OR
Commission file number 001-14157
(Exact name of registrant as specified in its charter)
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 ý No ¨ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
TELEPHONE AND DATA SYSTEMS, INC.
1st QUARTER REPORT ON FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATIONITEM 1. FINANCIAL STATEMENTSTELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSUnaudited
The accompanying notes to financial statements are an integral part of these statements.
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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited
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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETSUnaudited
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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETSLIABILITIES AND STOCKHOLDERS’ EQUITYUnaudited
(a) The sole asset of TDS Capital I is $154.6 million principal amount of 8.5% subordinated debentures due 2037 from TDS. The sole asset of TDS Capital II is $154.6 million principal amount of 8.04% subordinated debentures due 2038 from TDS.
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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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(1)Other consists of goodwill related to an investment in a cellular market owned by an ILEC subsidiary. (2)See Note 10 – Assets of Operations Held-for-Sale for discussion of allocation.
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Operating income before depreciation and amortization and Operating income before depreciation and amortization and loss on assets held-for-sale are measures of profit and loss used by the chief operating decision maker to review the operating performance of each reportable business segment and is reported above in accordance with SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information.”
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Telephone and Data Systems, Inc. (“TDS” or the “Company”) is a diversified telecommunications company providing high-quality telecommunications services to approximately 5.3 million wireless telephone and wireline telephone customer units. TDS conducts substantially all of its wireless telephone operations through its 82.2%-owned subsidiary, United States Cellular Corporation (“U.S. Cellular”) and its incumbent local exchange carrier (“ILEC”) and competitive local exchange carrier (“CLEC”) wireline telephone operations through its wholly owned subsidiary, TDS Telecommunications Corporation (“TDS Telecom”).
The following discussion and analysis should be read in conjunction with the Company’s interim consolidated financial statements and footnotes included herein, and with the Company’s audited consolidated financial statements and footnotes and Management’s Discussion and Analysis of Results of Operations and Financial Condition included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
RESULTS OF OPERATIONS
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Operating Revenues increased 21% ($142.2 million) during the first three months of 2003 primarily as a result of a 19% increase in customer units served. U.S. Cellular’s operating revenues increased 25% ($117.5 million) as customer units served increased by 736,000, or 21%, since March 31, 2002, to 4,240,000. Acquisitions contributed 9% (320,000 customer units) of U.S. Cellular’s customer growth in the past twelve months. TDS Telecom operating revenues increased 13% ($24.7 million) as equivalent access lines increased by 115,200, or 13%, since March 31, 2002 to 1,017,700. Acquisitions contributed 3% (27,000 equivalent access lines) of TDS Telecom’s equivalent access line growth in the past twelve months.
Operating Expenses rose 38% ($213.7 million) in 2003 reflecting growth in operations. U.S. Cellular’s operating expenses increased 51% ($203.4 million) primarily reflecting costs associated with providing service to an expanding customer base and additional expenses related to the Chicago market acquired in August 2002. Also included in U.S. Cellular’s operating expenses is a $23.5 million loss on assets of operations held-for-sale. TDS Telecom’s expenses increased 6% ($10.4 million) reflecting growth in operations offset somewhat by a reduction in bad debt expense.
Operating Income decreased 68% ($71.5 million) to $33.9 million in 2003. Operating margin decreased to 4.2% in 2003 from 15.8% in 2002 on a consolidated basis. U.S. Cellular’s operating income decreased 108% ($85.9 million) to an operating loss of $6.2 million in 2003 and its operating income margin, as a percentage of service revenues, decreased to (1.1)% in 2003 from 17.3% in 2002. TDS Telecom’s operating income increased 56% ($14.4 million) to $40.1 million in 2003 and its operating margin rose to 18.9% in 2003 from 13.8% in 2002.
Investment and Other Income (Expense)primarily includes interest and dividend income, investment income and gain (loss) on marketable securities and other investments. Investment and other income (expense) totaled $14.7 million in 2003 and $(23.1) million in 2002.
Interest and Dividend Incomeincreased $2.3 million to $4.3 million in 2003 primarily due to increased interest income earned on larger cash balances. The Company reported cash and cash equivalents of $1,315.9 million at March 31, 2003. The increase in cash is primarily from the cash received from the forward contracts during 2002.
Investment Income increased 16% ($1.7 million) in the first three months of 2003. Investment income represents the Company’s share of income in unconsolidated entities in which the Company has a minority interest and follows the equity method of accounting.
(Loss) on Marketable Securities and Other Investments totaled $3.5 million in 2003 and $37.4 million in 2002. A $3.5 million license cost impairment loss was recorded related to the investment in a non-operating market in Florida that will remain after the AT&T Wireless exchange. In 2002, management determined the decline in value of TDS’s investment in VeriSign, Inc. relative to its accounting cost basis was other than temporary and charged the loss to the income statement.
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Interest Expense increased 46% ($13.7 million) to $43.4 million in 2003. The increase in interest expense in 2003 was primarily due to amounts related to variable prepaid forward contracts ($10.3 million) and to the issuance of 30-year 8.75% Senior Notes ($2.8 million) by U.S. Cellular in November 2002.
Income Tax Expense decreased 83% ($18.6 million) in 2003 primarily due to the lower pretax income and the tax effects of the loss on marketable securities and other investments and the loss on assets held-for-sale. Losses totaled $27.0 million ($16.3 million, net of tax of $7.2 million and minority interest of $3.5 million) in 2003. A Loss of $37.4 million ($22.6 million, net of tax of $14.8 million) was recorded on marketable securities in 2002. The effective tax rate was not meaningful in 2003 and 48.3% in 2002. Excluding the tax on the losses, the effective tax rate was 42.2% in 2003 and 44.3% in 2002. For a discussion of the Company’s effective tax rates in 2003 and 2002, see Note 4 – Income Taxes.
U.S. Cellular recorded a loss of $23.5 million on assets held-for-sale for the difference between the book value of the markets to be given up to AT&T Wireless and the fair value of the assets to be received in the transaction. Because U.S. Cellular’s tax basis in the assets to be transferred to AT&T Wireless is lower than its book basis, the Company anticipates that it will record an additional charge to the income statement of approximately $12 million for taxes and will have a current tax liability of approximately $27 million related to the completion of the transaction, which is expected to close in the third quarter of 2003.
Minority Share of (Income) includes the minority public shareholders’ share of U.S. Cellular’s net income, the minority shareholders’ or partners’ share of U.S. Cellular’s subsidiaries’ net income or loss and other minority interests. U.S. Cellular’s minority public shareholders’ share of income in 2003 was reduced by $3.5 million due to U.S. Cellular’s loss on marketable securities and other investments and loss on assets held-for-sale.
Income (Loss) Before Cumulative Effect of Accounting Change totaled $(5.0) million, or $(0.09) per diluted share, in 2003 compared to $14.0 million, or $0.23 per diluted share, in 2002.
Cumulative Effect of Accounting Change. Effective January 1, 2002, U.S. Cellular changed its method of accounting for commissions expenses related to customer activations and began deferring expense recognition of a portion of commissions expenses in the amount of activation fees revenue deferred. The cumulative effect of this accounting change on periods prior to 2002 was recorded in 2002 and increased net income by $3.4 million, net of tax and minority interest, or $0.06 per diluted share.
Net Income (Loss) Available to Commontotaled $(5.1) million, or $(0.09) per diluted share, in 2003, compared to $17.3 million, or $.29 per diluted share, in 2002.
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U.S. CELLULAR OPERATIONS
TDS provides wireless telephone service through United States Cellular Corporation (“U.S. Cellular”), an 82.2%-owned subsidiary. U.S. Cellular owns, manages and invests in cellular markets throughout the United States. Growth in the customer base and the acquisition of Chicago 20MHz, LLC (“Chicago 20MHz”) are the primary reasons for the growth in U.S. Cellular’s revenues and expenses. The number of customer units served increased by 736,000 or 21%, since March 31, 2002, to 4,240,000 due to customer additions from its marketing channels as well as the addition of customers from the Chicago 20MHz acquisition.
On August 7, 2002, U.S. Cellular completed the acquisition of the assets and certain liabilities of Chicago 20MHz from PrimeCo Wireless Communications LLC (“PrimeCo”). Chicago 20MHz operates a wireless system in the Chicago Major Trading Area (“MTA”). Chicago 20MHz is the holder of certain FCC licenses, including a 20 megahertz (“MHz”) PCS license in the Chicago MTA (excluding Kenosha County, Wisconsin) covering a total population of 13.2 million. The Chicago 20MHz operations are included in consolidated operations for the first quarter of 2003 but not for the comparable quarter of 2002. The Chicago 20MHz operations contributed to the increases in the Company’s operating revenues and expenses during 2003 compared to 2002.
Operating revenues increased 25% ($117.5 million) in 2003 primarily related to the 21% increase in customer units. Average monthly service revenue per customer increased 2% ($0.91) to $45.05 in 2003 from $44.14 in 2002.
Retail service revenues (charges to U.S. Cellular’s customers for local system usage and usage of systems other than their local systems) increased 24% ($90.5 million) in 2003 due primarily to the growth in customers. Average retail service revenue per minute continued to decline while the average local minutes of use per customer increased 59% to 377 in 2003 from 237 in 2002. Competitive pressures and U.S. Cellular’s use of incentive programs and rate plans to stimulate overall usage, as well as the acquisition of Chicago 20MHz, whose customers used more minutes per month than the Company average resulted in a lower average monthly retail service revenue per minute of use. Average monthly retail service revenue per customer increased 4% ($1.26) to $37.05 in 2003 from $35.79 in 2002.
Inbound roaming revenues (charges to other wireless carriers whose customers use U.S. Cellular’s wireless systems when roaming) increased 1% ($0.3 million) in 2003. The increase in revenue related to inbound roaming on U.S. Cellular’s systems primarily resulted from an increase in roaming minutes used, almost fully offset by the decrease in revenue per roaming minute of use. The increase in inbound roaming minutes of use was primarily driven by the overall growth in the number of customers throughout the wireless industry. Average inbound roaming revenue per minute of use is expected to continue to decline in the future, reflecting the general downward trend in negotiated rates.
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Management anticipates that the rate of growth in inbound roaming minutes of use will continue to slow down due to newer customers roaming less than existing customers, reflecting further penetration of the consumer market. In addition, as new wireless operators begin service in U.S. Cellular’s markets, roaming partners could switch their business to these new operators.
Long-distance and other revenueincreased $12.7 million, or 39%, in 2003, primarily related to an increase in the volume of long-distance calls billed by U.S. Cellular from inbound roamers using U.S. Cellular’s systems to make long-distance calls. This effect was partially offset by price reductions primarily related to long-distance charges on roaming minutes of use as well as U.S. Cellular’s increasing use of pricing plans for its customers which include long-distance calling at no additional charge. The increase in long-distance and other revenue was also driven by the increase in amounts billed to U.S. Cellular’s customers to offset certain regulatory charges, such as universal service funding and E-911 infrastructure costs, which are being passed through to customers.
Equipment sales revenues increased 81% ($14.0 million) in 2003. U.S. Cellular changed its method of distributing handsets to its agent channels in the second quarter of 2002. U.S. Cellular began selling handsets to its agents at a price approximately equal to its cost before applying any rebates. Previously, the agents purchased handsets from third parties. Selling handsets to agents enables U.S. Cellular to provide better control over handset quality, set roaming preferences and pass along quantity discounts. Management anticipates that U.S. Cellular will continue to sell handsets to agents in the future, and that it will continue to provide rebates to agents who provide handsets to new and current customers.
Equipment sales revenue is recognized upon delivery of the related products to the agents, net of any anticipated agent rebates. In most cases, the agents receive a rebate from U.S. Cellular at the time these agents sign up a new customer or retain a current customer.
Handset sales to agents, net of all rebates, increased equipment sales revenues by approximately $17.7 million during 2003. Excluding those revenues, equipment sales would have decreased $3.7 million, or 22%, from 2002. Gross customer activations, the primary driver of equipment sales revenues, increased 47% in 2003. The increase in gross customer activations in 2003 was driven by an increase in store traffic in U.S. Cellular’s markets and the acquisition of Chicago 20MHz, which added to U.S. Cellular’s distribution network. The decrease in revenues is primarily attributable to lower revenue per handset in 2003, reflecting declining handset prices and the reduction in sales prices to end users as a result of increased competition.
Operating expenses increased 51% ($203.4 million) in 2003. The increase is primarily related to costs incurred to serve and expand the growing customer base.
System operations expenses increased 28% ($30.0 million). System operations expenses include charges from other telecommunications service providers for U.S. Cellular’s customers’ use of their facilities, costs related to local interconnection to the landline network, charges for maintenance of the network, long-distance charges and outbound roaming expenses. The increase was due to an increase in the cost of minutes used on the systems ($13.9 million), an increase in the cost of maintaining the network ($11.8 million) and an increase in the costs associated with customers roaming on other companies’ systems ($4.3 million). Management expects system operations to increase over the next few years, driven by increases in the number of cell sites and increases in minutes of use on the U.S. Cellular system and on other systems when roaming. The number of cell sites increased to 3,987 in 2003 from 3,049 in 2002.
In 2003, system operations expenses increased due to the acquisition of Chicago 20MHz. The increase in expenses in the Chicago 20MHz market was partially offset by a reduction in expenses in other markets, primarily in the Midwest, when customers in those markets used the Chicago 20MHz system. In 2002, U.S. Cellular paid roaming charges to third parties when its customers roamed in the Chicago market.
As the Chicago area has historically been U.S. Cellular’s customers’ most popular roaming destination, management anticipates that the continued integration of Chicago 20MHz into its operations will result in a further increase in minutes of use by U.S. Cellular’s customers on its systems and a corresponding decrease in minutes of use by its customers on other systems, resulting in a lower overall increase in minutes of use by U.S. Cellular’s customers on other systems. Such a shift in minutes of use should reduce U.S. Cellular’s per-minute cost of usage in the future, to the extent that U.S. Cellular’s customers use U.S. Cellular’s systems rather than other carriers’ networks.
Marketing and selling expensesincreased 37% ($29.7 million) in 2003. Marketing and selling expenses primarily consist of salaries, commissions and expenses of field sales and retail personnel and offices; agent
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commissions and related expenses; corporate marketing, merchandise management and telesales department salaries and expenses; advertising; and public relations expenses. The increase in 2003 was primarily due to the 47% increase in gross customer activations in 2003, which drove a $7.2 million increase in commissions and agent-related payments, and a $10.7 million increase in advertising costs, primarily related to the continued marketing of the U.S. Cellular brand in the Chicago 20MHz market.
Marketing cost per gross customer activation (“CPGA”), which includes marketing and selling expenses and cost of equipment sold, less equipment sales revenues (excluding agent rebates related to customer retention), decreased 1% to $358 in 2003 from $362 in 2002. Agent rebates related to the retention of current customers totaled $7.9 million in 2003. Due to the impact of such agent rebates, in 2003 CPGA is not calculable using financial information derived directly from the statement of operations. Future CPGA calculations will also be impacted by the effects of agent rebates related to customer retention.
Cost of equipment sold increased 113% ($34.4 million) in 2003. The increase in 2003 is primarily due to the $32.8 million in handset costs related to the sale of handsets to agents beginning in the second quarter of 2002. Excluding agent handset sales, cost of equipment sold increased by $1.6 million, or 5%, in 2003. This increase primarily reflects a 47% increase in gross customer activations, almost fully offset by reduced per unit handset prices.
General and administrative expensesincreased 45% ($49.0 million) in 2003. These expenses include the costs of operating U.S. Cellular’s customer care centers, the costs of serving and retaining customers and the majority of U.S. Cellular’s corporate expenses. The increase in general and administrative expenses is primarily due to increases in billing-related expenses ($10.8 million), bad debt expenses ($9.1 million), customer retention expenses ($5.7 million) and various customer service-related expenses as a result of the 21% increase in the customer base. The increase in billing-related expenses is primarily related to maintenance of the Chicago 20MHz billing system and the ongoing conversion of such billing system to the system used in U.S. Cellular’s other operations. The other factors above were also impacted by the acquisition of Chicago 20MHz.
U.S. Cellular anticipates that customer retention expenses will increase in the future as it changes to a single digital technology platform and certain customers will require new handsets. A substantial portion of these customer retention expenses are anticipated to be agent rebates, which are recorded as a reduction of equipment sales revenues.
Depreciation expense increased 45% ($29.9 million) in 2003 primarily due to the 34% increase in average fixed assets since March 31, 2002. Amortization expense increased 101% ($6.9 million) in 2003 primarily driven by the $4.3 million of amortization related to the customer list intangible assets acquired.
Loss on assets held-for-sale totaled $23.5 million in 2003. The loss was recorded on the difference between the book value of the markets to be transferred to AT&T Wireless and the fair value of the assets to be received in the transaction, as determined by an independent valuation. Subsequent to recording the loss, the recorded value of the assets U.S. Cellular expects to transfer to AT&T Wireless is equal to the fair value of the assets U.S. Cellular expects to receive from AT&T Wireless. This loss may require an adjustment at the time the transaction is completed if either the fair value of assets received or the recorded value of the assets transferred have changed.
Operating income (loss) decreased $85.9 million to a loss of $6.2 million in 2003. The decline in operating income reflects increased expenses from the acquisition and launch of the Chicago market; increased number of cell sites and fixed assets, equipment subsidies and network usage; and the loss on assets held for sale. U.S. Cellular expects most of the above factors to continue to have an effect on operating income for the next several quarters. Any changes in the above factors, as well as the effects of other drivers of U.S. Cellular’s operating results, may cause operating income to fluctuate over the next several quarters.
Related to U.S. Cellular’s acquisition and subsequent transition of the Chicago 20MHz operations, U.S. Cellular plans to incur additional expenses during the remainder of 2003 as it competes in the Chicago market. Additionally, U.S. Cellular plans to build out its network into other as yet unserved portions of its PCS licensed areas, and will begin marketing operations in those areas during 2003 and 2004. As a result, U.S. Cellular’s operating income and operating margins may be below historical levels for the full years of during 2003 and 2004 compared to the full year of 2002.
Management expects service revenues to continue to grow during the remainder of 2003. However, management anticipates that average monthly revenue per customer may decrease as retail service revenue
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per minute of use and inbound roaming revenue per minute of use decline. Management believes U.S. Cellular operating results reflect seasonality in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses which tend to be higher in the fourth quarter due to increased marketing activities and customer growth. This seasonality may cause operating income to vary from quarter to quarter. Management anticipates that the impact of such seasonality will decrease in the future, particularly as it relates to operating expense, as the proportion of full year customer activations derived from fourth quarter holiday sales is expected to decline.
Competitors licensed to provide wireless services have initiated service in substantially all of U.S. Cellular’s markets over the past several years. U.S. Cellular expects other wireless operators to continue deployment of their networks throughout all of its service areas during the remainder of 2003 and in 2004. U.S. Cellular’s management continues to monitor other wireless communications providers’ strategies to determine how this additional competition is affecting U.S. Cellular’s results. The effects of additional wireless competition and the downturn in the nation’s economy have significantly slowed customer growth in certain of U.S. Cellular’s markets. Management anticipates that overall customer growth may be slower in the future, primarily as a result of the increase in competition in U.S. Cellular’s markets and the maturation of the wireless industry.
Acquisition of Wireless Markets
On March 10, 2003, U.S. Cellular announced that it had entered into a definitive agreement with AT&T Wireless (“AWE”) to exchange wireless properties. U.S. Cellular will receive 10 and 20 MHz PCS licenses in 13 states, representing 12.2 million incremental population equivalents contiguous to existing properties and 4.4 million population equivalents that overlap existing properties in the Midwest and the Northeast. U.S. Cellular will also receive approximately $31 million in cash (excluding any working capital adjustment) and minority interests in six markets it currently controls. U.S. Cellular will transfer wireless assets and approximately 141,000 customers in 10 markets, representing 1.5 million population equivalents, in Florida and Georgia to AWE. The transaction is subject to regulatory approvals. The closing of the transfer of the U.S. Cellular properties and the assignments to U.S. Cellular of most of the PCS licenses is expected to occur in the third quarter of 2003. The assignment and development of certain licenses will be deferred by U.S. Cellular until later periods. The acquisition of licenses in the exchange will be accounted for as a purchase by U.S. Cellular and the transfer of the properties by U.S. Cellular will be accounted for as a sale. The Company will not report the transaction as discontinued operations as previously disclosed.
As a result of the agreement, the consolidated balance sheet of TDS as of March 31, 2003 reflects the wireless assets and liabilities to be transferred as assets and liabilities of operations held-for-sale in accordance with SFAS No. 144. The results of operations of the markets to be transferred continue to be included in results from operations.
U.S. Cellular allocated $93.7 million of goodwill to the operations held-for-sale in accordance with SFAS No. 142 “Goodwill and Other Intangible Assts.” Subsequent to the allocation, a $23.5 million loss was recorded and reported as a “loss on assets held-for–sale” for the difference between the book value of the markets to be given up to AT&T Wireless and the fair value of the assets to be received in the transaction. The Company anticipates that it will record an additional charge to the income statement of approximately $12 million for taxes and will have a current tax liability of approximately $27 million related to the completion of the transaction, which is expected to close in the third quarter of 2003.
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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 115,200 or 13%, since March 31, 2002 to 1,017,700.
TDS Telecom’s incumbent local exchange carriers (“ILEC”) subsidiaries served 713,800 equivalent access lines at March 31, 2003, a 5% (32,800 equivalent access lines) increase from the 681,000 equivalent access lines at March 31, 2002. Acquisitions in 2002 added 27,000 equivalent access lines while internal growth added 5,800 equivalent access lines.
TDS Telecom’s competitive local exchange carrier (“CLEC”) subsidiaries served 303,900 equivalent access lines at March 31, 2003, a 37% (82,400 equivalent access lines) increase from 221,500 equivalent access lines served at March 31, 2002.
Operating revenues increased 13% ($24.7 million) in 2003. CLEC operations, reflecting customer growth, contributed $14.7 million to the increase in operating revenues in 2003. Telephone companies acquired in 2002 contributed operating revenues of $5.2 million in 2003. In addition, the operations of relatively new services such as long distance resale, Internet service and digital subscriber line (“DSL”) service increased operating revenues $3.0 million in 2003.
Operating expenses increased 6% ($10.4 million) during 2003, reflecting primarily growth in access lines and growth in expenses related to the newer services and offset by a reduction in bad debt expense in 2003 as compared to 2002 due to the bankruptcies of certain long-distance carriers in 2002.
Operating income increased 56% ($14.4 million) to $40.1 million in 2003 reflecting improved operating results from CLEC operations, the reduction of bad debt expense and the operating results of acquired ILEC companies.
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Local Telephone OperationsOperating revenues increased 7% ($10.1 million) in 2003. Average monthly revenue per equivalent access line increased 2% ($1.33) to $74.68 in 2003 from $73.35 in 2002. Acquisitions increased operating revenues by $5.2 million in 2003. Revenues from Internet, DSL and other non-regulated lines of business increased miscellaneous revenues by $1.9 million in 2003. As of March 31, 2003, TDS Telecom ILEC operations were providing Internet service to 118,100 customers compared to 115,200 customers in 2002 and were providing DSL service to 12,800 customers compared to 3,300 customers in 2002. Revenues from reselling long distance service increased network access and long distance revenues by $1.0 million in 2003. As of March 31, 2003, TDS Telecom ILEC operations were providing long distance service to 202,100 customers compared to 146,100 customers in 2002.
Operating expenses increased by 5% ($5.2 million) in 2003. Operating expenses before depreciation and amortization increased by 5% ($4.0 million) in 2003. Acquisitions increased operating expenses before depreciation and amortization by $3.2 million in 2003. The cost of providing long-distance, Internet and DSL service to an increased customer base increased expenses by $3.1 million. Bad debt expense decreased by $3.9 million in 2003. Bad debt expense recorded in 2002 included $3.0 million related to the write-off of pre-petition accounts receivable due to the bankruptcy of Global Crossing. Depreciation and amortization increased 4% ($1.2 million) in 2003.
Operating income increased 12% ($4.9 million) to $45.4 million primarily due to the reduction in bad debt expense and the partial recovery of amounts due from Global Crossing and the contribution of the acquired companies. Local telephone operating expenses are expected to increase due to inflation while additional revenues and expenses are expected from new or expanded product offerings.
Competitive Local Exchange OperationsTDS Telecom’s CLEC strategy maintains a geographic focus and is designed to leverage TDS Telecom’s existing management and infrastructure to complement TDS Telecom’s ILEC clustering strategy. TDS Telecom has followed a strategy of controlled entry into certain targeted mid-size communities, regionally proximate to existing TDS Telecom facilities and service areas, with facilities-based entry as a CLEC. TDS Telecom intends to be the leading alternative provider for customers’ wired telecommunications in its CLEC markets.
Operating revenues (revenue from the provision of local and long-distance telephone service and revenue from a long-distance provider) increased 39% ($14.7 million) in 2003 as equivalent access lines served increased to 303,900 at March 31, 2003 from 221,500 at March 31, 2002. TDS Metrocom commercial customer revenues increased $4.6 million in 2003 while residential customer revenues increased $4.1 million. Operating revenue in 2003 also includes a one-time settlement, which increased access revenues by $1.8 million. Average monthly revenue per equivalent access line was $58.85 in 2003 and $61.01 in 2002.
Operating expenses increased 10% ($5.2 million) in 2003. Operating expenses before depreciation and amortization increased $3.9 million while depreciation and amortization increased $1.3 million.
Operating loss decreased 64% ($9.5 million) to $5.4 million. The decline in competitive local exchange operating losses primarily reflects growth in revenues complemented by cost constraint.
FINANCIAL RESOURCES
Cash Flows From Operating Activities.The Company generates substantial internal funds from the operations of U.S. Cellular and TDS Telecom. Cash flows from operating activities totaled $175.9 million in the first three months of 2003 compared to $183.1 million in 2002.
The following table is a summary of the components of cash flows operating activities.
Changes in working capital and other assets and liabilities provided $3.3 million in 2003 and $20.0 million in 2002 reflecting timing differences in the payment of accounts payable, the receipt of accounts receivable, the change in accrued taxes and materials and supplies balances.
Cash Flows from Investing ActivitiesTDS makes substantial investments each year to acquire, construct, operate and upgrade modern high-quality communications networks and facilities as a basis for creating long-term value for shareowners. In recent years, rapid changes in technology and new opportunities have required substantial investments in revenue enhancing and cost reducing upgrades to TDS’s networks. Cash flows used for investing activities required $151.4 million in the first three months of 2003 compared to $147.5 million in 2002.
Cash expenditures for capital additions required $161.4 million in 2003 and $128.3 million in 2002. The primary purpose of TDS’s construction and expansion expenditures is to provide for significant customer growth, to upgrade service, and to take advantage of service-enhancing and cost-reducing technological developments in order to maintain competitive services. U.S. Cellular’s capital additions totaled $140.9 million in 2003 and $100.1 million in 2002 representing expenditures to construct cell sites, to replace retired assets, to improve business systems and to migrate to a single digital equipment platform — CDMA. TDS Telecom capital expenditures for its local telephone operations totaled $15.4 million in 2003 and $19.2 million in 2002 representing expenditures for switch modernization and outside plant facilities to maintain and enhance the quality of service and offer new revenue opportunities. TDS Telecom’s capital expenditures for competitive local exchange operations totaled $3.7 million in 2003 and $9.0 million in 2002 for switching and other network facilities. Corporate capital expenditures totaled $1.3 million in 2003.
Distributions from unconsolidated investments provided $13.6 million in 2003 and $4.1 million in 2002. The Company acquired two PCS licenses for $17.1 million in 2002.
Cash Flows from Financing ActivitiesCash flows from financing activities required $7.5 million in the first three months of 2003 and $95.5 million in 2002. In 2003, U.S. Cellular repurchased and cancelled the remaining $45.2 million of 9% Series A Notes
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from PrimeCo for $40.7 million. The repurchase was financed using short-term debt. In 2002, TDS retired a total of $51.0 million of medium-term notes at par value. Notes Payable provided $72.0 million in 2003 and required by $31.0 million in 2002. Dividends paid on Common and Preferred Shares, excluding dividends reinvested, totaled $9.2 million in 2003 and $8.6 million in 2002.
During the first three months of 2003 cash required for the repurchase of TDS Common Shares totaled $24.6 million. An additional $4.8 million was paid in April 2003 to settle repurchases that occurred at the end of March 2003. In total, TDS has repurchased 750,300 Common Shares for an average price of $39.11 per share as of March 31, 2003.
LIQUIDITY AND CAPITAL RESOURCES
Management believes that internal cash flow, existing cash and cash equivalents, and funds available from line of credit arrangements provide sufficient financial resources to finance its near-term capital, business development and expansion expenditures. TDS and its subsidiaries have access to public and private capital markets to help meet their long-term financing needs. TDS and its subsidiaries anticipate accessing public and private capital markets to issue debt and equity securities when and if capital requirements, financial market conditions and other factors warrant.
However, the availability of financial resources is dependent on economic events, business developments, technological changes, financial conditions or other factors. 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 does not believe that any circumstances that could materially adversely affect TDS’s liquidity or capital resources are currently reasonably likely to occur, but it cannot provide assurances that such circumstances will not occur or that they will not occur rapidly. Economic downturns, changes in financial markets or other factors could rapidly change the availability of TDS’s liquidity and capital resources. Uncertainty of access to capital for telecommunications companies, further deterioration in the capital markets, other changes in market conditions or other factors could limit or restrict the availability of financing on terms and prices acceptable to TDS, which could require TDS to reduce its construction, development, acquisition and share repurchase programs.
The Company generates substantial internal funds from the operations of U.S. Cellular and TDS Telecom. Cash flows from operating activities totaled $175.9 million in the first three months of 2003 compared to $183.1 million in 2002. TDS and its subsidiaries had cash and cash equivalents totaling $1,315.9 million at March 31, 2003. TDS anticipates using a portion of the cash to repurchase common shares, reduce outstanding debt and for general corporate purposes.
The Company has entered into a number of variable prepaid forward contracts (“forward contracts”) related to the marketable equity securities that it holds. The forward contracts mature from May 2007 to August 2008 and, at the Company’s option, may be settled in shares of the respective security or cash. If shares are delivered in the settlement of the forward contract, the Company 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 taxes have been provided for the difference between the financial reporting basis and the income tax basis of the marketable equity securities and are included in deferred tax liabilities on the balance sheet. As of March 31, 2003, such deferred tax liabilities totaled $646.5 million.
Revolving Credit Facilities As discussed below, TDS and its subsidiaries had $1,425 million of revolving credit facilities available for general corporate purposes as well as an additional $75 million in bank lines of credit as of March 31, 2003.
TDS had a $600 million revolving credit facility for general corporate purposes at March 31, 2003. TDS had $3.3 million of letters of credit outstanding against the revolving credit agreement leaving $596.7 million available for use. The credit facility expires in January 2007. Borrowings bear interest at the London Interbank Borrowing Rate (“LIBOR”) plus a contractual spread based on the Company’s credit rating. The contractual spread was 30 basis points as of March 31, 2003 (for a rate of 1.59% based on the LIBOR rate at March 31, 2003).
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TDS also had $75 million of additional bank lines of credit for general corporate purposes at March 31, 2003, all of which was unused. The lines of credit expire in less than one year. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate (4.25% at March 31, 2003).
U.S. Cellular had a $500 million bank revolving line of credit (“1997 Revolving Credit Facility”) for general corporate purposes at March 31, 2003, $20 million of which was unused. The 1997 Revolving Credit Facility expires in August 2004. This line of credit provides for borrowings at LIBOR plus a contractual spread, based on U.S. Cellular’s credit rating, which was 19.5 basis points as of March 31, 2003 (for a rate of 1.49% based on the LIBOR rate at March 31, 2003).
U.S. Cellular also had a $325 million bank revolving line of credit (“2002 Revolving Credit Facility”) to be used for general corporate purposes at March 31, 2003, $273 million of which was unused. The 2002 Revolving Credit Facility expires in June 2007. This line of credit provides for borrowings with interest at LIBOR plus a margin percentage, based on U.S. Cellular’s credit rating, which was 55 basis points as of March 31, 2003 (for a rate of 1.84% based on the LIBOR rate at March 31, 2003).
TDS’s and U.S. Cellular’s interest costs would increase if their credit rating goes down which would increase their cost of financing, but their credit facilities would not cease to be available solely as a result of a decline in their credit rating. A downgrade in TDS’s or U.S. Cellular’s credit rating could adversely affect its ability to renew existing, or obtain access to new, credit facilities in the future. 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 provide representation on certain matters at the time of each borrowing. At March 31, 2003, TDS and U.S. Cellular were in compliance with all covenants and other requirements set forth in the credit agreements. The respective maturities of TDS’s and U.S. Cellular’s credit facilities would accelerate in the event of a change in control.
Long-term FinancingAt March 31, 2003, TDS and its subsidiaries are in compliance with all covenants and other requirements set forth in long-term debt indentures. TDS does not have any rating downgrade triggers that would accelerate the maturity dates of its long-term debt. However, a downgrade in TDS’s credit rating could adversely affect its ability to refinance existing, or obtain access to new, long-term debt in the future.
Capital ExpendituresU.S. Cellular’s estimated capital spending for 2003 totals approximately $600-$630 million, primarily to add cell sites to expand and enhance coverage, to provide additional capacity to accommodate increased network usage, to provide additional digital service capabilities including the migration toward a single digital platform — CDMA technology, to build out certain PCS licensed areas and to enhance office systems. U.S. Cellular’s capital expenditures for the three months ended March 31, 2003 totaled $140.9 million. U.S. Cellular plans to finance its cellular construction program using primarily internally generated cash and funds from the revolving credit facilities.
U.S. Cellular expects its conversion to CDMA to be completed during 2004, at a revised approximate cost of $385 million to $410 million spread over 2002 to 2004. Capital expenditures related to this conversion totaled $215 million in 2002, the capital expenditures in 2003 are estimated to be $50 million and the remaining $120 million to $145 million is planned for 2004. U.S. Cellular has contracted with multiple infrastructure vendors to provide a substantial portion of the equipment related to the conversion.
TDS Telecom’s estimated capital spending for 2003 approximates $170 million. The incumbent local telephone companies are expected to spend approximately $130 million to provide for normal growth and to upgrade plant and equipment to provide enhanced services. The competitive local exchange companies are expected to spend approximately $40 million to build switching and other network facilities to meet the needs of a growing customer base. TDS Telecom’s ILEC capital expenditures totaled $15.4 million and the CLEC capital expenditures totaled $3.7 million for the three months ended March 31, 2003. TDS Telecom plans to finance its construction program using primarily internally generated cash.
Acquisitions and DivestituresTDS reviews attractive opportunities to acquire additional telecommunications companies and wireless spectrum, which add value to the business. On March 10, 2003, U.S. Cellular announced that it had entered into a definitive agreement with AT&T Wireless (“AWE”) to exchange wireless properties. U.S. Cellular will receive 10 and 20 MHz PCS licenses in 13 states, representing 12.2 million incremental population equivalents contiguous to existing properties and 4.4 million population equivalents that overlap existing properties in the Midwest and the Northeast. U.S. Cellular will also receive approximately $31 million in cash (excluding any working capital adjustment) and minority interests in six markets it currently controls. U.S.
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Cellular will transfer wireless assets and approximately 141,000 customers in 10 markets, representing 1.5 million population equivalents, in Florida and Georgia to AWE. The transaction is subject to regulatory approvals. The closing of the transfer of the U.S. Cellular properties and the assignments to U.S. Cellular of most of the PCS licenses is expected to occur in the third quarter of 2003. The assignment and development of certain licenses will be deferred by U.S. Cellular until later periods. The acquisition of licenses in the exchange will be accounted for as a purchase by U.S. Cellular and the transfer of the properties by U.S. Cellular will be accounted for as a sale. The Company will not report the transaction as discontinued operations as previously disclosed.
During the quarter, the Company recorded a pre-tax loss of $23.5 million related to the difference between the fair value of the assets being exchanged with AT&T Wireless and their book value. The Company anticipates that it will record an additional charge to the income statement of approximately $12 million for taxes and will have a current tax liability of approximately $27 million upon the completion of the transaction. A final determination of gain or loss will be calculated at the time the transaction is completed, which is estimated to be in the third quarter of 2003, at which time the estimated loss will be adjusted.
Repurchase of Securities and DividendsAs market conditions warrant, TDS and U.S. Cellular may continue the repurchase of their common shares on the open market or at negotiated prices in private transactions. In 2003, the TDS Board of Directors authorized the repurchase of up to 3.0 million TDS Common Shares through February 2006. A total of 750,300 TDS Common Shares were repurchased in 2003 at an aggregate price of $29.4 million. TDS has 2,249,700 common shares remaining available for repurchase under the authorization. Share repurchases may be made from time to time on the open market or private transactions, at prices approximating then existing market prices. TDS has repurchased and may from time to time in the future repurchase shares under a 10b5-1 plan, which allows TDS to repurchase its shares during a period in which the TDS may be in possession of material non-public information, provided that TDS entered into the plan at a time when it was not in possession of material non-public information. In April 2003, the Company repurchased an additional 479,100 TDS Common Shares for a total of $20.5 million, representing an average per share price of $42.84.
U.S. Cellular, as market conditions warrant, may repurchase its common shares on the open market or at negotiate prices in private transactions. U.S. Cellular has approximately 859,000 shares remaining on its 1.4 million Common Share repurchase authorization that expires in December 2003. No U.S. Cellular Common Shares were repurchased in 2003.
The U.S. Cellular Board of Directors has authorized management to opportunistically repurchase LYONs in private transactions. U.S. Cellular may also purchase a limited amount of LYONs in open-market transactions from time to time. U.S. Cellular LYONs are convertible, at the option of their holders, at any time prior to maturity, redemption or purchase, into U.S. Cellular Common Shares at a conversion rate of 9.475 U.S. Cellular Common Shares per LYON. Upon conversion, U.S. Cellular has the option to deliver to holders either U.S. Cellular Common Shares or cash equal to the market value of the U.S. Cellular Common Shares into which the LYONs are convertible. U.S. Cellular may redeem the notes for cash at the issue price plus accrued original issue discount through the date of redemption.
TDS paid total dividends on its common and preferred stock of $9.2 million in the first quarter of 2003 and $8.6 million in the first quarter of 2002. TDS has no current plans to change its policy of paying dividends. TDS paid quarterly dividends per share of $.155 in 2003 and $.145 in 2002.
Securities Lending U.S. Cellular has entered into a securities loan agreement with an investment bank related to 1,680,000 of its Vodafone ADRs. Under the terms of the securities loan agreement, both U.S. Cellular and the investment bank have the right to terminate the loan at any time providing necessary time for share settlement (three business days). The investment bank is required to provide collateral that will be adjusted periodically to be not less than 100% of the fair market value of the loaned securities. U.S. Cellular earns a loan fee on the securities loaned.
Under SFAS No. 140, U.S. Cellular is required to account for the collateral as a secured borrowing. As a result, U.S. Cellular was required to record $32.2 million of Collateral investment pledged in current assets and a corresponding Collateral loan payable in current liabilities. The asset and liability will be offset upon the return of the loaned securities. Consequently, U.S. Cellular will not have to use cash flows from operations to extinguish the liability.
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Off Balance Sheet Arrangements TDS has no material transactions, arrangements, obligations (including contingent obligations) or other relationships with unconsolidated entities or other persons (“off-balance sheet arrangements”), 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 or significant components of revenues or expenses.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company prepares its consolidated financial statement in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Company’s significant accounting policies are discussed in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
The preparation of financial statements in accordance with generally accepted accounting principles requires management 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. Management 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.
Critical Accounting Estimates Management believes the following critical accounting estimates reflect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company’s senior management has discussed the development and selection of each of the following accounting estimates and the following disclosures with the audit committee of the Company’s board of directors.
License Costs and GoodwillThe Company reported $979.8 million and $1,038.6 million of wireless license costs and $1,008.6 million and $1,106.5 million of goodwill, at March 31, 2003 and December 31, 2002, respectively, as a result of the acquisitions of wireless licenses and markets, and the acquisition of operating telephone companies. Included in assets of operations held-for-sale was $55.1 million of license costs and $93.7 million of goodwill at March 31, 2003.
Wireless 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. 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 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. If the carrying amount exceeds the implied fair value, an impairment loss is recognized for that difference.
The fair value of an intangible asset and reporting unit goodwill 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 revenue or a similar performance measure. The use of these techniques involve assumptions by management about the following factors that are highly uncertain and can result in a range of values: future cash flows, the appropriate discount rate, and other factors and inputs.
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In the first quarter of 2003, the Company recorded a $3.5 million license cost impairment loss related to the investment in a non-operating market in Florida that will remain after the AT&T Wireless exchange.
Income TaxesThe 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 the company’s financial condition, changes in financial condition and results of operations.
The preparation of the consolidated financial statements requires the Company 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, such as depreciation expense, for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. The Company must then assess the likelihood that deferred tax assets will be recovered from future taxable income and to the extent management believes that recovery is not likely, establish a valuation allowance. Management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. The Company’s current net deferred tax asset was $20.3 million as of March 31, 2003, representing primarily the deferred tax effects of the allowance for doubtful accounts on accounts receivable.
The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of March 31, 2003 are as follows:
The valuation allowance relates to state net operating loss carry forwards and the federal operating loss carryforwards for those subsidiaries not included in the federal income tax return since it is more than likely that a portion will expire before such carryforwards can be utilized.
The deferred income tax liability relating to marketable equity securities of $646.5 million at March 31, 2003 represents deferred income taxes calculated on the difference between the book basis and the tax basis of the marketable securities. Income taxes will be payable when TDS sells the marketable securities.
The Company is routinely subject to examination of its income tax returns by the Internal Revenue Service (“IRS”) and other tax authorities. The Company 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. Management judgment is required in assessing the eventual outcome of these examinations. Changes to such assessments affect the calculation of the Company’s income tax expense. The IRS has completed audits of the Company’s federal income tax returns for tax years through 1996.
In the event of an increase in the value of tax assets or a decrease in the value of 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 the value of tax liabilities, TDS would increase the income tax expense or decrease the income tax benefit by an equivalent amount.
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Assets of Held for Sale OperationsIn connection with the exchange of wireless properties with AT&T Wireless, the consolidated balance sheet and supplemental data of TDS reflect the wireless assets and liabilities to be transferred as assets and liabilities of operations held-for-sale in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company will not report the transaction as discontinued operations as previously disclosed. The results of operations of the markets to be transferred continue to be included in results from continuing operations.
The value of goodwill allocated to the transferred markets is a critical accounting estimate because it is significant to the recorded value of the assets being transferred. An independent appraisal was performed to determine the fair value of the assets to be received from AT&T Wireless as well as the allocation of goodwill associated with the markets sold. The values of such allocations include underlying assumptions about uncertain matters that are material to the determination of the values, and different estimates could have had a material impact on the Company’s financial presentation that would have been used in the current period.
The following table summarizes the recorded value of the assets and liabilities of the 10 markets that U.S. Cellular will be transferring.
In accordance with SFAS No. 144, the Company recorded an estimated pre-tax loss of $23.5 million related to the pending sale of assets to AT&T Wireless. This loss was calculated by comparing the recorded value of the net assets to be transferred to the fair value of the assets to be acquired. A final determination of gain or loss will be calculated at the time the transaction is completed, which is estimated to be in the third quarter of 2003, at which time the estimated loss may be adjusted.
The Company anticipates that it will record an additional charge to the income statement of approximately $12 million for taxes and will have a current tax liability of approximately $27 million related to the completion of the transaction, which is expected to close in the third quarter of 2003.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following persons are partners of Sidley Austin Brown & Wood, 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 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 Acting 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 an Assistant Secretary of certain subsidiaries of TDS. Walter C.D. Carlson does not provide legal services to TDS or its subsidiaries.
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PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995SAFE HARBOR CAUTIONARY STATEMENT
This Management’s Discussion and Analysis of Results of Operations and Financial Condition and other sections of this Quarterly Report contain statements that are not based on historical fact, including the words “believes”, “anticipates”, “intends”, “expects”, and similar words. These statements constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the 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 factors include the following:
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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
TDS is subject to market rate risks due to fluctuations in interest rates and equity markets. The majority of TDS’s debt, excluding long-term debt related to the forward contracts, is in the form of long-term, fixed-rate notes, convertible debt, debentures and trust securities 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 bear interest at LIBOR plus a contractual spread. As of March 31, 2003, TDS had not entered into any significant financial derivatives to reduce its exposure to interest rate risks.
TDS maintains a portfolio of available-for-sale marketable equity securities. The market value of these investments aggregated $1,707.5 million at March 31, 2003 and $1,944.9 million at December 31, 2002. As of March 31, 2003, the net unrealized holding gain, net of tax and minority interest, included in accumulated other comprehensive income totaled $96.5 million. Management continues to review the valuation of the investments on a periodic basis. If management determines in the future that an unrealized loss is other than temporary, the loss will be recognized and recorded in the income statement.
TDS and subsidiaries have entered into a number of forward contracts related to the marketable equity securities that it holds. The 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 risk is hedged at or above the accounting cost basis thereby eliminating the other than temporary risk on these contracted securities.
Under the terms of the forward contracts, the Company will 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 August 2008 and, at the Company’s 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 the Company’s downside risk and upside potential on the contracted shares. The collars could be adjusted for any changes in dividends on the contracted shares. The forward contracts may be settled in shares of the respective marketable equity security or in cash upon expiration of the forward contract. If the Company elects to settle in shares, it 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, the Company 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 the Company elects to settle in cash it 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.
Deferred taxes have been provided for the difference between the financial reporting basis and the income tax basis of the marketable equity securities and are included in deferred tax liabilities on the balance sheet. As of March 31, 2003, such deferred tax liabilities totaled $646.5 million.
The following table summarizes certain facts relating to the contracted securities as of March 31, 2003.
(1) The per share amounts represent the range of floor and ceiling prices of all securities monetized. (2) U.S. Cellular owns 10.2 million and TDS Telecom owns 2.7 million Vodafone ADR’s.
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The following analysis presents the hypothetical change in the fair value of our marketable equity securities and derivative instruments at March 31, 2003, 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 securities or canceling any derivative instruments.
(1) Represents change in the fair value of the derivative instruments assuming the indicated increase or decrease in the underlying securities.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of a date within 90 days of the filing date of this Report on Form 10-Q, the principal executive officer and principal financial officer of TDS have concluded that TDS’ disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by TDS in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
(b) Changes in internal controls. There were no significant changes in TDS’ internal controls or in other factors that could significantly affect those controls subsequent to the date of their most recent evaluation.
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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES
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. Management does not believe that any such proceeding should have a material adverse impact on the financial position or results of operations of TDS.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
(b) Reports on Form 8-K filed during the quarter ended March 31, 2003:
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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)
Signature page for the TDS 2003 First Quarter Form 10-Q
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Certification of Chief Executive Officer
I, LeRoy T. Carlson, Jr., certify that:
designed such disclosure controls and procedures 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 quarterly report is being prepared;
evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
Date: May 14, 2003
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Certification of Chief Financial Officer
I, Sandra L. Helton, certify that: