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0001104659-07-013483.txt : 20070223
0001104659-07-013483.hdr.sgml : 20070223
20070223162745
ACCESSION NUMBER: 0001104659-07-013483
CONFORMED SUBMISSION TYPE: 10-Q
PUBLIC DOCUMENT COUNT: 7
CONFORMED PERIOD OF REPORT: 20060930
FILED AS OF DATE: 20070223
DATE AS OF CHANGE: 20070223
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-Q
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-14157
FILM NUMBER: 07646054
BUSINESS ADDRESS:
STREET 1: 30 NORTH LASALLE STREET
STREET 2: STE 4000
CITY: CHICAGO
STATE: IL
ZIP: 60602
BUSINESS PHONE: 3126301900
MAIL ADDRESS:
STREET 1: 30 NORTH LASALLE STREET
STREET 2: STE 4000
CITY: CHICAGO
STATE: IL
ZIP: 60602
10-Q
1
a06-25513_410q.htm
QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the
quarterly period ended September 30, 2006
OR
o TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the
transition period from
to
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 of
|
|
(I.R.S. Employer
Identification No.)
|
incorporation or
organization)
|
|
|
30 North
LaSalle Street, Chicago, Illinois 60602
(Address of principal executive offices) (Zip Code)
Registrants
telephone number, including area code: (312) 630-1900
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
o
Indicate by check whether
the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b 2 of the Exchange Act. (Check one):
Large accelerated
filer x Accelerated
filer o Non-accelerated
filer
Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No x
Indicate the number of
shares outstanding of each of the issuers classes of common stock, as of the
latest practicable date.
Class
|
|
Outstanding at September 30, 2006
|
Common Shares,
$.01 par value
|
|
51,433,050
Shares
|
Special Common
Shares, $.01 par value
|
|
57,782,076
Shares
|
Series A Common
Shares, $.01 par value
|
|
6,444,764 Shares
|
|
|
|
|
TELEPHONE AND DATA
SYSTEMS, INC.
QUARTERLY REPORT
ON FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2006
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TELEPHONE AND DATA
SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
|
|
2005
|
|
|
|
2005
|
|
|
|
2006
|
|
(As Restated)
|
|
2006
|
|
(As Restated)
|
|
|
|
(Dollars in thousands, except per share amounts)
|
|
Operating Revenues
|
|
$
|
1,112,070
|
|
$
|
1,027,947
|
|
$
|
3,239,834
|
|
$
|
2,929,857
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses
|
|
|
|
|
|
|
|
|
|
Cost of services
and products (exclusive of depreciation, amortization and accretion expense
shown below)
|
|
390,182
|
|
373,967
|
|
1,136,047
|
|
1,059,777
|
|
Selling, general
and administrative expense
|
|
424,234
|
|
380,252
|
|
1,228,221
|
|
1,078,031
|
|
Depreciation,
amortization and accretion expense
|
|
187,279
|
|
169,243
|
|
550,698
|
|
507,295
|
|
Total Operating
Expenses
|
|
1,001,695
|
|
923,462
|
|
2,914,966
|
|
2,645,103
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
110,375
|
|
104,485
|
|
324,868
|
|
284,754
|
|
|
|
|
|
|
|
|
|
|
|
Investment and Other Income
(Expense)
|
|
|
|
|
|
|
|
|
|
Equity in
earnings of unconsolidated entities
|
|
24,080
|
|
17,737
|
|
66,376
|
|
50,229
|
|
Interest and
dividend income
|
|
16,323
|
|
14,204
|
|
174,351
|
|
141,514
|
|
Interest expense
|
|
(59,365
|
)
|
(53,852
|
)
|
(177,185
|
)
|
(160,240
|
)
|
Fair value
adjustment of derivative instruments
|
|
34,619
|
|
(4,429
|
)
|
22,881
|
|
495,294
|
|
Gain on investments
|
|
|
|
|
|
91,418
|
|
500
|
|
Other expense
|
|
(4,319
|
)
|
(3,204
|
)
|
(6,187
|
)
|
(14,280
|
)
|
Total Investment
and Other Income
|
|
11,338
|
|
(29,544
|
)
|
171,654
|
|
513,017
|
|
|
|
|
|
|
|
|
|
|
|
Income Before Income Taxes and
Minority Interest
|
|
121,713
|
|
74,941
|
|
496,522
|
|
797,771
|
|
Income tax expense
|
|
35,718
|
|
29,492
|
|
185,246
|
|
317,982
|
|
Income Before Minority Interest
|
|
85,995
|
|
45,449
|
|
311,276
|
|
479,789
|
|
Minority share of
income
|
|
(10,756
|
)
|
(7,174
|
)
|
(33,281
|
)
|
(23,974
|
)
|
Income From Continuing
Operations
|
|
75,239
|
|
38,275
|
|
277,995
|
|
455,815
|
|
Discontinued
Operations, Net of Tax
|
|
|
|
340
|
|
|
|
340
|
|
Net Income
|
|
75,239
|
|
38,615
|
|
277,995
|
|
456,155
|
|
Preferred dividend
requirement
|
|
(51
|
)
|
(50
|
)
|
(152
|
)
|
(152
|
)
|
Net Income Available To Common
|
|
$
|
75,188
|
|
$
|
38,565
|
|
$
|
277,843
|
|
$
|
456,003
|
|
|
|
|
|
|
|
|
|
|
|
Basic
Weighted Average Shares Outstanding (000s)
|
|
115,768
|
|
115,423
|
|
115,759
|
|
115,217
|
|
Basic
Earnings Per Share (Note 6)
|
|
$
|
0.65
|
|
$
|
0.33
|
|
$
|
2.40
|
|
$
|
3.96
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
Weighted Average Shares Outstanding (000s)
|
|
116,862
|
|
116,103
|
|
116,623
|
|
116,063
|
|
Diluted
Earnings Per Share (Note 6)
|
|
$
|
0.64
|
|
$
|
0.33
|
|
$
|
2.38
|
|
$
|
3.92
|
|
|
|
|
|
|
|
|
|
|
|
Dividends Per Share
|
|
$
|
0.0925
|
|
$
|
0.0875
|
|
$
|
0.2775
|
|
$
|
0.2625
|
|
The accompanying
notes to consolidated financial statements are an integral part of these
statements.
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Cash Flows from Operating
Activities
|
|
|
|
|
|
Net income
|
|
$
|
277,995
|
|
$
|
456,155
|
|
Add (Deduct)
adjustments to reconcile net income to net cash provided by operating
activities
|
|
|
|
|
|
Depreciation,
amortization and accretion
|
|
550,698
|
|
507,295
|
|
Bad debts
expense
|
|
49,748
|
|
30,862
|
|
Stock-based
compensation expense
|
|
27,650
|
|
6,978
|
|
Deferred income
taxes
|
|
(67,956
|
)
|
179,141
|
|
Equity in
earnings of unconsolidated entities
|
|
(66,376
|
)
|
(50,229
|
)
|
Distributions
from unconsolidated entities
|
|
39,692
|
|
31,192
|
|
Minority share
of income
|
|
33,281
|
|
23,974
|
|
Fair value
adjustment of derivative instruments
|
|
(22,881
|
)
|
(495,294
|
)
|
(Gain) loss on
investments
|
|
(91,418
|
)
|
(500
|
)
|
Discontinued
operations
|
|
|
|
(340
|
)
|
Noncash interest
expense
|
|
15,981
|
|
15,242
|
|
Other noncash
expense
|
|
5,821
|
|
7,318
|
|
Other operating
activities
|
|
3,162
|
|
|
|
Changes in
assets and liabilities
|
|
|
|
|
|
Change in accounts
receivable
|
|
(67,149
|
)
|
(46,438
|
)
|
Change in
materials and supplies
|
|
15,431
|
|
22,154
|
|
Change in
accounts payable
|
|
(62,792
|
)
|
(49,362
|
)
|
Change in
customer deposits and deferred revenues
|
|
9,923
|
|
5,355
|
|
Change in
accrued taxes
|
|
24,505
|
|
38,664
|
|
Change in accrued
interest
|
|
6,971
|
|
4,766
|
|
Change in other
assets and liabilities
|
|
(11,286
|
)
|
(10,785
|
)
|
|
|
671,000
|
|
676,148
|
|
|
|
|
|
|
|
Cash Flows from Investing
Activities
|
|
|
|
|
|
Additions to
property, plant and equipment
|
|
(516,610
|
)
|
(464,958
|
)
|
Cash received
from divestitures
|
|
722
|
|
500
|
|
Cash paid for
acquisitions
|
|
(98,353
|
)
|
(126,160
|
)
|
Sales of
investments
|
|
102,549
|
|
|
|
Return of
investment
|
|
36,202
|
|
|
|
Other investing
activities
|
|
(6,168
|
)
|
(4,660
|
)
|
|
|
(481,658
|
)
|
(595,278
|
)
|
|
|
|
|
|
|
Cash Flows from Financing
Activities
|
|
|
|
|
|
Issuance of
notes payable
|
|
390,000
|
|
350,000
|
|
Issuance of
long-term debt
|
|
560
|
|
112,835
|
|
Repayment of
notes payable
|
|
(375,000
|
)
|
(380,000
|
)
|
Repayment of
long-term debt
|
|
(202,371
|
)
|
(241,447
|
)
|
Repayment of
medium-term notes
|
|
(35,000
|
)
|
(17,200
|
)
|
TDS Common
Shares and Special Common Shares issued for benefit plans
|
|
3,047
|
|
18,150
|
|
U.S. Cellular
Common Shares issued for benefit plans
|
|
3,856
|
|
22,228
|
|
Capital
(distributions) to minority partners
|
|
(10,085
|
)
|
(1,581
|
)
|
Dividends paid
|
|
(32,247
|
)
|
(30,415
|
)
|
Other financing
activities
|
|
1,863
|
|
(5
|
)
|
|
|
(255,377
|
)
|
(167,435
|
)
|
|
|
|
|
|
|
Net Increase (Decrease) in Cash
and Cash Equivalents
|
|
(66,035
|
)
|
(86,565
|
)
|
|
|
|
|
|
|
Cash and Cash Equivalents
|
|
|
|
|
|
Beginning of
period
|
|
1,095,791
|
|
1,171,105
|
|
End of period
|
|
$
|
1,029,756
|
|
$
|
1,084,540
|
|
The accompanying
notes to consolidated financial statements are an integral part of these
statements.
4
CONSOLIDATED BALANCE SHEETS
ASSETS
Unaudited
|
|
September 30,
2006
|
|
December 31,
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Current
Assets
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,029,756
|
|
$
|
1,095,791
|
|
Accounts receivable
|
|
|
|
|
|
Due from customers, less allowance
of $17,273 and $15,200, respectively
|
|
346,868
|
|
332,278
|
|
Other, principally connecting companies, less
allowance of $7,490 and $5,620, respectively
|
|
160,541
|
|
157,182
|
|
Marketable equity securities
|
|
975,957
|
|
|
|
Materials and supplies
|
|
89,269
|
|
103,211
|
|
Prepaid expenses
|
|
45,916
|
|
41,746
|
|
Deferred income tax asset
|
|
|
|
13,438
|
|
Other current assets
|
|
27,800
|
|
34,774
|
|
|
|
2,676,107
|
|
1,778,420
|
|
|
|
|
|
|
|
Investments
|
|
|
|
|
|
Marketable equity securities
|
|
1,427,864
|
|
2,531,690
|
|
Licenses
|
|
1,450,369
|
|
1,365,063
|
|
Goodwill
|
|
886,418
|
|
882,168
|
|
Customer lists, net of accumulated amortization of
$62,259 and $44,616, respectively
|
|
32,048
|
|
47,649
|
|
Investments in unconsolidated entities
|
|
243,849
|
|
217,180
|
|
Other investments, less valuation allowance of
$55,144 in both periods
|
|
11,528
|
|
12,274
|
|
|
|
4,052,076
|
|
5,056,024
|
|
|
|
|
|
|
|
Property,
Plant and Equipment
|
|
|
|
|
|
In service and under construction
|
|
7,568,197
|
|
7,131,977
|
|
Less accumulated depreciation
|
|
4,021,844
|
|
3,602,217
|
|
|
|
3,546,353
|
|
3,529,760
|
|
|
|
|
|
|
|
Other
Assets and Deferred Charges
|
|
55,913
|
|
55,830
|
|
|
|
$
|
10,330,449
|
|
$
|
10,420,034
|
|
The accompanying
notes to consolidated financial statements are an integral part of these
statements.
5
CONSOLIDATED
BALANCE SHEETS
LIABILITIES AND
STOCKHOLDERS EQUITY
Unaudited
|
|
September 30,
2006
|
|
December 31,
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Current Liabilities
|
|
|
|
|
|
Current portion
of long-term debt
|
|
$
|
3,091
|
|
$
|
237,948
|
|
Forward contracts
|
|
696,973
|
|
|
|
Notes payable
|
|
150,000
|
|
135,000
|
|
Accounts payable
|
|
297,640
|
|
359,934
|
|
Customer
deposits and deferred revenues
|
|
136,940
|
|
126,454
|
|
Accrued interest
|
|
35,917
|
|
28,946
|
|
Accrued taxes
|
|
58,023
|
|
46,061
|
|
Accrued
compensation
|
|
66,891
|
|
67,443
|
|
Derivative
liability
|
|
188,171
|
|
|
|
Deferred income
tax liability
|
|
226,435
|
|
|
|
Other current
liabilities
|
|
75,669
|
|
63,539
|
|
|
|
1,935,750
|
|
1,065,325
|
|
|
|
|
|
|
|
Deferred Liabilities and Credits
|
|
|
|
|
|
Net deferred
income tax liability
|
|
995,808
|
|
1,337,716
|
|
Derivative
liability
|
|
234,079
|
|
449,192
|
|
Asset retirement
obligation
|
|
219,546
|
|
190,382
|
|
Other deferred
liabilities and credits
|
|
116,939
|
|
107,924
|
|
|
|
1,566,372
|
|
2,085,214
|
|
|
|
|
|
|
|
Long-Term Debt
|
|
|
|
|
|
Long-term debt,
excluding current portion
|
|
1,631,905
|
|
1,633,519
|
|
Forward
contracts
|
|
1,024,053
|
|
1,707,282
|
|
|
|
2,655,958
|
|
3,340,801
|
|
|
|
|
|
|
|
Commitments and Contingencies (See
Note 22)
|
|
|
|
|
|
|
|
|
|
|
|
Minority Interest in
Subsidiaries
|
|
577,175
|
|
546,833
|
|
|
|
|
|
|
|
Preferred Shares
|
|
3,863
|
|
3,863
|
|
|
|
|
|
|
|
Common Stockholders Equity
|
|
|
|
|
|
Common Shares,
par value $.01 per share; authorized 100,000,000 shares; issued 56,504,000
and 56,481,000 shares, respectively
|
|
565
|
|
565
|
|
Special Common
Shares, par value $.01 per share; authorized 165,000,000 shares, issued
62,887,000 and 62,868,000 shares, respectively
|
|
629
|
|
629
|
|
Series A Common
Shares, par value $.01 per share; authorized 25,000,000 shares; issued and
outstanding 6,445,000 and 6,440,000 shares; respectively
|
|
64
|
|
64
|
|
Capital in
excess of par value
|
|
1,848,698
|
|
1,828,634
|
|
Treasury Shares,
at cost:
|
|
|
|
|
|
Common Shares,
5,071,000 and 5,105,000 shares, respectively
|
|
(207,524
|
)
|
(208,156
|
)
|
Special Common
Shares 5,105,000 and 5,128,000 shares, respectively
|
|
(209,391
|
)
|
(210,600
|
)
|
Accumulated
other comprehensive income
|
|
309,321
|
|
363,641
|
|
Retained
earnings
|
|
1,848,969
|
|
1,603,221
|
|
|
|
3,591,331
|
|
3,377,998
|
|
|
|
$
|
10,330,449
|
|
$
|
10,420,034
|
|
The accompanying
notes to consolidated financial statements are an integral part of these
statements.
6
TELEPHONE AND DATA
SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of
Presentation
The accounting policies of Telephone and Data Systems, Inc. (TDS)
conform to accounting principles generally accepted in the United States of
America (U.S. GAAP). The consolidated financial statements include the
accounts of TDS and its majority-owned subsidiaries, including TDSs
81.2%-owned wireless telephone subsidiary, United States Cellular Corporation (U.S.
Cellular), TDSs 100%-owned wireline telephone subsidiary, TDS
Telecommunications Corporation (TDS Telecom) and TDSs 80%-owned printing and
distribution company, Suttle Straus, Inc. In addition, the consolidated
financial statements include all entities in which TDS has a variable interest
that requires TDS to absorb a majority of the entitys expected gains or
losses, or both. All material intercompany accounts and transactions have been
eliminated.
The consolidated financial statements included herein have been
prepared by TDS, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and disclosures
normally included in financial statements prepared in accordance with U.S. GAAP
have been condensed or omitted pursuant to such rules and regulations. However,
TDS believes that the information and disclosures included herein are adequate
to make the information presented not misleading. It is suggested that these
consolidated financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in TDSs Annual Report on
Form 10-K/A for the year ended December 31, 2005 (Form 10-K/A).
The accompanying unaudited consolidated financial statements contain
all adjustments (consisting of only normal recurring items unless otherwise
disclosed) necessary to present fairly the financial position as of September
30, 2006 and December 31, 2005, and the results of operations for the three and
nine months ended September 30, 2006 and 2005 and the cash flows for the nine
months ended September 30, 2006 and 2005. The results of operations for the
three and nine months ended September 30, 2006, are not necessarily indicative
of the results to be expected for the full year.
Restatement
TDS and its audit
committee concluded on November 6, 2006, that TDS would amend its Annual Report
on Form 10-K for the year ended December 31, 2005 to restate its consolidated
financial statements and financial information for each of the three years in the
period ended December 31, 2005, including quarterly information for 2005 and
2004, and certain selected financial data for 2002. TDS and its audit committee also concluded
that TDS would amend its Quarterly Reports on Form 10-Q for the quarterly
periods ended March 31, 2006 and June 30, 2006 to restate the consolidated
financial statements and financial information included therewith.
The restatement
adjustments are described below.
· Forward
contracts and related derivative instruments - In reviewing the accounting and
disclosure of its prepaid forward contracts, TDS concluded that its continued
designation of the embedded collars within the forward contracts as cash flow
hedges of marketable equity securities was not appropriate. TDS did not contemporaneously de-designate,
re-designate, and assess hedge effectiveness when the embedded collars
were contractually modified for differences between the actual and expected
dividend rates on the underlying securities in 2004, 2003 and 2002. As a result, the embedded collars no longer
qualified for cash flow hedge accounting treatment upon the modification of the
terms of the collars for changes in dividend rates and, from that point
forward, must be accounted for as derivative instruments that do not qualify
for cash flow hedge accounting treatment.
Accordingly, all changes in the fair value of the embedded collars from
the time of the contractual modification of each collar must be recognized in
the statement of operations. The
restatement adjustments represent reclassifications of unrealized gains or
losses related to changes in the fair value of the embedded collars from other
comprehensive income or loss, included in common stockholders equity, to the
statement of operations.
7
· Expense
reclassifications - Certain prior period amounts, primarily labor, maintenance,
rent and utilities expenses at the competitive local exchange carriers (CLEC),
previously reported in selling, general and administrative expense have been corrected
to properly reflect the classification of the expenses in cost of service and
products for the nine months ended September 30, 2005. Certain expenses, primarily universal service
costs, at both the incumbent local exchange carriers (ILEC) and the CLEC
previously reported in cost of service and products have been adjusted to
properly reflect the classification of the expenses in selling, general and
administrative expense. For the ILEC,
cost of services and products decreased by $1.9 million and $5.2 million with a
corresponding increase in selling, general and administrative expenses in the
three and nine months ended September 30, 2005, respectively. For the CLEC, cost of services and products
increased by $5.7 million and $17.4 million with a corresponding decrease in
selling, general and administrative expenses in the three and nine months ended
September 30, 2005, respectively. On a
TDS consolidated basis, cost of services and products increased by $3.8 million
and $12.2 million with a corresponding decrease in selling, general and
administrative expenses in the three and nine months ended September 30, 2005,
respectively. The adjustments did not
affect previously reported revenues, operating income or net income.
· Establishment
of an Asset Retirement Obligation (ARO) - Upon initial implementation of
Statement of Financial Accounting Standards No. 143 Accounting for
Asset Retirement Obligations (SFAS No. 143) in 2003, TDS Telecoms ILEC
operations concluded that it was not necessary to record an ARO asset and
corresponding regulatory liability of equal amount. TDS Telecom's ILECs
have their rates regulated by the respective state public utility commissions
and the Federal Communications Commission (FCC), and therefore, reflect the
effects of the rate-making actions of these regulatory bodies in their
financial statements. In 2002, the FCC notified carriers by Order that it
would not be adopting SFAS No. 143 since the FCC concluded that SFAS No.
143 conflicted with the FCC's current accounting rules that require ILECs to
accrue for asset retirement obligations through prescribed depreciation rates.
Upon adoption of SFAS No. 143, and pursuant to the FCC's order and
the provisions of SFAS No. 71 Accounting for the Effects of Certain Types
of Regulation, (SFAS No. 71) the ILECs reclassified their existing
remediation liabilities, previously recorded in accumulated depreciation, to an
ARO liability and a separate regulatory liability. Upon further review,
TDS has concluded that upon adoption of SFAS No. 143, and in accordance
with SFAS No. 71, it should have recognized an ARO asset and a corresponding
ARO liability, rather than establish the ARO liability through a
reclassification of its existing remediation liabilities. The impact of
establishing the ARO asset increased Property, Plant and Equipment and the
corresponding ARO liability by $26.6 million and $27.3 million as of
September 30, 2006 and December 31, 2005, respectively. The adjustment did not affect previously
reported revenues, operating income or net income (loss).
· Contracts
with maintenance and support services U.S. Cellular entered into certain
equipment and software contracts that included maintenance and support
services. In one case, U.S. Cellular did
not properly allocate expenditures between equipment purchases and maintenance
and support services. In other cases,
U.S. Cellular did not properly record fees for maintenance and support services
over the specified term of the agreement.
The restatement adjustments properly record property, plant and
equipment, related depreciation expense and fees for maintenance and support
services in the correct periods.
· Classification
of Asset Retirement Obligation on the Statement of Cash Flows The additions
to property, plant and equipment and other deferred liabilities representing
additional asset retirement obligations (ARO) should be treated as non-cash
items in the statement of cash flows.
From 2004 through the second quarter of 2006, U.S. Cellular included
additional ARO liabilities as a change in other assets and liabilities in cash
flows from operating activities and the increase in the ARO asset balance as a
capital expenditure in cash flows from investing activities resulting in an
overstatement of cash flows from operating activities and an overstatement of
cash flows required by investing
activities. In the restatement,
adjustments were recorded in the statement of cash flows to offset the change
in ARO liabilities against the ARO asset. The reduction in the change in other
assets and liabilities in cash flows from operating activities and the
reduction in additions to property, plant and equipment in cash flows from
investing activities totaled $4.7 million in the nine months ended September 30, 2005.
8
· Income taxes
In the restatement, TDS adjusted its income tax expense, income taxes payable,
goodwill, deferred income tax assets and liabilities and related disclosures
for the years ended December 31, 2005, 2004, 2003 and 2002 for items identified
based on its annual analysis reconciling its 2005 income tax expense and income
tax balance sheet accounts as determined in its comparison of the 2005 year-end
income tax provision to the 2005 federal and state income tax returns. These
adjustments included corrections for certain accounts that had not previously
been included in the financial reporting basis used in determining the
cumulative temporary differences in computing deferred income tax assets and
liabilities, as well as adjustments to certain cumulative temporary differences
that had historically been incorrectly associated with operating license assets
which, in this restatement, have been correctly classified as investments in
partnership assets. Accordingly, the
company has adjusted the deferred tax liabilities related to these assets. Goodwill was adjusted by $10.2 million to
record the income tax effect of the difference between the financial reporting
basis and the income tax basis of certain acquisitions made prior to 2004.
TDS determined that the state deferred tax liabilities
attributable to marketable equity securities, as presented in prior periods,
should have been lower to reflect carryover of a higher stock basis than the
federal basis for certain states that have not adopted the federal consolidated
return regulations. TDS also identified
a valuation allowance related to state net operating loss carry forwards for
which deferred tax liabilities related to marketable equity securities provide
positive evidence supporting reductions to previously established valuation
allowances.
· Cash and
interest income In reviewing cash accounts, it was determined that cash and
interest income were overstated in the three months ended March 31, 2006 and
six months ended June 30, 2006. In the
restatement, TDS corrected the overstatement by reducing cash and interest
income.
· Property, plant
and equipment U.S. Cellular did not properly record certain transfers and
disposals of equipment removed from service.
Also, U.S. Cellular did not properly record depreciation expense for
certain leasehold improvements and other equipment due to the use of incorrect
asset lives. The restatement adjustments
properly record equipment disposals and depreciation expense in the correct
amounts and periods.
· Other items In
addition to the adjustments described above, TDS recorded a number of other
adjustments to correct and record revenues, expenses and equity in earnings of
unconsolidated entities in the periods in which such revenues, expenses and
equity in earnings of unconsolidated entities were earned or incurred. Adjustments
were also made to correct certain balance sheet amounts, including $2.1 million
corrections to purchase price accounting for certain acquisitions prior to
2003. These individual adjustments were
not material.
The table below
summarizes the impacts of the restatement on income before income taxes and
minority interest.
|
|
Three Month
Ended
September 30,
2005
|
|
Nine Months
Ended
September 30,
2005
|
|
|
|
(Increase (decrease), dollars
in thousands)
|
|
Income Before
Income Taxes and Minority Interest, as previously reported
|
|
$
|
83,223
|
|
$
|
312,601
|
|
Forward contracts and related derivative instruments
|
|
(4,665
|
)
|
495,011
|
|
Contracts with maintenance and support services
|
|
(123
|
)
|
(458
|
)
|
Property, plant and equipment
|
|
(1,827
|
)
|
(1,750
|
)
|
Other items
|
|
(1,667
|
)
|
(7,633
|
)
|
Total adjustment
|
|
(8,282
|
)
|
485,170
|
|
Income Before Income
Taxes and Minority Interest, as restated
|
|
$
|
74,941
|
|
$
|
797,771
|
|
9
The table below
summarizes the net income and diluted earnings per share impacts from the
restatement.
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
September
30, 2005
|
|
September
30, 2005
|
|
|
|
Net Income
|
|
Diluted
Earnings
Per Share
|
|
Net Income
|
|
Diluted
Earnings
Per Share
|
|
|
|
(Increase
(decrease), dollars in thousands,
except per share amounts)
|
|
As previously reported
|
|
$
|
41,566
|
|
$
|
0.36
|
|
$
|
161,671
|
|
$
|
1.39
|
|
Forward contracts and related derivative instruments
|
|
(1,681
|
)
|
(0.01
|
)
|
297,644
|
|
2.56
|
|
Contracts with maintenance and support services
|
|
(48
|
)
|
|
|
(188
|
)
|
|
|
Income taxes
|
|
549
|
|
|
|
1,647
|
|
0.01
|
|
Property, plant and
equipment
|
|
(916
|
)
|
(0.01
|
)
|
(874
|
)
|
(0.01
|
)
|
Other items
|
|
(855
|
)
|
(0.01
|
)
|
(3,745
|
)
|
(0.03
|
)
|
Total adjustment
|
|
(2,951
|
)
|
(0.03
|
)
|
294,484
|
|
2.53
|
|
As restated
|
|
$
|
38,615
|
|
$
|
0.33
|
|
$
|
456,155
|
|
$
|
3.92
|
|
10
The effect of the
restatement on the previously reported Consolidated Statements of Operations is
as follows:
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
|
September 30, 2005
|
|
September 30, 2005
|
|
|
|
As
Previously
Reported
|
|
As
Restated
|
|
As
Previously
Reported
|
|
As
Restated
|
|
|
|
(Dollars in thousands,
except per share amounts)
|
|
Operating
Revenues
|
|
$
|
1,028,751
|
|
$
|
1,027,947
|
|
$
|
2,934,397
|
|
$
|
2,929,857
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
Cost of service
and products
(exclusive of depreciation, amortization and accretion shown separately
below)
|
|
369,889
|
|
373,967
|
|
1,046,113
|
|
1,059,777
|
|
Selling, general and administrative expense
|
|
383,500
|
|
380,252
|
|
1,088,428
|
|
1,078,031
|
|
Depreciation, amortization and accretion expense
|
|
167,588
|
|
169,243
|
|
505,911
|
|
507,295
|
|
Total Operating Expenses
|
|
920,977
|
|
923,462
|
|
2,640,452
|
|
2,645,103
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
107,774
|
|
104,485
|
|
293,945
|
|
284,754
|
|
Investment and
Other Income (Expense)
|
|
|
|
|
|
|
|
|
|
Equity in
earnings of unconsolidated entities
|
|
18,065
|
|
17,737
|
|
51,007
|
|
50,229
|
|
Interest and
dividend income
|
|
14,204
|
|
14,204
|
|
141,386
|
|
141,514
|
|
Interest expense
|
|
(53,852
|
)
|
(53,852
|
)
|
(160,240
|
)
|
(160,240
|
)
|
Fair value
adjustment of derivative instruments
|
|
236
|
|
(4,429
|
)
|
283
|
|
495,294
|
|
Gain (loss) on
investments
|
|
|
|
|
|
500
|
|
500
|
|
Other income
(expense), net
|
|
(3,204
|
)
|
(3,204
|
)
|
(14,280
|
)
|
(14,280
|
)
|
Total Investment
and Other Income (Expense)
|
|
(24,551
|
)
|
(29,544
|
)
|
18,656
|
|
513,017
|
|
|
|
|
|
|
|
|
|
|
|
Income before
Income Taxes and Minority Interest
|
|
83,223
|
|
74,941
|
|
312,601
|
|
797,771
|
|
Income tax expense
|
|
32,766
|
|
29,492
|
|
127,141
|
|
317,982
|
|
Income before Minority
Interest
|
|
50,457
|
|
45,449
|
|
185,460
|
|
479,789
|
|
Minority share
of income
|
|
(9,231
|
)
|
(7,174
|
)
|
(24,129
|
)
|
(23,974
|
)
|
Income From Continuing
Operations
|
|
41,226
|
|
38,275
|
|
161,331
|
|
455,815
|
|
Discontinued
Operations, Net of Tax
|
|
340
|
|
340
|
|
340
|
|
340
|
|
Net Income
|
|
41,566
|
|
38,615
|
|
161,671
|
|
456,155
|
|
Preferred
dividend requirement
|
|
(50
|
)
|
(50
|
)
|
(152
|
)
|
(152
|
)
|
Net Income Available to
Common
|
|
$
|
41,516
|
|
$
|
38,565
|
|
$
|
161,519
|
|
$
|
456,003
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings per
Share
|
|
$
|
0.36
|
|
$
|
0.33
|
|
$
|
1.40
|
|
$
|
3.96
|
|
Diluted Earnings
per Share
|
|
$
|
0.36
|
|
$
|
0.33
|
|
$
|
1.39
|
|
$
|
3.92
|
|
11
The effect of the
restatement on the previously reported Consolidated Statements of Cash Flows is
as follows:
|
|
Nine
Months Ended
September 30, 2005
|
|
|
|
As
Previously
Reported
|
|
As
Restated
|
|
|
|
(Dollars in thousands)
|
|
CASH FLOWS FROM
OPERATING ACTIVITIES
|
|
|
|
|
|
Net income
|
|
$
|
161,671
|
|
$
|
456,155
|
|
Add (Deduct)
adjustments to reconcile net income to net cash provided by operating
activities
|
|
|
|
|
|
Depreciation,
amortization and accretion
|
|
505,911
|
|
507,295
|
|
Bad debts
expense
|
|
30,862
|
|
30,862
|
|
Stock based
compensation expense
|
|
6,978
|
|
6,978
|
|
Deferred income
taxes
|
|
(11,701
|
)
|
179,141
|
|
Equity in
earnings of unconsolidated entities
|
|
(51,007
|
)
|
(50,229
|
)
|
Distributions
from unconsolidated entities
|
|
31,488
|
|
31,192
|
|
Minority share of
income
|
|
24,129
|
|
23,974
|
|
Fair value
adjustment of derivative instruments
|
|
(283
|
)
|
(495,294
|
)
|
Gain on
investments
|
|
(500
|
)
|
(500
|
)
|
Discontinued operations
|
|
(340
|
)
|
(340
|
)
|
Noncash interest
expense
|
|
15,242
|
|
15,242
|
|
Other noncash
expense
|
|
7,318
|
|
7,318
|
|
Changes in
assets and liabilities
|
|
|
|
|
|
Change in
accounts receivable
|
|
(47,729
|
)
|
(46,438
|
)
|
Change in
materials and supplies
|
|
22,154
|
|
22,154
|
|
Change in
accounts payable
|
|
(49,362
|
)
|
(49,362
|
)
|
Change in
customer deposits and deferred revenues
|
|
1,778
|
|
5,355
|
|
Change in
accrued taxes
|
|
38,664
|
|
38,664
|
|
Change in
accrued interest
|
|
4,766
|
|
4,766
|
|
Change in other
assets and liabilities
|
|
(8,135
|
)
|
(10,785
|
)
|
|
|
681,904
|
|
676,148
|
|
|
|
|
|
|
|
CASH FLOWS FROM
INVESTING ACTIVITIES
|
|
|
|
|
|
Additions to
property, plant and equipment
|
|
(470,714
|
)
|
(464,958
|
)
|
Cash received
from divestitures
|
|
500
|
|
500
|
|
Cash paid for acquisitions
|
|
(126,160
|
)
|
(126,160
|
)
|
Other investing
activities
|
|
(4,660
|
)
|
(4,660
|
)
|
|
|
(601,034
|
)
|
(595,278
|
)
|
CASH FLOWS FROM
FINANCING ACTIVITIES
|
|
|
|
|
|
Issuance of
notes payable
|
|
350,000
|
|
350,000
|
|
Issuance of
long-term debt
|
|
112,835
|
|
112,835
|
|
Repayment of
notes payable
|
|
(380,000
|
)
|
(380,000
|
)
|
Repayment of
long-term debt
|
|
(241,447
|
)
|
(241,447
|
)
|
Repayment of
medium-term notes
|
|
(17,200
|
)
|
(17,200
|
)
|
TDS Common
Shares and Special Common Shares issued for benefit plans
|
|
18,150
|
|
18,150
|
|
U.S. Cellular
Common Shares issued for benefit plans
|
|
22,228
|
|
22,228
|
|
Capital
(distributions) to minority partners
|
|
(1,581
|
)
|
(1,581
|
)
|
Dividends paid
|
|
(30,415
|
)
|
(30,415
|
)
|
Other financing
activities
|
|
(5
|
)
|
(5
|
)
|
|
|
(167,435
|
)
|
(167,435
|
)
|
|
|
|
|
|
|
NET INCREASE (DECREASE)
IN CASH AND CASH EQUIVALENTS
|
|
(86,565
|
)
|
(86,565
|
)
|
|
|
|
|
|
|
CASH AND CASH
EQUIVALENTS
|
|
|
|
|
|
Beginning of
period
|
|
1,171,105
|
|
1,171,105
|
|
End of period
|
|
$
|
1,084,540
|
|
$
|
1,084,540
|
|
12
The effect of the
restatement on the previously reported Consolidated Balance Sheets is as
follows:
|
|
December
31, 2005
|
|
|
|
As Previously
Reported
|
|
As
Restated
|
|
|
|
(Dollars
in thousands)
|
|
CURRENT ASSETS
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
1,095,791
|
|
$
|
1,095,791
|
|
Accounts receivable
|
|
|
|
|
|
Due from customers
|
|
336,005
|
|
332,278
|
|
Other, principally connecting companies
|
|
160,577
|
|
157,182
|
|
Materials and supplies, at average cost
|
|
103,211
|
|
103,211
|
|
Prepaid expenses
|
|
40,704
|
|
41,746
|
|
Deferred income tax asset
|
|
13,438
|
|
13,438
|
|
Other current assets
|
|
29,243
|
|
34,774
|
|
|
|
1,778,969
|
|
1,778,420
|
|
|
|
|
|
|
|
INVESTMENTS
|
|
|
|
|
|
Marketable equity securities
|
|
2,531,690
|
|
2,531,690
|
|
Licenses
|
|
1,365,063
|
|
1,365,063
|
|
Goodwill
|
|
869,792
|
|
882,168
|
|
Customer lists,
net of accumulated amortization
|
|
49,318
|
|
47,649
|
|
Investments in
unconsolidated entities
|
|
215,424
|
|
217,180
|
|
Other
investments
|
|
12,274
|
|
12,274
|
|
|
|
5,043,561
|
|
5,056,024
|
|
|
|
|
|
|
|
PROPERTY, PLANT AND
EQUIPMENT
|
|
|
|
|
|
In service and
under construction
|
|
7,140,447
|
|
7,131,977
|
|
Less accumulated
depreciation
|
|
3,614,242
|
|
3,602,217
|
|
|
|
3,526,205
|
|
3,529,760
|
|
|
|
|
|
|
|
OTHER DEFERRED CHARGES
|
|
55,830
|
|
55,830
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$
|
10,404,565
|
|
$
|
10,420,034
|
|
13
|
|
December
31, 2005
|
|
|
|
As Previously
Reported
|
|
As
Restated
|
|
|
|
(Dollars
in thousands)
|
|
CURRENT
LIABILITIES
|
|
|
|
|
|
Current portion of long-term debt
|
|
$
|
237,948
|
|
$
|
237,948
|
|
Notes payable
|
|
135,000
|
|
135,000
|
|
Accounts payable
|
|
357,273
|
|
359,934
|
|
Customer deposits and deferred revenues
|
|
121,228
|
|
126,454
|
|
Accrued interest
|
|
28,946
|
|
28,946
|
|
Accrued taxes
|
|
47,180
|
|
46,061
|
|
Accrued compensation
|
|
67,443
|
|
67,443
|
|
Other current liabilities
|
|
61,086
|
|
63,539
|
|
|
|
1,056,104
|
|
1,065,325
|
|
|
|
|
|
|
|
DEFERRED
LIABILITIES AND CREDITS
|
|
|
|
|
|
Net deferred income tax liability
|
|
1,383,031
|
|
1,337,716
|
|
Derivative liability
|
|
449,192
|
|
449,192
|
|
Asset retirement obligation
|
|
163,093
|
|
190,382
|
|
Other deferred liabilities and credits
|
|
104,984
|
|
107,924
|
|
|
|
2,100,300
|
|
2,085,214
|
|
|
|
|
|
|
|
LONG-TERM DEBT
|
|
|
|
|
|
Long-term debt, excluding current portion
|
|
1,633,519
|
|
1,633,519
|
|
Forward contracts
|
|
1,707,282
|
|
1,707,282
|
|
|
|
3,340,801
|
|
3,340,801
|
|
|
|
|
|
|
|
MINORITY INTEREST
IN SUBSIDIARIES
|
|
552,884
|
|
546,833
|
|
|
|
|
|
|
|
PREFERRED SHARES
|
|
3,863
|
|
3,863
|
|
|
|
|
|
|
|
COMMON
STOCKHOLDERS EQUITY
|
|
|
|
|
|
Common Shares, par value $.01 per share
|
|
565
|
|
565
|
|
Special Common Shares, par value $.01 per share
|
|
629
|
|
629
|
|
Series A Common Shares, par value $.01 per share
|
|
64
|
|
64
|
|
Additional paid-in capital
|
|
1,826,420
|
|
1,828,634
|
|
Treasury Shares, at cost:
|
|
|
|
|
|
Common Shares
|
|
(208,156
|
)
|
(208,156
|
)
|
Special Common Shares
|
|
(210,600
|
)
|
(210,600
|
)
|
Accumulated other comprehensive income
|
|
309,009
|
|
363,641
|
|
Retained earnings
|
|
1,632,682
|
|
1,603,221
|
|
|
|
3,350,613
|
|
3,377,998
|
|
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
|
|
$
|
10,404,565
|
|
$
|
10,420,034
|
|
14
2. Summary of
Significant Accounting Policies
Change in Accounting Principle Stock-Based
Compensation
TDS has
established long-term incentive plans, employee stock purchase plans, dividend
reinvestment plans, and a non-employee director compensation plan which are
described more fully in Note 3 Stock-Based Compensation. Prior to
January 1, 2006, TDS accounted for these plans under the recognition and
measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25),
and related interpretations, as permitted by Financial Accounting Standards
Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation
(SFAS 123). Total stock-based employee compensation cost
recognized in the Consolidated Statements of Operations under APB 25 was
$2.9 million and $7.0 million for the three and nine months ended
September 30, 2005, primarily for restricted stock unit and deferred
compensation stock unit awards. No compensation cost was recognized in the
Consolidated Statements of Operations under APB 25 for stock option awards for
the three and nine months ended September 30, 2005, because all outstanding
options granted had an exercise price equal to the market value of the
underlying common stock on the date of grant. The employee stock purchase plans
and dividend reinvestment plans qualified as non-compensatory plans under
APB 25; therefore, no compensation cost was recognized for these plans
during the three and nine months ended September 30, 2005.
Effective January
1, 2006, TDS adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment (SFAS 123(R)),
using the modified prospective transition method. In addition, TDS applied the
provisions of Staff Accounting Bulletin No. 107 (SAB 107), issued by the SEC
in March 2005 in its adoption of SFAS 123(R). Under the modified prospective
transition method, compensation cost recognized during the three and nine
months ended September 30, 2006 includes: (a) compensation cost for all
share-based payments granted prior to but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the original
provisions of SFAS 123, and (b) compensation cost for all share-based payments
granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R). Results for prior
periods have not been restated.
Under SFAS 123(R),
the long-term incentive plans are considered compensatory plans; therefore,
recognition of compensation costs for grants made under these plans is
required.
Under SFAS 123(R),
the employee stock purchase plans are considered compensatory plans; therefore,
recognition of compensation costs for grants made under these plans is
required. However, due to restrictions on activity under these plans that were
in place during the nine months ended September 30, 2006, no compensation
expense was recognized during this period.
Under SFAS 123(R),
the dividend reinvestment plans are not considered compensatory plans,
therefore recognition of compensation costs for grants made under these plans
is not required.
Upon adoption of SFAS 123(R), TDS elected to continue to value its
share-based payment transactions using a Black-Scholes valuation model, which
was previously used by TDS for purposes of preparing the pro forma disclosures
under SFAS 123. Under the provisions of SFAS 123(R), stock-based compensation
cost recognized during the period is based on the portion of the share-based
payment awards that is ultimately expected to vest. Accordingly, stock-based
compensation cost recognized in 2006 has been reduced for estimated
forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual forfeitures
differ from those estimates. Pre-vesting forfeitures were estimated based on
historical experience related to similar awards, giving consideration to the
contractual terms of the stock-based awards, vesting schedules and expectations
of future employee behavior. TDS believes that its historical experience is the
best estimate of future expected life. In TDSs pro forma information required
under SFAS 123, TDS also reduced stock-based compensation cost for estimated
forfeitures. The expected life assumption was determined based on TDSs
historical experience. For purposes of both SFAS 123 and SFAS 123(R), the
expected volatility assumption was based on the historical volatility of TDSs
common stock. The dividend yield was included in the assumptions. The risk-free
interest rate assumption was determined using the implied yield currently
available for zero-coupon U.S. government issues with a remaining term equal to
the expected life of the stock options.
15
Compensation cost
for stock option awards granted after January 1, 2006 will be recognized over
the respective requisite service period of the awards, which is generally the
vesting period, on a straight-line basis over the requisite service period for
each separately vesting portion of the awards as if the awards were,
in-substance, multiple awards (graded vesting attribution method), which is the
same attribution method that was used by TDS for purposes of its pro forma disclosures
under SFAS 123.
Certain employees
were eligible for retirement at the time that compensatory stock options and
restricted stock units were granted to them. Under the terms of the TDS option
agreements, options granted to these individuals do not vest upon retirement.
Under the terms of the U.S. Cellular option and restricted stock unit
agreements, options and restricted stock units granted to retirement-eligible
employees will fully vest upon their retirement if the employees have reached
the age of 65. Similarly, under the terms of TDSs restricted stock unit
agreements, restricted stock units vest upon retirement if the employee has
reached the age of 66. Prior to the adoption of SFAS 123(R), TDS used the nominal
vesting method to recognize the pro forma stock-based compensation cost
related to options and restricted stock units awarded to retirement-eligible
employees. This method does not take into account the effect of early vesting
due to the retirement of eligible employees. Upon adoption of SFAS 123(R), TDS
adopted the non-substantive vesting method, which requires accelerated
recognition of the entire cost of options granted to retirement-eligible
employees over the period of time from the date of grant to the date the
employee reaches age 65. If the non-substantive vesting method had been applied
in prior periods, the effect on previously disclosed pro forma stock-based
compensation cost would not have been material.
On March 7, 2006, the TDS Compensation Committee approved amendments to
stock option award agreements. The amendments modify current and future options
to extend the exercise period until 30 days following (i) the lifting of a
"suspension" if options otherwise would expire or be forfeited during
the suspension period and (ii) the lifting of a blackout if options otherwise
would expire or be forfeited during a blackout period. TDS temporarily
suspended issuances of shares under the 2004 Long Term Incentive Plan between
March 17, 2006 and October 10, 2006 as a consequence of late SEC filings. TDS
became current with respect to its Form 10-K for the year then ended December
31, 2005 and other periodic SEC filings upon the filing of its Form 10-K for
the year then ended December 31, 2005 and other periodic SEC filings upon the
filing of its Form 10-Q for the quarter ended June 30, 2006, on October 10,
2006. As required under the provisions of SFAS 123(R), TDS evaluated the impact
of this plan modification and originally determined that the adjustment to
stock based compensation was not material.
However, in connection with the restatement discussed in Note 1 above,
TDS further reviewed the accounting for the plan modification. Upon such further review, TDS determined that
it should have recognized stock-based compensation expense of $1.6 million in
the three months ended March 31, 2006 as a result of this modification TDS recognized $0.0 million and $1.6 million
in stock-based compensation expense in the three and nine months ended
September 30, 2006, respectively, as a result of this modification.
Pension Plan
TDS sponsors a qualified noncontributory defined contribution pension
plan. The plan provides benefits for the employees of TDS Corporate, TDS
Telecom and U.S. Cellular. Under this plan, pension benefits and costs are
calculated separately for each participant and are funded currently. Pension
costs were $3.6 million and $11.5 million for the three and nine months ended
September 30, 2006, respectively, and $3.3 million and $10.1 million for the
three and nine months ended September 30, 2005, respectively.
TDS also sponsors an unfunded non-qualified deferred supplemental
executive retirement plan for certain employees which supplements the benefits
under the qualified plan to offset the reduction of benefits caused by the
limitation on annual employer contributions under the tax laws.
Other Postretirement Benefits
TDS sponsors two contributory defined benefit postretirement plans that
cover most employees of TDS Corporate, TDS Telecom and the subsidiaries of TDS
Telecom. One plan provides medical benefits and the other plan provides life
insurance benefits.
16
Net periodic benefit costs for the defined benefit
postretirement plans include the following components:
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
Service Cost
|
|
$
|
544
|
|
$
|
553
|
|
$
|
1,633
|
|
$
|
1,659
|
|
Interest on
accumulated benefit obligation
|
|
692
|
|
659
|
|
2,075
|
|
1,977
|
|
Expected return
on plan assets
|
|
(648
|
)
|
(558
|
)
|
(1,945
|
)
|
(1,673
|
)
|
Amortization of:
|
|
|
|
|
|
|
|
|
|
Prior service cost
|
|
(208
|
)
|
(279
|
)
|
(623
|
)
|
(838
|
)
|
Net loss
|
|
292
|
|
288
|
|
876
|
|
865
|
|
Net postretirement cost
|
|
$
|
672
|
|
$
|
663
|
|
$
|
2,016
|
|
$
|
1,990
|
|
TDS contributed $5.3 million for its 2006 contribution to the
postretirement plan assets.
Recent Accounting
Pronouncements
The Securities and Exchange Commission (SEC) released Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year
Misstatements When Quantifying Misstatements in Current Year Financial
Statements (SAB 108), in September 2006. SAB 108 provides guidance on how the
effects of the carryover or reversal of prior year financial statement
misstatements should be considered in quantifying a current year misstatement.
Prior practice allowed the evaluation of materiality on the basis of (1) the
error quantified as the amount by which the current year income statement was
misstated (rollover method) or (2) the cumulative error quantified as the
cumulative amount by which the current year balance sheet was misstated (iron
curtain method). Reliance on one or the other method in prior years could have
resulted in misstatement of the financial statements. The guidance provided in
SAB 108 requires both methods to be used in evaluating materiality. Immaterial
prior year errors may be corrected with the first filing of prior year
financial statements after adoption. The cumulative effect of the correction
would be reflected in the opening balance sheet with appropriate disclosure of
the nature and amount of each individual error corrected in the cumulative
adjustment, as well as a disclosure of the cause of the error and that the
error had been deemed to be immaterial in the past. SAB 108 is effective for
TDSs opening balance sheet in 2007. TDS is currently evaluating the impact
this Bulletin might have on its financial position or results of operations.
In September 2006, the FASB released Statement of Financial Accounting
Standards No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and
132(R) (SFAS 158). Under SFAS 158, companies must recognize a net liability
or asset to report the funded status of their defined benefit pension and other
postretirement benefit plans on their balance sheets. The recognition,
disclosure and measurement provisions of SFAS 158 are effective for TDS as of
December 31, 2006 on a prospective basis. The Company anticipates that the
after-tax effect on the December 31, 2006 financial statements will be to increase
liabilities and reduce stockholders equity by approximately $11.4 million.
This after-tax effect will be based on the plans projected valuations as of
December 31, 2006. The actual effects will change based on refined analysis and
actual measurement date assumptions as of December 31, 2006. The Company does
not anticipate any other significant impact from the adoption of SFAS 158.
17
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, Fair Value Measurements (SFAS 157). This Statement
defines fair value as used in numerous accounting pronouncements, establishes a
framework for measuring fair value in generally accepted accounting principles
(GAAP) and expands disclosure related to the use of fair value measures in
financial statements. SFAS 157 does not expand the use of fair value measures
in financial statements, but standardizes its definition and guidance in GAAP.
The Statement emphasizes that fair value is a market-based measurement and not
an entity-specific measurement based on an exchange transaction in which the
entity sells an asset or transfers a liability (exit price). SFAS 157
establishes a fair value hierarchy from observable market data as the highest
level to fair value based on an entitys own fair value assumptions as the
lowest level. The Statement is effective for TDSs 2008 quarterly and annual
financial statements; however, earlier application is encouraged. TDS is
currently evaluating the timing of adoption and the impact that adoption might
have on its financial position or results of operations.
The FASB issued
Interpretation 48, Accounting for Uncertainty
in Income Taxes -an interpretation of FASB
Statement No. 109 (FIN 48) in July 2006. FIN 48 clarifies
the accounting for uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes (SFAS 109). The
interpretation applies to all tax positions accounted for in accordance with
SFAS 109 and changes how tax positions are recognized and measured and how
uncertainties related to income tax positions are disclosed. It provides
guidance on recognition, derecognition and measurement of uncertain tax
positions in a period subsequent to that in which a position is taken; the
accounting for interest and penalties; the classification and presentation of
recorded amounts; and disclosure requirements. TDS will adopt the provisions of
FIN 48 effective January 1, 2007. Under FIN 48, TDS will evaluate the tax
uncertainty, assess the probability of the ultimate settlement with the
applicable taxing authority and record an amount based on that assessment. TDS
had previously set up tax accruals, as needed, to cover its potential liability
for income tax uncertainties pursuant to FASB Statement No. 5 Accounting for Contingencies. The FASB has issued
preliminary guidance regarding ultimate settlement of tax uncertainties. This
guidance, in the form of a FASB Staff Position, is not yet finalized. TDS will
use the finalized guidance to determine the amount of its cumulative effect
adjustment to be recorded to opening retained earnings upon adoption of FIN 48
effective January 1, 2007. TDS is currently reviewing the requirements of FIN
48 to determine the impact on its financial position or results of operations.
The primary impact of FIN 48 on TDSs existing tax accounting policies and
practices will be the documentation of all tax positions rather than only tax
positions that TDS considers probable of incurring a loss.
3. Stock-Based
Compensation
As a result of
adopting SFAS 123(R) on January 1, 2006, TDSs income before income taxes and
minority interest for the three and nine months ended September 30, 2006, was
$9.7 million and $18.9 million lower, respectively, than if it had continued to
account for share-based compensation under APB 25. Similarly, as a result of
adopting SFAS 123(R) on January 1, 2006, TDSs net income for the three and
nine months ended September 30, 2006, was $6.9 million and $10.5 million lower,
basic earnings per share for the three and nine months ended September 30, 2006
was $0.06 and $0.09 lower, and diluted earnings per share for the three and nine
months ended September 30, 2006 was $0.06 and $0.09 lower, respectively, than
if TDS had continued to account for stock-based compensation expense under APB
25.
18
Stock-Based
Compensation Expense
For comparison, the following table illustrates the
pro forma effect on net income and earnings per share had TDS applied the fair
value recognition provisions of SFAS 123(R) to its stock-based employee
compensation plans for the three and nine months ended September 30, 2005:
(Dollars in thousands, except per share amounts)
|
|
Three months ended
September 30, 2005
(As Restated)
|
|
Nine months ended
September 30, 2005
(As Restated)
|
|
Net income, as
reported
|
|
$
|
38,615
|
|
$
|
456,155
|
|
Add: Stock-based
compensation expense included in reported net
income, net of related tax effects and minority interest
|
|
1,535
|
|
3,554
|
|
Deduct:
Stock-based compensation expense determined under fair value
based method for all awards, net of related tax effects and minority
interest
|
|
(8,062
|
)
|
(17,588
|
)
|
Pro forma net
income
|
|
$
|
32,088
|
|
$
|
442,121
|
|
|
|
|
|
|
|
Earnings per
share:
|
|
|
|
|
|
Basicas
reported
|
|
$
|
0.33
|
|
$
|
3.96
|
|
Basicpro forma
|
|
0.28
|
|
3.84
|
|
Dilutedas
reported
|
|
0.33
|
|
3.92
|
|
Dilutedpro forma
|
|
$
|
0.27
|
|
$
|
3.80
|
|
Prior to the
adoption of SFAS 123(R), TDS presented all tax benefits resulting from tax
deductions associated with the exercise of stock options by employees as cash
flows from operating activities in the Consolidated Statements of Cash Flows.
SFAS 123(R) requires that excess tax benefits be classified as cash flows
from financing activities in the Consolidated Statements of Cash Flows. For
this purpose, the excess tax benefits are tax benefits related to teh
difference between the total tax deduction associated witht eh exercise of
stock options by employees and the amount of compensation cost recognized for
those options. For the nine months ended September 30, 2006 excess tax benefits
of $0.4million were included within Other Financing Activities of the Cash
Flows from Financing Activitiespursuant to this requirement of SFAS 123(R).
The following
table summarizes stock-based compensation expense recognized during the three
and nine months ended September 30, 2006:
|
|
(Amounts in thousands)
|
|
Stock option
awards
|
|
$
|
9,697
|
|
$
|
18,863
|
|
Restricted stock
unit awards
|
|
3,487
|
|
9,574
|
|
Deferred
compensation matching stock unit awards
|
|
(187
|
)
|
(789
|
)
|
Employee stock
purchase plans
|
|
|
|
|
|
Awards under
non-employee directors compensation plan
|
|
|
|
2
|
|
Total
stock-based compensation, before income taxes
|
|
12,997
|
|
27,650
|
|
Income tax
benefit
|
|
(3,202
|
)
|
(10,289
|
)
|
Total stock-based
compensation expense, net of income taxes
|
|
$
|
9,795
|
|
$
|
17,361
|
|
At September 30, 2006, unrecognized compensation cost for all
stock-based compensation awards was $28.4 million. The unrecognized
compensation cost for stock-based compensation awards at September 30, 2006 is
expected to be recognized over a weighted average period of 0.7 years.
For the three and nine month period ended September 30, 2006, $12.7
million and $27.4 million of stock-based compensation was recorded in Selling,
general and administrative expense and $0.3 million was recorded in cost of
services and products, respectively.
TDS
The information in this section relates to stock-based compensation
plans utilizing the equity instruments of TDS. Participants in these plans are
generally employees of TDS Corporate and TDS Telecom, although U.S. Cellular
employees are eligible to participate in the TDS Employee Stock Purchase Plan.
Information related to plans utilizing the equity instruments of U.S. Cellular
are shown in the U.S. Cellular section following the TDS section.
19
Under the TDS 2004 Long-Term Incentive Plan (and a predecessor plan),
TDS may grant fixed and performance-based incentive and non-qualified stock
options, restricted stock, restricted stock units, and deferred compensation
stock unit awards to key employees. TDS had reserved 4,006,000 Common Shares
and 11,893,000 Special Common Shares at September 30, 2006, for equity awards
granted and to be granted under this plan. At September 30, 2006, the only
types of awards outstanding are fixed non-qualified stock option awards,
restricted stock unit awards, and deferred compensation stock unit awards. At
September 30, 2006, TDS also had reserved 174,000 Common Shares and 323,000
Special Common Shares for issuance under the Automatic Dividend Reinvestment
and Stock Purchase Plan and 49,000 Series A Common Shares for issuance under
the Series A Common Share Automatic Dividend Reinvestment Plan, and 185,000
Common Shares and 320,000 Special Common Shares under an employee stock
purchase plan. The maximum number of TDS Common Shares, TDS Special Common
Shares and TDS Series A Common Shares that may be issued to employees under all
stock-based compensation plans in effect at September 30, 2006 was 4,365,000,
12,536,000 and 49,000 shares, respectively. TDS currently utilizes treasury
stock to satisfy stock option exercises, issuances under its employee stock
purchase plan, restricted stock unit awards and deferred compensation stock
unit awards. TDS has also created a Non-Employee Directors Plan under which it
has reserved 33,000 Common Shares and 75,000 Special Common Shares of TDS stock
for issuance as compensation to members of the board of directors who are not
employees of TDS.
Stock OptionsStock options granted to key employees are exercisable over
a specified period not in excess of ten years. Stock options generally vest
over periods up to four years from the date of grant. Stock options outstanding
at September 30, 2006 expire between 2006 and 2016. However, vested stock
options typically expire 30 days after the effective date of an employees
termination of employment for reasons other than retirement. Employees who
leave at the age of retirement have 90 days (or one year if they satisfy
certain requirements) within which to exercise their vested stock options. The
exercise price of the option generally equals the market value of TDS common
stock on the date of grant.
TDS did not grant any stock options during the three
months ended September 30, 2006 and September 30, 2005, respectively. TDS granted
1,105,000 and 630,000 stock options during the nine months ended September 30,
2006 and September 30, 2005, respectively. TDS estimates the fair value of
stock options granted using the Black-Scholes valuation model. The fair value
is then recognized as compensation cost on a straight-line basis over the
requisite service period, which is generally the vesting period, for each
separately vesting portion of the awards as if the awards were, in-substance,
multiple awards, which is the same attribution method that was used by TDS for
purposes of its pro forma disclosures under SFAS 123. TDS used the assumptions
shown in the table below in valuing the options granted in 2006:
Expected Life
|
|
4.9 Years
|
|
Expected Annual
Volatility Rate
|
|
25.9%
|
|
Dividend Yield
|
|
1.0%
|
|
Risk-free
Interest Rate
|
|
4.8%
|
|
Estimated Annual
Forfeiture Rate
|
|
0.6%
|
|
All TDS options outstanding at March 31, 2006 were granted prior to the
distribution of the TDS Special Common Share Dividend in 2005, more fully
described in TDSs 2005 Annual Report on Form 10-K/A. As a result of the
Special Common Share Dividend, an employee will receive one Common Share and
one Special Common Share per tandem option exercised. Each tandem option is
exercisable at its original exercise price. TDS options granted after the
distribution of the TDS Special Common Share Dividend will receive one Special
Common Share per option exercised.
20
A summary of TDS stock options (total and portion
exercisable) at September 30, 2006 and changes during the nine months then
ended is presented in the table and narrative below:
Tandem Options
|
|
|
|
|
|
Weighted
|
|
Weighted
Average
|
|
|
|
|
|
Number
|
|
Average
|
|
Remaining
|
|
|
|
|
|
of Tandem
|
|
Exercise
|
|
Contractual
|
|
Aggregate
|
|
|
|
Options(1)
|
|
Prices
|
|
Term
|
|
Intrinsic Value
|
|
Outstanding at
December 31, 2005 (2,461,000 exercisable)
|
|
2,701,000
|
|
$
|
73.85
|
|
6.5 Years
|
|
$
|
41,552,000
|
|
Granted
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
23,000
|
|
52.28
|
|
|
|
466,000
|
|
Forfeited
|
|
15,000
|
|
57.55
|
|
|
|
402,000
|
|
Expired
|
|
|
|
|
|
|
|
|
|
Outstanding at
September 30, 2006
(2,599,000 exercisable)
|
|
2,663,000
|
|
$
|
74.13
|
|
5.8 Years
|
|
$
|
40,460,000
|
|
(1) Upon exercise, each
tandem option is converted into one TDS Common Share and one TDS Special Common
Share.
Special Common Share Options
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
|
|
|
|
Number of
|
|
Exercise
|
|
Contractual
|
|
Aggregate
|
|
|
|
Options(2)
|
|
Prices
|
|
Term
|
|
Intrinsic Value
|
|
Outstanding at December 31, 2005
(0 exercisable)
|
|
|
|
|
|
|
|
|
|
Granted
|
|
1,105,000
|
|
$
|
38.01
|
|
10.0 Years
|
|
$
|
3,143,000
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
6,000
|
|
38.00
|
|
|
|
16,000
|
|
Expired
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 (6,000 exercisable)
|
|
1,099,000
|
|
$
|
38.01
|
|
9.7 Years
|
|
$
|
3,127,000
|
|
(2) Upon exercise, each Special Common share
option is converted into one TDS Special Common Share.
The aggregate intrinsic value in the table above
represents the total pretax intrinsic value (the difference between TDSs
closing stock price on the last trading day of the period and the exercise
price, multiplied by the number of in-the-money options) that would have been
received by the option holders had all option holders exercised their options
on September 30, 2006. This amount will change in future periods based on the
market price of TDSs stock. TDS received $0.0 and $1.2 million in cash from
the exercise of stock options during the three and nine months ended September
30, 2006.
21
A summary of TDSs nonvested stock options at
September 30, 2006 and changes during the nine months then ended is presented
in the tables that follow:
Tandem Options
|
|
|
|
Weighted
Average
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Stock Options(1)
|
|
Stock Options
|
|
Nonvested at
December 31, 2005
|
|
240,000
|
|
$
|
21.67
|
|
Granted
|
|
|
|
|
|
Vested
|
|
161,000
|
|
20.07
|
|
Forfeited
|
|
15,000
|
|
22.33
|
|
Nonvested at September
30, 2006
|
|
64,000
|
|
$
|
25.55
|
|
(1) Upon
exercise, each tandem stock option is converted into one TDS Common Share and
one TDS Special Common Share.
Special Common Share Options
|
|
|
|
Weighted
Average
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Stock Options(2)
|
|
Stock Options
|
|
Nonvested at
December 31, 2005
|
|
|
|
|
|
Granted
|
|
1,105,000
|
|
$
|
11.00
|
|
Vested
|
|
6,000
|
|
11.18
|
|
Forfeited
|
|
6,000
|
|
11.00
|
|
Nonvested at September
30, 2006
|
|
1,093,000
|
|
$
|
11.00
|
|
(2) Upon exercise, each Special Common share
option is converted into one TDS Special Common Share.
Restricted Stock UnitsBeginning in April 2005, TDS
granted restricted stock unit awards to key employees. These awards generally
vest after three years. All TDS restricted stock units outstanding at March 31,
2006 were granted prior to the distribution of the TDS Special Common Share
Dividend in 2005. As a result of the Special Common Share Dividend, an employee
will receive one Common Share and one Special Common Share upon the vesting of
such restricted stock units. The restricted stock unit awards outstanding at
March 31, 2006 will vest in December 2007. When vested, employees will receive
an equal number of TDS Common Shares and TDS Special Common Shares with respect
to such restricted stock units. Restricted stock unit awards granted after the
distribution of the TDS Special Common Share Dividend in 2005 are convertible
into one Special Common Share upon the vesting of such restricted stock units.
The restricted stock unit awards granted in 2006 will vest in December 2008.
When vested, employees will receive one TDS Special Common Share for each
restricted stock unit.
TDS estimates the fair
value of restricted stock units based on the closing market price of TDS shares
on the date of grant. The fair value is then recognized as compensation cost on
a straight-line basis over the requisite service periods of the awards, which
is generally the vesting period.
22
A summary of TDS nonvested restricted stock units at
September 30, 2006 and changes during the nine months then ended is presented
in the table that follows:
|
Tandem Restricted Stock Units
|
|
|
|
Weighted Average
Grant-Date
|
|
|
|
Number
|
|
Fair Values of
|
|
|
|
of Restricted
|
|
Restricted
|
|
|
|
Stock Units(1)
|
|
Stock Units
|
|
Nonvested at
December 31, 2005
|
|
90,000
|
|
$
|
77.55
|
|
Granted
|
|
|
|
|
|
Vested
|
|
|
|
|
|
Forfeited
|
|
1,000
|
|
78.10
|
|
Nonvested at September
30, 2006
|
|
89,000
|
|
$
|
77.55
|
|
(1) Upon
exercise, each tandem restricted stock unit is converted into one TDS Common
Share and one TDS Special Common Share.
|
Special Common Restricted Stock Units
|
|
|
|
Weighted Average
Grant-Date
|
|
|
|
Number
|
|
Fair Values of
|
|
|
|
of Restricted
|
|
Restricted
|
|
|
|
Stock Units(2)
|
|
Stock Units
|
|
Nonvested at
December 31, 2005
|
|
|
|
|
|
Granted
|
|
105,000
|
|
$
|
38.05
|
|
Vested
|
|
2,000
|
|
38.62
|
|
Forfeited
|
|
1,000
|
|
38.00
|
|
Nonvested at September
30, 2006
|
|
102,000
|
|
$
|
38.04
|
|
(2) Upon exercise, each Special Common
restricted stock unit is converted into one TDS Special Common Share.
Deferred Compensation Stock UnitsCertain TDS
employees may elect to defer receipt of all or a portion of their annual
bonuses and to receive stock unit matches on the amount deferred up to
$400,000. Deferred compensation, which is immediately vested, is deemed to be
invested in TDS Common Share units or, at the election of the committee that
administers the plan after the TDS Special Common Share Dividend in 2005, TDS
Special Common Share units. TDS match amounts depend on the amount of annual
bonus that is deferred into stock units. Participants receive a 25% stock unit
match for amounts deferred up to 50% of their total annual bonus and a 33%
match for amounts that exceed 50% of their total annual bonus. The matched
stock units vest ratably at a rate of one-third per year over three years. When
fully vested and upon distribution, employees will receive the vested TDS
Common Shares and/or TDS Special Common Shares, as applicable.
TDS estimates the fair value of deferred compensation
matching stock units based on the closing market price of TDS shares on the
date of grant. The fair value of the matched stock units is then recognized as
compensation cost on a straight-line basis over the requisite service periods
of the awards, which is generally the vesting period.
A summary of TDS nonvested deferred compensation stock
unit plans at September 30, 2006 and changes during the nine months then ended
is presented in the table that follows:
|
Tandem Deferred Compensation Stock Units
|
|
Number of
|
|
Weighted Average
Grant-Date
|
|
|
|
Tandem
|
|
Fair Values
|
|
|
|
Stock Units(1)
|
|
of Stock Units
|
|
Nonvested at
December 31, 2005
|
|
1,025
|
|
$
|
75.05
|
|
Granted
|
|
|
|
|
|
Vested
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
Nonvested at September
30, 2006
|
|
1,025
|
|
$
|
75.05
|
|
(1) Upon
exercise, each tandem deferred compensation stock unit outstanding at September
30, 2006 is converted into one TDS Common Share and one TDS Special Common
Share.
23
|
Special Common Deferred Compensation Stock Units
|
|
Number of
|
|
Weighted Average
Grant-Date
|
|
|
|
Special Common
|
|
Fair Values
|
|
|
|
Stock Units(2)
|
|
of Stock Units
|
|
Nonvested at
December 31, 2005
|
|
|
|
|
|
Granted
|
|
1,500
|
|
$
|
38.30
|
|
Vested
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
Nonvested at September
30, 2006
|
|
1,500
|
|
$
|
38.30
|
|
(2) Upon
exercise, each Special Common deferred compensation stock unit is converted
into one TDS Special Common Share.
Employee Stock Purchase PlanUnder the 2003 Employee
Stock Purchase Plan, eligible employees of TDS and its subsidiaries may
purchase a limited number of shares of TDS common stock on a quarterly basis.
Prior to 2006, such common stock consisted of TDS Common Shares. Beginning in
2006, such common stock consisted of TDS Special Common Shares. TDS had
reserved 185,000 Common Shares and 320,000 Special Common Shares at September
30, 2006 for issuance under this plan. The plan became effective on April 1,
2003 and will terminate on December 31, 2008. The per share cost to each
participant is 85% of the market value of the Common Shares or Special Common
Shares as of the issuance date. Under SFAS 123(R), the employee stock purchase
plan is considered a compensatory plan; therefore recognition of compensation
costs for stock issued under this plan is required. Compensation cost is
measured as the difference between the cost of the shares to the plan participants
and the fair market value of the shares on the date of issuance. However, due
to restrictions on activity under these plans in place during the three and
nine months ended September 30, 2006, no compensation expense was recognized
during this period.
Compensation of Non-Employee Directors TDS issued 0
and 2,600 shares under its Non-Employee Directors plan in the three and nine
months ended September 30, 2006.
Dividend Reinvestment PlansTDS had reserved 174,000
Common Shares and 323,000 Special Common Shares at September 30, 2006, for
issuance under Automatic Dividend Reinvestment and Stock Purchase Plans and
49,000 Series A Common Shares for issuance under the Series A Common Share Automatic
Dividend Reinvestment Plan. These plans enable holders of TDSs Common Shares,
Special Common Shares and Preferred Shares to reinvest cash dividends in Common
Shares and Special 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 TDSs Common Shares and Special Common Shares on the
American Stock Exchange for the ten trading days preceding the date on which
the purchase is made. Under SFAS 123(R) and SFAS 123, these plans are
considered non-compensatory plans, therefore no compensation expense is
recognized for stock issued under these plans.
U.S.
Cellular
The information in this section relates to stock-based
compensation plans utilizing the equity instruments of U.S. Cellular.
Participants in these plans are employees of U.S. Cellular. U.S. Cellular
employees are also eligible to participate in the TDS Employee Stock Purchase
Plan. Information related to plans utilizing the equity instruments of TDS are
shown in the previous section.
Under the U.S. Cellular 2005 Long-Term Incentive Plan,
U.S. Cellular may grant fixed and performance-based incentive and non-qualified
stock options, restricted stock, restricted stock units, and deferred compensation
stock unit awards to key employees. At September 30, 2006, the only types of
awards outstanding are fixed non-qualified stock option awards, restricted
stock unit awards, and deferred compensation stock unit awards.
24
At September 30, 2006, U.S. Cellular had reserved
5,403,000 Common Shares for equity awards granted and to be granted under this
plan and had also reserved 110,000 Common Shares for issuance to employees
under an employee stock purchase plan. The maximum number of U.S. Cellular
Common Shares that may be issued to employees under all stock-based
compensation plans in effect at September 30, 2006 was 5,513,000 shares. U.S.
Cellular currently utilizes treasury stock to satisfy stock option exercises,
issuances under its employee stock purchase plan, restricted stock unit awards
and deferred compensation stock unit awards. U.S. Cellular employees are also
eligible to participate in the TDS Employee Stock Purchase Plan, which was
described previously.
U.S. Cellular has also created a Non-Employee Director
Compensation Plan under which it has reserved 4,900 Common Shares of U.S.
Cellular at September 30, 2006 for issuance as compensation to members of the
board of directors who are not employees of U.S. Cellular.
On March 7, 2006, the U.S. Cellular Compensation
Committee, approved amendments to stock option award agreements. The amendments
modify current and future options to extend the exercise period until 30 days
following (i) the lifting of a suspension if options otherwise would expire or
be forfeited during the suspension period and (ii) the lifting of a blackout if
options otherwise would expire or be forfeited during a blackout period. U.S.
Cellular temporarily suspended issuances of shares under the 2005 Long Term
Incentive Plan between March 17, 2006 and October 10, 2006 as a consequence of
late SEC filings. As required under the provisions of SFAS 123(R), U.S.
Cellular evaluated the impact of this plan modification and originally
determined that the adjustment to stock based compensation was not
material. However, in connection with
the restatement discussed in Note 1 above, U.S. Cellular further reviewed
the accounting for the plan modification.
Upon such further review, U.S. Cellular determined that it should have
recognized Stock-Based compensation expense of $1.5 million in the three months
ended March 31, 2006 as a result of this modification. U.S. Cellular recognized $0.0 million and
$1.5 million in stock-based compensation expense in the three and nine months
ended September 30, 2006, respectively, as a result of this modification.
Stock Options Stock options granted to key employees
are exercisable over a specified period not in excess of ten years. Stock
options generally vest over periods up to four years from the date of grant.
Stock options outstanding at September 30, 2006 expire between 2006 and 2016.
However, vested stock options typically expire 30 days after the effective date
of an employees termination of employment for reasons other than retirement.
Employees who leave at the age of retirement have 90 days (or one year if they
satisfy certain requirements) within which to exercise their vested stock
options. The exercise price of the option generally equals the market value of
U.S. Cellular Common Shares on the date of grant.
U.S. Cellular did not grant any stock options during
the three months ended September 30, 2006 and September 30, 2005, respectively.
U.S. Cellular granted 551,000 and 757,000 stock options during the nine months
ended September 30, 2006 and September 30, 2005, respectively. U.S. Cellular
estimates the fair value of stock options granted using the Black-Scholes
valuation model. The fair value is then recognized as compensation cost on a
straight-line basis over the requisite service period, which is generally the
vesting period, for each separately vesting portion of the awards as if the
awards were, in-substance, multiple awards, which is the same attribution
method that was used by U.S. Cellular for purposes of its pro forma disclosures
under SFAS 123. U.S. Cellular used the assumptions shown in the table below in
valuing the options granted in 2006:
Expected Life
|
|
3.0 Years
|
|
Expected Annual
Volatility Rate
|
|
25.2
|
%
|
Dividend Yield
|
|
|
|
Risk-free
Interest Rate
|
|
4.7
|
%
|
Estimated Annual
Forfeiture Rate
|
|
4.4
|
%
|
25
A summary of U.S. Cellular stock options outstanding
(total and portion exercisable) at September 30, 2006 and changes during the
nine months then ended is presented in the table below:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Weighted
|
|
Average
|
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
|
|
|
|
Number of
|
|
Exercise
|
|
Contractual
|
|
Aggregate
|
|
|
|
Options
|
|
Prices
|
|
Term
|
|
Intrinsic Value
|
|
Outstanding at
December 31, 2005 (877,000 exercisable)
|
|
2,701,000
|
|
$
|
38.80
|
|
7.5 Years
|
|
$
|
56,469,000
|
|
Granted
|
|
551,000
|
|
59.46
|
|
|
|
132,000
|
|
Exercised
|
|
107,000
|
|
34.51
|
|
|
|
2,259,000
|
|
Forfeited
|
|
37,000
|
|
38.65
|
|
|
|
809,000
|
|
Expired
|
|
1,000
|
|
32.23
|
|
|
|
33,000
|
|
Outstanding at
September 30, 2006 (1,543,000 exercisable)
|
|
3,107,000
|
|
$
|
42.62
|
|
7.1 Years
|
|
$
|
53,083,000
|
|
The aggregate intrinsic value in the table above
represents the total pretax intrinsic value (the difference between U.S.
Cellulars closing stock price on the last trading day of the period and the
exercise price, multiplied by the number of in-the-money options) that would
have been received by the option holders had all option holders exercised their
options on September 30, 2006. This amount will change in future periods based
on the market price of U.S. Cellulars stock. U.S. Cellular received $0 and
$3.7 million in cash from the exercise of stock options during the three and
nine months ended September 30, 2006.
A summary of U.S. Cellular nonvested stock options at
September 30, 2006 and changes during the nine months then ended is presented
in the table that follows:
|
|
|
|
Weighted
Average
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Stock Options
|
|
Stock Options
|
|
Nonvested at
December 31, 2005
|
|
1,824,000
|
|
$
|
14.19
|
|
Granted
|
|
551,000
|
|
14.06
|
|
Vested
|
|
777,000
|
|
14.49
|
|
Forfeited
|
|
34,000
|
|
14.49
|
|
Nonvested at September
30, 2006
|
|
1,564,000
|
|
$
|
13.99
|
|
Restricted Stock UnitsU.S. Cellular grants restricted
stock unit awards to key employees, which generally vest after three years.
U.S. Cellular estimates the fair value of restricted
stock units based on the closing market price of U.S. Cellular shares on the
date of grant, which is not adjusted for any dividends foregone during the
vesting period because U.S. Cellular has never paid a dividend and has
expressed its intention to retain all future earnings in the business. The fair
value is then recognized as compensation cost on a straight-line basis over the
requisite service periods of the awards, which is generally the vesting period.
Awards granted under this plan prior to 2005 were classified as liability
awards due to a plan provision which allowed participants to elect tax
withholding in excess of minimum statutory tax rates. In 2005, this provision
was removed from the plan and awards after 2005 have been classified as equity
awards.
A summary of U.S. Cellular nonvested restricted stock
units at September 30, 2006 and changes during the nine months then ended is
presented in the tables that follow:
26
Liability Classified Awards
|
|
|
|
Weighted
Average
|
|
|
|
|
|
Grant-Date
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Restricted
|
|
Restricted
|
|
|
|
Stock Units
|
|
Stock Units
|
|
Nonvested at December
31, 2005
|
|
193,000
|
|
$
|
30.71
|
|
Granted
|
|
3,000
|
|
59.43
|
|
Vested
|
|
108,000
|
|
23.73
|
|
Forfeited
|
|
7,000
|
|
37.34
|
|
Nonvested at September 30, 2006
|
|
81,000
|
|
$
|
40.46
|
|
Equity Classified Awards
|
|
|
|
Weighted
Average
|
|
|
|
|
|
Grant-Date
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Restricted
|
|
Restricted
|
|
|
|
Stock Units
|
|
Stock Units
|
|
Nonvested at December
31, 2005
|
|
189,000
|
|
$
|
45.63
|
|
Granted
|
|
125,000
|
|
59.43
|
|
Vested
|
|
|
|
|
|
Forfeited
|
|
24,000
|
|
47.76
|
|
Nonvested at September 30, 2006
|
|
290,000
|
|
$
|
51.40
|
|
Long-Term Incentive Plan
Deferred Compensation Stock UnitsCertain U.S. Cellular employees may elect to
defer receipt of all or a portion of their annual bonuses and to receive a
company matching contribution on the amount deferred. All bonus compensation
that is deferred by employees electing to participate is immediately vested and
is deemed to be invested in U.S. Cellular Common Share stock units. Upon
distribution of such stock units, participants will receive U.S. Cellular
Common Shares. The amount of U.S. Cellulars matching contribution depends on
the portion of the annual bonus that is deferred. Participants receive a 25%
match for amounts deferred up to 50% of their total annual bonus and a 33%
match for amounts that exceed 50% of their total annual bonus; such matching
contributions also are deemed to be invested in U.S. Cellular Common Share
stock units. The matching contribution stock units vest ratably at a rate of
one-third per year over three years. Upon vesting and distribution of such
matching contribution stock units, participants will receive U.S. Cellular
Common Shares.
U.S. Cellular estimates the fair value of deferred compensation
matching contribution stock units based on the closing market price of U.S.
Cellular Common Shares on the date of match. The fair value of such matching
contribution stock units is then recognized as compensation cost on a
straight-line basis over the requisite service periods of the awards, which is
generally the vesting period.
A summary of U.S. Cellular nonvested deferred compensation stock units
at September 30, 2006 and changes during the nine months then ended is
presented in the table below:
Deferred Compensation Awards
|
|
|
|
Weighted
Average
|
|
|
|
Number of
|
|
Fair Values of
|
|
|
|
Stock Units
|
|
Stock Units
|
|
Nonvested at December
31, 2005
|
|
7,700
|
|
$
|
41.08
|
|
Granted
|
|
1,700
|
|
56.71
|
|
Vested
|
|
3,900
|
|
42.16
|
|
Forfeited
|
|
|
|
|
|
Nonvested at September 30, 2006
|
|
5,500
|
|
$
|
48.92
|
|
27
Employee Stock Purchase PlanUnder the 2003 Employee Stock Purchase
Plan, eligible employees of U.S. Cellular and its subsidiaries may purchase a
limited number of U.S. Cellular Common Shares on a quarterly basis. U.S.
Cellular had reserved 110,000 Common Shares at September 30, 2006 for issuance
under this plan. The plan became effective on April 1, 2003 and will terminate
on December 31, 2008. U.S. Cellular employees are also eligible to participate
in the TDS Employee Stock Purchase Plan, which was described previously. The
per share cost to each participant in these plans is 85% of the market value of
the Common Shares or Special Common Shares as of the issuance date. Under SFAS
123(R), the employee stock purchase plans are considered compensatory plans;
therefore recognition of compensation cost for stock issued under these plans
is required. Compensation cost is measured as the difference between the cost
of the shares to plan participants and the fair market value of the shares on
the date of issuance. However, due to restrictions on activity under these
plans in place during the three and nine months ended September 30, 2006, no
compensation expense was recognized during these periods for either plan.
Compensation of Non-Employee Directors U.S. Cellular issued 0 and 40
shares under its Non-Employee Director Compensation Plan in the three and nine
months ended September 30, 2006.
Prior to the adoption of SFAS 123(R), U.S. Cellular presented all tax
benefits resulting from tax deductions associated with the exercise of stock
options by employees as cash flows from operating activities in the
Consolidated Statements of Cash Flows. SFAS 123(R) requires that excess tax
benefits be classified as cash flows from financing activities in the
Consolidated Statement of Cash Flows. For this purpose, the excess tax benefits
are tax benefits related to the difference between the total tax deduction
associated with the exercise of stock options by employees and the amount of
compensation cost recognized for those options. For the nine months ended
September 30, 2006, excess tax benefits of $0.3 million were included in cash
flows from financing activities in the Consolidated Statements of Cash Flows
pursuant to this requirement of SFAS 123(R).
4. Income Taxes
The following
table summarizes the effective income tax rates for the three and nine months
ended September 30, 2006 and 2005.
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Effective Income
Tax (Benefit) Rate From:
|
|
|
|
|
|
|
|
|
|
Operations
excluding gain on investments and fair value adjustment of derivative
instruments
|
|
24.6
|
%
|
38.7
|
%
|
37.2
|
%
|
40.2
|
%
|
Gain on
investments and fair value adjustment of derivative instruments (1)
|
|
41.2
|
%
|
27.2
|
%
|
37.6
|
%
|
39.6
|
%
|
Income before income
taxes and minority interest
|
|
29.3
|
%
|
39.4
|
%
|
37.3
|
%
|
39.9
|
%
|
(1) In the second quarter of 2006, TDS Telecom recorded gains on investments
of $91.4 million. See Note 5 Gains on Investments. Also included in these amounts are fair value
adjustments of derivative instruments.
See Note 6 Fair Value Adjustment of Derivative Instruments.
The three- and nine-month
effective tax rates are lower than 2005 as a result of favorable outcomes upon the
completion of certain state income tax audits.
The loss of $4.7 million
from the fair value adjustment of derivative instruments in the quarter ended
September 30, 2005 included a loss on Vodafone derivative instruments,
partially offset by a gain on Deutsche Telekom derivative instruments. The
Vodafone derivative instruments have a lower effective tax rate than the
Deutsche Telekom derivative instruments.
In June of 2006, the
Internal Revenue Service commenced its audit of the 2002 2004 consolidated
federal tax returns of TDS and subsidiaries.
In October 2006, the Internal Revenue Service added the 2005 consolidated
federal tax return to the audit cycle.
The audit is in its preliminary stages.
28
5. Gain on Investment
The total gain on investment of $91.4 million primarily represents the
gain associated with TDS Telecoms gain on remittance of Rural Telephone Bank (RTB)
stock. TDS Telecom has in the past obtained financing from the RTB. In
connection with such financings, TDS Telecom purchased stock in the RTB. TDS
Telecom has repaid all of its debt to the RTB, but continued to own the RTB
stock. In August 2005, the board of directors of the RTB approved resolutions
to liquidate and dissolve the RTB. In order to effect the dissolution and
liquidation, shareholders were asked to remit their shares to receive cash
compensation for those shares. TDS Telecom remitted its shares and received
$101.7 million from the RTB and recorded a gain of $90.3 million in the second
quarter of 2006.
6. Fair Value
Adjustment of Derivative Instruments
Fair value adjustment of derivative instruments totaled a gain of $34.6
million and $22.9 million in the three and nine months ended September 30,
2006, respectively, and a gain (loss) of $(4.4) million and $495.3 million in
the three and nine months ended September 30, 2005, respectively. Fair value adjustment of derivative
instruments reflects the change in the fair value of the bifurcated embedded
collars within the forward contracts related to the Deutsche Telekom and
Vodafone marketable equity securities not designated as a hedge. The changes in
fair value of the embedded collars during cash flow hedge designation are
recorded to other comprehensive income. When the collars were de-designated in
the cash flow hedge, subsequent changes in fair value are recognized in the
consolidated statement of operations, along with the related income tax
effects. The accounting for the embedded
collars as derivative instruments not designated in a hedging relationship
results in increased volatility in the results of operations, as fluctuation in
the market price of the underlying Deutsche Telekom and Vodafone marketable
equity securities results in changes in the fair value of the embedded collars
being recorded in the consolidated statement of operations. Also included in the fair value adjustment of
derivative instruments are the gains and losses related to the ineffectiveness
of the VeriSign fair value hedge which aggregated an unrealized gain of $0.2
million and $1.0 million in the three and nine months ended September 30, 2006,
respectively, and an unrealized gain of $0.2 million and $0.3 million in the
three and nine months ended September 30, 2005, respectively.
7. Discontinued
Operations
TDS is a party to
an indemnity agreement with T-Mobile USA, Inc. (T-Mobile) regarding certain
contingent liabilities for Aerial Communications, Inc. (Aerial), a former
subsidiary of TDS. TDS has recorded an accrual for expenses, primarily tax
related, resulting from Aerials merger into VoiceStream Wireless Corporation (VoiceStream)
in 2000.
In July 2005, TDS
paid $7.1 million in settlement of items related to this indemnity agreement.
The net gain of
$0.3 million ($0.5 million, net of $0.2 million of income tax expense),
recorded in Discontinued Operations, Net of Tax, represents a reduction in the
indemnity accrual due to a favorable outcome of a state tax audit which reduced
the potential indemnity obligation.
8. Earnings per Share
Basic earnings per share is computed by dividing net income available
to common by the weighted average common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by weighted
average number of common shares outstanding for the period adjusted to include
the effect of potentially dilutive securities. Potentially dilutive securities
include incremental shares issuable upon exercise of outstanding stock options.
TDS distributed
one Special Common Share in the form of a stock dividend with respect to each
outstanding Common Share and Series A Common Share of TDS on May 13, 2005 to
shareholders of record on April 29, 2005. As a result of the Special Common
Share Dividend, each option outstanding on May 13, 2005 was converted into a
tandem option for one Common Share and one Special Common Share at the same
exercise price per tandem option exercised.
29
The net income
amounts used in computing earnings per share and the effects on the weighted
average number of common and Series A Common Shares and earnings per share of
potentially dilutive stock options are as follows:
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars and shares in thousands, except earnings per share)
|
|
Basic
Earnings per Share:
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
75,239
|
|
$
|
38,275
|
|
$
|
277,995
|
|
$
|
455,815
|
|
Preferred dividend requirement
|
|
(51
|
)
|
(50
|
)
|
(152
|
)
|
(152
|
)
|
Income from Continuing Operations Available to
Common
|
|
75,188
|
|
38,225
|
|
277,843
|
|
455,663
|
|
Discontinued Operations
|
|
|
|
340
|
|
|
|
340
|
|
Net income available to common used in basic
earnings per share
|
|
$
|
75,188
|
|
$
|
38,565
|
|
$
|
277,843
|
|
$
|
456,003
|
|
|
|
|
|
|
|
|
|
|
|
Diluted Earnings
per Share:
|
|
|
|
|
|
|
|
|
|
Income from continuing operations Available to
common used in basic earnings per share
|
|
$
|
75,188
|
|
$
|
38,225
|
|
$277,843
|
|
$
|
455,663
|
|
Minority income adjustment (1)
|
|
(270
|
)
|
(165
|
)
|
(945
|
)
|
(617
|
)
|
Preferred dividend adjustment (2)
|
|
50
|
|
12
|
|
150
|
|
149
|
|
Income from Continuing Operations Available to
Common
|
|
74,968
|
|
38,072
|
|
277,048
|
|
455,195
|
|
Discontinued Operations
|
|
|
|
340
|
|
|
|
340
|
|
Net income
available to common used in diluted earnings per share
|
|
$
|
74,968
|
|
$
|
38,412
|
|
$
|
277,048
|
|
$
|
455,535
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average
number of shares of common stock used in basic earnings per share:
|
|
|
|
|
|
|
|
|
|
Common Shares
|
|
51,486
|
|
51,293
|
|
51,480
|
|
51,183
|
|
Special Common Shares
|
|
57,836
|
|
57,697
|
|
57,832
|
|
57,604
|
|
Series A Common Shares
|
|
6,446
|
|
6,433
|
|
6,447
|
|
6,430
|
|
Weighted average number of shares of common stock
used in basic earnings per share
|
|
115,768
|
|
115,423
|
|
115,759
|
|
115,217
|
|
Effects of
Dilutive Securities:
|
|
|
|
|
|
|
|
|
|
Effects of stock options (3)
|
|
935
|
|
630
|
|
705
|
|
687
|
|
Conversion of preferred shares (4)
|
|
159
|
|
50
|
|
159
|
|
159
|
|
Weighted average number of shares of common stock
used in diluted earnings per share
|
|
116,862
|
|
116,103
|
|
116,623
|
|
116,063
|
|
|
|
|
|
|
|
|
|
|
|
Basic Earnings
per Share
|
|
|
|
|
|
|
|
|
|
Continuing Operations
|
|
$
|
0.65
|
|
$
|
0.33
|
|
$
|
2.40
|
|
$
|
3.96
|
|
Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
0.65
|
|
0.33
|
|
2.40
|
|
3.96
|
|
Diluted Earnings
per Share
|
|
|
|
|
|
|
|
|
|
Continuing Operations
|
|
$
|
0.64
|
|
$
|
0.33
|
|
$
|
2.38
|
|
$
|
3.92
|
|
Discontinued Operations
|
|
|
|
|
|
|
|
|
|
|
|
$
|
0.64
|
|
$
|
0.33
|
|
$
|
2.38
|
|
$
|
3.92
|
|
(1) The minority income
adjustment reflects the additional minority share of U.S. Cellulars income
computed as if all of U.S. Cellulars dilutive securities were outstanding.
(2) The preferred dividend
adjustment reflects the dividend reduction in the event any preferred series
were dilutive, and therefore converted for shares.
(3) Stock options
convertible into 669,061 Common Shares and 669,061 Special Common Shares were
not included in computing Diluted Earnings per Share in the three months ended
September 30, 2006, because their effects would have increased earnings per
share. Stock options convertible into 1,293,284 Common Shares and 2,398,003
Special Common Shares were not included in computing Diluted Earnings per Share
in the nine months ended September 30, 2006, because their effects would
have increased earnings per share. Stock options convertible into 674,249
Common Shares and 674,249 Special Common Shares were not included in computing
Diluted Earnings per Share in the three and nine months ended September 30,
2005 because their effects would have increased earnings per share.
(4) Preferred shares
convertible into 54,540 Common Shares and 54,540 Special Common Shares were not
included in computing Diluted Earnings per Share in the three months ended
September 30, 2005, because their effects would have increased earnings per
share.
30
9. Marketable Equity
Securities and Forward Contracts
TDS and its subsidiaries hold a substantial amount of marketable equity
securities that are publicly traded and can have volatile movements in share
prices. TDS and its subsidiaries do not make direct investments in publicly
traded companies and all of these interests were acquired as a result of sales,
trades or reorganizations of other assets.
Information regarding TDSs marketable equity securities is summarized
as follows:
|
|
September 30,
2006
|
|
December 31,
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Marketable
Equity Securities Current Assets
|
|
|
|
|
|
Deutsche Telekom AG 45,492,172 and 0 Ordinary
Shares, respectively
|
|
$
|
723,326
|
|
$
|
|
|
Vodafone Group Plc 8,964,698 and 0 American
Depositary Receipts, respectively
|
|
204,933
|
|
|
|
VeriSign, Inc. 2,361,333 and 0 Common Shares,
respectively
|
|
47,698
|
|
|
|
Aggregate fair
value included in Current Assets
|
|
975,957
|
|
|
|
|
|
|
|
|
|
Marketable
Equity Securities - Investments
|
|
|
|
|
|
Deutsche Telekom AG 85,969,689 and 131,461,861
Ordinary Shares, respectively
|
|
1,366,918
|
|
2,191,469
|
|
Vodafone Group Plc 2,362,976 and 12,945,915
American Depositary Receipts, respectively
|
|
54,018
|
|
277,949
|
|
VeriSign, Inc. - 0 and 2,361,333 Common Shares
|
|
|
|
51,760
|
|
Rural Cellular Corporation - 719,396 equivalent
Common Shares
|
|
6,928
|
|
10,511
|
|
Other
|
|
|
|
1
|
|
Aggregate fair
value included in investments
|
|
1,427,864
|
|
2,531,690
|
|
Total aggregate
fair value
|
|
2,403,821
|
|
2,531,690
|
|
Accounting cost
basis
|
|
1,507,476
|
|
1,543,677
|
|
Gross holding
gains
|
|
896,345
|
|
988,013
|
|
Gross realized
holding gains
|
|
(20,638
|
)
|
(24,700
|
)
|
Gross unrealized
holding gains
|
|
875,707
|
|
963,313
|
|
Equity method
unrealized gains
|
|
352
|
|
543
|
|
Income tax
(expense)
|
|
(342,921
|
)
|
(377,845
|
)
|
Minority share
of unrealized holding gains
|
|
(9,182
|
)
|
(7,738
|
)
|
Unrealized
holding gains, net of tax and minority share
|
|
523,956
|
|
578,273
|
|
Derivative
instruments, net of tax and minority share
|
|
(214,635
|
)
|
(214,632
|
)
|
Accumulated other
comprehensive income
|
|
$
|
309,321
|
|
$
|
363,641
|
|
The investment in Deutsche Telekom AG (Deutsche Telekom) resulted
from TDSs disposition of its over 80%-owned personal communication services
operating subsidiary, Aerial Communications, Inc., to VoiceStream Wireless
Corporation (VoiceStream) in exchange for stock of VoiceStream, which was
then acquired by Deutsche Telekom in exchange for Deutsche Telekom stock. The
investment in Vodafone Group Plc (Vodafone) resulted from certain
dispositions of non-strategic cellular investments to or settlements with
AirTouch Communications Inc. (AirTouch), in exchange for stock of AirTouch,
which was then acquired by Vodafone whereby TDS and its subsidiaries received
American Depositary Receipts representing Vodafone stock. The investment in
VeriSign, Inc. (VeriSign) is the result of the acquisition by VeriSign of
Illuminet, Inc., a telecommunication entity in which several TDS subsidiaries
held interests. The investment in Rural Cellular Corporation (Rural Cellular)
is the result of a consolidation of several cellular partnerships in which TDS
subsidiaries held interests in Rural Cellular, and the distribution of Rural
Cellular stock in exchange for these interests.
TDS has entered into a number of forward contracts related to the
marketable equity securities it holds. The economic hedge risk management
objective of the forward contracts is to hedge the value of the marketable
equity securities from losses due to decreases in the market prices of the
securities while retaining a share of gains from increases in the market prices
of such securities. The downside risk is hedged at or above the accounting cost
basis of the securities.
31
The forward contracts related to U.S. Cellulars 8,964,698 Vodafone
American Depositary Receipts (ADRs) and TDSs 2,361,333 VeriSign common
shares mature in May 2007. The forward contracts related to 45,492,172 Deutsche
Telekom ordinary shares mature between July and September of 2007. Accordingly,
the Vodafone ADRs, VeriSign common shares and Deutsche Telekom ordinary shares
are classified as Current Assets and the related forward contracts and
derivative liability are classified as Current Liabilities in the Consolidated
Balance Sheets at September 30, 2006.
Vodafone Special Distribution and Share Consolidation
At an Extraordinary General Meeting held on
July 25, 2006, shareholders of Vodafone approved a Special Distribution of
£0.15 per share (£1.50 per ADR) and a Share Consolidation under which every 8
ADRs of Vodafone were consolidated into 7 ADRs. As a result of the Special
Distribution which was paid on August 18, 2006, U.S. Cellular and TDS Telecom
received approximately $28.6 million and $7.6 million, respectively, in cash;
this amount, representing a return of capital for financial statement purposes,
was recorded as a reduction in the accounting basis of the marketable equity
securities. Also, as a result of the Share Consolidation which was effective on
July 28, 2006, U.S. Cellulars previous 10,245,370 Vodafone ADRs were
consolidated into 8,964,698 Vodafone ADRs and TDS Telecoms previous 2,700,545
Vodafone ADRs were consolidated into 2,362,976 ADRs.
Pursuant to terms of the Vodafone forward contracts, the Vodafone
contract collars were adjusted and substitution payments were made as a result
of the Special Distribution and the Share Consolidation. After adjustment, the
collars had downside limits (floor) ranging from $17.22 to $18.37 and upside
potentials (ceiling) ranging from $17.22 to $19.11. In the case of two forward
contracts, subsidiaries of TDS made a dividend substitution payment in the
amount of $3.2 million to the counterparties in lieu of further adjustments to
the collars for such forward contracts.
The dividend substitution payments were recorded in Other expense in the
Consolidated Statements of Operations.
See Note 16 Long-Term Debt and Forward Contracts for additional
information related to forward contracts.
10. Licenses and Goodwill
TDS has substantial amounts of goodwill as a result of the acquisition
of wireless markets, and the acquisition of operating telephone companies. The
changes in licenses and goodwill result primarily from acquisitions,
divestitures and impairments.
A summary of activity in licenses and goodwill for the nine months
ended September 30, 2006 and 2005 is provided below. TDS Telecoms incumbent
local exchange carriers are designated as ILEC and its competitive local
exchange carriers are designated as CLEC.
|
|
|
|
TDS
|
|
|
|
|
|
U.S.
|
|
Telecom
|
|
|
|
|
|
Cellular
|
|
CLEC
|
|
Total
|
|
|
|
(Dollars in thousands)
|
|
Licenses
|
|
|
|
|
|
|
|
Balance December
31, 2005
|
|
$
|
1,362,263
|
|
$
|
2,800
|
|
$
|
1,365,063
|
|
Acquisitions
|
|
5,534
|
|
|
|
5,534
|
|
Other (1)
|
|
79,772
|
|
|
|
79,772
|
|
Balance
September 30, 2006
|
|
$
|
1,447,569
|
|
$
|
2,800
|
|
$
|
1,450,369
|
|
|
|
|
|
|
|
|
|
Balance December
31, 2004
|
|
$
|
1,228,801
|
|
$
|
|
|
$
|
1,228,801
|
|
Acquisitions
|
|
133,633
|
|
|
|
133,633
|
|
Assets of Operations Held for Sale
|
|
(21,945
|
)
|
|
|
(21,945
|
)
|
Other
|
|
|
|
|
|
|
|
Balance September 30,
2005
|
|
$
|
1,340,489
|
|
$
|
|
|
$
|
1,340,489
|
|
(1) Includes $80 million representing deposits made to the FCC for Barat
Wireless licenses with respect to which Barat Wireless was the high bidder in
Auction 66. See Note 19 Acquisitions, Divestitures and Exchanges for more
information related to Barat Wireless.
32
|
|
U.S.
|
|
TDS Telecom
|
|
|
|
|
|
|
|
Cellular (1)
|
|
ILEC
|
|
CLEC
|
|
Other (2)
|
|
Total
|
|
Goodwill
|
|
(Dollars in thousands)
|
|
Balance December
31, 2005 (As Restated)
|
|
$
|
481,235
|
|
$
|
398,652
|
|
$
|
|
|
$
|
2,281
|
|
$
|
882,168
|
|
Acquisitions
|
|
3,932
|
|
|
|
|
|
|
|
3,932
|
|
Other Adjustments
|
|
318
|
|
|
|
|
|
|
|
318
|
|
Balance
September 30, 2006
|
|
$
|
485,485
|
|
$
|
398,652
|
|
$
|
|
|
$
|
2,281
|
|
$
|
886,418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December
31, 2004 (As Restated)
|
|
$
|
454,830
|
|
$
|
398,652
|
|
$
|
|
|
$
|
2,281
|
|
$
|
855,763
|
|
Acquisitions
|
|
237
|
|
|
|
|
|
|
|
237
|
|
Assets of Operations Held for Sale
|
|
(2,741
|
)
|
|
|
|
|
|
|
(2,741
|
)
|
Other
|
|
(10
|
)
|
|
|
|
|
|
|
(10
|
)
|
Balance September 30,
2005 (As Restated)
|
|
$
|
452,316
|
|
$
|
398,652
|
|
$
|
|
|
$
|
2,281
|
|
$
|
853,249
|
|
(1) As a result of the exchange agreement entered into with ALLTEL during
2005, U.S. Cellular reclassified $2.7 million of goodwill to Assets of
Operations Held for Sale as of September 30, 2005. The transaction closed in
the fourth quarter of 2005.
(2) Other consists of goodwill related to Suttle Straus.
See Note 19 Acquisitions Divestitures and Exchanges for additional
information related to transactions which affected licenses and goodwill.
Licenses and goodwill must be reviewed for impairment annually or more
frequently if events or changes in circumstances indicate that the asset might
be impaired. TDS and U.S. Cellular perform the annual impairment review on licenses
and goodwill during the second quarter of their fiscal year. Accordingly, the
annual impairment tests for licenses and goodwill were performed in the second
quarter of 2006 and 2005. Such impairment tests indicated that there was no
impairment of licenses or goodwill in either year.
11. Unconsolidated Entities
Investments in unconsolidated entities consist of amounts invested in
wireless and wireline entities in which TDS holds a minority interest. These
investments are accounted for using either the equity or cost method.
TDSs significant investments in unconsolidated entities included the
following:
|
|
September 30,
2006
|
|
September 30,
2005
|
|
Los Angeles SMSA
Limited Partnership
|
|
5.5
|
%
|
5.5
|
%
|
Midwest Wireless
Communications, L.L.C. (1)
|
|
14.2
|
%
|
14.2
|
%
|
North Carolina
RSA 1 Partnership
|
|
50.0
|
%
|
50.0
|
%
|
Oklahoma City SMSA
Limited Partnership
|
|
14.6
|
%
|
14.6
|
%
|
(1) In addition, at September 30, 2006 and 2005 U.S. Cellular owned a 49%
interest in an entity which owned an interest of approximately 2.9% in Midwest
Wireless Holdings, L.L.C., the parent company of Midwest Wireless
Communications, L.L.C. See Note 23 Subsequent Events for information on the
disposition of this interest.
33
Based primarily on data furnished to TDS by third parties, the
following summarizes the combined results of operations of all wireless and
wireline entities in which TDSs investments are accounted for by the equity
method:
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
Results of
operations
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
1,082,000
|
|
$
|
912,000
|
|
$
|
3,100,000
|
|
$
|
2,527,000
|
|
Operating expenses
|
|
744,000
|
|
631,000
|
|
2,135,000
|
|
1,754,000
|
|
Operating income
|
|
338,000
|
|
281,000
|
|
965,000
|
|
773,000
|
|
Other income, net (1)
|
|
10,000
|
|
1,000
|
|
32,000
|
|
15,000
|
|
Net Income
|
|
$
|
348,000
|
|
$
|
282,000
|
|
$
|
997,000
|
|
$
|
788,000
|
|
(1) Includes income tax related to small corporations.
See Note 23 Subsequent Events for additional information related to
TDSs investment in Midwest Wireless Communications, L.L.C.
12. Customer Lists
Customer lists
acquired in connection with purchases and exchanges of wireless markets are
being amortized based on average customer retention periods using the double
declining balance method in the first year, switching to straight-line over the
remaining estimated life. The acquisition of certain minority interests in the
nine months ended September 30, 2006 and 2005 added $2.0 million and $0.6
million, respectively, to the gross balance of customer lists. Customer list
amortization expense was $5.9 million and $17.6 million for the three and nine
months ended September 30, 2006, respectively, and $2.4 million and $7.6
million for the three and nine months ended September 30, 2005, respectively.
Amortization expense for the remainder of 2006 and for the years 2007-2011 is
expected to be $5.9 million, $9.8 million, $7.2 million, $5.4 million, $3.7
million and $0.1 million, respectively.
13. Property, Plant and
Equipment
In
accordance with SFAS 144, U.S. Cellular and TDS Telecom review long-lived
assets, including property, plant and equipment, for impairment whenever events
or changes in circumstances indicate that the carrying amount may not be fully
recoverable. U.S. Cellular performed impairment tests of property, plant and
equipment during the second quarter of 2006 and 2005. Such impairment tests
indicated that there was no impairment of property, plant and equipment in
either year.
14. Revolving Credit Facilities
TDS has a $600 million revolving credit facility available for general
corporate purposes. At September 30, 2006, letters of credit outstanding were
$3.4 million, leaving $596.6 million available for use. Borrowings under the
revolving credit facility bear interest at the London InterBank Offered Rate (LIBOR)
plus a contractual spread based on TDSs credit rating. TDS may select
borrowing periods of either seven days or one, two, three or six months. At
September 30, 2006, one-month LIBOR was 5.32% and the contractual spread was 60
basis points. If TDS provides less than two days notice of intent to borrow,
the related borrowings bear interest at the prime rate less 50 basis points
(the prime rate was 8.25% at September 30, 2006). This credit facility expires
in December 2009.
TDS also has $75 million of direct bank lines of credit at September
30, 2006, all of which were unused. The terms of the direct lines of credit
bear negotiated interest rates up to the prime rate (the prime rate was 8.25%
at September 30, 2006).
34
U.S. Cellular has a $700 million revolving credit facility available
for general corporate purposes. At September 30, 2006, outstanding notes
payable and letters of credit were $150.0 million and $0.5 million,
respectively, leaving $549.5 million available for use. Borrowings under the
revolving credit facility bear interest at the London InterBank Offered Rate (LIBOR)
plus a contractual spread based on U.S. Cellulars credit rating. U.S. Cellular
may select borrowing periods of either seven days or one, two, three or six
months. At September 30, 2006, the one-month LIBOR was 5.32% and the
contractual spread was 60 basis points. If U.S. Cellular provides less than two
days notice of intent to borrow, the related borrowings bear interest at the
prime rate less 50 basis points (the prime rate was 8.25% at September 30,
2006). This credit facility expires in December 2009.
TDSs and U.S. Cellulars interest cost on their revolving credit
facilities would increase if their current credit ratings from either Standard
& Poors Rating Service (Standard & Poors) or Moodys Investor
Service (Moodys) were lowered. However, the credit facilities would not
cease to be available or accelerate solely as a result of a decline in TDSs or
U.S. Cellulars credit rating. A downgrade in TDSs or U.S. Cellulars credit
rating could adversely affect their ability to renew existing, or obtain access
to new, credit facilities in the future. TDSs and U.S. Cellulars credit
ratings as of the dates indicated, are as follows:
Moodys (Issued November 10, 2005)
|
|
Baa3
|
|
under review for possible further downgrade
|
Standard & Poors (Issued February 13, 2007)
|
|
BBB-
|
|
on credit watch with negative implications
|
Fitch Ratings (Issued November 10, 2005)
|
|
BBB+
|
|
on ratings watch negative
|
TDSs and U.S. Cellulars credit ratings may be changed at any time and
such ratings should not be assumed to be accurate as of any future date.
The maturity dates of borrowings under TDSs and U.S. Cellulars
revolving credit facilities would accelerate in the event of a change in
control. The continued availability of the revolving credit facilities requires
TDS and U.S. Cellular to comply with certain negative and affirmative
covenants, maintain certain financial ratios and represent certain matters at
the time of each borrowing.
On November 10, 2005, TDS and U.S. Cellular announced that they would
restate certain financial statements which caused TDS and U.S. Cellular to be
late in certain SEC filings. The restatements and late filings resulted in
defaults under the revolving credit facilities and one line of credit facility.
However, TDS and U.S. Cellular were not in violation of any covenants that
require TDS and U.S. Cellular to maintain certain financial ratios and did not
fail to make any scheduled payments. TDS and U.S. Cellular received waivers
from the lenders associated with the revolving credit facilities, under which the
lenders agreed to waive any defaults that may have occurred as a result of the
restatements and late filings. The waivers required the Form 10-K for the year
ended December 31, 2005 to be filed by August 31, 2006, the Form 10-Q for the
quarter ended March 31, 2006 to be filed within 30 days after the filing of the
Form 10-K for the year ended December 31, 2005 and the Form 10-Q for the
quarter ended June 30, 2006 to be filed within 45 days after the filing of the
Form 10-Q for the quarter ended March 31, 2006. On October 6, 2006, TDS and
U.S. Cellular received amended waivers from the lenders associated with the
revolving credit facilities which extended the date by which the financial
statements of TDS and U.S. Cellular for the second quarter ended June 30, 2006
were required to be delivered to November 8, 2006. The Form 10-K for the year
ended December 31, 2005 was filed on July 28, 2006, the Form 10-Q for the
quarter ended March 31, 2006 was filed on August 25, 2006, and the Form 10-Q
for the quarter ended June 30, 2006 was filed on October 10, 2006.
35
In addition, TDS and its audit committee
concluded on November 6, 2006 to restate the Consolidated Financial Statements
as of and for the three years ended December 31, 2005. TDS and its audit
committee also concluded that TDS would amend its Quarterly Reports on Form
10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 to
restate the Consolidated Financial Statements and financial information
included therewith. The restatement
resulted in defaults under the revolving credit agreements and one line of
credit agreement. TDS and U.S. Cellular
were not in violation of any covenants that require TDS and U.S. Cellular to
maintain certain financial ratios. TDS
and U.S. Cellular did not fail to make any scheduled payments under such credit
agreements. TDS and U.S. Cellular
received waivers from the lenders associated with the credit agreements, under
which the lenders agreed to waive any defaults that may have occurred as a
result of the restatement. The waivers require the Form 10-K/A for the
year ended December 31, 2005, the Forms 10-Q/A for the quarterly periods
ended March 31, 2006 and June 30, 2006 and the Form 10-Q for the quarterly
period ended September 30, 2006 to be filed by March 14, 2007.
On October 26, 2006, Standard & Poors
Rating Services lowered its credit ratings on TDS and U.S. Cellular to BBB+
from A-. The outlook was stable. On November 7, 2006, Standard & Poors
Rating Services lowered its credit ratings on TDS and U.S. Cellular to BBB from
BBB+. The ratings were placed on credit
watch with negative implications. On
February 13, 2007, Standard & Poors Rating Services lowered its credit
ratings on TDS and U.S. Cellular to BBB- from BBB. The ratings remain on credit watch with
negative implications. The credit
ratings by Moodys Investors Service remain Baa3 under review for
possible further downgrade. The credit
ratings by Fitch remain BBB+ on ratings watch negative.
15. Asset Retirement
Obligations
TDS accounts for its asset retirement obligations in accordance with
SFAS No. 143, Accounting for Asset Retirement Obligations, (SFAS 143) and
FASB Interpretation No. 47, Accounting for Conditional Asset Retirement
Obligations (FIN 47), which require entities to record the fair value of a
liability for legal obligations associated with an asset retirement in the
period in which the obligations are incurred. At the time the liability is
incurred, TDS records a liability equal to the net present value of the
estimated cost of the asset retirement obligation and increases the carrying
amount of the related long-lived asset by an equal amount. Over time, the
liability is accreted to its present value each period, and the capitalized
cost is depreciated over the useful life of the related asset. Upon settlement
of the obligations, any difference between the cost to retire an asset and the
recorded liability (including accretion of discount) is recognized in the
Consolidated Statement of Operations as a gain or loss.
U.S. Cellular is
subject to asset retirement obligations associated primarily with its cell
sites, retail sites and office locations. Asset retirement obligations
generally include obligations to remediate leased land on which U.S. Cellulars
cell sites and switching offices are located. U.S. Cellular is also generally
required to return leased retail store premises and office space to their
pre-existing conditions.
TDS Telecoms incumbent local exchange carriers have recorded an asset
retirement obligation in accordance with the requirements of SFAS No. 143 and
FIN 47, and a regulatory liability for the costs of removal that state public
utility commissions have required to be recorded for regulatory accounting
purposes. The amounts recorded for regulatory accounting purposes are in
addition to the amounts required to be recorded in accordance with SFAS No 143
and FIN 47. These amounts combined make up the asset retirement obligation
for the incumbent local exchange carriers. The asset retirement obligation
calculated in accordance with the provisions of SFAS No. 143 and FIN 47 at
September 30, 2006 was $38.3 million. The regulatory liability in
excess of the amounts required to be recorded in accordance with SFAS No. 143 and
FIN 47 at September 30, 2006 was $62.3 million.
In accordance with the requirements of SFAS No. 143 and FIN 47, TDS
Telecoms competitive local exchange carrier has calculated an asset retirement
obligation of $3.0 million at September 30, 2006.
36
During the third quarter of 2006, U.S. Cellular
reviewed the assumptions related to its asset retirement obligations and, as a
result of the review, revised certain of those assumptions. Estimated
retirement obligations for cell sites were revised to reflect higher estimated
costs for removal of radio and power equipment, and estimated retirement
obligations for retail stores were revised to reflect a shift to larger stores
and slightly higher estimated costs for removal of fixtures. These changes are reflected in Revision in
estimated cash flows below. The table
below also summarizes other changes in asset retirement obligations during the
nine months ended September 30, 2006 and 2005.
TDS Telecoms incumbent local exchange carriers are designated as ILEC
in the table and its competitive local exchange carrier is designated as
CLEC.
|
|
U.S.
|
|
TDS Telecom
|
|
TDS
|
|
|
|
Cellular
|
|
ILEC
|
|
CLEC
|
|
Consolidated
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
Balance December 31, 2005 (As Restated)
|
|
$
|
90,224
|
|
$
|
97,509
|
|
$
|
2,649
|
|
$
|
190,382
|
|
Additional
liabilities incurred
|
|
5,922
|
|
3,552
|
|
186
|
|
9,660
|
|
Revision in
estimated cash flows
|
|
13,415
|
|
|
|
|
|
13,415
|
|
Acquisition of
assets
|
|
1,237
|
|
|
|
|
|
1,237
|
|
Disposition of
assets
|
|
(112
|
)
|
(513
|
)
|
|
|
(625
|
)
|
Accretion
expense
|
|
5,312
|
|
26
|
|
139
|
|
5,477
|
|
Ending Balance
September 30, 2006
|
|
$
|
115,998
|
|
$
|
100,574
|
|
$
|
2,974
|
|
$
|
219,546
|
|
16. Long-Term Debt and
Forward Contracts
The late filing of TDSs and U.S. Cellulars Forms 10-K for the year
ended December 31, 2005 and Forms 10-Q for the quarterly periods ended March
31, 2006 and June 30, 2006 and the failure to deliver such Forms 10-K and 10-Q
to the trustees of the TDS and U.S. Cellular debt indentures on a timely basis,
resulted in non-compliance under such debt indentures. However, this
non-compliance did not result in an event of default or a default. TDS and U.S.
Cellular believe that non-compliance was cured upon the filing of their Forms
10-K for the year ended December 31, 2005 and Forms 10-Q for the quarterly
periods ended March 31, 2006 and June 30, 2006. TDS and U.S. Cellular have not
failed to make nor do they expect to fail to make any scheduled payment of
principal or interest under such indentures.
In addition, the late filing of this Form 10-Q and the failure to
deliver such Form 10-Q to the trustees of the TDS debt indentures on a timely
basis also resulted in non-compliance under such debt indentures. However, this
non-compliance did not result in an event of default or a default and TDS
believes that such non-compliance was cured upon the filing of this Form
10-Q. In addition, the late filing of
the Form 10-Q for the quarterly period ended September 30, 2006 by U.S. Cellular
and the failure to deliver such Form 10-Q to the trustees of the U.S. Cellular
debt indentures on a timely basis resulted in non-compliance under such debt
indentures. However, this non-compliance did not result in an event of default
or a default and U.S. Cellular believes that such non-compliance was cured upon
the filing of this Form 10-Q. Neither
TDS nor U.S. Cellular has failed to make or expects to fail to make any
scheduled payment of principal or interest under such indentures.
Except as noted above, TDS believes that it and its subsidiaries were
in compliance as of September 30, 2006 with all covenants and other
requirements set forth in its long-term debt indentures. Such indentures do not
contain any provisions resulting in acceleration of the maturities of
outstanding debt in the event of a change in TDSs credit rating. However, a
downgrade in TDSs credit rating could adversely affect its ability to obtain
long-term debt financing in the future.
In January and February of 2006, TDS redeemed $35.0 million of
medium-term notes which carried interest rates of 10%.
TDS repaid $200.0 million plus accrued interest on its 7% unsecured
senior notes on August 1, 2006, using cash on-hand.
37
Forward Contracts
TDS maintains a portfolio of available-for-sale marketable equity
securities, the majority of which are the result of sales or trades of
non-strategic assets. Subsidiaries of TDS have prepaid forward contracts with
counterparties in connection with its Deutsche Telekom, Vodafone and VeriSign
marketable equity securities. The principal amount of the prepaid forward
contracts was accounted for as a loan. The prepaid forward contracts contain
embedded collars that are bifurcated and receive separate accounting treatment
in accordance with SFAS No. 133.
The Deutsche Telekom forward contracts mature from July 2007 to
September 2008, of which the forward contracts related to 45,492,172 ordinary
shares mature between July and September 2007. A majority of the contracts
require quarterly interest payments at the LIBOR rate plus 50 basis points (the
three-month LIBOR rate was 5.37% at September 30, 2006). The remaining
contracts are structured as zero coupon obligations with a weighted average
effective interest rate of 4.4% per year. No interest payments are required for
the zero coupon obligations during the contract period.
The Vodafone forward contracts mature in May and October 2007. The
Vodafone forward contracts require quarterly interest payments at the LIBOR
rate plus 50 basis points (the three-month LIBOR rate was 5.37% at
September 30, 2006).
Pursuant to terms of the Vodafone forward contracts, the Vodafone
contract collars were adjusted and substitution payments were made as a result
of the Special Distribution and the Share Consolidation. After adjustment, the
collars had downside limits (floor) ranging from $17.22 to $18.37 and upside
potentials (ceiling) ranging from $17.22 to $19.11. In the case of two forward
contracts, subsidiaries of TDS made a dividend substitution payment in the
amount of $3.2 million to the counterparties in lieu of further adjustments to
the collars for such forward contracts.
The dividend substitution payments were recorded in Other expense in the
Consolidated Statements of Operations.
The VeriSign forward contract matures in May 2007 and is structured as
a zero coupon obligation with an effective interest rate of 5.00% per year. TDS
is not required to make interest payments during the contract period.
The TDS VeriSign forward contracts related to 2,361,333 common shares
and the forward contracts related to U.S. Cellulars 8,964,698 Vodafone
ADRs mature in May 2007. The forward contracts related to 45,492,172 Deutsche
Telekom ordinary shares mature between July and September 2007. Accordingly,
such VeriSign common shares, Vodafone ADRs and Deutsche Telekom ordinary shares
are classified as Current Assets and the related forward contracts and
derivative liability are classified as Current Liabilities in the Consolidated
Balance Sheets at September 30, 2006.
The economic hedge risk management objective of the forward contracts
is to hedge the value of the marketable equity securities from losses due to
decreases in the market prices of the securities (downside limit) while
retaining a share of gains from increases in the market prices of such
securities (upside potential). The downside limit is hedged at or above the
accounting cost basis of the securities.
Under the terms of the forward contracts, subsidiaries of TDS and U.S.
Cellular will continue to own the contracted shares and will receive dividends
paid on such contracted shares, if any. The forward contracts, at TDSs and
U.S. Cellulars option, may be settled in shares of the respective
security or in cash, pursuant to formulas that collar the price of the
shares. The collars effectively reduce downside risk and upside potential on
the contracted shares. The collars are typically contractually adjusted for any
changes in dividends on the underlying shares. If the dividend increases, the
collars upside potential is typically reduced. If the dividend decreases, the
collars upside potential is typically increased. If TDS and U.S. Cellular
elect to settle in shares, they will be required to deliver the number of
shares of the contracted security determined pursuant to the formula. If shares
are delivered in the settlement of a forward contract, TDS and U.S. Cellular
would incur a current tax liability at the time of delivery based on the
difference between the tax basis of the marketable equity securities delivered
and the net amount realized through maturity. If TDS and U.S. Cellular elect to
settle in cash, they will be required to pay an amount in cash equal to the
fair market value of the number of shares determined pursuant to the formula.
TDS and U.S. Cellular have provided guarantees to the counterparties which
provide assurance that all principal and interest amounts are paid by its
subsidiaries upon settlement of the contracts.
38
TDS and U.S. Cellular are required to comply with certain covenants
under the forward contracts. On November 10, 2005, TDS and U.S. Cellular
announced that they would restate certain financial statements which caused TDS
and U.S. Cellular to be late in certain SEC filings. The restatements and late
filings resulted in defaults under the forward contracts. However, TDS and U.S.
Cellular were not in violation of any covenants that require TDS and U.S.
Cellular to maintain certain financial ratios. TDS and U.S. Cellular did not
fail to make any scheduled payments under such forward contracts. TDS and U.S.
Cellular received waivers from the counterparties associated with the forward
contracts, under which the counterparties agreed to waive any defaults that may
have occurred as a result of the restatements and late filings. The waivers
required the Form 10-K for the year ended December 31, 2005 to be filed by
August 31, 2006, the Form 10-Q for the quarterly period ended March 31, 2006 to
be filed within 30 days after the filing of the Form 10-K for the year ended
December 31, 2005 and the Form 10-Q for the quarterly period ended June 30,
2006 to be filed within 45 days after the filing of the Form 10-Q for the
quarterly period ended March 31, 2006. On October 6, 2006, TDS and U.S.
Cellular received amended waivers from the counterparties associated with the
forward contracts which extended the date by which the financial statements of
TDS and U.S. Cellular for the quarterly period ended June 30, 2006 were
required to be delivered to November 8, 2006. The Form 10-K for the year ended
December 31, 2005 was filed on July 28, 2006, the Form 10-Q for the quarterly
period ended March 31, 2006 was filed August 25, 2006, and the Form 10-Q for
the quarterly period ended June 30, 2006 was filed on October 10, 2006.
In addition, TDS and its audit committee
concluded on November 6, 2006 to restate the Consolidated Financial Statements
as of and for the three years ended December 31, 2005. TDS and its audit
committee also concluded that TDS would amend its Quarterly Reports on Form
10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 to
restate the Consolidated Financial Statements and financial information
included therewith. The restatement
resulted in defaults under certain of the forward contracts. TDS and U.S. Cellular were not in violation
of any covenants that require TDS and U.S. Cellular to maintain certain
financial ratios. TDS and U.S. Cellular
did not fail to make any scheduled payments under such forward contracts. TDS
and U.S. Cellular received waivers from the counterparty to such forward
contracts, under which the counterparty agreed to waive any defaults that may
have occurred as a result of the restatement. The waivers require the
Form 10-K/A for the year ended December 31, 2005, the Forms 10-Q/A for the
quarterly periods ended March 31, 2006 and June 30, 2006 and the Form 10-Q for
the quarterly period ended September 30, 2006 to be filed by March 14, 2007.
17. Minority Interest in
Subsidiaries
Under SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, certain minority interests in
consolidated entities with finite lives may meet the Statements definition of
a mandatorily redeemable financial instrument and thus require reclassification
as liabilities and remeasurement at the estimated amount of cash that would be
due and payable to settle such minority interests under the applicable entitys
organization agreement assuming an orderly liquidation of the finite-lived
entity, net of estimated liquidation costs (the settlement value). TDSs
consolidated financial statements include such minority interests that meet the
Statements definition of mandatorily redeemable financial instruments. These
mandatorily redeemable minority interests represent interests held by third
parties in consolidated partnerships and limited liability companies (L.L.C.s),
where the terms of the underlying partnership or L.L.C. agreement provide for a
defined termination date at which time the assets of the subsidiary are to be
sold, the liabilities are to be extinguished and the remaining net proceeds are
to be distributed to the minority interest holders and TDS in accordance with
the respective partnership and L.L.C. agreements. The termination dates of TDSs
mandatorily redeemable minority interests range from 2042 to 2103.
39
The settlement value of TDSs mandatorily redeemable minority interests
is estimated to be $149.1 million at September 30, 2006. This represents the
estimated amount of cash that would be due and payable to settle minority
interests assuming an orderly liquidation of the finite-lived consolidated
partnerships and L.L.C.s on September 30, 2006, net of estimated liquidation
costs. This amount is being disclosed pursuant to the requirements of FSP No.
FAS 150-3; TDS has no current plans or intentions to liquidate any of the
finite-lived partnerships or L.L.C.s prior to their scheduled termination
dates. The corresponding carrying value of the minority interests in
finite-lived consolidated partnerships and L.L.C.s at September 30, 2006 is
$32.7 million, and is included in Minority Interest in Subsidiaries in the
Consolidated Balance Sheets. The excess of the aggregate settlement value over
the aggregate carrying value of the mandatorily redeemable minority interests
of $116.4 million is primarily due to the unrecognized appreciation of the
minority interest holders share of the underlying net assets in the
consolidated partnerships and L.L.C.s. Neither the minority interest holders
share, nor TDSs share, of the appreciation of the underlying net assets of
these subsidiaries is reflected in the consolidated financial statements. The
estimate of settlement value was based on certain factors and assumptions.
Changes in those factors and assumptions could result in a materially larger or
smaller settlement amount.
18. Common Share Repurchase
Programs
In 2003, the Board of Directors of TDS authorized the repurchase of up
to 3.0 million TDS Common Shares, but this authorization expired in February
2006 and a new authorization has not yet been put in place. No TDS Common
Shares were repurchased in the first nine months of 2006 or 2005.
The Board of Directors of U.S. Cellular has authorized the repurchase of
a limited amount of U.S. Cellular Common Shares on a quarterly basis, primarily
for use in employee benefit plans. No U.S. Cellular Common Shares were
repurchased in the first nine months of 2006 or 2005.
19. Acquisitions,
Divestitures and Exchanges
TDS assesses its existing wireless interests on an ongoing basis with a
goal of improving the competitiveness of its operations and maximizing its
long-term return on investment. As part of this strategy, TDS reviews
attractive opportunities to acquire additional operating markets,
telecommunications companies and wireless spectrum. In addition, TDS may seek
to divest outright or include in exchanges for other wireless interests those
markets and wireless interests that are not strategic to its long-term success.
U.S. Cellular is a limited partner in Barat Wireless, L.P. (Barat
Wireless), an entity which participated in the auction of wireless spectrum
designated by the Federal Communications Commission (FCC) as Auction 66.
Barat Wireless was qualified to receive a 25% discount available to designated
entities, which are small businesses that have a limited amount of assets. At
the conclusion of the auction on September 18, 2006, Barat Wireless was the
high bidder with respect to 17 licenses and had bid $127.1 million, net of
its designated entity discount. The balance due from Barat Wireless at the
conclusion of the auction for the licenses with respect to which Barat Wireless
was the high bidder was approximately $47.1 million and was paid on
October 18, 2006. Although the bidding in Auction 66 ended on September 18,
2006, the FCC has not yet awarded the licenses to Barat Wireless, nor is there
any prescribed timeframe for the FCC to review the qualifications of Barat
Wireless and award the licenses.
Barat Wireless is in the process of developing its long-term business
and financing plans. As of October 31, 2006, U.S. Cellular had made
capital contributions and advances to Barat Wireless and/or its general partner
totaling $127.2 million. For financial reporting purposes, U.S. Cellular
will consolidate Barat Wireless and Barat Wireless, Inc., the general partner
of Barat Wireless, pursuant to the guidelines of FASB Interpretation No. 46(R),
Consolidation of Variable Interest Entities (revised December 2003) an
interpretation of ARB No. 51 (FIN 46(R)), as U.S. Cellular anticipates
benefiting from or absorbing a majority of Barat Wireless expected gains or
losses. Pending finalization of Barat Wireless permanent financing plan, and
upon request by Barat Wireless, U.S. Cellular may agree to make additional
capital contributions and advances to Barat Wireless and/or its general
partner.
40
On April 21, 2006, U.S. Cellular
purchased the remaining ownership interest in a Tennessee wireless market in
which it had previously owned a 16.7% interest for approximately $18.8 million
in cash, subject to a working capital adjustment. This acquisition increased
investments in licenses, goodwill and customer lists by $5.5 million, $4.0
million and $2.0 million, respectively.
On April 3, 2006, TDS Telecom exchanged customers and assets in certain
markets with another telecommunications provider and received $0.7 million in
cash.
U.S. Cellular is a limited partner in Carroll Wireless, L.P. (Carroll
Wireless), an entity which participated in the auction of wireless spectrum
designated by the FCC as Auction 58. Carroll Wireless was qualified to bid on
spectrum which was available only to companies that fall under the FCC
definition of designated entities, which are small businesses that have a
limited amount of assets. Carroll Wireless was a successful bidder for 17
licensed areas in Auction 58, which ended on February 15, 2005. The aggregate
amount paid to the FCC for the 17 licenses was $129.9 million, net of all
bidding credits to which Carroll Wireless was entitled as a designated entity.
These 17 licensed areas cover portions of 12 states and are in markets which
are either adjacent to or overlap current U.S. Cellular licensed areas.
On January 6, 2006, the FCC granted Carroll Wireless applications with
respect to 16 of the 17 licenses for which it had been the successful bidder
and dismissed one application, relating to Walla Walla, Washington. Following
the completion of Auction 58, the FCC determined that a portion of the Walla
Walla license was already licensed to another party and should not have been
included in Auction 58. Accordingly, in 2006, Carroll Wireless received a full
refund of the $228,000 previously paid to the FCC with respect to the Walla
Walla license.
Carroll Wireless is in the process of developing its long-term business
and financing plans. As of September 30, 2006, U.S. Cellular had made capital
contributions and advances to Carroll Wireless and/or its general partner of
approximately $129.9 million; $129.7 million of this amount is
included in Licenses in the Consolidated Balance Sheets. For financial
reporting purposes, U.S. Cellular consolidates Carroll Wireless and Carroll
PCS, Inc., the general partner of Carroll Wireless, pursuant to the guidelines
of FIN 46(R), as U.S. Cellular anticipates benefiting from or absorbing a
majority of Carroll Wireless expected respective gains or losses. Pending
finalization of Carroll Wireless permanent financing plan, and upon request by
Carroll Wireless, U.S. Cellular may make additional capital contributions and
advances to Carroll Wireless and/or its general partner. In November 2005, U.S.
Cellular approved additional funding of $1.4 million of which $0.1 million
was provided to Carroll Wireless through September 30, 2006.
In the first quarter of 2005, TDS adjusted the gain on investments
related to its sale to ALLTEL Corporation (ALLTEL) of certain wireless
properties on November 30, 2004. The adjustment of the gain, which resulted
from a working capital adjustment that was finalized in the first quarter of
2005, increased the total gain on the sale by $0.5 million to $51.4
million.
In addition, in 2005, U.S. Cellular purchased one new wireless market
and certain minority interests in other wireless markets in which it already
owned a controlling interest for $6.9 million in cash.
41
20. Accumulated Other
Comprehensive Income
The cumulative balances of unrealized gains and losses
on securities and derivative instruments and related income tax effects
included in Accumulated other comprehensive income are as follows.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Marketable Equity Securities
|
|
|
|
|
|
Balance, beginning of
period
|
|
$
|
578,273
|
|
$
|
1,077,710
|
|
Add (deduct):
|
|
|
|
|
|
Unrealized gains
(losses) on marketable equity securities
|
|
(87,605
|
)
|
(572,701
|
)
|
Income tax
(expense) benefit
|
|
34,923
|
|
227,077
|
|
|
|
(52,682
|
)
|
(345,624
|
)
|
Unrealized gain
(loss) of equity method companies
|
|
(190
|
)
|
282
|
|
Minority share
of unrealized losses
|
|
(1,445
|
)
|
921
|
|
Net change in
unrealized gains (losses) on marketable equity securities in comprehensive
income
|
|
(54,317
|
)
|
(344,421
|
)
|
Balance, end of period
|
|
$
|
523,956
|
|
$
|
733,289
|
|
|
|
|
|
|
|
Derivative Instruments
|
|
|
|
|
|
Balance, beginning of
period
|
|
$
|
(214,632
|
)
|
$
|
(213,760
|
)
|
Add (deduct):
|
|
|
|
|
|
Unrealized gain
(loss) on derivative instruments
|
|
|
|
|
|
Income tax
(expense) benefit
|
|
|
|
(19
|
)
|
|
|
|
|
(19
|
)
|
Minority share of
unrealized gains
|
|
(3
|
)
|
(19
|
)
|
Net change in
unrealized gains (losses) on derivative instruments included in comprehensive
income
|
|
(3
|
)
|
(38
|
)
|
Balance, end of period
|
|
$
|
(214,635
|
)
|
$
|
(213,798
|
)
|
|
|
|
|
|
|
Accumulated Other Comprehensive
Income
|
|
|
|
|
|
Balance, beginning of
period
|
|
$
|
363,641
|
|
$
|
863,950
|
|
Net change in
marketable equity securities
|
|
(54,317
|
)
|
(344,421
|
)
|
Net change in
derivative instruments
|
|
(3
|
)
|
(38
|
)
|
Net change in
unrealized gains (losses) included in comprehensive income
|
|
(54,320
|
)
|
(344,459
|
)
|
Balance, end of period
|
|
$
|
309,321
|
|
$
|
519,491
|
|
42
21. Business Segment
Information
Financial data for TDSs business segments for the
three and nine month period ended or at September 30, 2006 and 2005 are as
follows. TDS Telecoms incumbent local exchange carriers are designated as ILEC
in the table and its competitive local exchange carrier is designated as CLEC.
Three Months Ended or at
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
|
TDS Telecom
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
U.S. Cellular
|
|
ILEC
|
|
CLEC
|
|
Non-
Reportable
Segment(3)
|
|
Other
Reconciling
Items(1)
|
|
Total
|
|
Operating
revenues
|
|
$
|
888,523
|
|
$
|
162,242
|
|
$
|
59,370
|
|
$
|
7,434
|
|
$
|
(5,499
|
)
|
$
|
1,112,070
|
|
Cost of services
and products
|
|
305,864
|
|
48,275
|
|
31,662
|
|
5,463
|
|
(1,082
|
)
|
390,182
|
|
Selling, general
and administrative expense
|
|
358,392
|
|
46,251
|
|
21,855
|
|
1,321
|
|
(3,585
|
)
|
424,234
|
|
Operating income
before depreciation, amortization and accretion (2)
|
|
224,267
|
|
67,716
|
|
5,853
|
|
650
|
|
(832
|
)
|
297,654
|
|
Depreciation,
amortization and accretion expense
|
|
146,940
|
|
33,757
|
|
5,871
|
|
711
|
|
|
|
187,279
|
|
Operating income
(loss)
|
|
77,327
|
|
33,959
|
|
(18
|
)
|
(61
|
)
|
(832
|
)
|
110,375
|
|
Other items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of unconsolidated subsidiaries
|
|
23,483
|
|
|
|
|
|
|
|
597
|
|
24,080
|
|
Fair value adjustment of derivative instruments
|
|
(21,285
|
)
|
|
|
|
|
|
|
55,904
|
|
34,619
|
|
Marketable
equity securities
|
|
208,505
|
|
|
|
|
|
|
|
2,195,316
|
|
2,403,821
|
|
Investment in
unconsolidated entities
|
|
197,817
|
|
3,623
|
|
|
|
|
|
42,409
|
|
243,849
|
|
Total assets
|
|
5,573,507
|
|
1,692,675
|
|
144,684
|
|
23,834
|
|
2,895,749
|
|
10,330,449
|
|
Capital expenditures
|
|
$
|
152,771
|
|
$
|
26,986
|
|
$
|
4,552
|
|
$
|
838
|
|
$
|
1,169
|
|
$
|
186,316
|
|
Three Months Ended or at
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 (As Restated)
|
|
|
|
TDS Telecom
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
U.S.
Cellular
|
|
ILEC(4)
|
|
CLEC(4)
|
|
Non-
Reportable
Segment(3)
|
|
Other
Reconciling
Items(1)
|
|
Total
|
|
Operating
revenues
|
|
$
|
795,100
|
|
$
|
168,569
|
|
$
|
60,299
|
|
$
|
8,820
|
|
$
|
(4,841
|
)
|
$
|
1,027,947
|
|
Cost of services
and products
|
|
290,158
|
|
45,716
|
|
32,466
|
|
6,172
|
|
(545
|
)
|
373,967
|
|
Selling, general
and administrative expense
|
|
313,374
|
|
45,722
|
|
24,063
|
|
1,389
|
|
(4,296
|
)
|
380,252
|
|
Operating income
before depreciation, amortization and accretion (2)
|
|
191,568
|
|
77,131
|
|
3,770
|
|
1,259
|
|
|
|
273,728
|
|
Depreciation, amortization
and accretion expense
|
|
128,238
|
|
33,319
|
|
6,998
|
|
688
|
|
|
|
169,243
|
|
Operating income
(loss)
|
|
63,330
|
|
43,812
|
|
(3,228
|
)
|
571
|
|
|
|
104,485
|
|
Other items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of unconsolidated subsidiaries
|
|
17,416
|
|
58
|
|
|
|
|
|
263
|
|
17,737
|
|
Fair value adjustment of derivative instruments
|
|
(14,241
|
)
|
|
|
|
|
|
|
9,812
|
|
(4,429
|
)
|
Marketable
equity securities
|
|
270,582
|
|
|
|
|
|
|
|
2,526,642
|
|
2,797,224
|
|
Investment in
unconsolidated entities
|
|
184,768
|
|
3,623
|
|
|
|
|
|
41,273
|
|
229,664
|
|
Total assets
|
|
5,231,457
|
|
1,691,710
|
|
150,961
|
|
27,245
|
|
3,327,256
|
|
10,428,629
|
|
Capital expenditures
|
|
$
|
125,553
|
|
$
|
25,105
|
|
$
|
7,145
|
|
$
|
1,226
|
|
$
|
1,546
|
|
$
|
160,575
|
|
43
Nine Months Ended or at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2006
|
|
|
|
TDS Telecom
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
U.S.
Cellular
|
|
ILEC
|
|
CLEC
|
|
Non-
Reportable
Segment(3)
|
|
Other
Reconciling
Items(1)
|
|
Total
|
|
Operating
revenues
|
|
$
|
2,571,036
|
|
$
|
485,228
|
|
$
|
176,599
|
|
$
|
23,372
|
|
$
|
(16,401
|
)
|
$
|
3,239,834
|
|
Cost of services
and products
|
|
886,469
|
|
141,833
|
|
93,481
|
|
16,717
|
|
(2,453
|
)
|
1,136,047
|
|
Selling, general
and administrative expense
|
|
1,028,865
|
|
137,436
|
|
67,005
|
|
4,570
|
|
(9,655
|
)
|
1,228,221
|
|
Operating income
before depreciation, amortization and accretion (2)
|
|
655,702
|
|
205,959
|
|
16,113
|
|
2,085
|
|
(4,293
|
)
|
875,566
|
|
Depreciation,
amortization and accretion expense
|
|
429,451
|
|
100,585
|
|
18,530
|
|
2,132
|
|
|
|
550,698
|
|
Operating income
(loss)
|
|
226,251
|
|
105,374
|
|
(2,417
|
)
|
(47
|
)
|
(4,293
|
)
|
324,868
|
|
Other items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of unconsolidated subsidiaries
|
|
64,923
|
|
|
|
|
|
|
|
1,453
|
|
66,376
|
|
Fair value adjustment of derivative instruments
|
|
(17,392
|
)
|
|
|
|
|
|
|
40,273
|
|
22,881
|
|
Gain on investments
|
|
|
|
91,418
|
|
|
|
|
|
|
|
91,418
|
|
Marketable
equity securities
|
|
208,505
|
|
|
|
|
|
|
|
2,195,316
|
|
2,403,821
|
|
Investment in
unconsolidated entities
|
|
197,817
|
|
3,623
|
|
|
|
|
|
42,409
|
|
243,849
|
|
Total assets
|
|
5,573,507
|
|
1,692,675
|
|
144,684
|
|
23,834
|
|
2,895,749
|
|
10,330,449
|
|
Capital expenditures
|
|
$
|
421,378
|
|
$
|
73,808
|
|
$
|
11,576
|
|
$
|
2,955
|
|
$
|
6,893
|
|
$
|
516,610
|
|
Nine Months Ended or at
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2005 (As Restated)
|
|
|
|
TDS Telecom
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
U.S.
Cellular
|
|
ILEC(4)
|
|
CLEC(4)
|
|
Non-
Reportable
Segment(3)
|
|
Other
Reconciling
Items(1)
|
|
Total
|
|
Operating
revenues
|
|
$
|
2,245,526
|
|
$
|
494,791
|
|
$
|
179,212
|
|
$
|
24,083
|
|
$
|
(13,755
|
)
|
$
|
2,929,857
|
|
Cost of services
and products
|
|
821,160
|
|
129,006
|
|
94,677
|
|
16,659
|
|
(1,725
|
)
|
1,059,777
|
|
Selling, general
and administrative expense
|
|
877,116
|
|
137,087
|
|
71,623
|
|
4,235
|
|
(12,030
|
)
|
1,078,031
|
|
Operating income
before depreciation, amortization and accretion (2)
|
|
547,250
|
|
228,698
|
|
12,912
|
|
3,189
|
|
|
|
792,049
|
|
Depreciation,
amortization and accretion expense
|
|
382,244
|
|
101,165
|
|
21,823
|
|
2,063
|
|
|
|
507,295
|
|
Operating income
(loss)
|
|
165,006
|
|
127,533
|
|
(8,911
|
)
|
1,126
|
|
|
|
284,754
|
|
Other items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of unconsolidated subsidiaries
|
|
49,231
|
|
408
|
|
|
|
|
|
590
|
|
50,229
|
|
Fair value adjustment of derivative instruments
|
|
9,938
|
|
|
|
|
|
|
|
485,356
|
|
495,294
|
|
Gain (loss) on investments
|
|
551
|
|
(51
|
)
|
|
|
|
|
|
|
500
|
|
Marketable
equity securities
|
|
270,582
|
|
|
|
|
|
|
|
2,526,642
|
|
2,797,224
|
|
Investment in
unconsolidated entities
|
|
184,768
|
|
3,623
|
|
|
|
|
|
41,273
|
|
229,664
|
|
Total assets
|
|
5,231,457
|
|
1,691,710
|
|
150,961
|
|
27,245
|
|
3,327,256
|
|
10,428,629
|
|
Capital expenditures
|
|
$
|
379,088
|
|
$
|
59,965
|
|
$
|
18,681
|
|
$
|
3,204
|
|
$
|
4,020
|
|
$
|
464,958
|
|
(1) Consists of the TDS Corporate operations,
intercompany and intracompany revenue and expense eliminations, TDS Corporate
and TDS Telecom marketable equity securities and all other businesses not
included in the U.S. Cellular, TDS Telecom or the Non-Reportable segments.
(2) The amount of operating income before
depreciation, amortization and accretion is a non-GAAP financial measure. The
amount may also be commonly referred to by management as operating cash flow.
TDS has presented operating cash flow because this financial measure, in
combination with other financial measures, is an integral part of our internal
reporting system utilized by management to assess and evaluate the performance
of its business. Operating cash flow is also considered a significant
performance measure. It is used by management as a measurement of its success
in obtaining, retaining and servicing customers by reflecting its ability to
generate subscriber revenue while providing a high level of customer service in
a cost effective manner. The components of operating cash flow include the key
revenue and expense items for which operating managers are responsible and upon
which TDS evaluates its performance.
Other companies in the wireless industry may
define operating cash flow in a different manner or present other varying
financial measures, and, accordingly, TDSs presentation may not be comparable
to other similarly titled measures of other companies.
Operating cash flow should not be construed as
an alternative to operating income (loss), as determined in accordance with
GAAP, as an alternative to cash flows from operating activities, as determined
in accordance with GAAP, or as a measure of liquidity. TDS believes operating
cash flow is useful to investors as a means to evaluate TDSs operating
performance prior to non-cash depreciation and amortization expense, and
certain other non-cash charges. Although operating cash flow may be defined
differently by other companies in the wireless industry, TDS believes that
operating cash flow provides some commonality of measurement in analyzing
operating performance of companies in the wireless industry.
44
(3) Represents Suttle Straus.
(4) Certain prior period amounts, primarily labor, maintenance, rent and
utilities expenses at the competitive local exchange carriers (CLEC),
reported in selling, general and administrative expense have been moved to cost
of service and products in the current period to properly reflect the
classification of the expenses. Certain expenses, primarily universal service
costs, at both the incumbent local exchange carriers (ILEC) and the CLEC
previously reported in cost of service and products have been moved to selling,
general and administrative expense to properly reflect the classification of
the expenses. For the ILEC, cost of services and products decreased by $1.9
million and $5.2 million with a corresponding increase in selling, general and
administrative expenses in the three and nine months ended September 30, 2005,
respectively. For the CLEC, cost of services and products increased by $5.7
million and $17.4 million with a corresponding decrease in selling, general and
administrative expenses in the three and nine months ended September 30, 2005,
respectively. On a TDS consolidated basis, cost of services and products
increased by $3.8 million and $12.2 million with a corresponding decrease in
selling, general and administrative expenses in the three and nine months ended
September 30, 2005, respectively. The adjustments did not affect previously
reported revenues, operating income or net income.
The following table reconciles Total operating income
from reportable and other segments to Income before income taxes and minority
interest.
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Total operating
income from reportable and other segments
|
|
$
|
110,375
|
|
$
|
104,485
|
|
$
|
324,868
|
|
$
|
284,754
|
|
Total investment
and other income
|
|
11,338
|
|
(29,544
|
)
|
171,654
|
|
513,017
|
|
Income before income
taxes and minority interest
|
|
$
|
121,713
|
|
$
|
74,941
|
|
$
|
496,522
|
|
$
|
797,771
|
|
22. Commitments and
Contingencies
Contingent obligations, including indemnities, litigation and other
possible commitments are accounted for in accordance with SFAS No. 5, Accounting
for Contingencies, which requires that an estimated loss be recorded if it is
probable that an asset has been impaired or a liability has been incurred at
the date of the financial statements and the amount of the loss can be
reasonably estimated. Accordingly, those contingencies that are deemed to be
probable and where the amount of the loss is reasonably estimable are accrued
in the financial statements. If only a range of loss can be determined, the
best estimate within that range is accrued; if none of the estimates within
that range is better than another, the low end of the range is accrued.
Disclosure of a contingency is required if there is at least a reasonable
possibility that a loss has been or will be incurred, even if the amount is not
estimable. The assessment of contingencies is a highly subjective process that
requires judgments about future events. Contingencies are reviewed at least
quarterly to determine the adequacy of the accruals and related financial
statement disclosure. The ultimate outcome of contingencies could materially
impact the Consolidated Statements of Operations, Consolidated Balance Sheets
and Consolidated Statements of Cash Flows.
Indemnifications
TDS enters into agreements in the normal course of business that
provide for indemnification of counterparties. These agreements include certain
asset sales and financings with other parties. The terms of the
indemnifications vary by agreement. The events or circumstances that would
require TDS to perform under these indemnities are transaction specific;
however, these agreements may require TDS to indemnify the counterparty for costs
and losses incurred from litigation or claims arising from the underlying
transaction. TDS is unable to estimate the maximum potential liability for
these types of indemnifications as the amounts are dependent on the outcome of
future events, the nature and likelihood of which cannot be determined at this
time. Historically, TDS has not made any significant indemnification payments
under such agreements.
TDS is party to an indemnity agreement with T-Mobile USA Inc., (T-Mobile)
regarding certain contingent liabilities at Aerial Communications, Inc. (Aerial)
for the period prior to Aerials merger into VoiceStream Wireless. As of
September 30, 2006, TDS has recorded liabilities of $1.4 million relating to
this indemnity, which represents its best estimate of its probable liability.
45
Legal Proceedings
TDS
is involved in a number of legal proceedings before the FCC and various state
and federal courts and is involved in
various claims, including claims relating to charges among interexchange
carriers. If TDS believes that a loss arising from such legal
proceedings or claims is
probable and can be reasonably estimated, an amount is accrued in the financial
statements for the estimated loss. If only a range of loss can be determined,
the best estimate within that range is accrued; if none of the estimates within
that range is better than another, the low end of the range is accrued. The
assessment of legal proceedings and
claims is a highly subjective process that requires judgments about
future events. The legal proceedings
and claims are reviewed at least quarterly to determine the adequacy of
the accruals and related financial statement disclosure. The ultimate outcome
of legal proceedings and claims
could differ materially from amounts accrued in the financial statements.
TDS Telecom records revenues from originating and
terminating access for interexchange carriers based on contracts, tariffs or
operational data. Such contracts, tariffs and operational data could be subject
to dispute by interexchange carriers. In April 2006, an interexchange
carrier for which TDS Telecom provides both originating and terminating access
asserted a claim for refund, net of counterclaims, of up to $10 million for
past billed amounts for certain types of traffic. TDS Telecom has contested
this claim. Disputes with interexchange
carriers may take significant time to resolve and may require adjustments in
future periods to amounts invoiced, accrued or paid in prior periods.
Regulatory Environment
Changes in the telecommunications regulatory environment, including the
effects of potential changes in the rules governing universal service funding
and potential changes in the amounts or methods of intercarrier compensation,
could have a material adverse effect on TDS Telecoms financial condition,
results of operations and cash flows.
23. Subsequent Events
Midwest Wireless
As of September 30, 2006, U.S. Cellular owned approximately 14% of
Midwest Wireless Communications, L.L.C., which interest was convertible into an
interest of approximately 11% in Midwest Wireless Holdings, L.L.C., a
privately-held wireless telecommunications company that controlled Midwest
Wireless Communications. Midwest Wireless Holdings, through subsidiaries, held
FCC licenses and operated certain wireless markets in southern Minnesota,
northern and eastern Iowa and western Wisconsin. On November 18, 2005, ALLTEL
announced that it had entered into a definitive agreement to acquire Midwest
Wireless Holdings for $1.075 billion in cash, subject to certain conditions,
including approval by the FCC, other governmental authorities and the members
of Midwest Wireless Holdings. These conditions were satisfied and the closing
of this agreement occurred on October 3, 2006. As a result, U.S. Cellular
became entitled to receive approximately $106.0 million in cash in
consideration with respect to its interest in Midwest Wireless Communications.
Of this amount, $95.1 million was received on October 6, 2006; the remaining
balance is being held in reserve and in escrow to secure true-up,
indemnification and other adjustments and, subject to such adjustments, will be
distributed in installments over a period of four to fifteen months following
the closing. In addition, as of September 30, 2006, U.S. Cellular owned 49% of
an entity, accounted for under the equity method, which owned approximately
2.9% of Midwest Wireless Holdings. As a result of the closing of the
transaction, this entity will receive cash in consideration for its interest in
Midwest Wireless Holdings. Following that, this entity will be dissolved and
U.S. Cellular will be entitled to receive approximately $11.8 million in
cash, subject to the previously referenced discussion regarding adjustments and
installments. The net aggregate carrying value of U.S. Cellulars investments
in Midwest Wireless Communications and Midwest Wireless Holdings was approximately
$29.9 million at September 30, 2006.
46
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Telephone and Data
Systems, Inc. (TDS- AMEX symbol: TDS and TDS.S) is a diversified
telecommunications company providing high-quality telecommunications services
to approximately 6.9 million wireless telephone customers and wireline telephone
equivalent access lines. TDS conducts substantially all of its wireless telephone
operations through its 81.2%-owned subsidiary, United States Cellular
Corporation (U.S. Cellular), its incumbent local exchange carrier and
competitive local exchange carrier wireline telephone operations through its
wholly owned subsidiary, TDS Telecommunications Corporation (TDS Telecom),
and its printing and distribution operations through its 80%-owned
subsidiary, Suttle Straus, Inc.
The following discussion
and analysis should be read in conjunction with TDSs interim consolidated
financial statements included in Item 1 above, and with its audited
consolidated financial statements and Managements Discussion and Analysis of
Financial Condition and Results of Operations included in its Annual Report on
Form 10-K/A (Form 10-K/A) for the year ended December 31, 2005.
Restatement
TDS and its audit
committee concluded on November 6, 2006, that TDS would amend its Annual Report
on Form 10-K for the year ended December 31, 2005 to restate its consolidated
financial statements and financial information for each of the three years in
the period ended December 31, 2005, including quarterly information for 2005
and 2004, and certain selected financial data for 2002. TDS and its audit committee also concluded that
TDS would amend its Quarterly Reports on Form 10-Q for the quarterly periods
ended March 31, 2006 and June 30, 2006 to restate the consolidated financial
statements and financial information included therewith.
The restatement
adjustments are described below.
· Forward
contracts and related derivative instruments - In reviewing the accounting and
disclosure of its prepaid forward contracts, TDS concluded that its continued
designation of the embedded collars within the forward contracts as cash flow
hedges of marketable equity securities was not appropriate. TDS did not contemporaneously de-designate,
re-designate, and assess hedge effectiveness when the embedded collars were
contractually modified for differences between the actual and expected dividend
rates on the underlying securities in 2004, 2003 and 2002. As a result, the embedded collars no longer
qualified for cash flow hedge accounting treatment upon the modification of the
terms of the collars for changes in dividend rates and, from that point
forward, must be accounted for as derivative instruments that do not qualify
for cash flow hedge accounting treatment.
Accordingly, all changes in the fair value of the embedded collars from
the time of the contractual modification of each collar must be recognized in
the statement of operations. The
restatement adjustments represent reclassifications of unrealized gains or
losses related to changes in the fair value of the embedded collars from other
comprehensive income or loss, included in common stockholders equity, to the
statement of operations.
· Expense
reclassifications - Certain prior period amounts, primarily labor, maintenance,
rent and utilities expenses at the competitive local exchange carriers (CLEC),
previously reported in selling, general and administrative expense have been corrected
to properly reflect the classification of the expenses in cost of service and
products in the current period. Certain
expenses, primarily universal service costs, at both the incumbent local
exchange carriers (ILEC) and the CLEC previously reported in cost of service
and products have been adjusted to properly reflect the classification of the
expenses in selling, general and administrative expense. For the ILEC, cost of services and products
decreased by $1.9 million and $5.2 million with a corresponding increase in
selling, general and administrative expenses in the three and nine months ended
September 30, 2005, respectively. For
the CLEC, cost of services and products increased by $5.7 million and $17.4
million with a corresponding decrease in selling, general and administrative
expenses in the three and nine months ended September 30, 2005,
respectively. On a TDS consolidated
basis, cost of services and products increased by $3.8 million and $12.2
million with a corresponding decrease in selling, general and administrative
expenses in the three and nine months ended September 30, 2005,
respectively. The adjustments did not
affect previously reported revenues, operating income or net income.
47
· Establishment
of an Asset Retirement Obligation (ARO) - Upon initial implementation of
Statement of Financial Accounting Standards No. 143 Accounting for Asset
Retirement Obligations (SFAS No. 143) in 2003, TDS Telecoms ILEC operations
concluded that it was not necessary to record an ARO asset and corresponding
regulatory liability of equal amount.
TDS Telecom's ILECs have their rates regulated by the respective state
public utility commissions and the Federal Communications Commission (FCC),
and therefore, reflect the effects of the rate-making actions of these
regulatory bodies in their financial statements. In 2002, the FCC notified carriers by Order
that it would not be adopting SFAS No. 143 since the FCC concluded that SFAS
No. 143 conflicted with the FCC's current accounting rules that require ILECs
to accrue for asset retirement obligations through prescribed depreciation
rates. Upon adoption of SFAS No. 143,
and pursuant to the FCC's order and the provisions of SFAS No. 71 Accounting
for the Effects of Certain Types of Regulation, (SFAS No.71) the ILECs
reclassified their existing remediation liabilities, previously recorded in
accumulated depreciation, to an ARO liability and a separate regulatory
liability. Upon further review, TDS has
concluded that upon adoption of SFAS No. 143, and in accordance with SFAS No.
71, it should have recognized an ARO asset and a corresponding ARO liability,
rather than establish the ARO liability through a reclassification of its
existing remediation liabilities. The impact of establishing the ARO asset
increased Property, Plant and Equipment and the corresponding ARO liability by
$26.6 million and $27.3 million as of September 30, 2006 and December 31, 2005,
respectively. The adjustment did not
affect previously reported revenues, operating income or net income (loss).
· Contracts
with maintenance and support services U.S. Cellular entered into certain
equipment and software contracts that included maintenance and support
services. In one case, U.S. Cellular did
not properly allocate expenditures between equipment purchases and maintenance
and support services. In other cases,
U.S. Cellular did not properly record fees for maintenance and support services
over the specified term of the agreement.
The restatement adjustments properly record property, plant and
equipment, related depreciation expense and fees for maintenance and support
services in the correct periods.
· Classification
of Asset Retirement Obligation on the Statement of Cash Flows The additions
to property, plant and equipment and other deferred liabilities representing
additional asset retirement obligations (ARO) should be treated as non-cash
items in the statement of cash flows.
From 2004 through the second quarter of 2006, U.S. Cellular included
additional ARO liabilities as a change in other assets and liabilities in cash
flows from operating activities and the increase in the ARO asset balance as a
capital expenditure in cash flows from investing activities resulting in an
overstatement of cash flows from operating activities and an overstatement of
cash flows required by investing activities.
In the restatement, adjustments were recorded in the statement of cash
flows to offset the change in ARO liabilities against the ARO asset. The
reduction in the change in other assets and liabilities in cash flows from
operating activities and the reduction in additions to property, plant and
equipment in cash flows from investing activities totaled $4.7 million in the
nine months ended September 30, 2005.
· Income
taxes In the restatement, TDS adjusted its income tax expense, income taxes
payable, goodwill, deferred income tax assets and liabilities and related
disclosures for the years ended December 31, 2005, 2004, 2003 and 2002 for
items identified based on its annual analysis reconciling its 2005 income tax
expense and income tax balance sheet accounts as determined in its comparison
of the 2005 year-end income tax provision to the 2005 federal and state income
tax returns. These adjustments included corrections for certain accounts that
had not previously been included in the financial reporting basis used in
determining the cumulative temporary differences in computing deferred income
tax assets and liabilities, as well as adjustments to certain cumulative
temporary differences that had historically been incorrectly associated with
operating license assets which, in this restatement, have been correctly
classified as investments in partnership assets. Accordingly, the company has adjusted the
deferred tax liabilities related to these assets. Goodwill was adjusted by $10.2 million to
record the income tax effect of the difference between the financial reporting
basis and the income tax basis of certain acquisitions made prior to 2004.
TDS determined that the state deferred tax liabilities
attributable to marketable equity securities, as presented in prior periods,
should have been lower to reflect carryover of a higher stock basis than the
federal basis for certain states that have not adopted the federal consolidated
return regulations. TDS also identified
a valuation allowance related to state net operating loss carry forwards for
which deferred tax liabilities related to marketable equity securities provide
positive evidence supporting reductions to previously established valuation
allowances.
48
· Cash
and interest income In reviewing cash accounts, it was determined that cash
and interest income were overstated in the three months ended March 31, 2006
and six months ended June 30, 2006. In
the restatement, TDS corrected the overstatement by reducing cash and interest
income.
· Property,
plant and equipment U.S. Cellular did not properly record certain transfers
and disposals of equipment removed from service. Also, U.S. Cellular did not properly record
depreciation expense for certain leasehold improvements and other equipment due
to the use of incorrect asset lives. The
restatement adjustments properly record equipment disposals and depreciation
expense in the correct amounts and periods.
· Other
items In addition to the adjustments described above, TDS recorded a number
of other adjustments to correct and record revenues, expenses and equity in
earnings of unconsolidated entities in the periods in which such revenues,
expenses and equity in earnings of unconsolidated entities were earned or
incurred. Adjustments were also made to correct certain balance sheet amounts,
including $2.1 million corrections to purchase price accounting for certain
acquisitions prior to 2003. These
individual adjustments were not material.
The table below
summarizes the impacts of the restatement on income before income taxes and minority
interest.
|
|
Three Months
Ended
September 30, 2005
|
|
Nine Months
Ended
September 30, 2005
|
|
|
|
(Increase (decrease), dollars in thousands)
|
|
Income Before
Income Taxes and Minority Interest, as previously reported
|
|
$
|
83,223
|
|
$
|
312,601
|
|
Forward contracts and related derivative instruments
|
|
(4,665
|
)
|
495,011
|
|
Contracts with maintenance and support services
|
|
(123
|
)
|
(458
|
)
|
Property, plant and equipment
|
|
(1,827
|
)
|
(1,750
|
)
|
Other items
|
|
(1,667
|
)
|
(7,633
|
)
|
Total adjustment
|
|
(8,282
|
)
|
485,170
|
|
Income Before Income
Taxes and Minority Interest, as restated
|
|
$
|
74,941
|
|
$
|
797,771
|
|
The table below
summarizes the net income and diluted earnings per share impacts from the
restatement.
|
|
Three Months Ended
September 30, 2005
|
|
Nine Months Ended
September 30, 2005
|
|
|
|
Net Income
|
|
Diluted
Earnings
Per Share
|
|
Net Income
|
|
Diluted
Earnings
Per Share
|
|
|
|
(Increase (decrease), dollars in thousands, except per share amounts)
|
|
As previously
reported
|
|
$
|
41,566
|
|
$
|
0.36
|
|
$
|
161,671
|
|
$
|
1.39
|
|
Forward contracts and related derivative instruments
|
|
(1,681
|
)
|
(0.01
|
)
|
297,644
|
|
2.56
|
|
Contracts with maintenance and support services
|
|
(48
|
)
|
|
|
(188
|
)
|
|
|
Income taxes
|
|
549
|
|
|
|
1,647
|
|
0.01
|
|
Property, plant and
equipment
|
|
(916
|
)
|
(0.01
|
)
|
(874
|
)
|
(0.01
|
)
|
Other items
|
|
(855
|
)
|
(0.01
|
)
|
(3,745
|
)
|
(0.03
|
)
|
Total adjustment
|
|
(2,951
|
)
|
(0.03
|
)
|
294,484
|
|
2.53
|
|
As restated
|
|
$
|
38,615
|
|
$
|
0.33
|
|
$
|
456,155
|
|
$
|
3.92
|
|
49
OVERVIEW
The following is a
summary of certain selected information from the complete Management Discussion
and Analysis of Financial Condition and Results of Operations (MD&A) that
follows below. This Overview does not contain all of the information that may
be important and, therefore you should carefully read the entire MD&A and
not rely solely on this Overview.
Results of Operations
U.S. Cellular positions
itself as a regional operator, focusing its efforts on providing wireless
service to customers in the geographic areas where it has licenses to provide
such service. U.S. Cellular differentiates itself from its competitors through
a customer satisfaction strategy, reflecting broad product distribution, a
customer service focus and a high-quality wireless network.
U.S. Cellulars business
development strategy is to acquire, develop and operate controlling interests
in wireless licenses in areas adjacent to or in proximity to its other wireless
licenses, thereby building contiguous operating market areas. U.S. Cellulars
operating strategy is to strengthen the geographic areas where it can continue
to build long-term operating synergies and to exit those areas where it does
not have opportunities to build such synergies.
U.S. Cellular delivered
solid business results for the nine months ended September 30, 2006. Operating
highlights included the following:
· Total
customers increased 8% year-over-year to 5,729,000 and average monthly service
revenue per customer increased 4% to $46.92;
· The
postpay churn rate per month was 1.5%;
· Additions
to property, plant and equipment totaled $421.4 million, including expenditures
to construct cell sites, increase capacity in existing cell sites and switches,
outfit new and remodel existing retail stores and continue the development of
U.S. Cellulars office systems. Total cell sites in service increased 11%
year-over-year to 5,726; and
· In
April 2006, U.S. Cellular completed the purchase of the remaining majority interest
in the Tennessee RSA No. 3 Limited Partnership, a wireless market in which
it had previously owned a 16.7% interest, for approximately $18.8 million
in cash.
Service Revenues
increased $293.5 million, or 14%, to $2,382.7 million in the nine months ended
September 30, 2006 from $2,089.2 million in 2005. Revenues from data products
and services increased 60% to $147.8 million in the nine months ended September
2006 from $92.3 million in 2005 as customers continue to use U.S. Cellulars easyedgeSM products and
offerings such as Short Messaging Service (SMS), Speedtalk SM, a push-to-talk service, and
Blackberry® handsets and service.
Operating Income in the
nine months ended September 30, 2006 increased $61.3 million, or 37%, to $226.3
million from $165.0 million in 2005. The increase in Operating Income reflected
both higher operating revenues and a higher operating income margin (as a
percent of service revenues), which was 9.5% in the nine months ended September
30, 2006 compared to 7.9% in the same period of 2005.
See U.S. Cellular
Operations.
TDS Telecom - TDS Telecom
provides high-quality telecommunication services, including full-service local
exchange service, long distance telephone service and Internet access, to
rural, suburban and selected small urban area communities. TDS Telecoms
business plan is designed for a full-service telecommunications company,
including competitive local exchange carrier operations, by leveraging TDS
Telecoms strength as an incumbent local exchange carrier. TDS Telecom is
focused on achieving three central strategic objectives: growth, market
leadership, and profitability. TDS Telecoms strategy includes gaining
additional market share, deepening penetration of vertical services within
established markets and becoming the premier broadband provider in our chosen
markets.
50
TDS Telecoms operating
income in the nine months ended September 30, 2006 decreased $15.6 million, or
13% to $103.0 million from $118.6 million in 2005. The operating income
margins were 15.7% in 2006 and 17.7% in 2005. Despite the challenges faced in
the industry, TDS Telecom was able to increase equivalent access lines by 2%
primarily due to the growth of Digital Subscriber Lines (DSL) by over 42%
from September 2005 to September 2006.
See TDS Telecom
Operations.
Cash Flows and Investments
At September 30, 2006,
TDS and its subsidiaries had cash and cash equivalents totaling $1,029.8
million, available borrowing capacity of $1,146.1 million under its revolving
credit facilities and an additional $75 million of bank lines of credit. Also,
during the nine months ended September 30, 2006, TDS generated cash flows from
operating activities of $671.0 million. Management believes that cash on hand,
expected future cash flows from operating activities and sources of external
financing provide substantial financial flexibility and are sufficient to
permit TDS and its subsidiaries to finance their contractual obligations and
anticipated capital expenditures. TDS continues to seek to maintain a strong balance
sheet and an investment grade credit rating.
U.S. Cellular is a
limited partner in Barat Wireless, L.P. (Barat Wireless), an entity which
participated in the auction of wireless spectrum designated by the Federal
Communications Commission (FCC) as Auction 66. Barat Wireless was qualified
to receive a 25% discount available to designated entities. At the conclusion
of the auction on September 18, 2006, Barat Wireless was the high bidder with
respect to 17 licenses and had bid $127.1 million, net of its designated entity
discount. The balance due from Barat Wireless at the conclusion of the auction
for the licenses with respect to which Barat Wireless was the high bidder was
approximately $47.1 million and was paid on October 18, 2006. Although the
bidding in Auction 66 ended on September 18, 2006, the FCC has not yet awarded
any of the licenses to winning bidders, nor is there any prescribed timeframe
for the FCC to review the qualifications of the various winning bidders and
award licenses.
Barat Wireless is in the
process of developing its long-term business and financing plans. As of October
31, 2006, U.S. Cellular had made capital contributions and advances to
Barat Wireless and/or its general partner totaling $127.2 million. For
financial reporting purposes, U.S. Cellular consolidates Barat Wireless and
Barat Wireless, Inc., the general partner of Barat Wireless, pursuant to the
guidelines of FIN 46(R), as U.S. Cellular anticipates benefiting from or
absorbing a majority of Barat Wireless expected gains or losses. Pending
finalization of Barat Wireless permanent financing plan, and upon request by
Barat Wireless, U.S. Cellular may agree to make additional capital
contributions and advances to Barat Wireless and/or its general partner.
At
an Extraordinary General Meeting held on July 25, 2006, shareholders of
Vodafone approved a Special Distribution of £0.15 per share (£1.50 per American
Depositary Receipt (ADR)) and a Share Consolidation under which every 8 ADRs
of Vodafone were consolidated into 7 ADRs. As a result of the Special
Distribution which was paid on August 18, 2006, U.S. Cellular and TDS
Telecom received approximately $28.6 million and $7.6 million in cash,
respectively; the amounts, representing a return of capital, were recorded as a
reduction in the net carrying value of marketable equity securities in the
Consolidated Balance Sheets. Also, as a result of the Share Consolidation which
was effective on July 28, 2006, U.S. Cellulars previous 10,245,370
Vodafone ADRs were consolidated into 8,964,698 Vodafone ADRs and TDS Telecoms
previous 2,700,545 Vodafone ADRs were consolidated into 2,362,976 ADRs.
See Financial Resources
and Liquidity and Capital Resources for additional information related to
cash flows and investments. See Note 23 Subsequent Events of Notes to
Consolidated Financial Statements included in Item 1 above for information
related to cash proceeds from the sale of Midwest Wireless (approximately
$95.1 million).
51
RESULTS
OF OPERATIONS
Nine
Months Ended September 30, 2006 Compared to Nine Months Ended September 30,
2005
Operating Revenues increased
$309.9 million, or 11%, to $3,239.8 million during the nine months ended
September 30, 2006 from $2,929.9 million during the nine months ended September
30, 2005, primarily as a result of a 7% increase in customers and equivalent
access lines served. U.S. Cellulars operating revenues increased $325.5 million,
or 14%, to $2,571.0 million in 2006 from $2,245.5 million in 2005 as customers
served increased by 426,000, or 8%, since September 30, 2005, to 5,729,000. TDS
Telecoms operating revenues decreased $12.5 million, or 2%, to $657.6 million
in 2006 and $670.1 million in 2005. Equivalent access lines increased by 24,600,
or 2%, since September 30, 2005, to 1,205,000. An equivalent access line is
derived by converting a high-capacity data line to an estimated equivalent
number, in terms of capacity, of switched access lines.
Operating Expenses
increased $269.9 million, or 10%, to $2,915.0 million in 2006 from $2,645.1
million in 2005 primarily reflecting growth in operations. Operating expenses
include a $20.7 million increase in stock-based compensation expense primarily
due to the implementation of FASB Statement of Financial Accounting Standards (SFAS)
No. 123 (revised) (SFAS 123(R)), Share-Based Payment, as of January 1,
2006. U.S. Cellulars operating expenses increased $264.3 million, or 13%,
to $2,344.8 million in 2006 from $2,080.3 million in 2005 primarily reflecting
costs associated with acquiring customers and serving and retaining its
expanding customer base. TDS Telecoms expenses increased $3.2 million, or 1%,
to $554.7 million in 2006 from $551.5 million in 2005 primarily reflecting
increased cost of services and products related to digital subscriber lines and
long distance services and an increase in stock based compensation expense due
mainly to the implementation of SFAS 123(R).
Operating Income
increased $40.1 million, or 14%, to $324.9 million in 2006 from $284.8 million
in 2005. The operating margin was 10.0% in 2006 and 9.7% in 2005 on a
consolidated basis. U.S. Cellulars operating income increased $61.3 million,
or 37%, to $226.3 million from $165.0 million in 2005 and its operating margin,
as a percentage of service revenues, increased to 9.5% in 2006 from 7.9% in
2005. TDS Telecoms operating income decreased $15.6 million, or 13%, to $103.0 million
in 2006 from $118.6 million in 2005 and its operating margin decreased to 15.7%
in 2006 from 17.7% in 2005.
Investment and Other Income
(Expense) primarily includes interest and dividend income,
equity in earnings of unconsolidated entities, gains and losses on investments,
fair value adjustment of derivative instruments and interest expense.
Investment and other income (expense) totaled $171.7 million in 2006 and $513.0
million in 2005.
Equity in
earnings of unconsolidated entities increased $16.2 million,
or 32%, to $66.4 million in 2006 from $50.2 million in 2005. Equity in earnings
of unconsolidated entities represents TDSs share of net income from markets in
which it has a minority interest and that are accounted for by the equity
method. TDSs investment in the Los Angeles SMSA Limited Partnership
contributed $46.4 million and $37.8 million to equity in earnings of
unconsolidated entities for the nine months ended September 30, 2006 and 2005,
respectively.
Interest and dividend income
increased $32.9 million or 23%, to $174.4 million in 2006 from $141.5 million
in 2005 primarily due to increases in the dividends paid by Deutsche Telekom
($14.6 million) and Vodafone ($4.3 million), and higher average rates of
interest earned on investments in 2006 than 2005.
Interest expense
increased $17.0 million, or 11%, to $177.2 million in 2006 from $160.2 million
in 2005. The increase in interest expense in the nine months ended September
30, 2006 was primarily due to an increase in interest paid on forward contracts
related to interest rate increases ($19.4 million), the debt issuance of 6.625%
senior notes in March 2005 of $116.25 million ($1.9 million) and the
increase in interest rates on the revolving credit facilities ($5.0 million).
The increase in interest expense was partially offset by the repayment of TDS
Telecom subsidiary debt in March and June of 2005 ($5.2 million) the
repayment of $200 million of 7% senior notes by TDS in August 2006 ($2.4
million) and the repayment of Medium-term Notes ($2.3 million).
52
Fair value adjustment of
derivative instruments totaled a gain of $22.9 million in
2006 and a gain of $495.3 million in 2005.
Fair value adjustment of derivative instruments reflects the change in
the fair value of the bifurcated embedded collars within the forward contracts
related to the Deutsche Telekom and Vodafone marketable equity securities not
designated as a hedge. The changes in fair value of the embedded collars during
cash flow hedge designation are recorded to other comprehensive income. When
the collars were de-designated in the cash flow hedge, subsequent changes in
fair value are recognized in the consolidated statement of operations, along
with the related income tax effects. The
accounting for the embedded collars as derivative instruments not designated in
a hedging relationship results in increased volatility in the results of
operations, as fluctuation in the market price of the underlying Deutsche
Telekom and Vodafone marketable equity securities results in changes in the
fair value of the embedded collars being recorded in the consolidated statement
of operations. Also included in the fair
value adjustment of derivative instruments are the gains and losses related to
the ineffectiveness of the VeriSign fair value hedge which aggregated an
unrealized gain of $1.0 million in 2006 and an unrealized gain of $0.3 million
in 2005.
Gain on investments
totaled a net gain of $91.4 million in 2006 and $0.5 million in 2005. The net
gain in 2006 includes a $90.3 million gain at TDS Telecom from its remittance
of Rural Telephone Bank (RTB) shares. See Note 5 Gain on Investment.
Other expense
totaled $6.2 million in 2006 and $14.3 million in 2005. Borrowing costs on the
prepaid forward contracts decreased $1.0 million in 2006 compared to 2005. In
addition, in 2005 TDS Telecom recorded prepayment penalties and unamortized
debt issuance costs writeoffs of $2.2 million on the repayment of long-term
debt in March and June. In 2005, TDS incurred $2.9 million of expenses from the
Special Common Share Proposal and stock dividend.
Income Tax Expense
decreased $132.8 million to $185.2 million in 2006 from $318.0 million in 2005
primarily due to the decrease in pre-tax income. The overall effective tax
rates on income before income taxes and minority interest for the nine months
ended September 30, 2006 and 2005 were 37.3% and 39.9%, respectively. The
effective tax rate is lower than 2005 as a result of the settlement of certain
state income tax audits. For further analysis and discussion of TDSs effective
tax rates in 2006 and 2005, see Note 4 Income Taxes of Notes to Consolidated
Financial Statements included in Item 1 above.
Minority
Share of (Income) includes the minority public shareholders
share of U.S. Cellulars net income, the minority shareholders or partners
share of U.S. Cellulars subsidiaries net income or loss and other minority
interests.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Minority Share
of Income
|
|
|
|
|
|
U.S. Cellular
|
|
|
|
|
|
Minority Public Shareholders
|
|
$
|
(23,602
|
)
|
$
|
(17,245
|
)
|
Minority Shareholders or Partners
|
|
(9,552
|
)
|
(6,544
|
)
|
|
|
(33,154
|
)
|
(23,789
|
)
|
Other
|
|
(127
|
)
|
(185
|
)
|
|
|
$
|
(33,281
|
)
|
$
|
(23,974
|
)
|
Income
from Continuing Operations totaled $278.0 million, or $2.38
per diluted share, in 2006 compared to $455.8 million, or $3.92 per diluted
share, in 2005.
53
Discontinued
Operations
TDS is a party to
an indemnity agreement with T-Mobile USA, Inc. (T-Mobile) regarding certain
contingent liabilities for Aerial Communications, Inc. (Aerial), a former
subsidiary of TDS. TDS has recorded an accrual for expenses, primarily tax
related, resulting from Aerials merger into VoiceStream Wireless Corporation (VoiceStream)
in 2000. TDS paid $7.1 million in the nine months ended September 30, 2005
related to accrued liabilities for discontinued operations.
In the third
quarter of 2005, TDS recorded a gain of $0.3 million ($0.5 million, net of a
$0.2 million income tax expense), or $0.00 per diluted share, for discontinued
operations relating to a reduction in this indemnity accrual due to the
favorable outcome of a state tax audit which reduced the potential indemnity
obligation.
Net Income Available to Common
totaled $277.8 million, or $2.38 per diluted share, in 2006 and $456.0 million,
or $3.92 per diluted share, in 2005.
54
U.S.
CELLULAR OPERATIONS
TDS provides wireless
telephone service through U.S. Cellular, an 81.2%-owned subsidiary. U.S.
Cellular owns, operates and invests in wireless markets throughout the United
States. Growth in the customer base is the primary reason for the change in
U.S. Cellulars results of operations in 2006 and 2005. The number of customers
increased 8% to 5,729,000 at September 30, 2006, from 5,303,000 at September
30, 2005, due to customer additions from its marketing channels and
acquisition, divestitures and exchange activities.
SUMMARY OF HOLDINGS
U.S. Cellular
owned, or had the right to acquire pursuant to certain agreements, interests in
241 wireless markets at September 30, 2006. A summary of the number of markets
U.S. Cellular owns or has rights to acquire as of September 30, 2006 follows:
|
|
Number of
Markets
|
|
Consolidated
markets (1)
|
|
201
|
|
Consolidated
markets to be acquired pursuant to existing agreements (2)
|
|
17
|
|
Minority
interests accounted for using equity method
|
|
18
|
|
Minority
interests accounted for using cost method
|
|
5
|
|
Total markets to
be owned after completion of pending transactions
|
|
241
|
|
(1) Includes
majority interests in 190 markets and other interests in 11 licenses acquired
through Carroll Wireless, L.P. (Carroll Wireless). U.S. Cellular consolidates Carroll Wireless and Carroll PCS, Inc., the
general partner of Carroll Wireless, for financial reporting purposes, pursuant
to the guidelines of FASB Interpretation No. 46(R), Consolidation of
Variable Interest Entities (revised December 2003) an interpretation of ARB
No. 51 (FIN 46(R)), as U.S. Cellular anticipates benefiting from or
absorbing a majority of Carroll Wireless expected gains or losses.
Carroll
Wireless was the winning bidder of 17 wireless licenses in the auction of
wireless spectrum designated by the FCC as Auction 58. On January 6, 2006, the
FCC granted Carroll Wireless applications with respect to 16 of the 17 licenses
for which it was the winning bidder and dismissed one application relating to
Walla Walla, Washington. Following the completion of Auction 58, the FCC
determined that a portion of the Walla Walla license was already licensed to
another party and should not have been included in Auction 58. In March 2006,
Carroll Wireless received a full refund of the amount paid to the FCC with
respect to the Walla Walla license. Of the 16 licenses which were granted to
Carroll Wireless, 11 licenses represent markets which are incremental to U.S.
Cellulars currently owned or acquirable markets and 5 represent markets in
which U.S. Cellular currently owns spectrum. Only licenses which add
incremental territory to U.S. Cellulars consolidated operating markets are
included in the number of consolidated markets so as to avoid duplicate
reporting of overlapping markets.
(2) U.S. Cellular owns rights to acquire majority
interests in 17 wireless licenses resulting from an exchange transaction with
AT&T Wireless Services, Inc. (AT&T Wireless), now Cingular Wireless
LLC (Cingular), which closed in August 2003. Pursuant to the exchange
transaction, U.S. Cellular also has rights to acquire 4 additional licenses.
However, those 4 additional licenses are in markets where U.S. Cellular
currently owns spectrum. Only licenses which add incremental territory to U.S.
Cellulars consolidated operating markets are included in the number of
consolidated markets so as to avoid duplicate reporting of overlapping markets.
55
RESULTS
OF OPERATIONS
Nine
Months Ended September 30, 2006 Compared to Nine Months Ended September 30,
2005.
Following is a
table of summarized operating data for U.S. Cellulars consolidated operations.
|
|
2006
|
|
2005
|
|
As of September
30, (1a)
|
|
|
|
|
|
Total market population (2)(4)
|
|
55,543,000
|
|
44,690,000
|
|
Customers (3)
|
|
5,729,000
|
|
5,303,000
|
|
Market penetration (4)
|
|
10.3
|
%
|
11.9
|
%
|
Total full-time equivalent employees
|
|
7,571
|
|
7,375
|
|
Cell sites in service
|
|
5,726
|
|
5,149
|
|
For the Nine
Months Ended September 30, (1b)
|
|
|
|
|
|
Net customer additions (5)
|
|
224,000
|
|
352,000
|
|
Net retail customer additions (5)
|
|
200,000
|
|
281,000
|
|
Average monthly service revenue per customer (As
Restated) (6)
|
|
$
|
46.92
|
|
$
|
45.02
|
|
Postpay churn rate per month (7)
|
|
1.5
|
%
|
1.5
|
%
|
Sales and
marketing cost per gross customer addition (As Restated) (8)
|
|
$
|
467
|
|
$
|
445
|
|
(1a) Amounts in 2006 include information related to all markets included in
U.S. Cellulars consolidated operations as of September 30, 2006. Such markets
include (i) the market acquired during April 2006, (ii) the 15 markets acquired
from ALLTEL in the exchange transaction completed in December 2005 and (iii)
the 11 markets granted to Carroll Wireless by the FCC in January 2006 which are
incremental to U.S. Cellulars currently owned or acquirable markets. Such
markets exclude the two markets transferred to ALLTEL in the exchange
transaction completed in December 2005. Amounts in 2005 include information
related to all markets included in U.S. Cellulars consolidated operations as
of September 30, 2005. For further information on acquisitions, divestitures
and exchanges, see Summary of Holdings above.
(1b) Amounts in 2006 include results from all markets included in U.S.
Cellulars consolidated operations for the period January 1, 2006 through
September 30, 2006. Such markets include (i) the market acquired during April
2006, (ii) the 15 markets acquired from ALLTEL in the exchange transaction
completed in December 2005 for the period January 1 through September 30, 2006
and (iii) the 11 markets granted to Carroll Wireless by the FCC in January 2006
for the period January 6 through September 30, 2006. Such amounts exclude
results from the two markets transferred to ALLTEL in the exchange transaction
completed in December 2005. Amounts in 2005 include results from all markets
included in U.S. Cellulars consolidated operations for the period January 1,
2005 through September 30, 2005. For further information on acquisitions,
divestitures and exchanges, see Summary of Holdings above.
(2) Represents 100% of the population of the
markets in which U.S. Cellular had a controlling financial interest for
financial reporting purposes as of September 30 of each respective year.
(3) U.S. Cellulars
customer base consists of the following types of customers:
|
|
September 30,
|
|
|
|
2006
|
|
2005
|
|
Customers on
postpay service plans in which the end user is a customer of U.S. Cellular
(postpay customers)
|
|
4,818,000
|
|
4,475,000
|
|
End user
customers acquired through U.S. Cellulars agreement with a third party
(reseller customers) *
|
|
602,000
|
|
538,000
|
|
Total postpay
customers
|
|
5,420,000
|
|
5,013,000
|
|
Customers on
prepaid service plans in which the end user is a customer of U.S. Cellular
(prepaid customers)
|
|
309,000
|
|
290,000
|
|
Total customers
|
|
5,729,000
|
|
5,303,000
|
|
* Pursuant to its
agreement with the third party, U.S. Cellular is compensated by the third party
on a postpay basis; as a result, all customers whom U.S. Cellular has acquired
through this agreement are considered to be postpay customers.
(4) Calculated using
2005 and 2004 Claritas population estimates for 2006 and 2005, respectively. Total
market population is used only for the purposes of calculating market
penetration, which is calculated by dividing customers by the total market
population (without duplication of population in overlapping markets).
(5) Net customer
additions represents the number of net customers added to U.S. Cellulars overall
customer base through all of its marketing distribution channels, excluding any
customers transferred through acquisitions, divestitures or exchanges. Net
retail customer additions represents the number of net customers added to U.S.
Cellulars customer base through its marketing distribution channels, excluding
net reseller customers added to its reseller customer base, and excluding any
customers transferred through acquisitions, divestitures or exchanges. See Operating
Income below for information related to U.S. Cellulars estimate of net retail
customer additions for the full year 2006.
56
(6) Management uses this measurement to assess the
amount of service revenue that U.S. Cellular generates each month on a per
customer basis. Variances in this measurement are monitored and compared to
variances in expenses on a per customer basis. Average monthly service
revenue per customer is calculated as follows:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
|
|
|
|
Service Revenues
per Consolidated Statements of Operations
|
|
$
|
2,382,747
|
|
$
|
2,089,232
|
|
Divided by
average customers during period (000s) *
|
|
5,642
|
|
5,156
|
|
Divided by
number of months in each period
|
|
9
|
|
9
|
|
Average monthly service
revenue per customer
|
|
$
|
46.92
|
|
$
|
45.02
|
|
* Average customers during period is
calculated by adding the number of total customers, including reseller
customers, at the beginning of the first month of the period and at the end of
each month in the period and dividing by the number of months in the period
plus one. Acquired and divested customers are included in the calculation on a
prorated basis for the amount of time U.S. Cellular included such markets
during each period.
(7) Postpay churn rate
per month represents the percentage of the postpay customer base that
disconnects service each month, including both postpay customers and reseller
customers. Reseller customers can disconnect service without the associated
account numbers being disconnected from U.S. Cellulars network if the reseller
elects to reuse the customer telephone numbers. Only those reseller customer
numbers that are disconnected from U.S. Cellulars network are counted in the
number of postpay disconnects. The calculation is performed by first dividing
the total number of postpay and reseller customers who disconnect service
during the period by the number of months in such period, and then dividing
that quotient by the average monthly postpay customer base, which includes both
postpay and reseller customers, for such period.
(8) For a discussion
of the components of this calculation, see Operating expenses Selling,
general and administrative expenses, below.
Operating
Revenues increased $325.5 million, or 14%, to $2,571.0
million in 2006 from $2,245.5 million in 2005.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Retail service
|
|
$
|
2,087,092
|
|
$
|
1,836,279
|
|
Inbound roaming
|
|
117,895
|
|
107,842
|
|
Long-distance
and other service revenues
|
|
177,760
|
|
145,111
|
|
Service Revenues
|
|
$
|
2,382,747
|
|
$
|
2,089,232
|
|
Equipment sales
|
|
188,289
|
|
156,294
|
|
|
|
$
|
2,571,036
|
|
$
|
2,245,526
|
|
Service
revenues increased $293.5 million, or 14%, to $2,382.7
million in 2006 from $2,089.2 million in 2005. Service revenues primarily
consist of: (i) charges for access, airtime, roaming, recovery of regulatory
costs and value-added services, including data products and services, provided
to U.S. Cellulars retail customers and to end users through third party
resellers (retail service); (ii) charges to other wireless carriers whose
customers use U.S. Cellulars wireless systems when roaming (inbound roaming);
and (iii) charges for long-distance calls made on U.S. Cellulars systems. The
increase in service revenues was primarily due to growth in the customer base,
which increased to 5,729,000 in 2006 from 5,303,000 in 2005, and higher monthly
service revenue per customer, which averaged $46.92 in the first nine months of
2006 compared to $45.02 in the first nine months of 2005. See footnote 6 to the
table of summarized operating data in Results of Operations above for the
calculation of average monthly service revenue per customer.
Retail service revenues
increased $250.8 million, or 14%, to $2,087.1 million in 2006 from $1,836.3 million
in 2005. Growth in U.S. Cellulars customer base and an increase in average
monthly retail service revenue per customer were the primary reasons for the
increase in retail service revenues. Average monthly retail service revenue per
customer increased 4% to $41.10 in 2006 from $39.57 in 2005, reflecting growth
in average minutes of use per customer and higher revenues from data products
and services.
57
The number of customers
increased 8% to 5,729,000 at September 30, 2006, from 5,303,000 at September
30, 2005. The increase in the average number of customers was primarily driven
by the addition of approximately 349,000 net new customers that U.S. Cellular
generated from its marketing (including reseller) channels over the last twelve
months. U.S. Cellular anticipates that the percentage growth in its customer
base will be lower in the future, primarily as a result of increased
competition and higher penetration in its markets. However, as U.S. Cellular
expands its operations in its recently acquired and launched markets in future
years, it anticipates adding customers and revenues in those markets.
Monthly retail minutes of
use per customer increased 12% to 691 in 2006 from 617 in 2005. The increase in
monthly retail minutes of use was driven by U.S. Cellulars focus on designing
sales incentive programs and customer billing rate plans to stimulate overall
usage. The impact on retail service revenue of the increase in average monthly
retail minutes of use was offset in part by a decrease in average revenue per
minute of use in 2006 compared to 2005. The decrease in average revenue per
minute of use reflects the effects of increasing competition, which has led to
the inclusion of an increasing number of minutes in package pricing plans and
the inclusion of features such as unlimited night and weekend minutes and
unlimited incoming call minutes in certain pricing plans. Additionally, the
percentage of U.S. Cellulars customer base represented by prepaid and reseller
customers, which generate less revenue per customer on average than postpay
customers, increased from 15.6% at September 30, 2005 to 15.9% at September, 30
2006. U.S. Cellular has seen stabilization in its average revenue per minute of
use during 2006 but does anticipate that it could decline in the future,
reflecting increased competition and continued penetration of the consumer
market.
Revenues from data
products and services increased to $147.8 million in 2006 from $92.3 million in
2005 as U.S. Cellular continued to enhance its easyedgeSM products and introduce new offerings such as
Speedtalk SM, a
push-to-talk service, and Blackberry® handsets and services.
Inbound
roaming revenues increased $10.1 million, or 9%, to $117.9
million in 2006 from $107.8 million in 2005. The increase in revenues was
related primarily to an increase in roaming minutes of use, partially offset by
a decrease in average inbound roaming revenue per roaming minute of use. The
increase in inbound roaming minutes of use was driven primarily by the overall
growth in the number of customers throughout the wireless industry. The decline
in roaming revenue per minute of use was due primarily to the general downward
trend in negotiated rates.
U.S. Cellular
anticipates that inbound roaming minutes of use might continue to grow over the
next few years, reflecting continuing industry-wide growth in customers, but
that the rate of growth will decline due to higher penetration of the consumer
wireless market. In addition, U.S. Cellular anticipates that the rate of
decline in average inbound roaming revenue per roaming minute of use may be
lower over the next few years, reflecting the wireless industry trend toward
longer term negotiated rates.
Long-distance
and other service revenues increased $32.7 million, or 22%,
to $177.8 million in 2006 from $145.1 million in 2005. The increase reflected
an $8.8 million increase in long-distance revenues and a $23.9 million increase
in other service revenues. The increase in long-distance revenues was driven by
an increase in the volume of long-distance calls billed to U.S. Cellulars
customers and to other wireless carriers whose customers used U.S. Cellulars
systems to make long-distance calls. The growth in other service revenues was
primarily due to an increase of $6.5 million in tower rental revenues, driven
by an increase in the number of tower space lease agreements in effect, and by
an increase of $15.7 million in the amount of funds received from the federal
Universal Service Fund (USF). In the first nine months of 2006 and 2005, U.S.
Cellular was eligible to receive eligible telecommunication carrier funds in
seven and five states, respectively.
Equipment
sales revenues increased $32.0 million, or 20%, to $188.3
million in 2006 from $156.3 million in 2005. Equipment sales revenues include
revenues from sales of handsets and related accessories to both new and
existing customers, as well as revenues from sales of handsets to agents. All
equipment sales revenues are recorded net of anticipated rebates.
58
U.S. Cellular
continues to offer a competitive line of quality handsets to both new and
existing customers. U.S. Cellulars customer retention efforts include offering
new handsets at discounted prices to existing customers as the expiration date
of the customers service contract approaches. U.S. Cellular also continues to
sell handsets to agents; this practice enables U.S. Cellular to provide better
control over the quality of handsets sold to its customers, establish roaming
preferences and earn quantity discounts from handset manufacturers which are
passed along to agents. U.S. Cellular anticipates that it will continue to sell
handsets to agents in the future.
The increase in
equipment sales revenues in 2006 was driven by increases in both average
revenue per handset sold and the number of handsets sold to customers and
agents. Average revenue per handset sold increased 5% in 2006 primarily due to
changes in both the mix of handsets sold and promotional discounts. The number
of handsets sold increased 15% in 2006, partly due to sales of handsets to
existing customers to replace non-GPS enabled handsets. The number of customers
added to U.S. Cellulars customer base through its marketing distribution
channels (gross customer additions), which is a key driver of equipment sales
revenues, increased 2% in 2006.
Operating
Expenses increased $264.3 million, or 13%, to $2,344.8
million in 2006 from $2,080.5 million in 2005. The major components of
operating expenses are shown in the table below.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
System
operations (excluding depreciation,
amortization and accretion included below)
|
|
$
|
468,980
|
|
$
|
446,278
|
|
Cost of
equipment sold
|
|
417,489
|
|
374,882
|
|
Selling, general
and administrative
|
|
1,028,865
|
|
877,116
|
|
Depreciation,
amortization and accretion
|
|
429,451
|
|
382,244
|
|
|
|
$
|
2,344,785
|
|
$
|
2,080,520
|
|
System
operations expenses (excluding depreciation, amortization and accretion) increased $22.7 million, or 5%,
to $469.0 million in 2006 from $446.3 million in 2005. System operations
expenses include charges from landline telecommunications service providers for
U.S. Cellulars customers use of their facilities, costs related to local
interconnection to the landline network, charges for maintenance of U.S.
Cellulars network, long-distance charges, outbound roaming expenses and
payments to third-party data product and platform developers. Key components of
the overall increase in system operations expenses were as follows:
· maintenance,
utility and cell site expenses increased $27.3 million, or 17%, primarily due
to a 10% increase in full-time engineering employee equivalents and an 11%
increase in the number of cell sites within U.S. Cellulars network. The number
of cell sites increased to 5,726 in 2006 from 5,149 in 2005, as U.S. Cellular
continued to grow by expanding and enhancing coverage in its existing markets
by acquisitions and by launching operations in new markets;
· the cost of
network usage on U.S. Cellulars systems increased $13.8 million, or 8%, as
total minutes used on U.S. Cellulars systems increased 28% in 2006 compared to
2005, offset by the ongoing reduction in the per-minute cost of usage on U.S.
Cellulars network; and
· expenses
incurred when U.S. Cellulars customers used other carriers networks while
roaming decreased $18.4 million, or 15%, primarily due to a reduction in
roaming rates negotiated with other carriers and the elimination of roaming
expenses incurred in previous periods when U.S. Cellular customers traveled
into markets recently launched and now operated by U.S. Cellular.
In
total, management expects system operations expenses to increase over the next
few years, driven by the following factors:
· increases in
the number of cell sites within U.S. Cellulars systems as it continues to add
capacity and enhance quality in all markets and continues development
activities in new markets; and
· increases in
minutes of use, both on U.S. Cellulars systems and by U.S. Cellulars
customers on other systems when roaming.
These
factors are expected to be partially offset by anticipated decreases in the
per-minute cost of usage both on U.S. Cellulars systems and on other carriers
networks.
59
Cost of
equipment sold increased $42.6 million, or 11%, to $417.5
million in 2006 from $374.9 million in 2005. The increase was due primarily to
an increase in the number of handsets sold (15%), as discussed above. The effect of
the increase in the number of handsets sold was partially offset by a decrease
in the average cost per handset sold (4%), which reflected changes in both the
mix of handsets sold and vendor discounts.
Selling, general and administrative expenses
increased $151.8 million, or 17%, to $1,028.9 million in 2006 from $877.1
million in 2005. Selling, general and administrative expenses primarily consist
of salaries, commissions and other expenses of field sales and retail personnel
and offices; agent commissions and related expenses; corporate marketing,
merchandise management and telesales department salaries and expenses;
advertising; and public relations expenses. Selling, general and administrative expenses
also include the costs of operating U.S. Cellulars customer care centers and
the majority of U.S. Cellulars corporate expenses.
The increase in selling, general and administrative expenses in 2006 is
primarily due to higher expenses associated with acquiring, serving and retaining
customers, primarily as a result of the 8% increase in U.S. Cellulars customer
base. Key components of the increase in selling, general and administrative
expenses were as follows:
· a $47.3 million
increase in expenses related to sales employees and agents. The increase in
sales employee-related expenses was driven by an 11% increase in full-time
sales employee equivalents; new employees were added primarily in the newly
acquired and recently launched markets. In addition, initiatives focused on
providing wireless GPS enabled handsets to customers who did not previously
have such handsets, contributed to higher sales employee-related and
agent-related commissions;
· a $26.4 million
increase in advertising expenses related to marketing of the U.S. Cellular
brand in newly acquired and launched markets as well as increases in spending
for specific direct marketing, segment marketing, product advertising and
sponsorship programs;
· a $34.4 million
increase in expenses primarily related to the operations of U.S. Cellulars
regional support offices, primarily due to the 8% increase in the customer
base;
· a $18.4 million
increase in bad debt expense, reflecting both higher revenues and higher bad
debts experience as a percent of revenues;
· a $9.5 million
increase in consulting and outsourcing costs as U.S. Cellular increased its use
of third parties to perform certain functions and participate in certain
projects;
· an $10.4 million
increase in stock-based compensation expense primarily due to the
implementation of Statement of Financial Accounting Standards (SFAS) No. 123
(revised) (SFAS 123(R)), Share-Based Payment, as of January 1, 2006; and
· a $5.4 million
increase in expenses related to universal service fund contributions and other
regulatory fees and taxes. Most of the expenses related to universal service
fund contributions are offset by increases in retail service revenues for
amounts passed through to customers.
Sales and marketing cost
per gross customer addition increased 5% to $467 in 2006 from $445 in 2005,
primarily due to increased agent-related expenses, employee-related expenses
and advertising expenses, partially offset by reduced losses on sales of
handsets. Management uses the sales and marketing cost per gross customer addition
measurement to assess the cost of acquiring customers and the efficiency of its
marketing efforts. Sales and marketing cost per gross customer addition
is not calculable using financial information derived directly from the
Consolidated Statements of Operations. The definition of sales and marketing
cost per gross customer addition that U.S. Cellular uses as a measure of the
cost to acquire additional customers through its marketing distribution
channels may not be comparable to similarly titled measures that are reported
by other companies.
60
Below is a summary
of sales and marketing cost per gross customer addition for each period:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands,
except per customer amounts)
|
|
Components of
cost:
|
|
|
|
|
|
Selling, general and administrative expenses related
to the
acquisition of new customers(1)
|
|
$
|
448,315
|
|
$
|
388,863
|
|
Cost of equipment sold to new customers (2)
|
|
297,533
|
|
283,078
|
|
Less equipment sales revenues from new customers (3)
|
|
(211,167
|
)
|
(172,822
|
)
|
Total costs
|
|
$
|
534,681
|
|
$
|
499,119
|
|
Gross customer
additions (000s) (4)
|
|
1,146
|
|
1,121
|
|
Sales and marketing
cost per gross customer addition
|
|
$
|
467
|
|
$
|
445
|
|
(1) Selling,
general and administrative expenses related to the acquisition of new customers
is reconciled to total selling, general
and administrative expenses as follows:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Selling, general
and administrative expenses, as reported
|
|
$
|
1,028,865
|
|
$
|
877,116
|
|
Less expenses
related to serving and retaining customers
|
|
(580,550
|
)
|
(488,253
|
)
|
Selling, general and
administrative expenses related to the acquisition of new customers
|
|
$
|
448,315
|
|
$
|
388,863
|
|
(2) Cost
of equipment sold to new customers is reconciled to cost of equipment sold as
follows:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Cost of
equipment sold as reported
|
|
$
|
417,489
|
|
$
|
374,882
|
|
Less cost of
equipment sold related to the retention of current customers
|
|
(119,956
|
)
|
(91,804
|
)
|
Cost of equipment sold
to new customers
|
|
$
|
297,533
|
|
$
|
283,078
|
|
(3) Equipment
sales revenues from new customers is reconciled to equipment sales revenues as
follows:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Equipment sales
revenues as reported
|
|
$
|
188,289
|
|
$
|
156,294
|
|
Less equipment
sales revenues related to the retention of current customers, excluding agent
rebates
|
|
(40,398
|
)
|
(21,272
|
)
|
Add agent rebate
reductions of equipment sales revenues related to the retention of current
customers
|
|
63,276
|
|
37,800
|
|
Equipment sales
revenues from new customers
|
|
$
|
211,167
|
|
$
|
172,822
|
|
(4) Gross
customer additions represent customers added to U.S. Cellulars customer base
through its marketing distribution channels, including customers added through
third party resellers, during the respective periods presented.
Monthly general and administrative expenses per customer, including the net
costs related to the renewal or upgrade of service contracts of existing
current U.S. Cellular customers (net customer retention costs), increased 11%
to $14.25 in 2006 from $12.86 in 2005, primarily due to the increase in
employee-related expenses associated with serving and retaining customers. Also,
in 2006, U.S. Cellular increased spending on retention activities that are
focused on providing wireless GPS enabled handsets to customers who did not
previously have such handsets.
61
U.S. Cellular uses this monthly general and
administrative expenses per customer measurement to assess the cost of serving
and retaining its customers on a per unit basis.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands,
except per customer amounts)
|
|
Components of cost (1)
|
|
|
|
|
|
Selling, general and administrative expenses
as reported
|
|
$
|
1,028,865
|
|
$
|
877,116
|
|
Less selling, general and administrative
expenses related to the acquisition of new customers
|
|
(448,315
|
)
|
(388,863
|
)
|
Add cost of equipment sold related to the
retention of current customers
|
|
119,956
|
|
91,804
|
|
Less equipment sales revenues related to the
retention of current customers, excluding agent rebates
|
|
(40,398
|
)
|
(21,272
|
)
|
Add agent rebate reductions of equipment
sales revenues related to the retention of current customers
|
|
63,276
|
|
37,800
|
|
Net cost of serving and retaining customers
|
|
$
|
723,384
|
|
$
|
596,585
|
|
Divided by average customers during period
(000s) (2)
|
|
5,642
|
|
5,156
|
|
Divided by nine months in each period
|
|
9
|
|
9
|
|
Average monthly general and administrative
expenses per customer
|
|
$
|
14.25
|
|
$
|
12.86
|
|
(1) These components were previously identified in
the summary of sales and marketing cost per customer addition and related
footnotes above.
(2) The calculation of Average customers during
the period is set forth in footnote 6 of the table of summarized operating
data above.
Depreciation, amortization and
accretion expense increased $47.3 million, or 12%, to $429.5
million in 2006 from $382.2 million in 2005. The majority of the increase
reflects higher depreciation expense of $35.2 million due to higher fixed
assets; average fixed assets for the nine months ended September 30, 2006
increased 13% as compared to the same period in the prior year. The increase in
fixed assets in 2006 resulted from the following factors:
· the
addition of 577 cell sites to U.S. Cellulars network since September 30, 2005,
including both those built to improve coverage and capacity in U.S. Cellulars
existing service areas and those built in areas where U.S. Cellular has
recently launched service; and
· the
addition of radio channels and switching capacity to U.S. Cellulars network to
accommodate increased usage.
See Financial
Resources and Liquidity and Capital Resources for further discussions of
U.S. Cellulars capital expenditures.
In 2006,
depreciation expense included charges of $12.2 million related to disposals of
assets, trade-ins of older assets for replacement assets and write-offs of TDMA
equipment upon disposal or consignment for future sale. In 2005, depreciation
expense included charges of $16.8 million related to such disposals, trade-ins
and write-offs.
62
Operating
Income
Operating
income increased $61.3 million, or 37%, to $226.3 million in
2006 from $165.0 million in 2005. The operating income margin (as a percent of
service revenues) was 9.5% in 2006 and 7.9% in 2005. The increases in operating
income and operating income margin were due to the fact that operating revenues
increased more, in both dollar and percentage terms, than operating expenses,
as a result of the factors which are described in detail in Operating Revenues
and Operating Expenses above.
U.S. Cellular
expects the above factors to continue to have an effect on operating income and
operating income margin for the next several quarters. Any changes in the above
factors, as well as the effects of other factors that might impact U.S.
Cellulars operating results, could cause operating income and operating income
margin to fluctuate over the next several quarters.
The
following are estimates of full-year 2006 service revenues; depreciation,
amortization and accretion expenses; and operating income. Such estimates are
based on U.S. Cellulars currently owned and operated markets. The following
estimates were updated by U.S. Cellular on November 6, 2006 and continue to
represent U.S. Cellulars views as of the date of filing this Form 10-Q based
on current facts and circumstances. Such forward-looking statements should not
be assumed to be accurate as of any future date. U.S. Cellular undertakes no
duty to update such information whether as a result of new information, future
events or otherwise. There can be no assurance that final results will not
differ materially from these estimated results.
|
|
2006 Estimated Results
|
|
|
2005 Actual Results
(As Restated)
|
|
Service revenues
|
|
Approx. $3.2 billion
|
|
|
$
|
2.83 billion
|
|
Depreciation, amortization and accretion
expenses
|
|
Approx. $575 million
|
|
|
$
|
510.5 million
|
|
Operating income (1)(2)
|
|
$
|
275-325 million
|
|
|
$
|
231.2 million
|
|
|
|
|
|
|
|
|
|
|
(1) 2005
Actual Results includes a gain of $44.7 million resulting from sale of assets.
(2) 2006
Estimated Results reflect an estimate of stock-based compensation expense to be
recorded pursuant to U.S. Cellulars implementation of SFAS 123(R)
effective January 1, 2006.
63
TDS
TELECOM OPERATIONS
TDS operates its wireline
telephone operations through TDS Telecommunications Corporation (TDS Telecom),
a wholly owned subsidiary. Total equivalent access lines served by TDS Telecom
increased by 24,600 or 2%, since September 30, 2005 to 1,205,000. An equivalent
access line is derived by converting a high-capacity data line to an estimated
equivalent number, in terms of capacity, of switched access lines.
TDS Telecoms incumbent
local exchange carrier subsidiaries served 752,100 equivalent access lines at
September 30, 2006, a 2% (17,300 equivalent access lines) increase from 734,800
equivalent access lines at September 30, 2005.
TDS Telecoms competitive
local exchange carrier subsidiary served 452,900 equivalent access lines at September
30, 2006, a 2% (7,300 equivalent access lines) increase from 445,600 equivalent
access lines served at September 30, 2005.
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
|
(Dollars in thousands)
|
|
|
Incumbent Local Exchange
Carrier Operations
|
|
|
|
|
|
|
Operating Revenues
|
|
$
|
485,228
|
|
$
|
494,791
|
|
|
Operating Expenses
|
|
379,854
|
|
367,258
|
|
|
Operating Income
|
|
105,374
|
|
127,533
|
|
|
|
|
|
|
|
|
|
Competitive Local Exchange
Carrier Operations
|
|
|
|
|
|
|
Operating Revenues
|
|
176,599
|
|
179,212
|
|
|
Operating Expenses
|
|
179,016
|
|
188,123
|
|
|
Operating Income
(Loss)
|
|
(2,417
|
)
|
(8,911
|
)
|
|
|
|
|
|
|
|
|
Intercompany revenue
elimination
|
|
(4,186
|
)
|
(3,864
|
)
|
|
Intercompany expense
elimination
|
|
(4,186
|
)
|
(3,864
|
)
|
|
|
|
|
|
|
|
|
TDS Telecom Operating Income
|
|
$
|
102,957
|
|
$
|
118,622
|
|
|
TDS Telecom operating
expenses include a $5.7 million increase in stock-based compensation expense
primarily due to the implementation of SFAS 123(R) as of January 1, 2006.
Operating Income
decreased $15.6 million, or 13%, to $103.0 million in the nine months ended
September 30, 2006 from $118.6 million in 2005.
The following
estimates were updated by TDS Telecom on November 6, 2006 and continue to
represent TDS Telecoms views as of the date of filing this Form 10-Q based on
current facts and circumstances. Such forward-looking statements should not be
assumed to be accurate as of any future date. TDS Telecom undertakes no legal
duty to update such information whether as a result of new information, future
events or otherwise.
|
|
2006 Estimated
Results
|
|
2005 Actual
Results
|
|
Incumbent Local Exchange Operations:
|
|
|
|
|
|
Revenues
|
|
$
|
645-655 million
|
|
$
|
669.7 million
|
|
Depreciation and amortization expenses
|
|
$
|
135 million
|
|
$
|
135.2 million
|
|
Operating income
|
|
Approx. $135 million
|
|
$
|
168.9 million
|
|
|
|
|
|
|
|
Competitive Local Exchange Operations:
|
|
|
|
|
|
Revenues
|
|
$
|
230-240 million
|
|
$
|
239.3 million
|
|
Depreciation and amortization expenses
|
|
$
|
25 million
|
|
$
|
30.4 million
|
|
Operating
income (loss)
|
|
Approx. $(5) million
|
|
$
|
(8.2) million
|
|
64
Incumbent Local Exchange Carrier
Operations
Operating
Revenues decreased $9.6 million, or 2%, to $485.2 million in
the nine months ended September 30, 2006 from $494.8 million in 2005.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Local service
|
|
$
|
151,058
|
|
$
|
150,200
|
|
Network access and long
distance
|
|
266,994
|
|
275,452
|
|
Miscellaneous
|
|
67,176
|
|
69,139
|
|
|
|
$
|
485,228
|
|
$
|
494,791
|
|
Local service revenues
increased $0.9 million, or less than 1%, to $151.1 million in 2006 from $150.2
million in 2005. Revenue increases from advanced calling services and
interconnection more than offset the revenue decrease from physical access line
losses. Physical access lines decreased 3%, from September 30, 2005 to September
30, 2006. Of this decline, 36% was from second line disconnections, which was
significantly influenced by customers converting to digital subscriber line
service.
Network access and long distance
revenues decreased $8.5 million, or 3%, to $267.0 million in
2006 from $275.5 million in 2005. Revenues from long distance service increased
$5.0 million in 2006 reflecting an increase in long distance customers. As of
September 30, 2006, TDS Telecom incumbent local exchange carrier operations
were providing long distance service to 335,100 access lines compared to
316,100 access lines at September 30, 2005. Revenue generated from network usage, including
compensation from state and national revenue pools, decreased $13.5 million,
primarily due to a 4% decrease in access minutes of use, a decrease in revenues
resulting from revenue disputes with interchange carriers and lower average
access rates in 2006.
Miscellaneous revenues
from Internet, digital subscriber line and other non-regulated lines of
business decreased $1.9 million or 3%, to $67.2 million in 2006 from $69.1
million in 2005. Digital subscriber line revenues increased 46%, but were
offset by decreases in dial-up Internet, digital broadcast service, and other
non-regulated services revenues. Additionally, bundled service discounts
increased in the first nine months of 2006 as compared to 2005. As of September
30, 2006, TDS Telecom incumbent local exchange carrier operations were
providing dial-up Internet service and digital subscriber line service to 82,200
and 94,100 customers, respectively, as compared to 89,700 Internet customers
and 60,300 digital subscriber line service customers as of September 30, 2005.
Operating
Expenses increased by $12.6 million, or 3%, to $379.9 million
in 2006 from $367.3 million in 2005, primarily reflecting a $4.8 million
increase in stock based compensation expense due mainly to the implementation
of SFAS 123(R) as of January 1, 2006, and an increase in the cost of services
and products.
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
|
(Dollars in thousands)
|
|
|
Cost of services and
products (exclusive of depreciation, amortization and accretion included
below)
|
|
$
|
141,833
|
|
$
|
129,006
|
|
|
Selling, general and
administrative expense
|
|
137,436
|
|
137,087
|
|
|
Depreciation, accretion
and amortization
|
|
100,585
|
|
101,165
|
|
|
|
|
$
|
379,854
|
|
$
|
367,258
|
|
|
Cost of services and products
increased $12.8 million or 10%, to $141.8 million in 2006 from $129.0 million
in 2005. Increases in line charges and circuit expense and other related cost
of goods sold associated with growth in digital subscriber line customers
resulted in $3.1 million of expense increases. Growth in long distance
customers combined with increased usage stimulated by call plans increased
expense $3.7 million. The remainder of the increase was driven by increased
labor and contractor charges.
65
Selling, general and
administrative expenses increased by $0.3 million or less
than 1%, to $137.4 million from $137.1 million in 2005. Stock based compensation expense increased
$4.2 million primarily due to the implementation of SFAS 123(R) as of January
1, 2006 offset by decreases achieved through cost containment programs.
Depreciation, accretion and
amortization expenses decreased $0.6 million, or less than
1%, to $100.6 million in 2006 from $101.2 million in 2005 primarily due to
certain asset categories becoming fully depreciated.
Operating Income
decreased $22.1 million, or 17%, to $105.4 million in 2006 from $127.5 million
in 2005 primarily as a result of the decrease in network access revenues, the
implementation of SFAS 123(R) as of January 1, 2006 and the increase in cost of
services and products, all discussed above.
Competitive Local Exchange
Carrier Operations
Operating
Revenues (revenue from the provision of local and long
distance telephone service and data services) decreased $2.6 million, or 1%, to
$176.6 million from $179.2 million in 2005.
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Operating Revenues
|
|
$
|
176,599
|
|
$
|
179,212
|
|
|
|
|
|
|
|
|
|
Retail revenues
decreased $0.7 million to $161.1 million in 2006 from $161.8 million in 2005. A
3% growth in access lines increased revenues by $5.4 million. This increase was
more than offset by lower average revenue per customer resulting from
competitive pressures on voice and data product pricing.
Wholesale revenues,
which represent charges to other carriers, decreased $1.9 million to $15.5
million in 2006 from $17.4 million in 2005 primarily due to lower average
access rates and an increase in revenue disputes with interexchange carriers.
Operating
Expenses decreased $9.1 million, or 5%, to $179.0 million in
2006 from $188.1 million in 2005.
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
Cost of services and
products (exclusive of depreciation and amortization included below)
|
|
$
|
93,481
|
|
$
|
94,677
|
|
|
Selling, general and
administrative expense
|
|
67,005
|
|
71,623
|
|
|
Depreciation,
amortization and accretion
|
|
18,530
|
|
21,823
|
|
|
|
|
$
|
179,016
|
|
$
|
188,123
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services and products decreased
$1.2 million, or 1%, to $93.5 million in 2006 from $94.7 million in 2005. In
the first quarter of 2006, the Competitive Local Exchange Carrier (CLEC)
recognized a $2.9 million settlement from an inter-exchange carrier related to
pricing of certain services offered by the carrier. This was partially offset
by a $1.7 million increase in expense for the nine month period due to access
line growth.
Selling, general and
administrative expenses decreased $4.6 million, or 6%, to
$67.0 million in 2006 from $71.6 million in 2005. Costs to sell and service the
customer base have decreased as a result of changes in the mix of targeted
customers and consolidation of customer service and provisioning functions.
Depreciation and amortization
expenses decreased $3.3 million, or 15%, to $18.5 million in
2006 from $21.8 million in 2005 primarily due to certain assets becoming fully
depreciated.
66
Operating Loss
decreased $6.5 million to $2.4 million in 2006 from $8.9 million in 2005,
reflecting the decrease in operating expenses discussed above.
Incumbent and competitive
local exchange carriers are faced with significant challenges, including
growing competition from wireless and other wireline providers, changes in
regulation, and new technologies such as Voice over Internet Protocol. Despite
these challenges, TDS Telecom has successfully increased equivalent access line
levels while maintaining excellent customer satisfaction.
67
Three
Months Ended September 30, 2006 Compared to Three Months Ended September 30,
2005
Operating
Revenues increased $84.2 million, or 8%, to $1,112.1 million
during the third quarter of 2006 from $1,027.9 million in 2005 for reasons
generally the same as the first nine months.
U.S.
Cellular Operating Revenues
|
|
Three Months Ended
September 30,
|
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
Retail service
|
|
$
|
714,270
|
|
$
|
635,111
|
|
|
Inbound roaming
|
|
43,806
|
|
42,654
|
|
|
Long-distance and other
service revenues
|
|
63,744
|
|
51,240
|
|
|
Service Revenues
|
|
$
|
821,820
|
|
$
|
729,005
|
|
|
Equipment sales
|
|
66,703
|
|
66,095
|
|
|
|
|
$
|
888,523
|
|
$
|
795,100
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail
service revenues increased $79.2 million, or 12%, to 714.3
million in the third quarter of 2006 from $635.1 million in the third quarter
of 2005, primarily due to growth in U.S. Cellulars customer base (8%) and
average monthly retail service revenues per customer (4%). Revenues from data products and services
increased 74% to $56.7 million in 2006 from $32.5 million in 2005. Average monthly retail service revenue per
customer increased to $41.65 in 2006 from $40.22 in 2005, reflecting an
increase in monthly retail minutes of use per customer, to 725 in 2006 from 639
in 2005, offset by a decrease in average revenue per minute of use.
Inbound
roaming revenues increased $1.1 million, or 3%, to $43.8
million in the third quarter of 2006 from $42.7 million in the third quarter of
2005. The increase in revenues was related primarily to an increase in roaming
minutes of use, partially offset by a decrease in average inbound roaming
revenue per roaming minute of use.
Long-distance
and other service revenues increased $12.5 million, or 24%,
to $63.7 million in the third quarter of 2006 from $51.2 million in the third
quarter of 2005. The increase primarily reflected a $2.4 million increase in
long-distance revenues, a $2.2 million increase in rental revenues from other
wireless carriers which lease space on U.S. Cellulars towers and a $6.6
million increase in the amount of USF funds received.
Equipment
sales revenues increased $0.6 million, or 1%, to $66.7
million in the third quarter of 2006 from $66.1 million in the third quarter of
2005. The increase in equipment sales revenues in 2006 was driven by an
increase in the number of handsets sold to customers and agents, which was
partially offset by a decrease in average revenue per handset. The number of
handsets sold increased by 8% in 2006, partly due to sales of handsets to
existing customers to replace non-GPS enabled handsets.
TDS
Telecom Operating Revenues
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Incumbent Local
Exchange Carrier Operations
|
|
|
|
|
|
Local service
|
|
$
|
50,327
|
|
$
|
50,477
|
|
Network access
and long distance
|
|
89,016
|
|
94,139
|
|
Miscellaneous
|
|
22,899
|
|
23,953
|
|
|
|
$
|
162,242
|
|
$
|
168,569
|
|
Competitive Local
Exchange Carrier Operations
|
|
59,370
|
|
60,299
|
|
Intercompany revenue
elimination
|
|
(1,264
|
)
|
(1,126
|
)
|
TDS Telecom Operating Revenues
|
|
$
|
220,348
|
|
$
|
227,742
|
|
68
TDS Telecom
operating revenues decreased $7.4 million, or 3%, to $220.3 million during the
third quarter of 2006 from $227.7 million in 2005. Incumbent local exchange
carrier revenues decreased $6.4 million, or 4%, primarily due to lower average
network access rates and a decline in dial-up Internet customers, partially
offset by an increase in digital subscriber lines and long distance customers.
Competitive local exchange carrier revenues decreased $0.9 million primarily
due to lower average rates on retail and wholesale services, partially offset
by an increase in access lines.
Operating
Expenses increased $78.2 million, or 8%, to $1,001.7 million
during the third quarter of 2006 from $923.5 million in 2005 for reasons
generally the same as the first nine months.
U.S.
Cellular Operating Expenses
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
System operations
(excluding depreciation,
|
|
|
|
|
|
amortization and accretion included below)
|
|
$
|
165,107
|
|
$
|
159,335
|
|
Cost of equipment sold
|
|
140,757
|
|
130,823
|
|
Selling, general and
administrative
|
|
358,392
|
|
313,374
|
|
Depreciation,
amortization and accretion
|
|
146,940
|
|
128,238
|
|
|
|
$
|
811,196
|
|
$
|
731,770
|
|
System
operations expenses (excluding depreciation, amortization and accretion)
increased $5.8 million, or 4%, to $165.1 million in the third quarter of 2006
from $159.3 million in the third quarter of 2005. Cost
of usage on U.S. Cellulars systems increased $3.7 million and maintenance of
cell sites increased $8.9 million. These factors were offset by a $6.8 million
decline in net outbound roaming expense due to a reduction in roaming rates
negotiated with other carriers.
Cost of
equipment sold increased $10.0 million, or 8%, to $140.8
million in the third quarter of 2006 from $130.8 million in the third quarter
of 2005. The increase was due primarily to an increase in the number of
handsets sold (8%), as discussed above.
Selling,
general and administrative expenses increased $45.0 million,
or 14%, to $358.4 million in the third quarter of 2006 from $313.4 million in
the third quarter of 2005. The increase reflects higher expenses associated
with acquiring, serving and retaining customers, primarily as a result of the
increase in U.S. Cellulars customer base (8%). Key components of the increase
in selling, general and administrative expenses were as follows:
· an $11.8 million
increase in expenses related to sales employees and agents. The increase in
sales employee-related expenses reflected a 5% increase in full-time sales
employee equivalents; new employees were added primarily in the newly acquired
and recently launched markets. In addition, increased spending for customer
retention activities, including initiatives focused on providing wireless GPS enabled
handsets to customers who did not previously have such handsets, contributed to
higher sales employee-related and agent-related costs;
· a $2.7 million
increase in advertising expenses related to marketing of the U.S. Cellular
brand in newly acquired and launched markets as well as increases in spending
for specific direct marketing, segment marketing, product advertising and
sponsorship programs;
· a $16.9 million
increase in expenses related to the operations of U.S. Cellulars regional
support offices and customer care centers, primarily due to the 8% increase in
the customer base;
· a $9.7 million
increase in bad debt expense reflecting both higher revenues and higher bad
debts experience as a percent of sales;
· a
$3.4 million increase in stock-based compensation expense primarily due to the
implementation of SFAS 123(R) as of January 1, 2006.
69
Sales and marketing cost per gross customer addition
increased to $496 in the third quarter of 2006 from $491 in the same period of
2005, primarily due to increased employee-related and agent-related expenses
and advertising expenses, partially offset by reduced losses on sales of
handsets. Below is a summary of sales and marketing cost per gross customer
addition for each period.
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands, except per
customer amounts)
|
|
Components of cost:
|
|
|
|
|
|
Selling, general
and administrative expenses related to the acquisition of new customers (1)
|
|
$
|
154,079
|
|
$
|
144,202
|
|
Cost of
equipment sold to new customers (2)
|
|
101,409
|
|
99,119
|
|
Less equipment
sales revenues from new customers (3)
|
|
(74,442
|
)
|
(69,125
|
)
|
Total costs
|
|
$
|
181,046
|
|
$
|
174,196
|
|
Gross customer
additions (000s) (4)
|
|
365
|
|
355
|
|
Sales and marketing cost per gross customer addition
|
|
$
|
496
|
|
$
|
491
|
|
(1) Selling, general and administrative expenses
related to the acquisition of new customers is reconciled to total selling,
general and administrative expenses as
follows:
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Selling, general and
administrative expenses, as reported
|
|
$
|
358,392
|
|
$
|
313,374
|
|
Less expenses related
to serving and retaining customers
|
|
(204,313
|
)
|
(169,172
|
)
|
Selling, general and administrative expenses related to the
acquisition of new customers
|
|
$
|
154,079
|
|
$
|
144,202
|
|
(2) Cost of equipment sold to new customers is reconciled to cost of
equipment sold as follows:
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Cost of
equipment sold as reported
|
|
$
|
140,757
|
|
$
|
130,823
|
|
Less cost of
equipment sold related to the retention of current customers
|
|
(39,348
|
)
|
(31,704
|
)
|
Cost of equipment sold
to new customers
|
|
$
|
101,409
|
|
$
|
99,119
|
|
(3) Equipment sales revenues from new customers is reconciled to equipment
sales revenues as follows:
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
|
|
|
Equipment sales
revenues as reported
|
|
$
|
66,703
|
|
$
|
66,095
|
|
Less equipment
sales revenues related to the retention of current customers, excluding agent
rebates
|
|
(13,530
|
)
|
(9,169
|
)
|
Add agent rebate
reductions of equipment sales revenues related to the retention of current
customers
|
|
21,269
|
|
12,199
|
|
Equipment sales
revenues from new customers
|
|
$
|
74,442
|
|
$
|
69,125
|
|
(4) Gross customer additions represent customers
added to U.S. Cellulars customer base through its marketing distribution
channels, including customers added through third party resellers, during the
respective periods presented.
70
Monthly general and administrative expenses per
customer, including the net costs related to the renewal or upgrade of service
contracts of existing U.S. Cellular customers (net customer retention costs),
increased 14% to $14.66 in the third quarter of 2006 from $12.91 in the third
quarter of 2005, primarily due to the increase in employee-related expenses
associated with serving and retaining customers. Also, in the third quarter of
2006, U.S. Cellular continued to focus on retention activities related to
providing GPS-enabled handsets to customers who did not previously have such
handsets. This measurement is reconciled to total selling, general and
administrative expenses as follows:
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands,
except per customer amounts)
|
|
Components of
cost (1)
|
|
|
|
|
|
Selling, general
and administrative expenses as reported
|
|
$
|
358,392
|
|
$
|
313,374
|
|
Less selling,
general and administrative expenses related to the acquisition of new
customers
|
|
(154,079
|
)
|
(144,202
|
)
|
Add cost of
equipment sold related to the retention of current customers
|
|
39,348
|
|
31,704
|
|
Less equipment
sales revenues related to the retention of current customers, excluding agent
rebates
|
|
(13,530
|
)
|
(9,169
|
)
|
Add agent rebate
reductions of equipment sales revenues related to the retention of current
customers
|
|
21,269
|
|
12,199
|
|
|
|
|
|
|
|
Net cost of
serving and retaining customers
|
|
$
|
251,400
|
|
$
|
203,906
|
|
Divided by
average customers during period (000s) (2)
|
|
5,716
|
|
5,264
|
|
Divided by three
months in each period
|
|
3
|
|
3
|
|
|
|
|
|
|
|
Average monthly general
and administrative expenses per customer
|
|
$
|
14.66
|
|
$
|
12.91
|
|
(1) These components were previously identified in the summary of sales and
marketing cost per customer addition and related footnotes.
(2) The calculation of Average customers during
the period is set forth in footnote 6 to the table of summarized operating
data above.
Depreciation,
amortization and accretion expense increased $18.7 million,
or 15%, to $146.9 million in the third quarter of 2006 from $128.2 million in
the third quarter of 2005. The majority of the increase reflects higher fixed
assets; average fixed asset balances for the third quarter of 2006 increased
13% compared to the same period in the prior year. Such increased fixed assets
balances resulted, to a large degree, from the addition of 577 cell sites to
U.S. Cellulars network since September 30, 2005.
In the third
quarter of 2006, depreciation expense included charges of $6.1 million related
to disposals of assets, trade-ins of older assets for replacement assets and
write-offs of TDMA equipment upon disposal or consignment for future sale. In
the third quarter of 2005, depreciation expense included charges of $5.7 million
related to such disposals, trade-ins and write-offs.
71
TDS
Telecom Operating Expenses
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Incumbent Local
Exchange Carrier Operations (ILEC)
|
|
|
|
|
|
Cost of services and products (exclusive of
depreciation and amortization included below)
|
|
$
|
48,275
|
|
$
|
45,716
|
|
Selling, general and administrative expense
|
|
46,251
|
|
45,722
|
|
Depreciation, amortization and accretion
|
|
33,757
|
|
33,319
|
|
|
|
128,283
|
|
124,757
|
|
Competitive
Local Exchange Carrier Operations (CLEC)
|
|
|
|
|
|
Cost of services and products (exclusive of
depreciation, amortization and accretion included below)
|
|
31,662
|
|
32,466
|
|
Selling, general and administrative expense
|
|
21,855
|
|
24,063
|
|
Depreciation, amortization and accretion
|
|
5,871
|
|
6,998
|
|
|
|
59,388
|
|
63,527
|
|
Intercompany
expense elimination
|
|
(1,264
|
)
|
(1,126
|
)
|
TDS Telecom Operating
Expenses
|
|
$
|
186,407
|
|
$
|
187,158
|
|
TDS Telecom operating
expenses decreased $0.8 million, or less than 1%, to $186.4 million in 2006
from $187.2 million in 2005. ILEC operating expenses increased $3.5 million, of
which $3.2 million was due to the increase in stock based compensation expense
primarily due to the implementation of SFAS 123(R) as of January 1, 2006.
Expenses from CLEC operations decreased $4.1 million in 2006 primarily as a
result of changes in the mix of targeted customers and the consolidation of
customer service and provisioning functions. Additionally, lower depreciation
due to certain assets becoming fully depreciated contributed to the lower CLEC
operating expenses.
TDS
Operating Income increased $5.9 million, or 6%, to $110.4
million in the three months ended September 30, 2006 from $104.5 million in
2005. U.S. Cellulars operating income increased $14.0 million while TDS
Telecoms operating income decreased $6.6 million.
Investment
and Other Income (Expense) totaled $11.3
million in 2006 and $(29.5) million in 2005.
Equity in
earnings of unconsolidated entities increased $6.4 million,
or 36%, to $24.1 million in 2006 from $17.7 million in 2005. Equity in earnings
of unconsolidated entities represents TDSs share of income from markets in
which it has a minority interest and that are accounted for by the equity
method. TDSs investment in the Los Angeles SMSA Limited Partnership contributed
$16.0 million and $12.7 million to equity in earnings of unconsolidated
entities for the three months ended September 30, 2006 and 2005, respectively.
Interest
and dividend income increased $2.1 million, or 15%, to $16.3
million in 2006 from $14.2 million in 2005 primarily due to higher
average rates of interest earned on investments in 2006 than 2005.
Interest
(expense) increased $5.5 million, or 10%, to $59.4 million in
2006 from $53.9 million in 2005 for reasons generally the same as for the first
nine months.
72
Fair
value adjustment of derivative instruments totaled a gain of
$34.6 million in 2006 and a loss of $4.4 million in 2005. Fair value adjustment of derivative
instruments reflects the change in the fair value of the bifurcated embedded collars
within the forward contracts related to the Deutsche Telekom and Vodafone
marketable equity securities not designated as a hedge. The changes in fair
value of the embedded collars during cash flow hedge designation are recorded
to other comprehensive income. When the collars were de-designated in the
cash flow hedge, subsequent changes in fair value are recognized in the
consolidated statement of operations, along with the related income tax
effects. The accounting for the embedded
collars as derivative instruments not designated in a hedging relationship
results in increased volatility in the results of operations, as fluctuation in
the market price of the underlying Deutsche Telekom and Vodafone marketable
equity securities will result in changes in the fair value of the embedded
collars being recorded in the consolidated statement of operations. Also included in the fair value adjustment of
derivative instruments are the gains and losses related to the ineffectiveness
of the VeriSign fair value hedge which aggregated an unrealized gain of $0.2
million in 2006 and an unrealized gain of $0.2 million in 2005.
Other
expense, net totaled $4.3 million in 2006 and $3.2 million in
2005. In the third quarter of 2005, TDS incurred $2.9 million of expenses
from the Special Common Share Proposal and the stock dividend.
Income
Tax Expense increased $6.2 million to $35.7 million in 2006
from $29.5 million in 2005 primarily due to higher pretax income partially
offset by a lower effective tax rate. The effective tax rate was 29.3% in 2006
and 39.4% in 2005. For further analysis and discussion of TDSs effective
income tax rates in the third quarters of 2006 and 2005, see Note 4 - Income
Taxes of Notes of Consolidated Financial Statements included in Item 1 above.
Minority Share of (Income) totaled
$(10.8) million in 2006 compared to $(7.2) million in the third quarter of
2005.
|
|
Three Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Minority Share
of Income
|
|
|
|
|
|
U.S. Cellular
|
|
|
|
|
|
Minority Public Shareholders
|
|
$
|
(6,742
|
)
|
$
|
(4,380
|
)
|
Minority Shareholders or Partners
|
|
(4,006
|
)
|
(2,726
|
)
|
|
|
(10,748
|
)
|
(7,106
|
)
|
Other
|
|
(8
|
)
|
(68
|
)
|
|
|
$
|
(10,756
|
)
|
$
|
(7,174
|
)
|
Income
from Continuing Operations totaled $75.2 million, or $0.64 per
diluted share, in 2006 compared to $38.3 million, or $0.33 per diluted share,
in 2005.
Discontinued Operations. TDS is
a party to an indemnity agreement with T-Mobile USA, Inc. (T-Mobile)
regarding certain contingent liabilities for Aerial Communications, Inc. (Aerial),
a former subsidiary of TDS. TDS has recorded an accrual for expenses, primarily
tax related, resulting from Aerials merger into VoiceStream Wireless
Corporation (VoiceStream) in 2000. In the third quarter of 2005, TDS recorded
a gain of $0.3 million ($0.5 million, net of a $0.2 million income tax
expense), or $0.00 per diluted share, for discontinued operations relating to a
reduction in this indemnity accrual due to favorable outcome of a state tax
audit which reduced the potential indemnity obligation.
Net Income Available to Common
totaled $75.2 million, or $0.64 per diluted share, in 2006, compared to $38.6 million,
or $0.33 per diluted share, in 2005.
73
RECENT
ACCOUNTING PRONOUNCEMENTS
The Securities and
Exchange Commission (SEC) released Staff Accounting Bulletin No. 108,
Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in Current Year Financial Statements (SAB
108), in September 2006. SAB 108 provides guidance on how the effects of the
carryover or reversal of prior year financial statement misstatements should be
considered in quantifying a current year misstatement. Prior practice allowed
the evaluation of materiality on the basis of (1) the error quantified as the
amount by which the current year income statement was misstated (rollover
method) or (2) the cumulative error quantified as the cumulative amount by
which the current year balance sheet was misstated (iron curtain method).
Reliance on either method in prior years could have resulted in misstatement of
the financial statements. The guidance provided in SAB 108 requires both
methods to be used in evaluating materiality. Immaterial prior year errors may
be corrected with the first filing of prior year financial statements after
adoption. The cumulative effect of the correction would be reflected in the
opening balance sheet with appropriate disclosure of the nature and amount of
each individual error corrected in the cumulative adjustment, as well as a
disclosure of the cause of the error and that the error had been deemed to be
immaterial in the past. SAB 108 is effective for TDSs opening balance sheet in
2007. TDS is currently evaluating the impact this Bulletin might have on its
financial position or results of operations.
In September 2006, the
FASB released Statement of Financial Accounting Standards No. 158, Employers
Accounting for Defined Benefit Pension and Other Postretirement Plans, an
amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158). Under
SFAS 158, companies must recognize a net liability or asset to report the
funded status of their defined benefit pension and other postretirement benefit
plans on their balance sheets. The recognition, disclosure and measurement
provisions of SFAS 158 are effective for TDS as of December 31, 2006 on a prospective
basis.
The Company anticipates
that the after-tax effect on the December 31, 2006 financial statements will be
to increase liabilities and reduce stockholders equity by approximately $11.4
million. The actual effects will change based on refined analysis and actual
measurement date assumptions as of December 31, 2006. The Company does not
anticipate any other significant impact from the adoption of SFAS 158.
In September 2006, the
FASB issued Statement of Financial Accounting Standards No. 157, Fair Value
Measurements
(SFAS 157). This Statement defines fair value as used in numerous
accounting pronouncements, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP) and expands disclosure
related to the use of fair value measures in financial statements. SFAS 157
does not expand the use of fair value measures in financial statements, but
standardizes its definition and guidance in GAAP. The Statement emphasizes that
fair value is a market-based measurement and not an entity-specific measurement
based on an exchange transaction in which the entity sells an asset or
transfers a liability (exit price). SFAS 157 establishes a fair value hierarchy
from observable market data as the highest level to fair value based on an
entitys own fair value assumptions as the lowest level. The Statement is
effective for TDSs 2008 quarterly and annual financial statements however,
earlier application is encouraged. TDS is currently evaluating the timing of
adoption and the impact that adoption might have on its financial position or
results of operations.
74
The FASB issued
Interpretation 48, Accounting for Uncertainty in Income Taxes -an
interpretation of FASB Statement No. 109 (FIN 48) in July 2006. FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprises financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes (SFAS 109). The interpretation applies to all
tax positions accounted for in accordance with SFAS 109 and changes how tax
positions are recognized and measured and how uncertainties related to income
tax positions are disclosed. It provides guidance on recognition, derecognition
and measurement of uncertain tax positions in a period subsequent to that in
which a position is taken; the accounting for interest and penalties; the
classification and presentation of recorded amounts; and disclosure
requirements. TDS will adopt the provisions of FIN 48 effective January 1,
2007. Under FIN 48, TDS will evaluate the tax uncertainty, assess the
probability of the ultimate settlement with the applicable taxing authority and
record an amount based on that assessment. TDS had previously set up tax
accruals, as needed, to cover its potential liability for income tax
uncertainties pursuant to FASB Statement No. 5 Accounting for Contingencies.
The FASB has issued preliminary guidance regarding ultimate settlement of tax
uncertainties. This guidance, in the form of a FASB Staff Position, is not yet
finalized. TDS will use the finalized guidance to determine the amount of its
cumulative effect adjustment to be recorded to opening retained earnings upon
adoption of FIN 48 effective January 1, 2007. TDS is currently reviewing the
requirements of FIN 48 to determine the impact on its financial position or
results of operations. The primary impact of FIN 48 on TDSs existing tax
accounting policies and practices will be the documentation of all tax
positions rather than only tax positions that TDS considers probable of
incurring a loss.
75
FINANCIAL
RESOURCES
TDS operates a
capital- and sales and marketing-intensive business. In recent years, TDS has
generated cash from its operating activities, received cash proceeds from
divestitures, used its short-term credit facilities and used long-term debt
financing to fund its construction costs and operating expenses. TDS
anticipates further increases in wireless customers, revenues, operating
expenses, cash flows from operating activities and fixed asset additions in the
future. Cash flows may fluctuate from quarter to quarter and from year to year
due to seasonality, market startups and other factors. The following table
provides a summary of TDSs cash flow activities for the periods shown:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Cash flows from
(used in)
|
|
|
|
|
|
Operating activities
|
|
$
|
671,000
|
|
$
|
676,148
|
|
Investing activities
|
|
(481,658
|
)
|
(595,278
|
)
|
Financing activities
|
|
(255,377
|
)
|
(167,435
|
)
|
Net increase/(decrease)
in cash and cash equivalents
|
|
$
|
(66,035
|
)
|
$
|
(86,565
|
)
|
Cash Flows from Operating
Activities
TDS generated substantial
cash flows from operating activities during the first nine months of 2006 and
2005. Such cash flows were $669.1 million and $671.0 million, respectively.
Excluding changes in assets and liabilities from operations, cash flows from
operating activities totaled $755.4 million in 2006 and $711.8 million in 2005.
Changes in assets and liabilities from operations required $84.4 million in
2006 and required $35.6 million in 2005, reflecting higher net working capital
balances required to support higher levels of business activity as well as
differences in the timing of collections and payments.
The following table is a
summary of the components of cash flows from operating activities:
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in thousands)
|
|
Net income
|
|
$
|
277,995
|
|
$
|
456,155
|
|
Adjustments to
reconcile net income to net cash provided by operating activities
|
|
477,402
|
|
255,979
|
|
Discontinued
operations
|
|
|
|
(340
|
)
|
|
|
$
|
755,397
|
|
$
|
711,794
|
|
Changes in
assets and liabilities
|
|
(84,397
|
)
|
(35,646
|
)
|
|
|
$
|
671,000
|
|
$
|
676,148
|
|
Cash Flows from Investing
Activities
TDS makes substantial
investments each year to acquire wireless licenses and properties and to construct,
operate and upgrade modern high-quality communications networks and facilities
as a basis for creating long-term value for shareholders. In recent years,
rapid changes in technology and new opportunities have required substantial
investments in revenue enhancing upgrades to TDSs networks. Cash flows for
investing activities required $481.7 million in the first nine months of 2006
compared to $595.3 million in the first nine months of 2005.
76
Cash used for property,
plant and equipment and system development totaled $516.6 million in 2006 and
$465.0 million in 2005. The primary purpose of TDSs construction and expansion
expenditures is to provide for significant customer and usage growth, to
upgrade service, and to take advantage of service-enhancing and cost-reducing
technological developments in order to maintain competitive services. U.S.
Cellulars capital additions totaled $421.4 million in 2006 and $379.1 million
in 2005 representing expenditures to construct cell sites, increase capacity in
existing cell sites and switches, remodel new and existing retail stores and
continue the development of office systems. TDS Telecoms capital expenditures
for its incumbent local exchange carrier operations totaled $73.8 million in
2006 and $60.0 million in 2005 representing expenditures for switch
modernization and outside plant facilities to maintain and enhance the quality
of service and to offer new revenue opportunities. TDS Telecoms capital
expenditures for its competitive local exchange carrier operations totaled
$11.6 million in 2006 and $18.7 million in 2005 for switching and other network
facilities. Corporate and other capital expenditures totaled $9.8 million in
2006 and $7.2 million in 2005.
TDS Telecom in the past
obtained financing from the RTB. In connection with such financings, TDS
Telecom purchased stock in the RTB. TDS Telecom has repaid all of its debt to
the RTB, but continued to own the RTB stock. In August 2005, the board of
directors of the RTB approved resolutions to liquidate and dissolve the RTB. In
order to effect the dissolution and liquidation, shareholders were asked to
remit their shares to receive cash compensation for those shares. TDS Telecom
remitted its shares and received $101.7 million from the RTB in the second
quarter of 2006.
Acquisitions required
$98.4 million and $126.2 million and divestitures provided $0.7 million and
$0.5 million in 2006 and 2005, respectively. During the second quarter of 2006,
U.S. Cellular acquired, for approximately $18.8 million in cash, the remaining
ownership interest in a wireless property in Tennessee in which the Company
previously owned a 16.7% interest. As of September 30, 2006, U.S. Cellular made
capital contributions and advances in Barat Wireless, which is consolidated
with U.S. Cellular for financial reporting purposes, and/or its general partner
of $79.9 million to provide initial funding of Barat Wirelesss participation
in the FCCs Auction 66. On October 17, 2006, U.S. Cellular made additional
capital contributions and advances of $47.3 million to Barat Wireless and/or
its general partner, resulting in a total of $127.2 million of advances and
contributions made to Barat Wireless and/or its general partner. In 2005,
Carroll Wireless, which is consolidated with U.S. Cellular for financial
reporting purposes, paid $120.9 million to the FCC to complete the payment for
the licenses in which it was the winning bidder in the FCCs Auction 58. See
Acquisitions, Exchanges and Divestitures in the Liquidity and Capital Resources
section below for more information on these transactions.
At
an Extraordinary General Meeting held on July 25, 2006, shareholders of
Vodafone approved a Special Distribution of £0.15 per share (£1.50 per ADR) and
a Share Consolidation under which every 8 ADRs of Vodafone were consolidated
into 7 ADRs. As a result of the Special Distribution which was paid on August
18, 2006, U.S. Cellular and TDS Telecom received approximately $28.6 million
and $7.6 million, respectively, in cash; this amount, representing a return of
capital, was recorded as a reduction in the net carrying value of marketable
equity securities in the Consolidated Balance Sheet. Also, as a result of the
Share Consolidation which was effective on July 28, 2006, U.S. Cellulars
previous 10,245,370 Vodafone ADRs were consolidated into 8,964,698 Vodafone
ADRs and TDS Telecoms previous 2,700,545 Vodafone ADRs were consolidated into
2,362,976 ADRs.
Cash Flows from Financing
Activities
Cash flows from financing
activities primarily reflect issuances and repayments of short-term debt,
proceeds from issuance of long-term debt and from entering into forward
contracts, repayments of long-term debt and repurchases of common shares. TDS
has used short-term debt to finance acquisitions, to repurchase common shares
and for other general corporate purposes. Cash flows from operating activities,
proceeds from forward contracts and, from time to time, the sale of
non-strategic cellular and other investments have been used to reduce
short-term debt. In addition, from time to time, TDS has used proceeds from the
issuance of long-term debt to reduce short-term debt.
77
Cash flows from financing
activities required $255.4 million in the nine months ended September 30, 2006,
and required $167.4 million in the same period of 2005. Redemptions of
medium-term notes required $35.0 million in 2006 and $17.2 million in 2005.
Cash received from short term borrowings on revolving lines of credit provided
$390.0 million in 2006 while repayments required $375.0 million in 2006. Cash
received from short-term borrowings provided $350.0 million in 2005 while
repayments required $380.0 million in 2005. Issuances of long-term debt,
consisting of $116.25 million of 6.625% notes by TDS provided proceeds of
$112.8 million in 2005 after underwriting discounts. Repayments of long-term
debt, including $200.0 million of 7% unsecured senior notes plus accrued
interest on August 1, 2006, required $202.4 million in 2006 while repayments of
long-term debt, including Rural Utilities Service (RUS) debt, required $241.4
million in 2005. Proceeds from re-issuances of treasury shares in connection
with employee benefit plans provided $6.9 million in 2006 and $40.4 million in
2005. Dividends paid on TDS Common Shares and Preferred Shares, required $32.2
million in 2006 and $30.4 million in 2005.
Distributions to minority partners totaled $10.1 million in 2006 and
$1.6 million in 2005.
LIQUIDITY
AND CAPITAL RESOURCES
As indicated above, TDS
generated cash flows from operating activities of $671.0 million and $676.1
million during the first nine months of 2006 and 2005, respectively. At
September 30, 2006, TDS had cash and cash equivalents of $1,029.8 million. TDS
believes that cash flows from operating activities, existing cash and cash
equivalents and funds available from the revolving credit facilities provide
substantial financial flexibility for TDS to meet both its short- and long-term
needs for the foreseeable future. In addition, TDS and its subsidiaries may
have access to public and private capital markets to help meet their long-term
financing needs.
However, the availability
of external financial resources is dependent on economic events, business
developments, technological changes, financial conditions or other factors,
some of which are not in TDSs control. If at any time financing is not
available on terms acceptable to TDS, TDS might be required to reduce its
business development and capital expenditure plans, which could have a
materially adverse effect on its business and financial condition. TDS cannot
provide assurances that circumstances that could materially adversely affect
TDSs liquidity or capital resources will not occur. Economic downturns,
changes in financial markets or other factors could affect TDSs liquidity and
availability of capital resources. Uncertainty of access to capital for
telecommunications companies, deterioration in the capital markets, other
changes in market conditions or other factors could limit or restrict the
availability of financing on terms acceptable to TDS, which could require TDS
to reduce its construction, development and acquisition programs.
Deutsche Telekom
paid a dividend of EUR 0.72 per share in May 2006. Using a weighted-average
exchange rate of $1.27 per EUR, TDS recorded dividend income of $120.3 million,
before taxes, in the second quarter of 2006.
At
an Extraordinary General Meeting held on July 25, 2006, shareholders of
Vodafone approved a Special Distribution of £0.15 per share (£1.50 per ADR) and
a Share Consolidation under which every 8 ADRs of Vodafone were consolidated
into 7 ADRs. As a result of the Special Distribution which was paid on August
18, 2006, U.S. Cellular and TDS Telecom received approximately $28.6 million
and $7.6 million, respectively, in cash; this amount, representing a return of
capital, was recorded as a reduction in the net carrying value of marketable
equity securities in the Consolidated Balance Sheet. Also, as a result of the
Share Consolidation which was effective on July 28, 2006, U.S. Cellulars
previous 10,245,370 Vodafone ADRs were consolidated into 8,964,698 Vodafone
ADRs and TDS Telecoms previous 2,700,545 Vodafone ADRs were consolidated into
2,362,976 ADRs.
Pursuant to terms of the
Vodafone forward contracts, the Vodafone contract collars were adjusted and
substitution payments were made as a result of the Special Distribution and the
Share Consolidation. After adjustment, the collars had downside limits (floor)
ranging from $17.22 to $18.37 and upside potentials (ceiling) ranging from
$17.22 to $19.11. In the case of two forward contracts, subsidiaries of TDS
made a dividend substitution payment in the amount of $3.2 million to the
counterparties in lieu of further adjustments to the collars for such forward
contracts. The dividend substitution
payments were recorded in Other expense in the Consolidated Statements of
Operations.
78
Revolving Credit Facilities
TDS has a $600 million
revolving credit facility available for general corporate purposes. At
September 30, 2006, letters of credit were $3.4 million, leaving $596.6 million
available for use. Borrowings under the revolving credit facility bear interest
at the London InterBank Offered Rate (LIBOR) plus a contractual spread based
on TDSs credit rating. TDS may select borrowing periods of either seven days
or one, two, three or six months. At September 30, 2006, the one-month LIBOR
was 5.32% and the contractual spread was 60 basis points. If TDS provides less
than two days notice of intent to borrow, the related borrowings bear interest
at the prime rate less 50 basis points (the prime rate was 8.25% at September
30, 2006). This credit facility expires in December 2009.
TDS also has $75 million
of direct bank lines of credit at September 30, 2006, all of which were unused.
The terms of the direct lines of credit provide for borrowings at negotiated
rates up to the prime rate (the prime rate was 8.25% at September 30, 2006).
U.S. Cellular has a $700
million revolving credit facility available for general corporate purposes. At
September 30, 2006, outstanding notes payable and letters of credit were $150.0
million and $0.5 million, respectively, leaving $549.5 million available for
use. Borrowings under the revolving credit facility bear interest at the London
InterBank Offered Rate (LIBOR) rate plus a contractual spread based on U.S.
Cellulars credit rating. U.S. Cellular may select borrowing periods of either
seven days or one, two, three or six months. At September 30, 2006, the one-month
LIBOR was 5.32% and the contractual spread was 60 basis points. If U.S.
Cellular provides less than two days notice of intent to borrow, the related
borrowings bear interest at the prime rate less 50 basis points (the prime rate
was 8.25% at September 30, 2006). This credit facility expires in December
2009.
TDSs and U.S. Cellulars
interest costs on their revolving credit facilities would increase if their
credit ratings from either Standard & Poors Rating Services (Standard
& Poors) or Moodys Investor Service (Moodys) were lowered. However,
their credit facilities would not cease to be available solely as a result of a
decline in their credit ratings. A downgrade in TDSs or U.S. Cellulars credit
ratings could adversely affect their ability to renew existing, or obtain
access to new, credit facilities in the future. TDSs and U.S. Cellulars
credit ratings as of the dates indicated, are as follows:
Moodys (Issued November 10,
2005)
|
|
Baa3
|
|
under review for possible further downgrade
|
Standard &
Poors (Issued February 13, 2007)
|
|
BBB-
|
|
on credit watch with negative implications
|
Fitch Ratings
(Issued November 10, 2005)
|
|
BBB+
|
|
on ratings watch negative
|
TDSs and U.S. Cellulars
credit ratings may be changed at any time and such ratings should not be
assumed to be accurate as of any future date.
The maturity dates of
borrowings under certain of TDSs and U.S. Cellulars revolving credit
facilities would accelerate in the event of a change in control. The continued
availability of the revolving credit facilities requires TDS and U.S. Cellular
to comply with certain negative and affirmative covenants, maintain certain
financial ratios and represent certain matters at the time of each borrowing.
On November 10, 2005 TDS
and U.S. Cellular announced that they would restate certain financial
statements, which caused TDS and U.S. Cellular to be late in certain SEC
filings. The restatements and the late filings resulted in defaults under the
revolving credit facilities and one line of credit facility. However, TDS and
U.S. Cellular were not in violation of any covenants that require TDS and U.S.
Cellular to maintain certain financial ratios and TDS and U.S. Cellular did not
fail to make any scheduled payments. TDS and U.S. Cellular received waivers
from the lenders associated with the revolving credit facilities, under which
the lenders agreed to waive any defaults that may have occurred as a result of
the restatements and late filings. The waivers required the Form 10-K for the
year ended December 31, 2005 to be filed by August 31, 2006, the Form 10-Q for
the quarterly period ended March 31, 2006 to be filed within 30 days after the
filing of the Form 10-K for the year ended December 31, 2005 and the Form 10-Q
for the quarterly period ended June 30, 2006 to be filed within 45 days after
the filing of the Form 10-Q for the quarterly period ended March 31, 2006. On
October 6, 2006, TDS and U.S. Cellular received amended waivers from the
lenders associated with the revolving credit facilities which extended the date
by which the financial statements of TDS and U.S. Cellular, for the quarterly
period ended June 30, 2006, were required to be delivered to November 8, 2006.
The Form 10-K for the year ended December 31, 2005 was filed on July 28, 2006,
the Form 10-Q for the quarterly period ended March 31, 2006 was filed on August
25, 2006 and the Form 10-Q for the quarterly period ended June 30, 2006 was
filed on October 10, 2006.
79
In
addition, TDS and its audit committee concluded on November 6, 2006 to restate
the Consolidated Financial Statements as of and for the three years ended
December 31, 2005. TDS and its audit committee also concluded that TDS would
amend its Quarterly Reports on Form 10-Q for the quarterly periods ended March
31, 2006 and June 30, 2006 to restate the Consolidated Financial Statements and
financial information included therewith.
The restatement resulted in defaults under the revolving credit
agreements and one line of credit agreement.
TDS and U.S. Cellular were not in violation of any covenants that
require TDS and U.S. Cellular to maintain certain financial ratios. TDS and U.S. Cellular did not fail to make
any scheduled payments under such credit agreements. TDS and U.S. Cellular received waivers from
the lenders associated with the credit agreements, under which the lenders
agreed to waive any defaults that may have occurred as a result of the
restatement. The waivers require the Form 10-K/A for the year ended
December 31, 2005, the Forms 10-Q/A for the quarterly periods ended March 31,
2006 and June 30, 2006 and the Form 10-Q for the quarterly period ended
September 30, 2006 to be filed by March 14, 2007.
On October 26, 2006,
Standard & Poors Rating Services lowered its credit ratings on TDS and
U.S. Cellular to BBB+ from A-. The
outlook was stable. On November 7, 2006,
Standard & Poors Rating Services lowered its credit ratings on TDS and
U.S. Cellular to BBB from BBB+. The
ratings were placed on credit watch with negative implications. On February 13, 2007, Standard & Poors
Rating Services lowered its credit ratings on TDS and U.S. Cellular to BBB-
from BBB. The ratings remain on credit
watch with negative implications. The
credit ratings by Moodys Investors Service remain Baa3 under review for
possible further downgrade. The credit
ratings by Fitch remain BBB+ on ratings watch negative.
Long-term Debt
The late filing of TDSs
and U.S. Cellulars Forms 10-K for the year ended December 31, 2005 and Forms
10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006, and the
failure to deliver such Forms 10-K and 10-Q to the trustees of the TDS and U.S.
Cellular debt indentures on a timely basis, resulted in non-compliance under
such debt indentures. However, this non-compliance did not result in an event
of default or a default. TDS and U.S. Cellular believe that non-compliance was
cured upon the filing of their Forms 10-K for the year ended December 31, 2005
and Forms 10-Q for the quarterly periods ended March 31, 2006 and June 30,
2006. TDS and U.S. Cellular have not failed to make nor do they expect to fail to
make any scheduled payment of principal or interest under such indentures.
In addition, the late
filing of this Form 10-Q and the failure to deliver such Form 10-Q to the
trustees of the TDS debt indentures on a timely basis also resulted in
non-compliance under such debt indentures. However, this non-compliance did not
result in an event of default or a default and TDS believes that such
non-compliance was cured upon the filing of this Form 10-Q. In addition, the late filing of the Form
10-Q for the quarterly period ended September 30, 2006 by U.S. Cellular and the
failure to deliver such Form 10-Q to the trustees of the U.S. Cellular debt
indentures on a timely basis resulted in non-compliance under such debt
indentures. However, this non-compliance did not result in an event of default
or a default and U.S. Cellular believes that such non-compliance was cured upon
the filing of this Form 10-Q. Neither
TDS nor U.S. Cellular has failed to make or expects to fail to make any
scheduled payment of principal or interest under such indentures.
Except as noted above,
TDS believes that it and its subsidiaries were in compliance as of September
30, 2006 with all covenants and other requirements set forth in their long-term
debt indentures. Such indentures do not contain any provisions resulting in
acceleration of the maturities of outstanding debt in the event of a change in
TDSs credit rating. However, a downgrade in TDSs credit rating could
adversely affect its ability to obtain long-term debt financing in the future.
TDS repaid $200.0 million
plus accrued interest on its 7% unsecured senior notes on August 1, 2006.
Marketable Equity Securities and
Forward Contracts
TDS and its subsidiaries
hold a substantial amount of marketable equity securities that are publicly
traded and can have volatile movements in share prices. TDS and its
subsidiaries do not make direct investments in publicly traded companies and
all of these interests were acquired as a result of sales, trades or
reorganizations of other assets.
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TDSs investment in
Deutsche Telekom AG (Deutsche Telekom) resulted from TDSs disposition of its
over 80%-owned personal communications services operating subsidiary, Aerial
Communications, Inc., to VoiceStream Wireless Corporation (VoiceStream) in exchange
for stock of VoiceStream, which was then acquired by Deutsche Telekom in
exchange for Deutsche Telekom stock. The investment in Vodafone Group Plc (Vodafone)
resulted from certain dispositions of non-strategic cellular investments to or
settlements with AirTouch Communications, Inc. (AirTouch) in exchange for
stock of AirTouch, which was then acquired by Vodafone whereby TDS and its
subsidiaries received American Depositary Receipts representing Vodafone stock.
(See Note 23 Subsequent Events of Notes to Consolidated Financial Statements
included in Item 1 above for additional information related to TDSs investment
in Vodafone ADRs.) The investment in VeriSign, Inc. (VeriSign) is the result
of the acquisition by VeriSign of Illuminet, Inc., a telecommunications entity
in which several TDS subsidiaries held interests. The investment in Rural
Cellular Corporation (Rural Cellular) is the result of a consolidation of
several cellular partnerships in which TDS subsidiaries held interests into
Rural Cellular, and the distribution of Rural Cellular stock in exchange for
these interests.
Subsidiaries of TDS and
U.S. Cellular have entered into a number of forward contracts with
counterparties related to the marketable equity securities that they hold. The
forward contracts mature from May 2007 to September 2008 and, at TDSs and U.S.
Cellulars option, may be settled in shares of the respective securities or
cash. Currently, TDS and U.S. Cellular intend to settle the forward contracts
by delivering shares of the respective securities. TDS and U.S. Cellular have
provided guarantees to the counterparties which provide assurance that all
principal and interest amounts will be paid by their subsidiaries when due. If
shares are delivered in the settlement of a forward contract, TDS and U.S.
Cellular would incur a current tax liability at the time of delivery based on
the difference between the tax basis of the marketable equity securities
delivered and the net amount realized through maturity. Deferred income taxes
have been provided for the difference between the book basis and the tax basis
of the marketable equity securities and are included in deferred tax
liabilities on the Consolidated Balance Sheets. As of September 30, 2006, such
deferred income tax liabilities related to current and noncurrent marketable
equity securities totaled $318.3 million and $486.4 million, respectively
The TDS VeriSign forward
contracts related to 2,361,333 common shares and the forward contracts related
to U.S. Cellulars 8,964,698 Vodafone ADRs mature in May 2007. The forward
contracts related to 45,492,172 Deutsche Telekom ordinary shares mature between
July and September 2007. Accordingly, such VeriSign common shares, Vodafone
ADRs and Deutsche Telekom ordinary shares are classified as Current Assets and
the related forward contracts and derivative liability are classified as
Current Liabilities in the Consolidated Balance Sheets at September 30,
2006. TDS and U.S. Cellular are required
to comply with certain covenants under the forward contracts.
On November 10, 2005 TDS
and U.S. Cellular announced that they would restate certain financial
statements which caused them to be late in certain SEC filings. The
restatements and late filings resulted in defaults under certain of the forward
contracts. However, TDS and U.S. Cellular were not in violation of any
covenants that require TDS and U.S. Cellular to maintain certain financial
ratios and TDS and U.S. Cellular did not fail to make any scheduled payments.
TDS and U.S. Cellular received waivers from the counterparties associated with
such forward contracts, under which the counterparties agreed to waive any
defaults that may have occurred as a result of the restatements and late
filings. The waivers required the Form 10-K for the year ended December 31,
2005 to be filed by August 31, 2006, the Form 10-Q for the quarterly period
ended March 31, 2006 to be filed within 30 days after the filing of the Form
10-K for the year ended December 31, 2005 and the Form 10-Q for the quarterly
period ended June 30, 2006 to be filed within 45 days after the filing of the
Form 10-Q for the quarterly period ended March 31, 2006. On October 6, 2006,
TDS and U.S. Cellular received amended waivers from the counterparties
associated with the forward contracts which extended the date by which the
financial statements of TDS and U.S. Cellular for the quarterly period ended
June 30, 2006 were required to be delivered to November 8, 2006. The Form 10-K
for the year ended December 31, 2005 was filed on July 28, 2006, the Form 10-Q
for the quarterly period ended March 31, 2006 was filed on August 25, 2006 and
the Form 10-Q for the quarterly period ended June 30, 2006 was filed on October
10, 2006.
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In
addition, TDS and its audit committee concluded on November 6, 2006 to restate
the Consolidated Financial Statements as of and for the three years ended
December 31, 2005. TDS and its audit committee also concluded that TDS would
amend its Quarterly Reports on Form 10-Q for the quarterly periods ended March
31, 2006 and June 30, 2006 to restate the Consolidated Financial Statements and
financial information included therewith.
The restatement resulted in defaults under certain of the forward
contracts. TDS and U.S. Cellular were
not in violation of any covenants that require TDS and U.S. Cellular to
maintain certain financial ratios. TDS
and U.S. Cellular did not fail to make any scheduled payments under such
forward contracts. TDS and U.S. Cellular received waivers from the counterparty
to such forward contracts, under which the counterparty agreed to waive any
defaults that may have occurred as a result of the restatement. The
waivers require the Form 10-K/A for the year ended December 31, 2005, the Forms
10-Q/A for the quarterly periods ended March 31, 2006 and June 30, 2006 and the
Form 10-Q for the quarterly period ended September 30, 2006 to be filed by March
14, 2007.
Capital Expenditures
U.S. Cellulars
anticipated capital expenditures for 2006 primarily reflect plans for construction,
system expansion and the buildout of certain of its licensed areas. U.S.
Cellular plans to finance its capital expenditures using cash flows from
operating activities and short-term financing. U.S. Cellulars estimated
capital expenditures for 2006 are currently expected to range from $580 million
to $610 million. These expenditures primarily address the following needs:
· Expand and enhance U.S. Cellulars
coverage in its service areas.
· Provide additional capacity to
accommodate increased network usage by current customers.
· Enhance
U.S. Cellulars retail store network and office systems.
TDS Telecoms anticipated
capital spending for 2006 is currently expected to range from $125 to $135
million. The incumbent local exchange carriers are expected to spend $105 to
$115 million to provide upgrades to plant and equipment and to provide enhanced
services. The competitive local exchange carrier is expected to spend
approximately $20 million to build switching and other network facilities to
meet the needs of a growing customer base. TDS Telecom plans to finance its
construction program using primarily internally generated cash.
Acquisitions, Exchanges and
Divestitures
TDS assesses its existing
wireless interests on an ongoing basis with a goal of improving competitiveness
of its operations and maximizing its long-term return on investment. As part of
this strategy, TDS reviews attractive opportunities to acquire additional
operating markets, telecommunications companies and wireless spectrum. In
addition, TDS may seek to divest outright or include in exchanges for other
wireless interests those markets and wireless interests that are not strategic
to its long-term success. TDS may from time-to-time be engaged in negotiations
relating to the acquisition, divestiture or exchange of companies, strategic
properties or wireless spectrum. In addition, TDS may participate as a bidder,
or member of a bidding group, in auctions administered by the FCC.
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As of September 30, 2006,
U.S. Cellular owned approximately 14% of Midwest Wireless Communications,
L.L.C., which interest was convertible into an interest of approximately 11% in
Midwest Wireless Holdings, L.L.C., a privately-held wireless telecommunications
company that controlled Midwest Wireless Communications. Midwest Wireless
Holdings, through subsidiaries, held FCC licenses and operated certain wireless
markets in southern Minnesota, northern and eastern Iowa and western Wisconsin.
On November 18, 2005, ALLTEL Corporation (ALLTEL) announced that it had
entered into a definitive agreement to acquire Midwest Wireless Holdings for
$1.075 billion in cash, subject to certain conditions, including approval by
the FCC, other governmental authorities and the members of Midwest Wireless
Holdings. These conditions were satisfied and the closing of this agreement
occurred on October 3, 2006. As a result, U.S. Cellular became entitled to
receive approximately $106.0 million in cash in consideration with respect to
its interest in Midwest Wireless Communications. Of this amount, $95.1 million
was received on October 6, 2006; the remaining balance is being held in reserve
and in escrow to secure true-up, indemnification and other adjustments and,
subject to such adjustments, will be distributed in installments over a period
of four to fifteen months following the closing. In addition as of September
30, 2006, U.S. Cellular owned 49% of an entity, accounted for under the equity
method, which owned approximately 2.9% of Midwest Wireless Holdings. As a
result of the closing of the transaction, this entity will receive cash in
consideration for its interest in Midwest Wireless Holdings. Following that,
this entity will be dissolved and U.S. Cellular will be entitled to receive
approximately $11.8 million in cash, subject to the previously referenced
discussion regarding adjustments and installments. The net aggregate carrying
value of U.S. Cellulars investments in Midwest Wireless Communications and
Midwest Wireless Holdings was approximately $29.9 million at September 30,
2006.
U.S. Cellular is a
limited partner in Barat Wireless, L.P. (Barat Wireless), an entity which
participated in the auction of wireless spectrum designated by the FCC as
Auction 66. Barat Wireless was qualified to receive a 25% discount available to
designated entities which are small businesses that have a limited amount of
assets. At the conclusion of the auction on September 18, 2006, Barat Wireless
was the high bidder with respect to 17 licenses and had bid $127.1 million, net
of its designated entity discount. The balance due from Barat Wireless at the
conclusion of the auction for the licenses with respect to which Barat Wireless
was the high bidder was approximately $47.1 million and was paid on October 18,
2006. Although the bidding in Auction 66 ended on September 18, 2006, the FCC
has not yet awarded the licenses to Barat Wireless, nor is there any prescribed
timeframe for the FCC to review the qualifications of Barat Wireless and award the
licenses.
Barat Wireless is in the
process of developing its long-term business and financing plans. As of October
31, 2006, U.S. Cellular had made capital contributions and advances to Barat
Wireless and/or its general partner of $127.2 million. For financial reporting
purposes, U.S. Cellular consolidates Barat Wireless and Barat Wireless, Inc.,
the general partner of Barat Wireless, pursuant to the guidelines of FIN 46(R),
as U.S. Cellular anticipates benefiting from or absorbing a majority of Barat
Wireless expected gains or losses. Pending finalization of Barat Wireless
permanent financing plan, and upon request by Barat Wireless, U.S. Cellular may
agree to make additional capital contributions and advances to Barat Wireless
and/or its general partner.
On April 3, 2006, TDS
Telecom exchanged customers and assets in certain markets with another
telecommunications provider and received $0.7 million in cash.
On April 21, 2006, U.S.
Cellular completed the purchase of the remaining majority interest in Tennessee
RSA No. 3 Limited Partnership, a wireless market in which it had previously
owned a 16.7% interest for approximately $18.8 million in cash, subject to a
working capital adjustment. This acquisition increased investments in licenses,
goodwill and customer lists by $5.5 million, $4.0 million and $2.0 million,
respectively.
U.S. Cellular is a
limited partner in Carroll Wireless, an entity which participated in the
auction of wireless spectrum designated by the FCC as Auction 58. Carroll
Wireless was qualified to bid on spectrum which was available only to companies
that fall under the FCC definition of designated entities, which are small
businesses that have a limited amount of assets. Carroll Wireless was a
successful bidder for 17 licensed areas in Auction 58, which ended on February
15, 2005. The aggregate amount paid to the FCC for the 17 licenses was $129.9
million, net of all bidding credits to which Carroll Wireless was entitled as a
designated entity. These 17 licensed areas cover portions of 11 states and are
in markets which are either adjacent to or overlap current U.S. Cellular
licensed areas.
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On January 6, 2006, the
FCC granted Carroll Wireless applications with respect to 16 of the 17
licenses for which it had been the successful bidder and dismissed one
application, relating to Walla Walla, Washington. Following the completion of
Auction 58, the FCC determined that a portion of the Walla Walla license was
already licensed to another party and should not have been included in Auction
58. Accordingly, in 2006, Carroll Wireless received a full refund of the
$228,000 previously paid to the FCC with respect to the Walla Walla license.
Carroll Wireless is in
the process of developing its long-term business and financing plans. As of
September 30, 2006, U.S. Cellular had made capital contributions and advances
to Carroll Wireless and/or its general partner of approximately $129.9 million;
$129.7 million of this amount is included in Licenses in the Consolidated
Balance Sheets. For financial reporting purposes, U.S. Cellular consolidates
Carroll Wireless and Carroll PCS, Inc., the general partner of Carroll
Wireless, pursuant to the guidelines of FIN 46(R), as U.S. Cellular anticipates
absorbing a majority of Carroll Wireless expected gains or losses. Pending
finalization of Carroll Wireless permanent financing plan, and upon request by
Carroll Wireless, U.S. Cellular may agree to make additional capital
contributions and advances to Carroll Wireless and/or its general partner. In
November 2005, U.S. Cellular approved additional funding of $1.4 million of
which $0.1 million was provided to Carroll Wireless through September 30, 2006.
In the first quarter of
2005, TDS adjusted the gain on investments related to its sale to ALLTEL of
certain wireless properties on November 30, 2004. The adjustment, which
resulted from a working capital adjustment that was finalized in the first
quarter of 2005, increased the total gain on the sale by $0.5 million to $51.4
million.
In addition, in 2005,
U.S. Cellular purchased one new wireless market and certain minority interests
in other wireless markets in which it already owned a controlling interest for
$6.9 million in cash.
Repurchase of Securities and Dividends
TDS does not have a share
repurchase program as of September 30, 2006. No TDS common shares were
repurchased in the first nine months ended September 30, 2006 or 2005.
U.S. Cellular has an
ongoing authorization from its Board of Directors to repurchase a limited
amount of U.S. Cellular Common Shares on a quarterly basis, primarily for use
in employee benefit plans. No U.S. Cellular Common Shares were repurchased in
the first nine months of 2006 or 2005.
TDS paid total dividends
on its Common Shares and Preferred Shares of $32.2 million in the first nine
months of 2006 and $30.4 million in 2005. TDS paid quarterly dividends per
share of $0.0925 in 2006 and $0.0875 in 2005.
Contractual and Other Obligations
There has been no
material change to Contractual and Other Obligations included in the Managements
Discussion and Analysis of Results of Operations and Financial Condition
included in TDSs Form 10-K for the year ended December 31, 2005.
Off-Balance Sheet Arrangements
TDS has no transactions,
agreements or contractual arrangements with unconsolidated entities involving off-balance
sheet arrangements, as defined by SEC rules, that have or are reasonably
likely to have a material current or future effect on financial condition,
changes in financial condition, results of operations, liquidity, capital
expenditures, capital resources, revenues or expenses.
Investments in
Unconsolidated Entities. TDS has certain variable interests
in investments in which TDS holds a minority interest. Such investments totaled
$243.8 million as of September 30, 2006 and are accounted for using either the
equity or cost method. TDSs maximum loss exposure for these variable interests
is limited to the aggregate carrying amount of the investments.
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Indemnity Agreements. TDS
enters into agreements in the normal course of business that provide for
indemnification of counterparties. These include certain asset sales and
financings with other parties. The terms of the indemnifications vary by
agreement. The events or circumstances that would require TDS to perform under
these indemnities are transaction specific; however, these agreements may
require TDS to indemnify the counterparty for costs and losses incurred from
litigation or claims arising from the underlying transaction. TDS is unable to
estimate the maximum potential liability for these types of indemnifications as
the amounts are dependent on the outcome of future events, the nature and
likelihood of which cannot be determined at this time. Historically, TDS has not
made any significant indemnification payments under such agreements. TDS is
party to an indemnity agreement with T-Mobile regarding certain contingent
liabilities at Aerial Communications for the period prior to Aerials merger
into VoiceStream Wireless in 2000. As of September 30, 2006, TDS has recorded
liabilities of $1.4 million relating to this indemnity.
APPLICATION
OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
TDS prepares its
consolidated financial statements in accordance with accounting principles generally
accepted in the United States of America (U.S. GAAP). TDSs significant
accounting policies are discussed in detail in Note 1 Summary of Significant
Accounting Policies of the Notes to the Consolidated Financial Statements
included in TDSs Form 10-K/A for the year ended December 31, 2005.
The preparation of
financial statements in accordance with U.S. GAAP requires TDS to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. TDS bases its estimates on historical experience
and on various other assumptions and information that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities. Actual
results may differ from estimates under different assumptions or conditions.
Management believes the
following critical accounting estimates reflect its more significant judgments
and estimates used in the preparation of its consolidated financial statements.
Management has discussed the development and selection of each of the following
accounting policies and estimates and the following disclosures with the audit
committee of TDSs Board of Directors.
Licenses and Goodwill
As of September 30, 2006,
TDS reported $1,450.4 million of licenses and $886.4 million of goodwill, as a
result of acquisitions of interests in wireless licenses and businesses, and
the acquisition of operating telephone companies. Licenses include those won by
Barat Wireless in FCC Auction 66 completed in September 2006 and by Carroll
Wireless in the FCC Auction 58 completed in February 2005, as well as license
rights that will be received when the 2003 AT&T Wireless exchange
transaction is fully completed.
Licenses and goodwill
must be reviewed for impairment annually, or more frequently if events or
changes in circumstances indicate that the asset might be impaired. TDS
performs the annual impairment review on licenses and goodwill during the
second quarter of its fiscal year. There can be no assurance that upon review
at a later date material impairment charges will not be required.
The intangible asset
impairment test consists of comparing the fair value of the intangible asset to
the carrying amount of the intangible asset. If the carrying amount exceeds the
fair value, an impairment loss is recognized for the difference. The goodwill
impairment test is a two-step process. The first step compares the fair value
of the reporting unit as identified in accordance with SFAS No. 142, Goodwill
and Other Intangible Asset (SFAS 142) to its carrying value. If the carrying
amount exceeds the fair value, the second step of the test is performed to
measure the amount of impairment loss, if any. The second step compares the
implied fair value of reporting unit goodwill with the carrying amount of that
goodwill. To calculate the implied fair value of goodwill, an enterprise
allocates the fair value of the reporting unit to all of the assets and
liabilities of that reporting unit (including any unrecognized intangible
assets) as if the reporting unit had been acquired in a business combination
and the fair value was the price paid to acquire the reporting unit. The excess
of the fair value of the reporting unit over the amounts assigned to the assets
and liabilities of the reporting unit is the implied fair value of goodwill. If
the carrying amount of goodwill exceeds the implied fair value of goodwill, an
impairment loss of goodwill is recognized for that difference.
85
The fair value of an
asset or reporting unit is the amount at which that asset or reporting unit
could be bought or sold in a current transaction between willing parties.
Therefore, quoted market prices in active markets are the best evidence of fair
value and should be used when available. If quoted market prices are not
available, the estimate of fair value is based on the best information
available, including prices for similar assets and the use of other valuation
techniques. Other valuation techniques include present value analysis,
multiples of earnings or revenues or similar performance measures. The use of
these techniques involves assumptions by management about factors that are
highly uncertain including future cash flows, the appropriate discount rate and
other inputs. Different assumptions for these inputs or valuation methodologies
could create materially different results.
U.S. Cellular tests
goodwill for impairment at the level of reporting referred to as a reporting
unit. For purposes of impairment testing of goodwill in 2006 and 2005, U.S.
Cellular identified five reporting units pursuant to paragraph 30 of SFAS 142.
The five reporting units represent five geographic groupings of FCC licenses,
constituting five geographic service areas. For purposes of impairment testing
of licenses in 2006 and 2005, U.S. Cellular combined its FCC licenses into five
units of accounting pursuant to FASB Emerging Issues Task Force Issue 02-7, Units
of Accounting for Testing Impairment of Indefinite-Lived Intangible Assets (EITF
02-7), and SFAS 142, using the same geographic groupings as its reporting
units. In addition, in 2006, U.S. Cellular identified six additional geographic
groupings of licenses, which, because they are currently undeveloped and not
expected to generate cash flows from operating activities in the foreseeable
future, are considered separate units of accounting for purposes of impairment
testing.
For purposes of
impairment testing of goodwill, U.S. Cellular prepares valuations of each of
the five reporting units for purposes of impairment testing of goodwill. A
discounted cash flow approach is used to value each of the reporting units,
using value drivers and risks specific to each individual geographic region.
The cash flow estimates incorporate assumptions that market participants would
use in their estimates of fair value. Key assumptions made in this process are
the selection of a discount rate, estimated future cash flow levels, projected
capital expenditures and selection of terminal value multiples. Similarly, for
purposes of impairment testing of licenses, U.S. Cellular prepares valuations
(of each of five units of accounting determined pursuant to EITF 02-7) using an
excess earnings methodology. This excess earnings methodology estimates the
fair value of the intangible assets (FCC license units of accounting) by
measuring the future cash flows of the license groups, reduced by charges for
contributory assets such as working capital, trademarks, existing subscribers,
fixed assets, assembled workforce and goodwill. For undeveloped licenses, U.S.
Cellular prepares estimates of fair value for each unit of accounting by
reference to fair market values indicated by recent auctions and market
transactions.
TDS Telecom has recorded
goodwill primarily as a result of the acquisition of operating telephone
companies. TDS Telecom has assigned goodwill to its incumbent local exchange
carrier reporting unit. This goodwill is valued using a multiple of cash flow
valuation technique for purposes of goodwill impairment testing.
U.S. Cellular and TDS
Telecom performed the annual testing for impairment in the second quarter of
2006 and 2005. Based on that testing, there was no impairment of licenses or
goodwill either year.
Property, Plant and Equipment
U.S. Cellulars
operations and TDS Telecoms competitive local exchange carrier provide for
depreciation using the straight-line method over the estimated useful lives of
the assets. TDS Telecoms incumbent local exchange carrier operations provide
for depreciation on a group basis according to depreciable rates approved by
state public utility commissions. Annually, U.S. Cellular and TDS Telecom
review their property, plant and equipment lives to ensure that the estimated
useful lives are appropriate. The estimated useful lives of property, plant and
equipment are critical accounting estimates because changing the lives of assets
can result in larger or smaller charges for depreciation expense. Factors used
in determining useful lives include technology changes, regulatory
requirements, obsolescence and type of use. U.S. Cellular and TDS Telecom did
not change the useful lives of their property, plant and equipment in the nine
months ended September 30, 2006 or 2005.
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TDS reviews long-lived
assets for impairment at least annually or more frequently if events or
circumstances indicate that the assets might be impaired. The tangible asset
impairment test is a two-step process. The first step compares the carrying
value of the assets with the undiscounted cash flows over the remaining asset
life. If the carrying value of the assets is greater than the undiscounted cash
flows, then the second step of the test is performed to measure the amount of
impairment loss. The second step compares the estimated fair value of the
assets to the carrying value of the assets. If the estimated fair value of the
assets is less than the carrying value of the assets, an impairment loss is
recognized for the difference.
The fair value of a
tangible asset is the amount at which that asset could be bought or sold in a
current transaction between willing parties. Therefore, quoted market prices in
active markets are the best evidence of fair value and should be used when
available. If quoted market prices are not available, the estimate of fair
value is based on the best information available, including prices for similar
assets and the use of other valuation techniques. A present value analysis of
cash flow scenarios is often the best available valuation technique with which
to estimate the fair value of a long-lived asset. The use of this technique
involves assumptions by management about factors that are highly uncertain
including future cash flows, the appropriate discount rate, and other inputs.
Different assumptions for these inputs or different valuation methodologies
could create materially different results.
Other valuation
techniques include a market approach and income approach. The market approach
compares the asset group to similar companies whose securities are actively
traded. Ratios or multiples of value relative to certain significant financial
measures, such as revenue and earnings, are developed based upon the comparable
companies. The valuation multiples are applied to the appropriate financial
measures of the asset group to indicate its value. The income approach uses a
discounted cash flow analysis based on value drivers and risks specific to its
asset group. The cash flow estimates incorporate assumptions that market
participants would use in their estimates of fair value. Key assumptions made
in this process are the selection of a discount rate, estimated future cash
flow levels, projected capital expenditures, and determination of terminal
value.
In
accordance with SFAS 144, U.S. Cellular and TDS Telecom review long-lived
assets, including property, plant and equipment, for impairment whenever events
or changes in circumstances indicate that the carrying amount may not be fully
recoverable. U.S. Cellular performed impairment tests of property, plant and
equipment during the second quarter of 2006 and 2005. Such impairment tests
indicated that there was no impairment of property, plant and equipment in
either year.
Derivative Instruments
TDS utilizes derivative
financial instruments to reduce marketable equity security market value risk.
TDS does not hold or issue derivative financial instruments for trading
purposes. TDS recognizes all derivatives as either assets or liabilities on the
Consolidated Balance Sheets and measures those instruments at fair value.
Changes in fair value of those instruments are reported in the Consolidated
Statements of Operations or classified as accumulated other comprehensive
income, net of tax, in the Consolidated Balance Sheets depending on the use of
the derivative and whether it qualifies for hedge accounting. The accounting
for gains and losses associated with changes in the fair value of the
derivative and the effect on the consolidated financial statements depend on
the derivatives hedge designation and whether the hedge is anticipated to be
highly effective in achieving offsetting changes in the fair value of the
hedged item or cash flows of the asset hedged.
The VeriSign
forward contract is designated as a fair value hedge, where effectiveness of
the hedge is assessed based upon the intrinsic value of the underlying options.
The intrinsic value of the forward contract is defined as the difference
between the applicable option strike price and the market value of the
contracted shares on the balance sheet date. Changes in the intrinsic value of
the options are expected to be perfectly effective at offsetting changes in the
fair value of the hedged item. Changes in the fair value of the options are
recognized in the Statement of Operations along with the changes in the fair
value of the underlying marketable equity securities.
87
TDS originally designated
the embedded collars within its forward contracts as cash flow hedges of the
Deutsche Telekom and Vodafone marketable equity securities. Accordingly, all changes in the fair value of
the embedded collars were recorded in other comprehensive income, net of income
taxes. Subsequently, upon contractual modifications to the terms of the
collars, the embedded collars no longer qualified for the hedge accounting
treatment and all changes in fair value of the collars from the time of the
contractual modification to the terms of the collars are included in the Consolidated
Statements of Operations.
The accounting for the
embedded collars as derivative instruments that do not qualify for cash flow
hedge accounting and fair value hedges is expected to result in increased
volatility in the results of operations, as fluctuation in the market price of
the underlying Deutsche Telekom, Vodafone and VeriSign marketable equity
securities will result in changes in the fair value of the embedded collars
being recorded in the statement of operations.
The embedded collars are
valued using the Black-Scholes valuation model.
The inputs in the model include the stock price, strike price (differs
for call options and put options), risk-free interest rate, volatility of the
underlying stock, dividend yield and the term of the contracts. Different assumptions could create materially
different results. A one percent change
in the risk free interest rate could change the fair value of the embedded
collars by approximately $20 million.
Changing the volatility index by one unit could change the fair value of
the embedded collar by approximately $10 million.
Asset Retirement Obligations
TDS accounts for its
asset retirement obligations in accordance with SFAS No. 143, Accounting for
Asset Retirement Obligations, (SFAS 143) and FASB Interpretation No. 47, Accounting
for Conditional Asset Retirement Obligations (FIN 47), which require
entities to record the fair value of a liability for legal obligations
associated with an asset retirement in the period in which the obligations are
incurred. At the time the liability is incurred, TDS records a liability equal
to the net present value of the estimated cost of the asset retirement
obligation and increases the carrying amount of the related long-lived asset by
an equal amount. Over time, the liability is accreted to its present value each
period, and the capitalized cost is depreciated over the useful life of the
related asset. Upon settlement of the obligations, any difference between the
cost to retire an asset and the recorded liability (including accretion of
discount) is recognized in the Consolidated Statements of Operations as a gain
or loss.
The calculation of the
asset retirement obligation is a critical accounting estimate for TDS because
changing the factors used in calculating the obligation could result in larger
or smaller estimated obligations that could have a significant impact on TDSs
results of operations and financial condition. Such factors may include
probabilities or likelihood of remediation, cost estimates, lease renewals and
salvage values. Actual results may differ materially from estimates under
different assumptions or conditions.
U.S. Cellular is subject
to asset retirement obligations associated primarily with its cell sites,
retail sites and office locations. Asset retirement obligations generally
include costs to remediate leased land on which U.S. Cellulars cell sites and
switching offices are located. Also, U.S. Cellular is also generally required
to return leased retail store premises and office space to their pre-existing
conditions.
TDS Telecoms incumbent
local exchange carriers have recorded an asset retirement obligation in
accordance with the requirements of SFAS No. 143 and FIN 47, and a regulatory
liability for the costs of removal that state public utility commissions have
required to be recorded for regulatory accounting purposes. The amounts
recorded for regulatory accounting purposes are in addition to the amounts
required to be recorded in accordance with SFAS No 143 and FIN 47. These
amounts combined make up the asset retirement obligation for the incumbent
local exchange carriers. The asset retirement obligation calculated in
accordance with the provisions of SFAS No. 143 and FIN 47 at September 30, 2006
was $38.3 million. The regulatory liability in excess of the amounts required
to be recorded in accordance with SFAS No. 143 and FIN 47 at September 30, 2006
was $62.3 million.
88
During the third quarter
of 2006, U.S. Cellular reviewed the assumptions related to its asset retirement
obligations and, as a result of the review, revised certain of those
assumptions. Estimated retirement obligations for cell sites were revised to reflect
higher estimated costs for removal of radio and power equipment, and estimated
retirement obligations for retail stores were revised to reflect a shift to
larger stores and slightly higher estimated costs for removal of fixtures. These changes are reflected in Revision in
estimated cash flows below. The table
below also summarizes other changes in asset retirement obligations during the
nine months ended September 30, 2006 and 2005.
TDS Telecoms incumbent local exchange carriers are designated as ILEC
in the table and its competitive local exchange carrier is designated as
CLEC.
|
|
U.S.
|
|
TDS Telecom
|
|
TDS
|
|
|
|
Cellular
|
|
ILEC
|
|
CLEC
|
|
Consolidated
|
|
|
|
(Dollars in thousands)
|
|
Beginning Balance
December 31, 2005 (As Restated)
|
|
$
|
90,224
|
|
$
|
97,509
|
|
$
|
2,649
|
|
$
|
190,382
|
|
Additional
liabilities accrued
|
|
5,922
|
|
3,552
|
|
186
|
|
9,660
|
|
Revision in
estimated cash flows
|
|
13,415
|
|
|
|
|
|
13,415
|
|
Acquisition of
assets
|
|
1,237
|
|
|
|
|
|
1,237
|
|
Disposition of
assets
|
|
(112
|
)
|
(513
|
)
|
|
|
(625
|
)
|
Accretion
expense
|
|
5,312
|
|
26
|
|
139
|
|
5,477
|
|
Ending Balance September 30, 2006
|
|
$
|
115,998
|
|
$
|
100,574
|
|
$
|
2,974
|
|
$
|
219,546
|
|
Income Taxes
The accounting for income
taxes, the amounts of income tax assets and liabilities and the related income
tax provision are critical accounting estimates because such amounts are
significant to TDSs financial condition and results of operations.
The preparation of the
consolidated financial statements requires TDS to calculate a provision for
income taxes. This process involves estimating the actual current income tax
liability together with assessing temporary differences resulting from the
different treatment of items for tax and accounting purposes, such as
depreciation expense, as well as estimating the impact of potential adjustments
to filed tax returns. Temporary differences result in deferred income tax
assets and liabilities, which are included within the Consolidated Balance
Sheets. TDS must then assess the likelihood that deferred income tax assets
will be realized based on future taxable income and to the extent TDS believes
that realization is not likely, establish a valuation allowance. Managements judgment
is required in determining the provision for income taxes, deferred income tax
assets and liabilities and any valuation allowance recorded against deferred
income tax assets.
In the event of an
increase in the value of tax assets or a decrease in tax liabilities, TDS would
decrease the income tax expense or increase the income tax benefit by an
equivalent amount. In the event of a decrease in the value of tax assets or an
increase in tax liabilities, TDS would increase the income tax expense or decrease
the income tax benefit by an equivalent amount. Increases or decreases in the
market value related to marketable equity securities and derivatives, and the
associated change in the deferred tax asset or liability, are recorded through
Other comprehensive income.
TDSs net current
deferred income tax (liability) asset totaled $(226.4) million, at September
30, 2006 and $13.4 million at December 31, 2005. The net current deferred
income tax liability at September 30, 2006 primarily represents deferred income
taxes on the current portion of marketable equity securities. The net current
deferred income tax asset (liability) at December 31, 2005 primarily
represents the deferred income tax effects of the allowance for doubtful
accounts on customer accounts receivable.
89
TDSs noncurrent deferred
income tax assets and liabilities as of September 30, 2006 and December 31,
2005 and the underlying temporary differences are as follows:
Deferred Tax Asset
noncurrent
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
75,393
|
|
$
|
71,981
|
|
Derivative instruments
|
|
96,170
|
|
185,707
|
|
Other
|
|
42,745
|
|
45,405
|
|
|
|
$
|
214,308
|
|
$
|
303,093
|
|
Less valuation allowance
|
|
(46,922
|
)
|
(43,677
|
)
|
Total Deferred Tax Asset
|
|
$
|
167,386
|
|
$
|
259,416
|
|
|
|
|
|
|
|
Deferred Tax Liability noncurrent
|
|
|
|
|
|
Marketable equity securities
|
|
$
|
486,363
|
|
$
|
890,081
|
|
Property, plant and equipment
|
|
330,583
|
|
366,400
|
|
Partnership investments
|
|
98,537
|
|
107,638
|
|
Licenses/Intangibles
|
|
247,711
|
|
233,013
|
|
Total Deferred Tax Liability
|
|
$
|
1,163,194
|
|
$
|
1,597,132
|
|
Net Deferred
Income Tax Liability
|
|
$
|
995,808
|
|
$
|
1,337,716
|
|
State net operating loss
carryforwards are available to offset future taxable income primarily of the
individual subsidiaries which generated the losses. Certain subsidiaries that
are not included in the federal consolidated income tax return, but file
separate federal tax returns, had federal net operating loss carryforwards
available to offset future taxable income. A valuation allowance was
established for a portion of the state and federal net operating loss
carryforwards since it is more likely than not that a portion of such
carryforwards will expire before they can be utilized.
The deferred income tax
liability relating to the current and noncurrent portions of marketable equity
securities totaled $318.3 million and $486.4 million, respectively, as of
September 30, 2006. The deferred income tax liability related to marketable
equity securities totaled $890.1 million as of December 31, 2005. The December
31, 2005 balance of deferred income tax liability related wholly to noncurrent
marketable equity securities. In 2006, $318.3 million of deferred income tax
liability related to marketable equity securities was classified as current and
$78.2 million of the deferred income tax asset related to derivatives was
classified as current. The current deferred income tax liability and current
deferred income tax asset relate to certain forward contracts which mature
before October 2007. The foregoing amounts represent deferred income taxes
calculated on the difference between the fair value and the tax basis of the
marketable equity securities. Income taxes will be payable when TDS disposes of
the marketable equity securities.
TDS is routinely subject
to examination of its income tax returns by the Internal Revenue Service (IRS)
and other tax authorities. TDS periodically assesses the likelihood of
adjustments to its tax liabilities resulting from these examinations to
determine the adequacy of its provision for income taxes, including related
interest. Managements judgment is required in assessing the eventual outcome
of these examinations. Changes to such assessments affect the calculation of
TDSs income tax expense.
In June of 2006, the
Internal Revenue Service commenced its audit of the 2002 2004 consolidated
federal tax returns of TDS and subsidiaries. The audit is in its preliminary
stages.
Stock-based Compensation
As a result of the
adoption of a new accounting pronouncement effective January 1, 2006, TDSs
accounting policy related to stock-based compensation has changed as described
below and is now a critical accounting policy due to the significant
assumptions and estimates involved.
90
As described in more
detail in Notes 2 and 3 of the Notes to the Condensed Consolidated Financial
Statements included in Item 1 above, TDS has established long-term incentive
plans, employee stock purchase plans and dividend reinvestment plans, all of
which are stock-based compensation plans. Prior to the first quarter of 2006,
TDS accounted for share-based payments in accordance with Accounting Principles
Board No. 25 (APB 25), Accounting for Stock Issued to Employees and related
interpretations as allowed by SFAS 123. Accordingly, prior to the first quarter
of 2006, compensation cost for share-based payments was measured using the
intrinsic value method as prescribed by APB 25. Under the intrinsic value
method, compensation cost is measured as the amount by which the market value
of the underlying equity instrument on the grant date exceeds the exercise
price. Effective January 1, 2006, TDS adopted the fair value recognition
provisions of SFAS No. 123(R), using the modified prospective transition
method. In addition, TDS applied the provisions of Staff Accounting Bulletin
No. 107 Share-Based Payments (SAB 107), issued by the Securities and Exchange
Commission in March 2005, in its adoption of SFAS 123(R). Under the modified
prospective transition method, compensation cost recognized during the nine
months ended September 30, 2006 includes: (a) compensation cost for all
share-based payments granted prior to but not yet vested as of January 1, 2006,
based on the grant date fair value estimated in accordance with the original
provisions of SFAS 123, and (b) compensation cost for all share-based payments
granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R).
Upon adoption of SFAS
123(R), TDS elected to value its share-based payment transactions using a
Black-Scholes valuation model, which was previously used by TDS for purposes of
preparing the pro forma disclosures under SFAS 123. The variables in the model
include, but are not limited to, TDSs and/or U.S. Cellulars expected stock
price volatility over the term of the awards, expected forfeitures, time of
exercise, risk-free interest rate and expected dividends. Different assumptions
could create materially different results. Under the provisions of SFAS 123(R),
stock-based compensation expense recognized during the period is based on the
portion of the share-based payment awards that are expected to ultimately vest.
Contingencies, Indemnities and
Commitments
Contingent obligations,
including indemnities, litigation and other possible commitments are accounted
for in accordance with SFAS No. 5, Accounting for Contingencies, which
requires that an estimated loss be recorded if it is probable that an asset has
been impaired or a liability has been incurred at the date of the financial
statements and the amount of the loss can be reasonably estimated. Accordingly,
those contingencies that are deemed to be probable and where the amount of such
settlement is reasonably estimable are accrued in the financial statements. If
only a range of loss can be determined, the best estimate within that range is
accrued; if none of the estimates within that range is better than another, the
low end of the range is accrued. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been or will be
incurred, even if the amount is not estimable. The assessment of contingencies
is a highly subjective process that requires judgments about future events.
Contingencies are reviewed at least quarterly to determine the adequacy of the
accruals and related financial statement disclosure. The ultimate settlement of
contingencies could materially impact the Consolidated Statement of Operations,
the Consolidated Balance Sheets and the Consolidated Statements of Cash Flows.
TDS
Telecom records revenues from originating and terminating access for
interexchange carriers based on contracts, tariffs or operational data. Such
contracts, tariffs and operational data could be subject to dispute by
interexchange carriers. In April 2006, an interexchange carrier for
which TDS Telecom provides both originating and terminating access asserted a
claim for refund, net of counterclaims, of up to $10 million for past billed
amounts for certain types of traffic. TDS Telecom has contested this claim. Disputes with interexchange carriers may
take significant time to resolve and may require adjustments in future periods
to amounts invoiced, accrued or paid in prior periods.
91
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
The following persons are
partners of Sidley Austin LLP, the principal law firm of TDS and its
subsidiaries: Walter C.D. Carlson, a
trustee and beneficiary of a voting trust that controls TDS, the non-executive
chairman of the board and member of the board of directors of TDS and a
director of U.S. Cellular, a subsidiary of TDS; William S. DeCarlo, the General
Counsel of TDS and an Assistant Secretary of TDS and certain subsidiaries of
TDS; and Stephen P. Fitzell, the General Counsel of U.S. Cellular and TDS
Telecommunications Corporation and an
Assistant Secretary of certain subsidiaries of TDS. Walter C.D. Carlson does
not provide legal services to TDS or its subsidiaries.
OTHER
MATTERS
The Securities and
Exchange Commission (SEC) Division of Corporation Finance routinely sends
public companies comment letters relating to their
filings with the SEC. In September 2006, TDS received a comment
letter from the staff of the SEC regarding its review of the TDS 2005
annual report on Form 10-K and quarterly report on Form 10-Q for the quarterly
period ended March 31, 2006. The comments principally asked TDS to provide
additional information to the SEC and to make additional disclosures in its
Forms 10-K and 10-Q on a prospective basis. TDS responded to the SECs comment letter on October 13, 2006. By letter dated November 15, 2006, the SEC
informed TDS that the SEC had completed its review of the aforementioned Form
10-K and related filings. The requested additional disclosures have been
included in this quarterly report on Form 10-Q and in the amendments to the
annual report on Form 10-K/A for the year ended December 31, 2005 and the
quarterly reports on Form 10-Q/A for the quarterly periods ended March 31, 2006
and June 30, 2006.
92
PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995
SAFE HARBOR CAUTIONARY STATEMENT
This Form 10-Q (Form
10-Q), including exhibits, contains statements that are not based on
historical fact and represent forward-looking statements, as this term is
defined in the Private Securities Litigation Reform Act of 1995. All
statements, other than statements of historical facts, that address activities,
events or developments that TDS intends, expects, projects, believes or
anticipates will or may occur in the future are forward-looking statements. The
words believes, anticipates, estimates, expects, plans, intends and
similar expressions are intended to identify these forward-looking statements,
but are not the exclusive means of identifying them. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
that may cause actual results, events or developments to be significantly
different from any future results, events or developments expressed or implied
by such forward-looking statements. Such risks, uncertainties and other factors
include those set forth below, as more fully discussed under Risk Factors in
TDSs Form 10-K/A for the year ended December 31, 2005. However, such factors
are not necessarily all of the important factors that could cause actual
results, performance or achievements to differ materially from those expressed
in, or implied by, the forward-looking statements contained in this document.
Other unknown or unpredictable factors also could have material adverse effects
on future results, performance or achievements. TDS undertakes no obligation to
update publicly any forward-looking statements whether as a result of new
information, future events or otherwise. You should carefully consider the Risk
Factors in TDSs Form 10-K for the year ended December 31, 2005, the following
factors and other information contained in, or incorporated by reference into,
this Form 10-Q to understand the material risks relating to TDSs business.
· Intense
competition in the markets in which TDS operates could adversely affect TDSs
revenues or increase its costs to compete.
· Consolidation
in the telecommunications industry could adversely affect TDSs revenues and
increase its costs of doing business.
· Advances
or changes in telecommunications technology, such as Voice over Internet Protocol
or WiMAX, could render certain technologies used by TDS obsolete, could reduce
TDSs revenues or increase its costs of doing business.
· Changes
in the regulatory environment or a failure by TDS to timely or fully comply
with any regulatory requirements could adversely affect TDSs financial
condition, results of operations or ability to do business.
· Changes
in TDSs enterprise value, changes in the supply or demand of the market for
wireless licenses or telephone company franchises, adverse developments in the
business or the industry in which TDS is involved and/or other factors could
require TDS to recognize impairments in the carrying value of TDSs license
costs, goodwill and/or physical assets.
· Early
redemptions of debt or repurchases of debt, issuances of debt, changes in
prepaid forward contracts, changes in operating leases, changes in purchase
obligations or other factors or developments could cause the amounts reported
under Contractual or Other Obligations in TDSs Managements Discussion and
Analysis of Financial Condition and Results of Operations to be different from
the amounts actually incurred.
· Changes
in accounting standards or changes in TDSs accounting policies, estimates or
in the assumptions underlying the accounting estimates, including those
described in Application of Critical Accounting Policies and Estimates above,
could have an adverse effect on TDSs financial condition or results of
operations.
· Settlements,
judgments, restraints on its current or future manner of doing business and/or
legal costs resulting from pending and future litigation could have an adverse
effect on TDSs financial condition, results of operations or ability to do
business.
· Costs,
integration problems or other factors associated with acquisitions/divestitures
of properties and/or licenses and/or expansion of TDSs business could have an
adverse effect on TDSs business, financial condition or results of operations.
93
· A
significant portion of TDSs wireless revenues is derived from customers who
buy services through independent agents and dealers who market TDSs services
on a commission basis. If TDSs relationships with these agents and dealers are
seriously harmed, its wireless revenues could be adversely affected.
· TDSs
investments in technologies which are unproven or for which success has not yet
been demonstrated may not produce the benefits that TDS expects.
· An
inability to obtain or maintain roaming arrangements with other carriers on
terms that are acceptable to TDS, and/or changes in roaming rates and the lack
of standards and roaming agreements for wireless data products, could have an
adverse effect on TDSs business, financial condition or results of operations.
· Changes
in access to content for data or video services and access to new handsets
being developed by vendors, or an inability to manage its supply chain or
inventory successfully, could have an adverse effect on TDSs business,
financial condition or results of operations.
· A
failure by TDSs service offerings to meet customer expectations could limit
TDSs ability to attract and retain customers and have an adverse effect on TDSs
operations.
· A
failure by TDS to complete significant network build-out and system
implementation as part of its plans to build out new markets and improve the
quality and capacity of its network could have an adverse effect on its
operations.
· A
failure by TDSs wireless business to acquire adequate radio spectrum could
have an adverse effect on TDSs business and operations.
· Financial
difficulties of TDSs key suppliers or vendors, or termination or impairment of
TDSs relationships with such suppliers or vendors, could result in a delay or
termination of TDSs receipt of equipment or services, which could adversely
affect TDSs business and results of operations.
· An
increase in TDSs debt in the future could subject TDS to various restrictions
and higher interest costs and decrease its cash flows and earnings.
· An
inability to attract and/or retain management, technical, sales and other
personnel could have an adverse effect on TDSs business, financial condition
or results of operations.
· TDS
has significant investments in entities that it does not control. Losses in the
value of such investments could have an adverse effect on TDSs results of
operations or financial condition.
· Changes
in guidance or interpretations of accounting requirements, changes in industry
practice, identification of errors or changes in management assumptions could
require amendments to or restatements of financial information or disclosures
included in this or prior filings with the SEC.
· Uncertainty
of access to capital for telecommunications companies, deterioration in the
capital markets, other changes in market conditions, changes in TDSs credit
ratings or other factors could limit or restrict the availability of financing
on terms acceptable to TDS, which could require TDS to reduce its construction,
development and acquisition programs.
· Changes
in income tax rates, laws, regulations or rulings, or federal or state tax
assessments could have an adverse effect on TDSs financial condition or
results of operations.
· War,
conflicts, hostilities and/or terrorist attacks or equipment failure, power
outages, natural disasters or breaches of network or information technology
security could have an adverse effect on TDSs business, financial condition or
results of operations.
· Changes
in general economic and business conditions, both nationally and in the markets
in which TDS operates could have an adverse effect on TDSs business, financial
condition or results of operations.
· Changes
in facts or circumstances, including new or additional information that affects
the calculation of potential liabilities for contingent obligations under
guarantees, indemnities or otherwise, could require TDS to record charges in
excess of amounts accrued in the financial statements, if any, which could have
an adverse effect on TDSs financial condition or results of operations.
94
· A
failure to successfully remediate existing material weaknesses in internal
control over financial reporting in a timely manner or the identification of
additional material weaknesses in the effectiveness of internal control over
financial reporting could result in inaccurate financial statements or
inadequate disclosures or fail to prevent fraud, which could have an adverse
effect on TDSs business, financial condition or results of operations.
· The
restatement of financial statements by TDS and related matters, including
resulting delays in filing periodic reports with the SEC, could have an adverse
effect on TDSs credit rating, liquidity, financing arrangements, capital
resources and ability to access the capital markets, including pursuant to
shelf registration statements; could adversely affect TDSs listing
arrangements on the American Stock Exchange and/or New York Stock Exchange;
and/or could have other negative consequences, any of which could have an
adverse effect on the trading prices of TDSs publicly traded equity and/or
debt and/or on TDSs business, financial condition or results of operations.
· The
pending SEC investigation regarding the restatement of TDSs financial
statements could result in substantial expenses, and could result in monetary
or other penalties.
· The
possible development of adverse precedent in litigation or conclusions in
professional studies to the effect that radio frequency emissions from
handsets, wireless data devices and/or cell sites cause harmful health
consequences, including cancer or tumors, or may interfere with various
electronic medical devices such as pacemakers, could have an adverse effect on
TDSs wireless business, financial condition or results of operations.
· TDSs
assets are concentrated in the U.S. telecommunications industry. As a result,
its results of operations may fluctuate based on factors related entirely to
conditions in this industry.
· As
TDS continues to implement its strategies, there are internal and external
factors that could impact its ability to successfully meet its objectives.
· Any
of the foregoing events or other events could cause revenues, customer
additions, operating income, capital expenditures and/or any other financial or
statistical information to vary from TDSs forward estimates by a material
amount.
· The
market prices of TDSs Common Shares and Special Common Shares are subject to
fluctuations due to a variety of factors.
· Certain
matters, such as control by the TDS Voting Trust and provisions in the TDS
Restated Certificate of Incorporation, may serve to discourage or make more
difficult a change in control of TDS.
TDS undertakes no
obligation to update publicly any forward-looking statements whether as a
result of new information, future events or otherwise. Readers should evaluate
any statements in light of these important factors.
95
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
MARKET RISK
Long-term Debt
TDS is subject to market
risks due to fluctuations in interest rates and equity markets. The majority of
TDSs debt, excluding long-term debt related to the forward contracts, is in
the form of long-term, fixed-rate notes with original maturities ranging up to
40 years. Accordingly, fluctuations in interest rates can lead to significant
fluctuations in the fair value of such instruments. The long-term debt related
to the forward contracts consists of both variable-rate debt and fixed-rate
zero coupon debt. The variable-rate forward contracts require quarterly
interest payments that are dependent on market interest rates. Increases in
interest rates will result in increased interest expense. As of September 30,
2006, TDS had not entered into any financial derivatives to reduce its exposure
to interest rate risks.
Reference is made to the
disclosure under Market Risk Long-Term Debt in TDSs Form 10-K for the year
ended December 31, 2005, for additional information related to required
principal payments, average interest rates, and the estimated fair values of
long-term debt.
In January and February
of 2006, TDS redeemed $35.0 million of medium-term notes which carried an
interest rate of 10%.
TDS repaid $200.0 million
plus accrued interest on its 7% unsecured senior notes on August 1, 2006, using
cash on-hand.
Marketable Equity Securities and
Derivatives
TDS maintains a portfolio
of available-for-sale marketable equity securities, the majority of which were
obtained in connection with the sale of non-strategic investments. The market
value of these investments aggregated $2,403.8 million at September 30, 2006
and $2,531.7 million as of December 31, 2005, respectively. TDSs cumulative
net unrealized holding gain, net of tax and minority interest, included in
Accumulated other comprehensive income in the Consolidated Balance Sheets
totaled $524.0 million at September 30, 2006.
Subsidiaries of TDS and U.S. Cellular have a number of
forward contracts with counterparties related to the marketable equity
securities that they hold. TDS and U.S. Cellular have provided guarantees to
the counterparties which provide assurance to the counterparties that all
principal and interest amounts will be paid by their subsidiaries when due. The
economic hedge risk management objective of the forward contracts is to hedge
the value of the marketable equity securities from losses due to decreases in
the market prices of the securities (downside limit) while retaining a share
of gains from increases in the market prices of such securities (upside
potential). The downside limit is hedged at or above the cost basis of the
securities.
Under the terms of the
forward contracts, TDS and U.S. Cellulars subsidiaries continue to own the
contracted shares and will receive dividends paid on such contracted shares, if
any. The forward contracts mature from May 2007 to September 2008 and, at TDSs
and U.S. Cellulars option, may be settled in shares of the respective security
or in cash, pursuant to formulas that collar the price of the shares. The
collars effectively limit downside risk and upside potential on the contracted
shares. The collars are typically contractually adjusted for any changes in dividends
on the underlying shares. If the dividend increases, the collars upside
potential is typically reduced. If the dividend decreases, the collars upside
potential is typically increased. If TDS and U.S. Cellular elect to settle in
shares, they will be required to deliver the number of shares of the contracted
security determined pursuant to the formula. If shares are delivered in the
settlement of the forward contract, TDS and U.S. Cellular would incur a current
tax liability at the time of delivery based on the difference between the tax
basis of the marketable equity securities delivered and the net amount realized
under the forward contract through maturity. If TDS and U.S. Cellular elect to
settle in cash, they will be required to pay an amount in cash equal to the
fair market value of the number of shares determined pursuant to the formula.
96
Deferred income taxes
have been provided for the difference between the financial reporting basis and
the income tax basis of the marketable equity securities and derivatives. The
deferred income tax liability related to marketable equity securities totaled $804.7
million as of September 30, 2006; of this amount, $318.3 million was classified
as current and $486.4 million was classified as noncurrent. The deferred income
tax liability related to marketable equity securities totaled $890.1 million as
of December 31, 2005; the entire amount was classified as noncurrent. The
deferred income tax asset related to derivatives totaled $174.4 million as of
September 30, 2006; of this amount, $78.2 million was classified as current and
$96.2 million was classified as noncurrent. At December 31, 2005, the deferred
income tax asset related to derivatives totaled $185.7 million; the entire
amount was classified as noncurrent.
The TDS VeriSign forward
contracts related to 2,361,333 common shares and the forward contracts related
to U.S. Cellulars 8,964,698 Vodafone ADRs mature in May 2007. The forward
contracts related to 45,492,172 Deutsche Telekom ordinary shares mature between
July and September 2007. Accordingly, such VeriSign common shares, Vodafone
ADRs and Deutsche Telekom ordinary shares are classified as Current Assets and
the related forward contracts and derivative liability are classified as
Current Liabilities in the Consolidated Balance Sheets at September 30, 2006.
The following table
summarizes certain details related to the contracted securities as of September
30, 2006.
|
|
|
|
Collar(1)
|
|
|
|
|
|
|
|
Downside
|
|
Upside
|
|
Loan
|
|
|
|
|
|
Limit
|
|
Potential
|
|
Amount
|
|
Security
|
|
Shares
|
|
(Floor)
|
|
(Ceiling)
|
|
(000s)
|
|
VeriSign
|
|
2,361,333
|
|
$
|
8.82
|
|
$
|
11.46
|
|
$
|
20,819
|
|
Vodafone (2)
|
|
11,327,674
|
|
$
|
17.22-$18.37
|
|
$
|
17.22-$19.11
|
|
201,038
|
|
Deutsche Telekom
|
|
131,461,861
|
|
$
|
10.74-$12.41
|
|
$
|
13.04-$15.69
|
|
1,532,257
|
|
|
|
|
|
|
|
|
|
1,754,114
|
|
Unamortized debt
discount
|
|
|
|
|
|
|
|
33,087
|
|
|
|
|
|
|
|
|
|
$
|
1,721,027
|
(3)
|
(1) The per share amounts represent the range of floor and ceiling prices of
all securities monetized.
(2) U.S. Cellular owned 10.2
million and TDS Telecom owned 2.7 million Vodafone American Depositary Receipts
as of September 30, 2006. See LIQUIDITY AND CAPITAL RESOURCES above for a
discussion of the Special Distribution and Share Consolidation related to the
Vodafone ADRs that was effected on July 28, 2006. As a result of the Share
Consolidation, the aggregate number of shares underlying ADRs was reduced from
12,945,915 to 11,327,674. The collars also were adjusted as a result of the
Special Distribution and Share Consolidation.
(3) A total of $697.0
million is included in current liabilities in the caption Forward contracts
and $1,024.0 million is included in Long-Term Debt in the caption Forward
Contracts.
The following analysis
presents the hypothetical change in the fair value of marketable equity
securities and derivative instruments at September 30, 2006, using the
Black-Scholes model assuming hypothetical price fluctuations of plus and minus
10%, 20% and 30%. The table presents hypothetical information as required by
SEC rules. Such information should not be inferred to suggest that TDS has any
intention of selling any marketable equity securities or canceling any
derivative instruments.
|
|
Valuation of investments assuming
|
|
September 30,
|
|
Valuation of investments assuming
|
|
|
|
indicated decrease
|
|
2006
|
|
indicated increase
|
|
|
|
-30%
|
|
-20%
|
|
-10%
|
|
Fair Value
|
|
+10%
|
|
+20%
|
|
+30%
|
|
|
|
(Dollars
in millions)
|
|
Marketable Equity
Securities
|
|
$
|
1,682.7
|
|
$
|
1,923.0
|
|
$
|
2,163.4
|
|
$
|
2,403.8
|
|
$
|
2,644.2
|
|
$
|
2,884.6
|
|
$
|
3,124.9
|
|
Derivative Instruments (1)
|
|
$
|
139.5
|
|
$
|
(32.2
|
)
|
$
|
(232.9
|
)
|
$
|
(422.2
|
)
|
$
|
(636.1
|
)
|
$
|
(859.1
|
)
|
$
|
(1,088.7
|
)
|
(1) Represents the fair value of the derivative instruments assuming the
indicated increase or decrease in the underlying securities.
97
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure
Controls and Procedures
TDS maintains disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the Exchange Act)) that are designed to
ensure that information required to be disclosed in its reports filed or
submitted under the Exchange Act is processed, recorded, summarized and
reported within the time periods specified in the SECs rules and forms, and
that such information is accumulated and communicated to TDSs management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives.
As required by SEC Rule
13a-15(b), TDS carried out an evaluation, under the supervision and with the
participation of management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of TDSs
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report. Based on this evaluation, the Chief Executive Officer and the
Chief Financial Officer concluded that TDSs disclosure controls and procedures
were not effective as of September 30, 2006, at the reasonable assurance level,
because of the material weaknesses described below. Notwithstanding the
material weaknesses that existed as of September 30, 2006, management has
concluded that the consolidated financial statements included in this Quarterly
Report on Form 10-Q present fairly, in all material respects, the financial
position, results of operation and cash flows of TDS and its subsidiaries in
conformity with accounting principles generally accepted in the United States
of America.
A material weakness is a
control deficiency, or combination of control deficiencies, that results in
more than a remote likelihood that a material misstatement of the annual or
interim financial statements will not be prevented or detected. Management
identified the following material weaknesses in internal control over financial
reporting as of December 31, 2005, which continued to exist as of September 30,
2006:
1. TDS did not have a
sufficient complement of personnel with an appropriate level of accounting
knowledge, experience and training in the application of generally accepted
accounting principles commensurate with the financial reporting requirements
and the complexity of TDSs operations and transactions. Further, TDS did not
have a sufficient number of qualified personnel to create, communicate and
apply accounting policies and procedures in compliance with accounting
principles generally accepted in the United States of America (GAAP). This control
deficiency contributed to the material weaknesses discussed in items 2, 3, 4, 5
and 6 below and the restatement of TDSs annual consolidated financial
statements for 2005, 2004, 2003 and 2002, the interim consolidated financial
statements for all quarters in 2005, 2004 and 2003, the interim consolidated
financial statements for the first and second quarters of 2006, as well as
adjustments, including audit adjustments, to the 2006 and 2005 third quarter
interim consolidated financial statements and the 2005 annual consolidated
financial statements. Additionally, this control deficiency could result in a
misstatement of substantially all accounts and disclosures that would result in
a material misstatement to TDSs interim or annual consolidated financial
statements that would not be prevented or detected.
2. TDS did not
maintain effective controls over its accounting for certain vendor contracts.
Specifically, effective controls were not designed and in place to ensure that
certain vendor contracts were raised to the appropriate level of accounting
personnel or that accounting personnel reached the appropriate conclusions in
order to accurately and timely record the effects of the contracts in
conformity with generally accepted accounting principles. This control
deficiency primarily affected network operations expense, selling, general and
administrative expense, accounts payable, other deferred charges and accrued
liabilities. This control deficiency resulted
in the restatement of TDSs annual consolidated financial statements for 2004,
2003 and 2002, the interim consolidated financial statements for all quarters
in 2004 and 2003, the interim consolidated financial statements for the first
and second quarters of 2005, as well as adjustments, including audit
adjustments, to the 2005 third quarter
interim consolidated financial statements and the 2005 annual
consolidated financial statements. Additionally, this control deficiency could
result in a misstatement of the aforementioned accounts that would result in a
material misstatement to TDSs interim or annual consolidated financial
statements that would not be prevented or detected.
98
3. TDS did not
maintain effective controls over the completeness, accuracy, presentation and
disclosure of its accounting for income taxes, including the determination of
income tax expense, income taxes payable, liabilities accrued for tax
contingencies and deferred income tax assets and liabilities. Specifically, TDS
did not have effective controls designed and in place to accurately calculate
income tax expense and income tax payable, monitor the difference between the
income tax basis and the financial reporting basis of assets and liabilities
and reconcile the resulting basis difference to its deferred income tax asset
and liability balances. This control deficiency resulted in the restatement of TDSs annual consolidated financial
statements for 2005, 2004, 2003 and 2002, the interim consolidated financial
statements for all quarters in 2005, 2004 and 2003, the interim consolidated
financial statements for the first and second quarters of 2006 as well
as adjustments, including audit adjustments, to the 2006 and 2005 third quarter interim consolidated
financial statements and the 2005 annual consolidated financial
statements. Additionally, this control deficiency could result in a
misstatement of the aforementioned accounts that would result in a material
misstatement to TDSs interim or annual consolidated financial statements that
would not be prevented or detected.
4. TDS did not
maintain effective controls over the complete and accurate recording of leases.
Specifically, effective controls were not designed and in place to ensure the
accuracy of lease information, the use of appropriate lease terms including
renewal option periods, calculation of rent expense on a straight-line basis
for leases with escalation clauses and the complete and accurate accumulation
of future lease commitments in conformity with GAAP. This control deficiency
affected rent expense, deferred liabilities and related lease disclosures and
resulted in an audit adjustment to the disclosure of future minimum rental
payments reflected in the 2005 annual consolidated financial statements.
Additionally, this control deficiency could result in a misstatement of the
aforementioned accounts that would result in a material misstatement to TDSs
interim or annual consolidated financial statements that would not be prevented
or detected.
5. TDS did not
maintain effective controls over accounting for prepaid forward contracts and
related bifurcated embedded derivative instruments. Specifically, effective controls were not
designed and in place to de-designate, re-designate and assess hedge
effectiveness of the bifurcated embedded collars within the forward contracts
as cash flow hedges of marketable equity securities when the embedded collars
were contractually modified for differences between the actual and expected
dividend rates on the underlying securities.
This control deficiency affected other comprehensive income on the
consolidated balance sheet and fair value adjustments of derivative instruments
and income tax expense on the consolidated statement of operations. This control deficiency resulted in the
restatement of TDSs annual consolidated financial statements for 2005, 2004
and 2003, the interim consolidated financial statements for all quarters in
2005 and 2004, the interim consolidated financial statements for the first and
second quarters of 2006, as well as adjustments, including audit adjustments,
to the 2006 third quarter interim consolidated financial statements. Additionally, this control deficiency could
result in a misstatement of the aforementioned accounts that would result in a
material misstatement to TDSs interim or annual consolidated financial
statements that would not be prevented or detected.
6. TDS did not
maintain effective controls over its accounting for property, plant and
equipment. Specifically, effective
controls were not designed and in place to ensure accurate recording of
transfers and disposals of equipment.
This control deficiency affected depreciation expense, property, plant
and equipment and accumulated depreciation.
This control deficiency resulted in the restatement of TDSs annual
consolidated financial statements for 2005, 2004 and 2003, the interim
consolidated financial statements for all quarters in 2005 and 2004, the
interim consolidated financial statements for the first and second quarters of
2006, as well as adjustments, including audit adjustments, to the 2006 third
quarter interim consolidated financial statements. Additionally, this control deficiency could
result in a misstatement of the aforementioned accounts that would result in a
material misstatement to TDSs interim or annual consolidated financial
statements that would not be prevented or detected.
99
Remediation of Material
Weaknesses in Internal Control Over Financial Reporting
Prior to the
identification of the material weaknesses described above, TDS had begun the
following processes to enhance its internal control over financial reporting:
· Focus
on Fundamentals
o This program,
initiated in the second quarter 2004, was a self-assessment of TDSs policies
and processes surrounding reporting and financial analysis, internal controls,
and implementation of new accounting pronouncements.
· Controller
Review Committee
o The Controller
Review Committee was formed in the fourth quarter of 2004 and consists of TDSs
Corporate Controller and Assistant Corporate Controller, U.S. Cellulars
Controller and TDS Telecoms Chief Financial Officer. The Committee meets
regularly to discuss accounting treatment for current, unusual or nonrecurring
matters. In addition, the Committee engaged external consultants to provide
technical accounting training related to current accounting developments on a
quarterly basis.
· Enhancements
and additions to technical accounting personnel
o TDS a Vice
President and Assistant Corporate Controller was hired in the second quarter of
2005; a Manager, Accounting and Reporting was added in the second quarter of
2005 and a Manager, External Reporting was added in the third quarter of 2005.
o U.S. Cellular a
Vice President and Controller was hired in the second quarter of 2005 and was
designated as U.S. Cellulars principal accounting officer in the third quarter
of 2005; a Director, Operations Accounting was hired in the second quarter of
2005 and a Manager, Accounting Policy was added in the first quarter of 2005.
TDS believes the above
changes have improved its internal control over financial reporting.
Management is currently
addressing each of the material weaknesses in internal control over financial
reporting and is committed to remediating them as expeditiously as possible.
Further, management is undertaking a multi-year program to improve and increase
automation of financial reporting and other finance functions. Management will
devote significant time and resources to the remediation effort. Managements
remediation plans include the following:
· Review
of Existing Internal Control Over Financial Reporting TDS has engaged
external consultants to assist in reviewing its existing internal control over
financial reporting with the intent of improving the design and operating
effectiveness of controls and processes. Such improvements will include the
development and enhancement of written accounting policies and procedures as
well as communication thereof. In addition, management has currently enhanced
controls related to certain of the items that resulted in the restatement of
TDSs interim and annual consolidated financial statements as discussed above.
· Training
Management has engaged external consultants to assist TDS in developing and
implementing a training program specific to the needs of accounting personnel.
· Recruiting
TDS is actively recruiting the necessary personnel to improve its internal
control processes and enhance the overall level of expertise. Management is
assessing both skill and resource levels in the finance organizations and is
adding staffing as well as additional key director level positions to
strengthen the organizations. In the second quarter of 2006, U.S. Cellular
hired a new Director of Accounting Policy and Reporting. In the third quarter
of 2006, TDS hired a Director of Accounting Policy and a Director of Internal
Controls and Sarbanes-Oxley Compliance.
· Financial
Infrastructure In late 2005, the Finance Leadership Team, consisting of key
finance leaders from each of TDSs business units and Corporate headquarters,
commenced a Financial Infrastructure initiative. This multi-year initiative is
focused on longer-term improvements in key financial processes and support
systems, with an emphasis on simplification of the financial reporting
structure, automation, preventive controls versus detective controls, and
system-based controls versus manual controls.
100
· Income
Tax Accounting TDS has engaged external tax advisors to assist in enhancing
controls with respect to monitoring the difference between the income tax basis
and financial reporting basis of assets and liabilities and reconciling the
difference to the deferred income tax asset and liability balances. The scope
of this project encompasses controls over income taxes on a TDS enterprise-wide
basis, including U.S. Cellular. In addition, TDS is in the process of
implementing a tax provisioning software which TDS believes will enhance its
internal controls related to income taxes on a TDS enterprise-wide basis.
· Accounting
for Contracts TDS has enhanced controls related to monitoring, review and
communication of contract activity. These controls include additional
monitoring procedures, enhanced review processes and increased communication.
· Leases
In 2005, TDS began implementation of a new real estate management system.
Implementation of additional system functionality and related supporting
processes and procedures in 2006 will enhance controls related to the
administration, accounting and reporting for leases, including controls related
to the accuracy, completeness and disclosure of future minimum rental payments
and the calculation of straight-line rent expense.
· Forward contracts and related derivative
instruments TDS will enhance controls related to derivative instrument
transactions. TDS has engaged external financial reporting advisors to provide
expertise related to forward contracts, derivative instruments and hedge
accounting on an ongoing basis. More
specifically, the financial reporting advisors will provide training designed
to ensure that all relevant personnel involved in derivative instrument
transactions understand and apply hedge accounting in compliance with Statement
of Financial Accounting Standards No. 133 Accounting for Derivative
Instruments and Hedging Activities.
Until internal personnel are trained, the financial reporting advisors
will consult on any forward contracts and derivative instrument transactions.
· Property, plant
and equipment TDS has begun implementation of a new fixed assets management
system. This system and supporting
processes and procedures, including a cycle count program covering cell sites
and switches, will improve controls related to accounting and reporting for
property, plant and equipment, including controls related to disposals and
transfers of decommissioned assets.
Changes in Internal
Control Over Financial Reporting
Except for the addition
of technical accounting personnel as discussed above, there were no changes in
TDSs internal control over financial reporting during the quarter ended
September 30, 2006, that have materially affected, or are reasonably likely to
materially affect TDSs internal control over financial reporting. However, as
discussed immediately above, management is currently taking a number of steps
to address each of the material weaknesses in internal control over financial
reporting and is committed to remediating them.
Solely for purposes of
updating the foregoing disclosure, the following information is provided. There
were certain changes to TDSs internal control over financial reporting
subsequent to the quarter ended September 30, 2006. These changes include the resignation of
TDSs Vice President and Assistant Controller in February 2007, and the
reorganization of responsibilities as a result thereof. Subject to such changes, TDS believes that
the foregoing disclosures continue to be correct in all material respects.
101
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
TDS is involved in a
number of legal proceedings before the FCC and various state and federal
courts. If TDS believes that a loss arising from such legal proceedings is
probable and can be reasonably estimated, an amount is accrued in the financial
statements for the estimated loss. If only a range of loss can be determined, the best estimate within that
range is accrued; if none of the estimates within that range is better than
another, the low end of the range is accrued. The assessment of legal
proceedings is a highly subjective process that requires judgments about future
events. The legal proceedings are reviewed at least quarterly to determine the
adequacy of the accruals and related financial statement disclosure. The
ultimate settlement of proceedings may differ materially from amounts accrued
in the financial statements and could have a material effect on TDSs results
of operations, financial condition or cash flows.
Item 1A. Risk Factors.
In addition to the
information set forth in this Form 10-Q, you should carefully consider the
factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on
Form 10-K/A for the year ended December 31, 2005, which could materially affect
TDSs business, financial condition or future results of operations. The risks
described in this Form 10-Q and in our Annual Report on Form 10-K/A may not be
the only risks facing TDS. Additional unidentified or unrecognized risks and
uncertainties may materially adversely affect TDSs business, financial
condition or results of operations. Subject to the foregoing, TDS has not
identified for disclosure any material changes to the risk factors as
previously disclosed in TDSs Form 10-K/A for the year ended December 31, 2005,
except as follows.
U.S.
Cellular could be subject to sanctions, including monetary forfeitures, for
failure to comply with the FCCs E-911 handset rules.
By an order issued in
2002, the FCCs E-911 rules required that 100 percent of all new digital
handsets sold or otherwise activated by wireless carriers, including U.S.
Cellular, be Global Positioning System-capable by May 30, 2004. The FCCs
E-911 rules also required that 95 percent of all handsets in use on U.S.
Cellulars network be GPS-capable by December 31, 2005; in December 2005, U.S.
Cellular filed a request for a limited waiver of the FCCs 95 percent
requirement. Since filing its initial waiver request, U.S. Cellular
voluntarily submitted two different supplements to the waiver request that
reported its progress toward meeting the 95 percent requirement. The most
recent supplement reported that as of September 30, 2006, U.S. Cellulars
overall GPS-capable handset penetration was 94.48 percent.
On January 5, 2007, the
FCC released orders denying the 95 percent GPS-capable handset penetration
waivers of nine wireless carriers, including U.S. Cellular (FCC Order).
The FCC Order denying U.S. Cellulars handset penetration waiver imposed
periodic reporting obligations on U.S. Cellular with respect to its (i)
progress towards achieving the 95% penetration requirement, and (ii) receipt
and disposition of phase two E-911 requests from local public safety
agencies. The FCC Order also referred this matter to the FCCs
Enforcement Bureau for possible further action, which could include the
assessment of a monetary forfeiture. On January 19, 2007, as required by
the FCC Order, U.S. Cellular filed a certification with the FCC confirming that
its overall GPS-capable handset penetration exceeded 95 percent some time
during the fourth quarter of 2006. U.S.
Cellular is currently evaluating its response to the FCC Order. However,
there is no guarantee that U.S. Cellular will not be subject to sanctions, including
monetary forfeitures, for failure to comply with the FCCs E-911 handset
penetration rule.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds.
The table required by
this item is not included because there have been no purchases made by or on
behalf of TDS, or any open market purchases made by any affiliated purchaser
(as defined by the SEC) of any TDS common shares during the quarter covered by
this Form 10-Q.
In addition, TDS did not
have a share repurchase program during the quarter ended September 30, 2006.
102
Item 4. Submission of Matters to a Vote of
Security-Holders.
At the Annual Meeting of
Shareholders of TDS, held on September 12, 2006, the following number of votes
were cast for the matters indicated:
1. Election
of Directors:
a. For
the election of eight Directors of the Company by the holders of Series A
Common Shares and Preferred Shares:
Nominee
|
For
|
Withhold
|
Broker
Non-vote
|
James Barr III
|
63,679,269
|
|
48,140
|
|
0
|
LeRoy T. Carlson
|
63,727,219
|
|
190
|
|
0
|
LeRoy T. Carlson, Jr.
|
63,727,219
|
|
190
|
|
0
|
Dr. Letitia G.C.
Carlson
|
63,727,219
|
|
190
|
|
0
|
Walter C.D. Carlson
|
63,727,025
|
|
384
|
|
0
|
Sandra L. Helton
|
63,719,639
|
|
7,770
|
|
0
|
Donald C. Nebergall
|
63,727,219
|
|
190
|
|
0
|
George W. Off
|
63,727,219
|
|
190
|
|
0
|
b. For
the election of four Directors of the Company by the holders of Common Shares:
Nominee
|
For
|
Withhold
|
Broker
Non-vote
|
Christopher D.
OLeary
|
|
100,529,379
|
|
1,863,625
|
0
|
Mitchell H.
Saranow
|
|
99,127,121
|
|
3,265,883
|
0
|
Martin L.
Solomon
|
|
100,514,489
|
|
1,878,515
|
0
|
Herbert S.
Wander
|
|
98,743,702
|
|
3,649,302
|
0
|
2. Proposal to
Ratify the Selection of PricewaterhouseCoopers LLP as Independent Public
Accountants for 2006:
For
|
Against
|
Abstain
|
Broker
Non-vote
|
109,732,705
|
1,488,261
|
35,512
|
0
|
Item
5. Other Information.
The following information
is being provided to update prior disclosures made pursuant to the requirements
of Form 8-K, Item 2.03 - Creation of a Direct Financial Obligation or an
Obligation Under an Off-Balance Sheet Arrangement of a Registrant.
U.S. Cellular has
borrowed $150 million under its Revolving Credit Facility as of September 30,
2006. The borrowings occurred throughout the first nine months of 2006. U.S.
Cellular anticipates repaying such borrowings with future operating cash flows
from operating activities or long-term debt financing. As of September 30,
2006, the notes range in maturity dates from 3 days to 18 days and all bear
interest of 5.93%. The notes can be renewed when they come due based on the
London InterBank Offered Rate (LIBOR) plus a contractual spread; the
applicable spread is 60 basis points at September 30, 2006. The notes were used
primarily to fund the general obligations of U.S. Cellular as well as funding
for Barat Wireless in Auction 66.
The foregoing description
is qualified by reference to the description of the Revolving Credit Facility
under Item 1.01 in U.S. Cellulars Current Report on Form 8-K dated December 9,
2004, and a copy of the Revolving Credit Facility, which is included as Exhibit
4.1 of U.S. Cellulars Current Report on such Form 8-K dated December 9, 2004
and is incorporated by reference herein.
103
Item 6. Exhibits
Exhibit 3.1 Restated Bylaws, as amended as of
December 4, 2006 effective January 1, 2007 are hereby incorporated by reference
to Exhibit 99.5 to the TDS Form 8-K dated November 30, 2006.
Exhibit 10.0 Supplemental Executive Retirement Plan
(As Amended and Restated, Effective January 1, 2005) is hereby incorporated by
reference to Exhibit 99.1 to TDSs Current Report on Form 8-K dated November 2,
2006.
Exhibit 10.1 Retention Agreement between TDS and
Kenneth R. Meyers dated December 4, 2006, is hereby incorporated by reference
to Exhibit 99.3 to the TDS Form 8-K dated November 30, 2006.
Exhibit 10.2 Employment Agreement and General
Release between TDS and Sandra L. Helton dated November 30, 2006 and amendment
thereto dated December 4, 2006 are hereby incorporated by reference to Exhibit
99.4 to the TDS Form 8-K dated November 30, 2006.
Exhibit 10.3 TDS 2007 Bonus Deferral Agreement
between LeRoy T. Carlson, Jr. and TDS dated December 5, 2006 is hereby
incorporated by reference to Exhibit 10.2 to the TDS Form 8-K dated December 5,
2006.
Exhibit 10.4 TDS 2007 Bonus Deferral Agreement
between LeRoy T. Carlson and TDS dated November 10, 2006 is hereby incorporated
by reference to Exhibit 10.2 to the TDS Form 8-K dated November 10, 2006.
Exhibit 10.5 TDS 2007 Bonus Deferral Agreement
between Kenneth R. Meyers and TDS dated December 6, 2006 is hereby incorporated
by reference to Exhibit 99.2 to the TDS Form 8-K dated December 8, 2006.
Exhibit 10.6 Executive Deferred Compensation
Agreement Phantom Stock Account for 2007 bonus year between John E.
Rooney and U.S. Cellular dated December 13, 2006 is hereby incorporated by
reference to Exhibit 10.1 to U.S. Cellular Corporations Current Report on Form
8-K filed on December 13, 2006.
Exhibit 10.7 Executive Deferred Compensation
Agreement Interest Account for 2007 between John E. Rooney and U.S. Cellular
dated December 13, 2006 is hereby incorporated by reference to Exhibit 10.2 to
U.S. Cellular Corporations Current Report on Form 8-K filed on December
13, 2006.
Exhibit 11 Computation of earnings per common share
is included herein as Note 8 of Notes to Consolidated Financial Statements.
Exhibit 12 Statement regarding computation of
ratios.
Exhibit 31.1 Chief Executive Officer certification
pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
Exhibit 31.2 Chief Financial Officer certification
pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
Exhibit 32.1 Chief Executive Officer certification
pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
Exhibit 32.2 Chief Financial Officer certification
pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
The foregoing exhibits
include only the exhibits that relate specifically to this Form 10-Q or that
supplement the exhibits identified in TDSs Form 10-K/A for the year ended
December 31, 2005. Reference is made to TDSs Form 10-K/A for the year ended
December 31, 2005 for a complete list of exhibits, which are incorporated
herein except to the extent supplemented or superseded above.
104
SIGNATURES
Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
TELEPHONE AND DATA
SYSTEMS, INC.
(Registrant)
Date February
23, 2007
|
|
/s/ LeRoy T. Carlson, Jr.
|
|
|
LeRoy T. Carlson, Jr.,
|
|
|
President and Chief Executive Officer
|
|
|
|
|
|
|
Date February 23, 2007
|
|
/s/ Kenneth R. Meyers
|
|
|
Kenneth R. Meyers,
|
|
|
Executive Vice President and
|
|
|
Chief Financial Officer
|
|
|
|
|
|
|
Date February 23, 2007
|
|
/s/ D. Michael Jack
|
|
|
D. Michael Jack,
|
|
|
Senior Vice President and
|
|
|
Corporate Controller
|
|
|
(Principal Accounting Officer)
|
Signature page for
the TDS 2006 Third Quarter Form 10-Q
EX-12
2
a06-25513_4ex12.htm
EX-12
Exhibit
12
TELEPHONE AND DATA
SYSTEMS, INC.
RATIOS OF EARNINGS TO FIXED CHARGES
|
|
Nine Months Ended
September 30,
|
|
|
|
2006
|
|
2005
(As Restated)
|
|
|
|
(Dollars in Thousands)
|
|
EARNINGS:
|
|
|
|
|
|
Income before
income taxes and minority interest
|
|
$
|
496,522
|
|
$
|
797,771
|
|
Add (deduct):
|
|
|
|
|
|
Equity in
earnings of unconsolidated entities
|
|
(66,376
|
)
|
(50,229
|
)
|
Distributions
from unconsolidated entities
|
|
39,692
|
|
31,192
|
|
Minority
interests in pre-tax income of subsidiaries that do not have fixed charges
|
|
(10,130
|
)
|
(7,340
|
)
|
|
|
$
|
459,708
|
|
$
|
771,394
|
|
Add fixed
charges:
|
|
|
|
|
|
Consolidated
interest expense
|
|
177,185
|
|
160,240
|
|
Interest portion
(1/3) of consolidated rent expense
|
|
30,840
|
|
29,641
|
|
|
|
$
|
667,733
|
|
$
|
961,275
|
|
|
|
|
|
|
|
FIXED CHARGES:
|
|
|
|
|
|
Consolidated
interest expense
|
|
$
|
177,185
|
|
$
|
160,240
|
|
Interest portion
(1/3) of consolidated rent expense
|
|
30,840
|
|
29,641
|
|
|
|
$
|
208,025
|
|
$
|
189,881
|
|
|
|
|
|
|
|
RATIO OF
EARNINGS TO FIXED CHARGES
|
|
3.21
|
|
5.06
|
|
|
|
|
|
|
|
Tax-effected
preferred dividends
|
|
$
|
245
|
|
$
|
256
|
|
Fixed charges
|
|
208,025
|
|
189,881
|
|
Fixed charges
and preferred dividends
|
|
$
|
208,270
|
|
$
|
190,137
|
|
|
|
|
|
|
|
RATIO OF EARNINGS TO
FIXED CHARGES AND PREFERRED DIVIDENDS
|
|
3.21
|
|
5.06
|
|
EX-31.1
3
a06-25513_4ex31d1.htm
EX-31
Exhibit
31.1
Certification of Chief
Executive Officer
I, LeRoy T. Carlson, Jr.,
certify that:
1. I have reviewed
this quarterly report on Form 10-Q of Telephone and Data Systems, Inc.;
2. Based on my
knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my
knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;
4. The registrants
other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant
and have:
a) designed such
disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) designed such
internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles;
c) evaluated the
effectiveness of the registrants disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed in this
report any change in the registrants internal control over financial reporting
that occurred during the registrants most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
registrants internal control over financial reporting; and
5. The registrants
other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of the registrants board of directors (or
persons performing the equivalent functions):
a) all
significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to
adversely affect the registrants ability to record, process, summarize and
report financial information; and
b) any
fraud, whether or not material, that involves management or other employees who
have a significant role in the registrants internal control over financial
reporting.
Date: February 23, 2007
|
|
|
|
|
|
|
/s/ LeRoy T. Carlson, Jr.
|
|
|
LeRoy T. Carlson, Jr.
|
|
|
President and Chief Executive Officer
|
EX-31.2
4
a06-25513_4ex31d2.htm
EX-31
Exhibit
31.2
Certification of Chief
Financial Officer
I, Kenneth R. Meyers,
certify that:
1. I have reviewed
this quarterly report on Form 10-Q of Telephone and Data Systems, Inc.;
2. Based on my
knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in
light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my
knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and
for, the periods presented in this report;
4. The registrants
other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant
and have:
a) designed
such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in
which this report is being prepared;
b) designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
c) evaluated
the effectiveness of the registrants disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) disclosed
in this report any change in the registrants internal control over financial
reporting that occurred during the registrants most recent fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the
registrants internal control over financial reporting; and
5. The registrants
other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrants
auditors and the audit committee of the registrants board of directors (or
persons performing the equivalent functions):
a) all
significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to
adversely affect the registrants ability to record, process, summarize and
report financial information; and
b) any
fraud, whether or not material, that involves management or other employees who
have a significant role in the registrants internal control over financial
reporting.
Date: February 23, 2007
|
|
|
|
|
|
|
/s/ Kenneth R. Meyers
|
|
|
Kenneth R. Meyers
|
|
|
Executive Vice President and
|
|
|
Chief Financial Officer
|
EX-32.1
5
a06-25513_4ex32d1.htm
EX-32
Exhibit
32.1
Certification
Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
I, LeRoy T.
Carlson, Jr., the chief executive officer of Telephone and Data Systems, Inc.,
certify that (i) the quarterly report on Form 10-Q for the third quarter of
2006 fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and (ii) the information contained in the Form
10-Q fairly presents, in all material respects, the financial condition and
results of operations of Telephone and Data Systems, Inc.
|
|
|
|
|
|
|
|
/s/ LeRoy T. Carlson, Jr.
|
|
|
LeRoy T. Carlson, Jr.
|
|
|
February 23, 2007
|
|
|
|
A signed original of this
written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has
been provided to Telephone and Data Systems, Inc. and will be retained by
Telephone and Data Systems, Inc. and furnished to the Securities and Exchange
Commission or its staff upon request.
EX-32.2
6
a06-25513_4ex32d2.htm
EX-32
Exhibit
32.2
Certification
Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code
I, Kenneth R.
Meyers, the chief financial officer of Telephone and Data Systems, Inc.,
certify that (i) the quarterly report on Form 10-Q for the third quarter of
2006 fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and (ii) the information contained in the Form
10-Q fairly presents, in all material respects, the financial condition and
results of operations of Telephone and Data Systems, Inc.
|
|
|
|
|
|
|
|
/s/ Kenneth R. Meyers
|
|
|
Kenneth R. Meyers
|
|
|
February 23, 2007
|
|
|
|
A signed original of this
written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has
been provided to Telephone and Data Systems, Inc. and will be retained by
Telephone and Data Systems, Inc. and furnished to the Securities and Exchange
Commission or its staff upon request.
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end
-----END PRIVACY-ENHANCED MESSAGE-----