such conversion. 35 COMMON SHARE REPURCHASE PROGRAM In December 1996, the Company authorized the repurchase of up to 3.0 million TDS Common Shares over a period of three years. The Company may use repurchased shares to fund acquisitions and for other corporate purposes. Subject to prevailing market conditions, purchases may be made from time to time through open market purchases or at negotiated prices in private transactions. The actual number of Common Shares which may be repurchased will be subject to the trading price of the Common Shares, the Company's financial position and other factors. Through December 31, 1997, the Company purchased 1,798,100 Common Shares for $69.9 million. No Common Shares were repurchased in 1998. The Company reissued 33,400 and 4,700 Common Shares in 1998 and 1997, respectively, for incentive and compensation plans and 998,800 Common Shares in 1997 for acquisitions. ACCUMULATED OTHER COMPREHENSIVE INCOME Effective January 1, 1998, the Company implemented the provisions of SFAS No. 130, "Reporting Comprehensive Income." Under SFAS No. 130, the Company is required to report all changes in equity during a period, except those resulting from investments and distributions by owners, in a financial statement for the period in which they are recognized. The Company has chosen to disclose Comprehensive Income, which encompasses Net Income and Net Unrealized Gains on Securities, in the Consolidated Statements of Common Stockholders' Equity. Prior years have been restated to conform to the requirements of SFAS No. 130. The income tax effects allocated to and the cumulative balance of unrealized gains on securities are as follows:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Balance, beginning of year $ 683 $513 $ 7 Add: Unrealized gains on securities 147,620 473 819 Income tax effect 59,316 210 313 --------------------------------- 88,304 263 506 Minority share of unrealized gains 13,198 -- -- --------------------------------- Net unrealized gains 75,106 263 506 --------------------------------- Deduct: Gain on sales of securities 300 154 -- Income tax expense 120 61 -- --------------------------------- Net realized gains included in Net Income 180 93 -- --------------------------------- Net Unrealized gains included in Comprehensive Income 74,926 170 506 --------------------------------- Balance, end of year $ 75,609 $683 $513 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
NOTE 17 DIVIDEND REINVESTMENT, INCENTIVE AND COMPENSATION PLANS The following table summarizes Common and Series A Common Shares issued, including reissued Treasury Shares, for the employee stock ownership plans and dividend reinvestment plans described below.
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ Common Shares Tax-deferred savings plan 13,270 32,354 36,269 Dividend reinvestment plan 14,883 25,273 28,827 Stock-based compensation plans 44,662 69,109 35,273 --------------------------------- 72,815 126,736 100,369 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ Series A Common Shares Dividend reinvestment plan 13,627 19,731 26,445 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
TAX-DEFERRED SAVINGS PLAN TDS had reserved 158,695 Common Shares for issuance under the TDS Tax-Deferred Savings Plan, a qualified profit-sharing plan pursuant to Sections 401(a) and 401(k) of the Internal Revenue Code. Participating employees have the option of investing their contributions in TDS Common Shares, U.S. Cellular Common Shares, Aerial Common Shares or five nonaffiliated funds. DIVIDEND REINVESTMENT PLANS TDS had reserved 445,859 Common Shares for issuance under the Automatic Dividend Reinvestment and Stock Purchase Plan and 158,896 Series A Common Shares for issuance under the Series A Common Share Automatic Dividend Reinvestment Plan. These plans enable holders of TDS's Common Shares and Preferred Shares to reinvest cash dividends in Common Shares and holders of Series A Common Shares to reinvest cash dividends in Series A Common Shares. The purchase price of the shares is 95% of the market value, based on the average of the daily high and low sales prices for TDS's Common Shares on the American Stock Exchange for the ten trading days preceding the date on which the purchase is made. STOCK-BASED COMPENSATION PLANS TDS had reserved 3,013,795 Common Shares for options granted and to be granted to key employees. TDS has established certain plans that provide for the grant of stock options to officers and employees. The options are exercisable over a 36 specified period not in excess of ten years. The options expire from 1999 to 2008 or the date of the employee's termination of employment, if earlier. TDS accounts for stock options, stock appreciation rights ("SARs") and employee stock purchase plans under Accounting Principles Board ("APB") Opinion No. 25. No compensation costs have been recognized for the stock option and employee stock purchase plans. Compensation expense for SARs, measured on the difference between the year-end market price of the Common Shares and SAR prices, was $91,000 and $263,000 in 1997 and 1996, respectively. Had compensation cost for all plans been determined consistent with SFAS No. 123 "Accounting for Stock-Based Compensation," the Company's net income (loss) and earnings per share would have been reduced to the following pro forma amounts:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net Income (Loss) As Reported $ 64,408 $ (9,549) $128,139 Pro Forma 58,918 (13,506) 126,495 Basic Earnings per Share As Reported 1.03 (.19) 2.09 Pro Forma .94 (.26) 2.06 Diluted Earnings per Share As Reported 1.03 (.19) 2.07 Pro Forma $ .94 $ (.26) $ 2.05 - ------------------------------------------------------------------------------
A summary of the status of the Company's stock option plans at December 31, 1998, 1997 and 1996 and changes during the years then ended is presented in the table and narrative below:
Weighted Weighted Number Average Average of Shares Option Prices Fair Values - ----------------------------------------------------------------------------- Stock Options: Outstanding December 31, 1995 (240,160 exercisable) 516,445 $32.47 Granted 89,228 $41.00 $13.30 Exercised (11,025) $13.10 Canceled (3,210) $39.89 -------- Outstanding December 31, 1996 (405,996 exercisable) 591,438 $34.08 Granted 68,137 $43.90 $10.61 Exercised (43,824) $19.51 Canceled (41,243) $40.78 -------- Outstanding December 31, 1997 (492,917 exercisable) 574,508 $35.87 Granted 463,433 $42.09 $11.73 Exercised (21,227) $30.36 Canceled (14,089) $47.45 -------- Outstanding December 31, 1998 (776,653 exercisable) 1,002,625 $38.70 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
Of the options outstanding at December 31, 1998, 776,653 options are exercisable, have exercise prices between $4.15 and $47.60 with a weighted average exercise price of $37.90, and a weighted average remaining contractual life of 6.3 years. The remaining 225,972 options are not exercisable, have exercise prices between $4.15 and $46.87 with a weighted average exercise price of $41.47, and a weighted average remaining contractual life of 8.3 years. STOCK OPTIONS. The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively: risk-free interest rates of 5.2%, 6.1% and 5.6%; expected dividend yields of 1.0%, 1.0% and 1.0%; expected lives of 7.0 years, 5.0 years and 5.1 years and expected volatility of 20.4%, 19.2% and 20.5%. STOCK APPRECIATION RIGHTS allow the grantee to receive an amount in cash or Common Shares, or a combination thereof, equivalent to the difference between the exercise price and the fair market value of Common Shares on the exercise date. The following table summarizes outstanding rights which expired in March 1997. The fair value of each stock appreciation right grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997 and 1996, respectively: risk-free interest rates of 4.9% and 5.2%; expected dividend yields of 1.0% and 1.0%; expected lives of 0.1 year and 0.2 year; and expected volatility of 20.5% and 18.4%.
YEAR ENDED DECEMBER 31, 1997 1996 - ----------------------------------------------------------------------------- Outstanding beginning of period 10,070 16,034 Granted 630 5,923 Exercised (10,700) (11,887) --------------------- Outstanding end of period -- 10,070 - ----------------------------------------------------------------------------- - -----------------------------------------------------------------------------
EMPLOYEE STOCK PURCHASE PLAN. TDS had reserved 138,765 Common Shares for sale to the employees of TDS and its subsidiaries. The fair value of the employees' purchase rights was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants of rights in 1998, 1997 and 1996, respectively: risk-free interest rate of 5.4%, 5.6% and 5.6%; expected dividend yield of 1.0%, 1.0% and 1.0%; expected lives of 2.0 years, 1.2 years and 0.5 year; and expected volatility of 17.4%, 16.9% and 15.3%. 37 NOTE 18 EMPLOYEE BENEFIT PLANS PENSION PLAN The Company sponsors two qualified noncontributory defined contribution pension plans. One plan (the "TDS Plan") provides benefits for the employees of TDS, TDS Telecom and substantially all of the telephone company subsidiaries. (Employees of certain telephone subsidiaries are covered under other pension plans or receive direct pension payments.) The other plan provides pension benefits for U.S. Cellular and Aerial employees. Under these plans, pension costs are calculated separately for each participant and are funded currently. TDS also sponsors an unfunded non-qualified deferred compensation plan to supplement the benefits under these plans to offset the reduction of benefits caused by the limitation on annual employee compensation under the tax laws. Total pension costs were $7.7 million, $5.3 million and $4.6 million in 1998, 1997 and 1996, respectively. OTHER POSTRETIREMENT BENEFITS The Company sponsors two defined benefit postretirement plans that cover most of the employees of TDS, TDS Telecom and its telephone subsidiaries. One plan provides medical benefits and the other plan provides life insurance benefits. Both plans are contributory, with retiree contributions adjusted annually. The medical plan anticipates future cost sharing changes that are consistent with the Company's intent to increase retiree contributions by the health care cost trend rate. An amount not to exceed 25% of the total contribution to the TDS Plan will be contributed to fund the cost of the medical benefits annually. An additional contribution equal to a reasonable amortization of the past service cost may be made without regard to the 25% limitation described above. The Company's postretirement medical and life insurance plans are currently underfunded. The following table reconciles the beginning and ending balances of the benefit obligation and the fair value of plan assets for the other postretirement benefit plans:
DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Change in Benefit Obligation Benefit obligation at beginning of year $21,339 $ 17,781 Service cost 933 875 Interest cost 1,486 1,346 Amendments 198 1,534 Actuarial gain (1,968) 276 Benefits paid (652) (473) --------------------- Benefit obligation at end of year 21,336 21,339 --------------------- Change in Plan Assets Fair value of plan assets at beginning of year 14,604 10,259 Actual return on plan assets 723 2,469 Employer contribution 2,171 2,349 Acquisition 2,130 -- Benefits paid (652) (473) --------------------- Fair value of plan assets at end of year 18,976 14,604 --------------------- Funded Status (2,360) (6,735) Unrecognized net actuarial gain (8,517) (6,720) Unrecognized prior service cost 1,414 2,091 --------------------- Prepaid (accrued) benefit cost $(9,463) $(11,364) - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
The following table sets forth the weighted average assumptions used in accounting for the plans:
DECEMBER 31, 1998 1997 - ------------------------------------------------------------------------------ Discount rate 7.0% 7.0% Expected return on plan assets 8.0% 8.0% - ------------------------------------------------------------------------------
For measurement purposes, a 9.9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1998; the rate was assumed to decrease over six years to 6.1% and to remain at 6.1% thereafter. Net periodic benefit cost for the years ended December 31, 1998, 1997 and 1996 include the following components:
YEAR ENDED DECEMBER 31, 1998 1997 1996 - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) Service cost $ 933 $ 875 $ 796 Interest cost on accumulated postretirement benefit obligation 1,486 1,346 1,125 Expected return on plan assets (1,271) (632) (753) Net amortization and deferral (160) (344) 99 --------------------------------- Net postretirement cost $ 988 $1,245 $1,267 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
38 The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage-point increase or decrease in assumed health care cost trend rates would result in a $506,000 increase or decrease in the total of service and interest cost components and a $3.5 million increase or decrease in the postretirement benefit obligation, respectively. NOTE 19 COMMITMENTS CONSTRUCTION AND EXPANSION The primary purpose of TDS's construction and expansion program is to provide for normal growth, to upgrade communications service, to expand into new communication areas, and to take advantage of service-enhancing and cost- reducing technological developments. The U.S. Cellular capital additions budget totals approximately $300 million for 1999, to expand and enhance coverage, including adding digital service capabilities to its systems and to enhance office systems. The TDS Telecom capital additions budget totals approximately $120 million for 1999, including approximately $45 million for outside plant facilities and $35 million for switching facilities in the Incumbent Local Exchange Carrier ("ILEC") markets and $12 million for current Competitive Local Exchange Carrier ("CLEC") operations. The Aerial capital additions budget totals approximately $130 million for 1999, including approximately $100 million for cell sites and switching equipment and $27 million for systems development. In addition, Aerial will require an estimated $125 million for working capital and operating expenses and $80 million for interest expense. LEASE COMMITMENTS TDS and its subsidiaries have leases for certain cellular plant facilities, office space and data processing equipment, most of which are classified as operating leases. For the years 1998, 1997 and 1996, rent expense for noncancelable, long-term leases was $52.1 million, $36.9 million and $20.9 million, respectively, and rent expense under cancelable, short-term leases was $9.1 million, $8.7 million and $7.6 million, respectively. At December 31, 1998, the aggregate minimum rental commitments under noncancelable, long-term operating leases were as follows:
MINIMUM FUTURE RENTAL PAYMENTS - ------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) 1999 $45,875 2000 41,915 2001 36,590 2002 25,493 2003 16,865 Thereafter $87,983 - ------------------------------------------------------------------------------
NOTE 20 BUSINESS SEGMENT INFORMATION TDS is a diversified telecommunications service company with established cellular telephone and local telephone operations and developing personal communications services ("PCS") operations. The Company manages these operations through separate subsidiaries as described below. For the year ended December 31, 1998, cellular operations provided 64% of the Company's consolidated revenues, telephone operations provided 27% and PCS operations provided 9%. The Company's long-term business development strategy is to expand its existing operations through internal growth and acquisitions and to explore and develop other telecommunications businesses that management believes will utilize the Company's expertise in customer-based telecommunications. The Company conducts substantially all of its cellular operations through its 81.0%-owned subsidiary United States Cellular Corporation ("U.S. Cellular"). At December 31, 1998, U.S. Cellular provided cellular telephone service to 2,183,000 customers through 138 majority-owned and managed ("consolidated") cellular systems in 24 states. Cellular revenues primarily consist of: (i) charges for access, airtime and value-added services provided to U.S. Cellular's local retail customers who use the local systems operated by U.S. Cellular; (ii) charges to customers of other systems who use U.S. Cellular's cellular systems when roaming; (iii) charges for long-distance calls made on U.S. Cellular's systems; and (iv) equipment sales. The Company conducts its telephone operations through its wholly-owned subsidiary TDS Telecommunications Corporation ("TDS Telecom"). At December 31, 1998, TDS Telecom operated 105 telephone companies serving 547,500 access lines in 28 states. TDS Telecom is expanding by offering additional lines of telecommunications products and services to existing customers and through the selective acquisition of local exchange telephone companies serving rural and suburban areas. Telephone revenues consist of: (i) local telephone exchange service provided within the franchise serving area of TDS Telecom's telephone subsidiaries; (ii) compensation for carrying interstate and intrastate long-distance traffic on TDS Telecom's operating telephone subsidiaries' networks; (iii) miscellaneous revenues related to (a) leasing, selling, installing, maintaining and repairing customer premise telecommunications equipment, such as telephone answering equipment or business systems and associated peripheral equipment, and wiring, (b) providing billing and collection services for interexchange carriers, (c) leasing network facilities, (d) sale of satellite dishes (Digital Broadcast Satellite or "DBS") and (e) providing Internet services; and (iv) revenues from CLEC operations. 39 The Company conducts its broadband PCS operations through its 82.3%-owned subsidiary Aerial Communications, Inc. ("Aerial"). Aerial provides PCS service in the Minneapolis, Tampa-St. Petersburg-Orlando, Houston, Pittsburgh, Kansas City and Columbus Major Trading Areas ("MTAs"). Aerial has commenced service in all its markets and provided service to 311,900 PCS telephones as of December 31, 1998. PCS revenues primarily consist of: (i) charges for access, airtime and value-added services provided to Aerial's retail customers who use the network operated by Aerial; (ii) charges for long-distance calls made on Aerial's systems; and (iii) equipment sales revenue representing the sale of handsets and related accessories to retailers, independent agents, and end user customers. In December 1998, TDS announced that it was pursuing a tax-free spin-off of its 82.3% interest in Aerial, as well as reviewing other alternatives. See Note 1 -- Corporate Restructuring. TDS contributed substantially all of the assets and certain, limited liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC ("TSR Wireless") for a 30% interest in TSR Wireless effective March 31, 1998. American Paging's revenues are netted against its expenses in the Consolidated Statements of Operations with the resulting operating loss reported as American Paging Operating (Loss). American Paging revenues primarily consist of dispatch services, subscriber device rental and equipment sales representing sales of pagers to customers. Beginning April 1, 1998, TDS followed the equity method of accounting for its 30% interest in TSR Wireless and reported these results as a component of Investment income. U.S. Cellular, TDS Telecom and Aerial are billed for all services they receive from TDS, consisting primarily of information processing and general management services. Such billings are based on expenses specifically identified to U.S. Cellular, TDS Telecom and Aerial and on allocations of common expenses. Such allocations are based on the relationship of U.S. Cellular's, TDS Telecom's and Aerial's assets, employees, investment in plant and expenses to the total assets, employees, investment in plant and expenses of TDS. Management believes the method used to allocate common expenses is reasonable and that all expenses and costs applicable to U.S. Cellular, TDS Telecom and Aerial are reflected in the accompanying business segment information on a basis which is representative of what they would have been if U.S. Cellular, TDS Telecom and Aerial operated on a stand-alone basis. Financial data for the Company's business segments for each of the years ended December 31, 1998, 1997 and 1996 are as follows:
YEAR ENDED OR AT DECEMBER 31, 1998 U.S. Cellular TDS Telecom Aerial All Other(1) Total - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Operating revenues $1,162,467 $ 488,104 $ 155,154 $ 17,783 $1,823,508 Operating cash flow 382,854 205,814 (196,584) (3,511) 388,573 Depreciation and amortization expense 206,779 111,402 83,401 7,895 409,477 Operating income (loss) 176,075 94,412 (279,985) (11,406) (20,904) Significant noncash items: Deferred taxes (2) 107,201 17,471 2,578 (77,901) 49,349 Investment income 42,451 1,121 (128) (2,798) 40,646 Minority share of (income) loss (6,039) (339) 23,620 11,271 28,513 Gain on sale of cellular and other investments 215,154 38,803 -- 8,741 262,698 Noncash interest expense 20,189 -- 16,210 -- 36,399 Total Assets 3,047,636 1,572,339 961,347 3,429,433 9,010,755 Investment in equity method investees 136,027 28,987 1,443 125,024 291,481 Capital expenditures $ 330,411 $ 143,125 $ 74,580 $ 10,216 $ 558,332 - ----------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED OR AT DECEMBER 31, 1997 U.S. Cellular TDS Telecom Aerial All Other(1) Total - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Operating revenues $ 876,965 $ 437,624 $ 55,952 $ 94,413 $1,464,954 Operating cash flow 261,922 198,164 (157,480) (3,267) 299,339 Depreciation and amortization expense 132,379 98,021 39,071 32,040 301,511 Operating income (loss) 129,543 100,143 (196,551) (35,307) (2,172) Significant noncash items: Deferred taxes (2) 24,077 2,691 1,806 (11,338) 17,236 Investment income 77,121 3,285 (2,518) 3,262 81,150 Minority share of (income) loss (12,298) (1,155) -- 21,769 8,316 Gain on sale of cellular and other investments 30,318 722 -- 10,398 41,438 Noncash interest expense 15,948 -- 8,341 -- 24,289 Total Assets 2,508,916 1,406,060 960,648 3,560,782 8,436,406 Investment in equity method investees 197,786 42,167 510 25,501 265,964 Capital expenditures $ 318,748 $ 151,460 $ 274,709 $ 41,400 $ 786,317 - -----------------------------------------------------------------------------------------------------------------------------------
40
YEAR ENDED OR AT DECEMBER 31, 1996 U.S. Cellular TDS Telecom Aerial All Other(1) Total - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Operating revenues $ 680,068 $ 395,059 $ -- $ 104,187 $1,179,314 Operating cash flow 196,205 190,995 -- (2,849) 384,351 Depreciation and amortization expense 108,839 88,346 -- 33,777 230,962 Operating income (loss) 87,366 102,649 -- (36,626) 153,389 Significant noncash items: Deferred taxes (2) 63,137 (2,659) 2,231 12,306 75,015 Investment income 51,518 6,906 (304) 335 58,455 Minority share of (income) loss (13,743) (1,300) -- (11,273) (26,316) Gain on sale of cellular and other investments 132,718 -- 2,582 3,435 138,735 Noncash interest expense 15,674 -- 1,368 -- 17,042 Total Assets 2,085,899 1,363,900 672,827 2,837,543 6,960,169 Investment in equity method investees 254,281 50,639 6,149 24,076 335,145 Capital expenditures $ 248,123 $ 144,440 $ 112,939 $ 44,702 $ 550,204 - -----------------------------------------------------------------------------------------------------------------------------------
(1) CONSISTS OF THE TDS CORPORATE OPERATIONS, AMERICAN PAGING OPERATIONS AND ALL OTHER BUSINESSES NOT INCLUDED IN THE U.S. CELLULAR, TDS TELECOM OR AERIAL SEGMENTS. (2) TAX BENEFITS ASSOCIATED WITH NET OPERATING LOSS CARRYFORWARDS REMAIN AT THE TDS CORPORATE LEVEL.
YEAR ENDED OR AT DECEMBER 31, 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) Reconciliation of Segment Revenues to Consolidated Revenues: Total Revenues for reportable segments $ 1,823,508 $ 1,464,954 $ 1,179,314 American Paging revenues included in "American Paging Operating (Loss)" (17,783) (94,413) (104,187) ------------------------------------------- Consolidated Revenues $ 1,805,725 $ 1,370,541 $ 1,075,127 - ----------------------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------------------- Reconciliation of Segment Total Assets to Consolidated Total Assets: Total Assets for reportable segments $ 9,010,755 $ 8,436,406 $ 6,960,169 Intercompany eliminations (3) (3,483,210) (3,464,805) (2,759,200) ------------------------------------------- Consolidated Total Assets $ 5,527,545 $ 4,971,601 $ 4,200,969 - ----------------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------------
(3) INTERCOMPANY ELIMINATIONS CONSIST PRIMARILY OF THE ELIMINATION OF TDS'S BOOK VALUE INVESTMENT IN ITS SUBSIDIARIES AND THE ELIMINATION OF INTERCOMPANY RECEIVABLES. 41 NOTE 21 CONTINGENCIES The Company is involved in legal proceedings before the FCC and various state and federal courts from time to time. Management does not believe that any of such proceedings should have a material adverse impact on the financial position, results of operations or cash flows of the Company. In September 1998, pursuant to a purchase agreement between TDS, Aerial, Aerial Operating Company, Inc. ("AOC"), and Sonera Ltd., a limited liability company organized under the laws of Finland ("Sonera"), Sonera purchased 2.4 million shares of common stock of AOC representing a 19.423% equity interest in AOC, subject to adjustment under certain circumstances, for an aggregate purchase price of $200 million. Sonera has the right, subject to adjustment under certain circumstances, to exchange each share of AOC common stock which it owns for 6.72919 Common Shares of Aerial. Upon the exchange of all of the AOC shares, Sonera would own an 18.452% equity interest in Aerial, reflecting a purchase price equivalent to $12.33 per Common Share of Aerial (the "Equivalent Purchase Price"). Following the announcement by TDS in December 1998, that it intended to distribute to its shareholders all of the capital stock of Aerial that it owns, and that Aerial would seek additional financing from sources other than TDS in connection therewith, Sonera contacted TDS to express certain concerns about the announcement. Sonera has asserted that the TDS announcement reflects a change in circumstances that warrant the renegotiation of certain matters related to its investment in AOC, including an adjustment in the Equivalent Purchase Price, and has raised the possibility of litigation in connection therewith. TDS and Aerial intend to attempt to reach a mutually acceptable resolution of the concerns raised by Sonera. There can be no assurance that this matter will not lead to litigation, or that it will not have a material adverse effect on TDS or Aerial or on the plans relating to the refinancing and spin-off of Aerial. - ------------------------------------------------------------------------------- Report of Independent Public Accountants - ------------------------------------------------------------------------------- TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF TELEPHONE AND DATA SYSTEMS, INC.: We have audited the accompanying consolidated balance sheets of Telephone and Data Systems, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Telephone and Data Systems, Inc. and Subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Arthur Andersen LLP Chicago, Illinois January 27, 1999 - ------------------------------------------------------------------------------- 42 Consolidated Quarterly Income Information (Unaudited) - -------------------------------------------------------------------------------
QUARTER ENDED March 31 June 30 Sept. 30 Dec. 31 - ---------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1998 Operating Revenues $390,069 $446,951 $473,808 $494,897 Operating Income (Loss) from Ongoing Operations (14,126) 5,493 25,083 (25,948) Gain on Sale of Cellular and Other Investments 221,442 10,516 3,399 27,341 Net Income (Loss) Available to Common 73,730 (14,095) 5,910 (2,788) From Operations (38,754) (19,218) 4,009 (17,610) From Gains $112,484 $ 5,123 $ 1,901 $ 14,822 Weighted Average Shares Outstanding (000s) 60,750 60,984 61,036 61,157 Basic Earnings per Share $ 1.21 $ (.23) $ .10 $ (.05) Diluted Earnings per Share 1.20 (.23) .10 (.05) From Operations (.64) (.32) .07 (.29) From Gains $ 1.84 $ .09 $ .03 $ .24 1997 Operating Revenues $289,487 $331,513 $362,899 $386,642 Operating Income (Loss) from Ongoing Operations 50,466 14,769 5,310 (37,410) Gain on Sale of Cellular and Other Investments -- 10,598 13,767 17,073 Net Income (Loss) Available to Common 9,136 6,351 8,549 (35,476) From Operations 9,136 2,344 106 (38,940) From Gains $ -- $ 4,007 $ 8,443 $ 3,464 Weighted Average Shares Outstanding (000s) 61,184 60,051 59,511 60,099 Basic Earnings per Share $ .15 $ .11 $ .14 $ (.59) Diluted Earnings per Share .15 .11 .14 (.59) From Operations .15 .04 -- (.65) From Gains $ -- $ .07 $ .14 $ .06 - ----------------------------------------------------------------------------------------------------------------
NOTE: CERTAIN 1997 AMOUNTS WERE RECLASSIFIED FOR CURRENT PERIOD PRESENTATION. NET INCOME AVAILABLE TO COMMON FOR 1998 INCLUDED SIGNIFICANT GAINS FROM THE SALES OF CELLULAR AND OTHER INVESTMENTS. THE TABLE ABOVE SUMMARIZES THE EFFECT OF THE GAINS ON NET INCOME (LOSS) AVAILABLE TO COMMON AND DILUTED EARNINGS PER SHARE. MANAGEMENT BELIEVES U.S. CELLULAR'S OPERATING RESULTS REFLECT SEASONALITY IN BOTH SERVICE REVENUES, WHICH TEND TO INCREASE MORE SLOWLY IN THE FIRST AND FOURTH QUARTERS, AND OPERATING EXPENSES, WHICH TEND TO BE HIGHER IN THE FOURTH QUARTER DUE TO INCREASED MARKETING ACTIVITIES AND CUSTOMER GROWTH. THIS SEASONALITY MAY CAUSE OPERATING INCOME TO VARY FROM QUARTER TO QUARTER. AERIAL BEGAN COMMERCIAL SERVICE IN THE SECOND QUARTER OF 1997. THE SIGNIFICANT DECREASE IN OPERATING INCOME (LOSS) FROM ONGOING OPERATIONS AND NET INCOME (LOSS) AVAILABLE TO COMMON BEGINNING IN THE SECOND QUARTER OF 1997 IS PRIMARILY A RESULT OF THE COMMENCEMENT OF PCS OPERATIONS. - ------------------------------------------------------------------------------- Shareowners' Information 43 - ------------------------------------------------------------------------------- TDS STOCK AND DIVIDEND INFORMATION TDS's Common Shares are listed on the American Stock Exchange ("AMEX") under the symbol "TDS" and in the newspapers as "TeleData." As of February 26, 1999, TDS Common Shares were held by 3,556 record owners and the Series A Common Shares were held by 97 record owners. TDS has paid cash dividends on Common Shares since 1974, and paid dividends of $.44 and $.42 per Common and Series A Common Share during 1998 and 1997, respectively. The Common Shares of United States Cellular Corporation, an 81.0%-owned subsidiary of TDS, are listed on the AMEX under the symbol "USM" and in the newspapers as "US Cellu." The Common Shares of Aerial Communications, Inc., an 82.3%-owned subsidiary of TDS are listed on the NASDAQ National Market under the symbol "AERL" and in the newspapers as "AerialComm." MARKET PRICE PER COMMON SHARE BY QUARTER TDS's Series A Common Shares and Preferred Shares are not actively traded and therefore, quotations are not reported for such securities. Dividends on TDS's Preferred Shares have been paid quarterly since the dates of issue. The high and low sales prices of the Common Shares on the AMEX as reported by the Dow Jones News Service are as follows: 1998 1st 2nd 3rd 4th - ---------------------------------------------------------------- High $50.13 49.75 44.25 47.88 Low $43.19 38.25 30.94 30.63 Dividends Paid $ .11 .11 .11 .11 - ---------------------------------------------------------------- 1997 1st 2nd 3rd 4th - ---------------------------------------------------------------- High $42.00 40.50 45.31 49.94 Low $34.50 36.25 36.56 39.50 Dividends Paid $ .105 .105 .105 .105 - ---------------------------------------------------------------- EX-21 7 EXHIBIT 21 TELEPHONE AND DATA SYSTEMS, INC. SUBSIDIARY AND AFFILIATED COMPANIES DECEMBER 31, 1998 EXHIBIT 21
TDS COMPANIES ------------- TELEPHONE COMPANIES - ------------------- TDS TELECOMMUNICATIONS CORPORATION DELAWARE NORTHEAST REGION - ---------------- THE CHICHESTER TELEPHONE COMPANY NEW HAMPSHIRE DEPOSIT TELEPHONE COMPANY, INC. NEW YORK EDWARDS TELEPHONE COMPANY, INC. NEW YORK HAMPDEN TELEPHONE COMPANY MAINE HARTLAND & ST. ALBANS TELEPHONE COMPANY MAINE THE ISLAND TELEPHONE COMPANY MAINE KEARSARGE TELEPHONE COMPANY NEW HAMPSHIRE LUDLOW TELEPHONE COMPANY VERMONT MAHANOY & MAHANTANGO TELEPHONE COMPANY PENNSYLVANIA MERIDEN TELEPHONE COMPANY, INC. NEW HAMPSHIRE NORTHFIELD TELEPHONE COMPANY VERMONT ORISKANY FALLS TELEPHONE CORP. NEW YORK PERKINSVILLE TELEPHONE COMPANY, INC. VERMONT PORT BYRON TELEPHONE COMPANY NEW YORK SOMERSET TELEPHONE COMPANY MAINE SUGAR VALLEY TELEPHONE COMPANY PENNSYLVANIA VERNON TELEPHONE COMPANY NEW YORK WARREN TELEPHONE COMPANY MAINE WEST PENOBSCOT TELEPHONE & TELEGRAPH COMPANY MAINE SOUTHEAST REGION - ---------------- AMELIA TELEPHONE CORPORATION VIRGINIA BARNARDSVILLE TELEPHONE COMPANY NORTH CAROLINA BLUE RIDGE TELEPHONE COMPANY GEORGIA BUTLER TELEPHONE COMPANY, INC. ALABAMA CALHOUN CITY TELEPHONE COMPANY, INC. MISSISSIPPI CAMDEN TELEPHONE AND TELEGRAPH COMPANY GEORGIA CONCORD TELEPHONE EXCHANGE, INC. TENNESSEE HUMPHREYS COUNTY TELEPHONE COMPANY TENNESSEE LESLIE COUNTY TELEPHONE COMPANY KENTUCKY LEWISPORT TELEPHONE COMPANY, INC. KENTUCKY McCLELLANVILLE TELEPHONE COMPANY, INC. SOUTH CAROLINA MYRTLE TELEPHONE COMPANY MISSISSIPPI NELSON BALLGROUND TELEPHONE COMPANY GEORGIA NEW CASTLE TELEPHONE COMPANY VIRGINIA NORWAY TELEPHONE COMPANY SOUTH CAROLINA OAKMAN TELEPHONE COMPANY, INC. ALABAMA PEOPLES TELEPHONE COMPANY ALABAMA QUINCY TELEPHONE COMPANY FLORIDA SALEM TELEPHONE COMPANY, INC. KENTUCKY SALUDA MOUNTAIN TELEPHONE COMPANY NORTH CAROLINA SERVICE TELEPHONE COMPANY, INC. NORTH CAROLINA SOUTHEAST MISSISSIPPI TELEPHONE COMPANY MISSISSIPPI ST STEPHEN TELEPHONE COMPANY SOUTH CAROLINA TELLICO TELEPHONE COMPANY, INC. TENNESSEE TENNESSEE TELEPHONE COMPANY TENNESSEE VIRGINIA TELEPHONE COMPANY VIRGINIA WILLISTON TELEPHONE COMPANY SOUTH CAROLINA
Page 1 TELEPHONE AND DATA SYSTEMS, INC. SUBSIDIARY AND AFFILIATED COMPANIES DECEMBER 31, 1998
WESTERN DIVISION - ---------------- ARIZONA TELEPHONE COMPANY ARIZONA ASOTIN TELEPHONE COMPANY WASHINGTON CLEVELAND COUNTY TELEPHONE CO., INC. ARKANSAS DECATUR TELEPHONE COMPANY ARKANSAS DELTA COUNTY TELE-COMM, INC. COLORADO HAPPY VALLEY TELEPHONE COMPANY CALIFORNIA HOME TELEPHONE COMPANY OREGON HORNITOS TELEPHONE COMPANY CALIFORNIA LEWIS RIVER TELEPHONE COMPANY WASHINGTON MCDANIEL TELEPHONE COMPANY DELAWARE MID-AMERICA TELEPHONE, INC. OKLAHOMA NEW LONDON TELEPHONE COMPANY MISSOURI OKLAHOMA COMMUNICATION SYSTEMS, INC. OKLAHOMA ORCHARD FARM TELEPHONE COMPANY MISSOURI POTLATCH TELEPHONE COMPANY IDAHO SOUTHWESTERN TELEPHONE COMPANY ARIZONA STOUTLAND TELEPHONE COMPANY MISSOURI STRASBURG TELEPHONE COMPANY COLORADO TROY TELEPHONE COMPANY, INC. IDAHO WINTERHAVEN TELEPHONE COMPANY CALIFORNIA WYANDOTTE TELEPHONE CO. OKLAHOMA MIDWEST REGION - -------------- ARVIG TELEPHONE COMPANY MINNESOTA BADGER TELECOM, INC. WISCONSIN BLACK EARTH TELEPHONE COMPANY, INC. WISCONSIN BONDUEL TELEPHONE COMPANY WISCONSIN BRIDGE WATER TELEPHONE COMPANY MINNESOTA BURLINGTON, BRIGHTON & WHEATLAND TELEPHONE COMPANY WISCONSIN CENTRAL STATE TELEPHONE COMPANY WISCONSIN DANUBE COMMUNICATIONS, INC. MINNESOTA EASTCOAST TELECOM, INC. WISCONSIN GRANTLAND TELECOM, INC. WISCONSIN MIDWAY TELEPHONE COMPANY WISCONSIN MID-STATE TELEPHONE COMPANY MINNESOTA MT VERNON TELEPHONE COMPANY WISCONSIN RIVERSIDE TELECOM, INC. WISCONSIN SCANDINAVIA TELEPHONE COMPANY WISCONSIN STOCKBRIDGE & SHERWOOD TELEPHONE COMPANY, INC. WISCONSIN TENNEY TELEPHONE COMPANY WISCONSIN UTELCO, INC. WISCONSIN WAUNAKEE TELEPHONE COMPANY, INC. WISCONSIN WINSTED TELEPHONE COMPANY MINNESOTA
Page 2 TELEPHONE AND DATA SYSTEMS, INC. SUBSIDIARY AND AFFILIATED COMPANIES DECEMBER 31, 1998
MID-CENTRAL DIVISION - -------------------- ARCADIA TELEPHONE COMPANY OHIO CAMDEN TELEPHONE COMPANY INDIANA CHATHAM TELEPHONE COMPANY MICHIGAN COMMUNICATION CORPORATION OF MICHIGAN MICHIGAN COMMUNICATIONS CORPORATION OF INDIANA INDIANA COMMUNICATIONS CORPORATION OF SOUTHERN INDIANA INDIANA CONTINENTAL TELEPHONE COMPANY OHIO HOME TELEPHONE COMPANY, INC. INDIANA HOME TELEPHONE COMPANY OF PITTSBORO, INC. INDIANA ISLAND TELEPHONE COMPANY MICHIGAN LITTLE MIAMI COMMUNICATIONS CORPORATION OHIO OAKWOOD TELEPHONE COMPANY OHIO S & W TELEPHONE COMPANY, INC. INDIANA SHIAWASSEE TELEPHONE COMPANY MICHIGAN TIPTON TELEPHONE COMPANY, INC. INDIANA TRI-COUNTY TELEPHONE COMPANY, INC. INDIANA TOWNSHIP TELEPHONE CO. DELAWARE VANLUE TELEPHONE COMPANY OHIO WOLVERINE TELEPHONE COMPANY MICHIGAN MANAGEMENT SERVICES - ------------------- TDS TELECOM INC.(f.k.a. Central Region TSSD, Inc.) IOWA ARVIG CELLULAR, INC. MINNESOTA ARVIG TELCOM, INC. MINNESOTA CAMDEN CELLULAR, INC. DELAWARE GEORGIA RSA # 12 PARTNERSHIP GEORGIA METROPLEX COMMUNICATIONS CORPORATION WASHINGTON METROPLEX RSA-7 CELLULAR COMMUNICATIONS CORPORATION WASHINGTON METROPLEX SECURITY COMPANY WASHINGTON U.S. LINK, INC. MINNESOTA CABLE COMPANIES - --------------- ACORN CABLE COMPANY WASHINGTON CAROLINA CABLE T.V. CO., INC. SOUTH CAROLINA COMVIDEO SYSTEMS, INC. CALIFORNIA DELTA COUNTY CATV, INC. DELAWARE INTERLAKE CABLEVISION, INC. MINNESOTA LEWISPORT CABLE TV COMPANY KENTUCKY METROPLEX CABLE INC. WASHINGTON TDS CABLE COMMUNICATIONS COMPANY, INC. IOWA TRI-COUNTY COMMUNICATIONS CORPORATION INDIANA VOLUTEER TV CABLE CO. TENNESSEE WARREN CABLE COMPANY MAINE
Page 3 TELEPHONE AND DATA SYSTEMS, INC. SUBSIDIARY AND AFFILIATED COMPANIES DECEMBER 31, 1998
SERVICE COMPANIES - ----------------- AFFILIATE FUND DELAWARE AMERICAN COMMUNICATIONS CONSULTANTS, INC. TENNESSEE AMERICAN RADIO COMMUNICATIONS, INC. DELAWARE COMMVEST, INC. DELAWARE NATIONAL TELEPHONE & TELEGRAPH COMPANY CALIFORNIA RUDEVCO, INC. CALIFORNIA S & W NEWCO, INC. INDIANA SUTTLE PRESS INC. WISCONSIN TDS DATACOM, INC. DELAWARE TDS METROCOM, INC. DELAWARE TDSNET ALABAMA TDS REAL ESTATE INVESTMENT CORPORATION WISCONSIN TEL RADIO COMMUNICATION PROPERTIES, INC. WISCONSIN TELECOMMUNICATION TECHNOLOGIES FUND, INC. MARYLAND TDS CAPITAL TRUST I DELAWARE TDS CAPITAL TRUST III DELAWARE TDS CAPITAL TRUST III DELAWARE RADIO PAGING COMPANIES - ---------------------- AMERICAN MESSAGING SERVICES, LLC MINNESOTA AMERICAN PAGING, INC. (OF CALIFORNIA) CALIFORNIA API MERGER CORP. (f.k.a. American Paging, Inc.) DELAWARE APIXUS, INC. MINNESOTA PAGING HOLDING CO. DELAWARE PERSONAL COMMUNICATON SERVICE COMPANIES - --------------------------------------- AERIAL COMMUNICATIONS, INC. DELAWARE AERIAL OPERATING COMPANY, INC. (f.k.a. APT OPERATING CO.) DELAWARE APT COLUMBUS, INC. DELAWARE APT HOUSTON, INC. DELAWARE APT KANSAS CITY, INC. DELAWARE APT MINNEAPOLIS, INC. DELAWARE APT TAMPA / ORLANDO, INC. DELAWARE APT PITTSBURGH GENERAL PARTNER, INC. PENNSYLVANIA APT PITTSBURGH LIMITED PARTNERSHIP Partnership
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CELLULAR COMPANIES - ------------------ CELLULAR OPERATING MSA - ---------------------- UNITED STATES CELLULAR CORPORATION DELAWARE BANGOR CELLULAR TELEPHONE CO., L.P. DELAWARE CALIFORNIA RURAL SERVICE AREA #1, INC. CALIFORNIA CAMDEN CELLULAR TELEPHONE COMPANY, INC. DELAWARE CAROLINA CELLULAR, INC. NORTH CAROLINA CARRYPHONE, INC. DELAWARE CEDAR RAPIDS CELLULAR TELEPHONE, L.P. Partnership CELLVEST, INC. DELAWARE CENTRAL CELLULAR TELEPHONES, LTD. ILLINOIS CENTRAL FLORIDA CELLULAR TELEPHONE COMPANY, INC. FLORIDA CHARLOTTESVILLE MSA CELLULAR PARTNERSHIP Partnership COMMUNITY CELLULAR TELEPHONE COMPANY TEXAS CROOK COUNTY RSA LIMITED PARTNERSHIP Partnership DAVENPORT CELLULAR TELEPHONE COMPANY, GP Partnership DAVENPORT CELLULAR TELEPHONE COMPANY, INC. DELAWARE DUBUQUE CELLULAR TELEPHONE, L.P. DELAWARE EAU CLAIRE MSA, INC. WISCONSIN EVANSVILLE CELLULAR TELEPHONE COMPANY, L.P. Partnership FARMERS CELLULAR TELEPHONE COMPANY, INC. DELAWARE FARMERS MUTUAL CELLULAR TELEPHONE COMPANY, INC. DELAWARE FLORIDA RSA # 8, INC. DELAWARE GEORGIA RSA # 11, INC. (f.k.a. USCOC of Georgia RSA #14, Inc) GEORGIA GRAY BUTTE JOINT VENTURE Partnership GREEN BAY CELLTELCO PARTNERSHIP Partnership HARDY CELLULAR TELEPHONE COMPANY DELAWARE HBM, INC. DELAWARE ILLINOIS RSA # 3, INC. ILLINOIS INDIANA RSA # 4, INC. DELAWARE INDIANA RSA # 5, INC. INDIANA INDIANA RSA NO. 5 LIMITED PARTNERSHIP Partnership IOWA # 13, INC. DELAWARE IOWA RSA # 12, INC. DELAWARE IOWA RSA # 3, INC. DELAWARE IOWA RSA # 9, INC. DELAWARE IOWA RSA NO. 12 LIMITED PARTNERSHIP DELAWARE JACKSONVILLE CELLULAR PARTNERSHIP Partnership JACKSONVILLE CELLULAR TELEPHONE CO. (f.k.a. GTE Mobilnet of Jacksonville II, Inc.) DELAWARE JANESVILLE CELLULAR TELEPHONE COMPANY, INC. DELAWARE JEFFERSON CELLULAR TELEPHONE COMPANY, INC. IOWA JOPLIN CELLULAR TELEPHONE COMPANY, INC. DELAWARE JOPLIN CELLULAR TELEPHONE COMPANY, L.P. Partnership KANSAS RSA # 15, INC. (f.k.a. Ohio RSA # 1, Inc.) OHIO KENOSHA CELLULAR TELEPHONE, L.P. (f.k.a. Owensboro Cellular Telephone, L.P.) Partnership LACROSSE CELLULAR TELEPHONE COMPANY, INC. DELAWARE LAR-TEX CELLULAR TELEPHONE COMPANY, INC. DELAWARE LEAF RIVER VALLEY CELLULAR TELEPHONE COMPANY ILLINOIS LEWISTON CELLTELLCO PARTNERSHIP Partnership MADISON CELLULAR TELEPHONE COMPANY Partnership MAINE RSA # 1, INC. MAINE
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MAINE RSA # 4, INC. MAINE MAINE RSA NO. 4 LIMITED PARTNERSHIP Partnership MANCHESTER-NASHUA CELLULAR TELEPHONE, L.P. Partnership MARGARETVILLE CELLULAR TELEPHONE COMPANY NEW YORK MCDANIEL CELLULAR TELEPHONE COMPANY DELAWARE MIDWEST PAYROLL CORPORATION DELAWARE MINFORD CELLULAR TELEPHONE COMPANY DELAWARE MINNESOTA INVCO OF RSA # 10, INC. DELAWARE MINNESOTA INVCO OF RSA # 11, INC. DELAWARE MINNESOTA INVCO OF RSA # 5, INC. DELAWARE MINNESOTA INVCO OF RSA # 7, INC. DELAWARE MINNESOTA INVCO OF RSA # 8, INC. DELAWARE MINNESOTA INVCO OF RSA # 9, INC. DELAWARE MISSOURI # 15 RURAL CELLULAR, INC. MISSOURI MISSOURI RSA 11, INC. DELAWARE NH #1 RURAL CELLULAR, INC. NEW HAMPSHIRE NORTH CAROLINA RSA # 4, INC. DELAWARE NORTH CAROLINA RSA # 6, INC. CALIFORNIA NORTH CAROLINA RSA # 9, INC. NORTH CAROLINA NORTH CAROLINA RSA 1 PARTNERSHIP Partnership OHIO STATE CELLULAR PHONE COMPANY, INC. FLORIDA OREGON RSA # 2, INC. OREGON OREGON RSA # 3, INC. OREGON OREGON RSA # 6, INC. OREGON OREGON RSA NO. 2 LIMITED PARTNERSHIP Partnership OREGON RSA NO. 3 LIMITED PARTNERSHIP Partnership PEACE VALLEY CELLULAR TELEPHONE COMPANY DELAWARE PINE ISLAND CELLULAR TELEPHONE COMPANY DELAWARE RACINE CELLULAR TELEPHONE COMPANY Partnership ROCHESTER CELLULAR TELEPHONE COMPANY, L.P. Partnership SCOTT COUNTY CELLULAR TELEPHONE COMPANY DELAWARE SHEBOYGAN CELLULAR TELEPHONE CO. DELAWARE SOUTH CANAAN CELLULAR TELEPHONE CO. (DELAWARE) DELAWARE ST. LAWRENCE SEAWAY RSA CELLULAR, LP Partnership TENNESSEE # 4 SUB 2, INC. TENNESSEE TENNESSEE RSA # 3, INC. DELAWARE TEXAHOMA CELLULAR TELEPHONE COMPANY TEXAS TEXAHOMA CELLULAR, L.P. Partnership TEXAS # 20 RURAL CELLULAR, INC. TEXAS TEXAS INVCO OF RSA # 6, INC. DELAWARE TOWNSHIP CELLULAR TELEPHONE CO. DELAWARE TRI-STATES CELLULAR COMMUNICATIONS, INC. MISSOURI TULSA GENERAL PARTNERS, INC. DELAWARE UNITED STATES CELLUALAR OPERATING COMPANY OF CUMBERLAND, INC. MARYLAND UNITED STATES CELLULAR INVESTMENT CO. OF ALLENTOWN PENNSYLVANIA UNITED STATES CELLULAR INVESTMENT CO. OF OKLAHOMA CITY, INC. OKLAHOMA UNITED STATES CELLULAR INVESTMENT COMPANY DELAWARE UNITED STATES CELLULAR INVESTMENT COMPANY OF EAU CLAIRE, INC. WISCONSIN UNITED STATES CELLULAR INVESTMENT COMPANY OF GREEN BAY, INC. WISCONSIN UNITED STATES CELLULAR INVESTMENT COMPANY OF PORTSMOUTH, INC. NEW HAMPSHIRE UNITED STATES CELLULAR INVESTMENT COMPANY OF ROCKFORD (f.k.a. ACC of Rockford) DELAWARE UNITED STATES CELLULAR INVESTMENT CORPORATION OF LOS ANGELES INDIANA UNITED STATES CELLULAR OPERATING COMPANY DELAWARE
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UNITED STATES CELLULAR OPERATING COMPANY OF BANGOR MAINE UNITED STATES CELLULAR OPERATING COMPANY OF CEDAR RAPIDS DELAWARE UNITED STATES CELLULAR OPERATING COMPANY OF COLUMBIA MISSOURI UNITED STATES CELLULAR OPERATING COMPANY OF DES MOINES IOWA UNITED STATES CELLULAR OPERATING COMPANY OF DUBUQUE IOWA UNITED STATES CELLULAR OPERATING COMPANY OF EVANSVILLE INDIANA UNITED STATES CELLULAR OPERATING COMPANY OF FT. PIERCE FLORIDA UNITED STATES CELLULAR OPERATING COMPANY OF JOPLIN MISSOURI UNITED STATES CELLULAR OPERATING COMPANY OF KENOSHA (f.k.a. USCOC of Owensboro) DELAWARE UNITED STATES CELLULAR OPERATING COMPANY OF KNOXVILLE TENNESSEE UNITED STATES CELLULAR OPERATING COMPANY OF LACROSSE WISCONSIN UNITED STATES CELLULAR OPERATING COMPANY OF LEWISTON-AUBURN MAINE UNITED STATES CELLULAR OPERATING COMPANY OF MANCHESTER-NASHUA, INC. NEW HAMPSHIRE UNITED STATES CELLULAR OPERATING COMPANY OF MEDFORD OREGON UNITED STATES CELLULAR OPERATING COMPANY OF RICHLAND WASHINGTON UNITED STATES CELLULAR OPERATING COMPANY OF ROCHESTER MINNESOTA UNITED STATES CELLULAR OPERATING COMPANY OF TEXAHOMA TEXAS UNITED STATES CELLULAR OPERATING COMPANY OF TULSA, INC. OKLAHOMA UNITED STATES CELLULAR OPERATING COMPANY OF WATERLOO IOWA UNITED STATES CELLULAR OPERATING COMPANY OF WAUSAU, INC. WISCONSIN UNITED STATES CELLULAR OPERATING COMPANY OF YAKIMA WASHINGTON UNITED STATES CELLULAR TELEPHONE COMPANY (GREATER KNOXVILLE), L.P. Partnership UNITED STATES CELLULAR TELEPHONE COMPANY GREATER TULSA, L.L.C. OKLAHOMA UNIVERSAL CELLULAR FOR EAU CLAIRE MSA, INC. WISCONSIN USCC PAYROLL CORPORATION DELAWARE USCC REAL ESTATE CORPORATION DELAWARE USCIC OF AMARILLO, INC. DELAWARE USCIC OF BROWNSVILLE, INC. DELAWARE USCIC OF FRESNO, INC. CALIFORNIA USCIC OF JACKSON, INC. DELAWARE USCIC OF MCALLEN, INC. DELAWARE USCIC OF NORTH CAROLINA RSA # 1, INC. DELAWARE USCOC OF CHARLOTTESVILLE, INC. VIRGINIA USCOC OF CORPUS CHRISTI, INC. TEXAS USCOC OF GREATER IOWA, INC. (f.k.a. Canton Cellular Telephone Company) PENNSYLVANIA USCOC OF HAWAII 3, INC. DELAWARE USCOC OF IDAHO RSA # 5, INC. DELAWARE USCOC OF ILLINOIS RSA # 1, INC. VIRGINIA USCOC OF ILLINOIS RSA # 4, INC. ILLINOIS USCOC OF IOWA RSA # 1, INC. IOWA USCOC OF IOWA RSA # 16, INC. DELAWARE USCOC OF JACKSONVILLE, INC. (f.k.a. GTE Mobilnet of Jacksonville, Inc.) NORTH CAROLINA USCOC OF JACK-WIL, INC. DELAWARE USCOC OF MISSOURI RSA # 13, INC. DELAWARE USCOC OF MISSOURI RSA # 5, INC. ILLINOIS USCOC OF NEW HAMPSHIRE RSA # 2, INC. DELAWARE USCOC OF NORTH CAROLINA RSA # 7, INC. NORTH CAROLINA USCOC OF OKLAHOMA RSA # 10, INC. OKLAHOMA USCOC OF OREGON RSA # 5, INC. DELAWARE USCOC OF PENNSYLVANIA RSA NO. 10-B2, INC. DELAWARE
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USCOC OF PORTLAND, INC. MAINE USCOC OF ROCKFORD, INC. (f.k.a. ACC of Rockford, Inc.) ILLINOIS USCOC OF SOUTH CAROLINA RSA # 4, INC. SOUTH CAROLINA USCOC OF TALLAHASSEE FLORIDA USCOC OF VICTORIA, INC. TEXAS USCOC OF VIRGINIA RSA # 2, INC. VIRGINIA USCOC OF VIRGINIA RSA # 3, INC. VIRGINIA USCOC OF WASHINGTON 4, INC. DELAWARE USCOC OF WILMINGTON, INC. (f.k.a. GTE Mobilnet of Wilmington, Inc.) NORTH CAROLINA VENUS CELLULAR TELEPHONE COMPANY, INC. DELAWARE VERMONT RSA NO. 2-B2, INC. DELAWARE VICTORIA CELLULAR CORPORATION TEXAS VICTORIA CELLULAR PARTNERSHIP Partnership VIRGINIA RSA # 4, INC. VIRGINIA VIRGINIA RSA # 7, INC. VIRGINIA WARD BUTTE JOINT VENTURE Partnership WASHINGTON RSA # 5, INC. WASHINGTON WATERLOO / CEDAR FALLS CELLTELCO PARTNERSHIP Partnership WESTERN SUB-RSA LIMITED PARTNERSHIP Partnership WILMINGTON CELLULAR PARTNERSHIP Partnership WILMINGTON CELLULAR TELEPHONE CO. (f.k.a. GTE Mobilnet of Wilmington II, Inc.) NORTH CAROLINA WISCONSIN RSA # 7, INC. (f.k.a. Wisconsin RSA # 7, Inc.) DELAWARE YAKIMA MSA LIMITED PARTNERSHIP Partnership YAKIMA VALLEY PAGING LIMITED PARTNERSHIP Partnership
Page 8 EX-23 8 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference in this Form 10-K of Telephone and Data Systems, Inc. of our report dated January 27, 1999 on the consolidated financial statements of Telephone and Data Systems, Inc. and Subsidiaries, (the "Company") included in the Company's 1998 Annual Report to Shareholders, to the inclusion in this Form 10-K of our report dated January 27, 1999 on the financial statement schedules of the Company and to the incorporation by reference of such reports into the Company's previously filed S-8 Registration Statements, File No. 33-1192, File No. 33-35172, File No. 33-57257, File No. 33-64035, File No. 333-01041, File No. 333-23947, File No. 333-58121 and File No. 333-58127, and into the Company's previously filed S-3 Registration Statements, File No. 33-8564, File No. 33-8857, File No. 33-68456, File No. 33-59435 and File No. 333-38355, and into the Company's previously filed S-4 Registration Statements, File No. 33-45570, File No. 33-64293 and File No. 333-42535. ARTHUR ANDERSEN LLP Chicago, Illinois March 30, 1999 EX-27.1 9 EXHIBIT 27.1
5 This schedule contains summary financial information extracted from the consolidated financial statements of Telephone and Data Systems, Inc. as of December 31, 1998, and for the year then ended, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 50,083 388,359 219,691 12,608 36,621 405,439 3,895,427 1,222,838 5,527,545 623,379 1,553,096 0 25,985 619 2,237,289 5,527,545 0 1,805,725 0 1,815,223 (293,067) 0 149,864 133,705 69,297 64,408 0 0 0 64,408 1.03 1.03
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