- ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 ------------------------------------------------- OR 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) Registrant's telephone number, including area code: (312) 630-1900 Not Applicable --------------------------------------------------------- (Former address of principal executive offices) (Zip Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at July 31, 1998 ----------------------- ---------------------------- Common Shares, $.01 par value 54,087,749 Shares Series A Common Shares, $.01 par value 6,942,975 Shares - -------------------------------------------------------------------------------
TELEPHONE AND DATA SYSTEMS, INC. FORM 10-Q TABLE OF CONTENTS Page No. -------- Part I. Financial Information Management's Discussion and Analysis of Results of Operations and Financial Condition 2-13 Consolidated Statements of Income - Three Months and Six Months Ended June 30, 1998 and 1997 14 Consolidated Statements of Cash Flows - Six Months Ended June 30, 1998 and 1997 15 Consolidated Balance Sheets - June 30, 1998 and December 31, 1997 16-17 Notes to Consolidated Financial Statements 18-25 Part II. Other Information 26-28 Signatures 29
PART I. FINANCIAL INFORMATION ----------------------------- TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Telephone and Data Systems, Inc. ("TDS" or the "Company") is a diversified telecommunications company which provides high-quality telecommunications services to approximately 2.7 million cellular telephone, local telephone and personal communications service ("PCS") customer units. TDS's long-term business development strategy is to expand its operations through internal growth and acquisitions, and to explore and develop telecommunications businesses that management believes utilize TDS's expertise in customer- based telecommunications. TDS reported a 36% increase in revenues for the first half of 1998 on 49% growth in customers since June 30, 1997. United States Cellular Corporation ("U.S. Cellular") revenues increased 33% primarily due to a 52% increase in customer units. TDS Telecommunications Corporation ("TDS Telecom") reported a 13% increase in revenues on an 8% increase in access lines and increased activity in its new business ventures. Aerial Communications, Inc. ("Aerial") reported revenues of $67.4 million in the first half of 1998 and 204,000 customer units at June 30, 1998. Aerial launched service in its markets between late March and late June of 1997. Consolidated cash flow and operating income were down due to Aerial's losses as it continues to develop its markets and attract new customers. An increase in depreciation expense due to U.S. Cellular's change in useful lives and the buildout of Aerial's network also caused operating income to decline. U.S. Cellular's cash flow and operating income increased 41% and 27%, respectively, reflecting the increase in customers. TDS Telecom's cash flow and operating income declined by 2% and 17%, respectively, reflecting start-up costs in the new business ventures and increased operating expenses in the telephone operations. Aerial's cash outflow and operating loss more than doubled as its markets were in operation only the second quarter of 1997 compared to the first half of 1998. Investment and other income totaled $242.9 million, consisting primarily of $232.0 million of gains from the sale of cellular interests and other investments recorded in the first half of 1998. Interest expense increased 87% as a result of the increase in short- and long-term debt balances primarily to finance Aerial's activities. Net income available to common nearly tripled over the first half of 1997 due primarily to significant gains recorded on the sale of cellular interests and other investments. RESULTS OF OPERATIONS Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997 Telephone and Data Systems, Inc. reported net income available to common of $59.6 million, or $.97 per diluted share, in the first half of 1998, compared to $15.5 million, or $.25 per diluted share, in the first half of 1997. Net income included significant gains from the sale of cellular interests and other investments totaling $117.6 million, or $1.92 per share, in 1998, compared to $4.0 million, or $.07 per share, in 1997. 2
Net income from U.S. Cellular, excluding gains, decreased slightly to $37.7 million, or $.62 per share, in 1998, from $38.2 million, or $.63 per share, in 1997. U.S. Cellular's operating performance was offset by a decline in investment income and an increase in interest expense. Net income from TDS Telecom, excluding gains, decreased to $11.3 million, or $.19 per share, in 1998 from $15.7 million, or $.26 per share, in 1997, primarily due to an $8.6 million decrease in operating income. Aerial's activities reduced net income by $145.4 million, or $2.39 per share, in 1998 compared to $64.3 million, or $1.06 per share in 1997. Net income from Parent and Other increased to $38.3 million, or $.63 per share, in 1998 from $21.8 million, or $.35 per share, in 1997 due primarily to the increase in the tax benefit associated with Aerial's losses. The business units compute their federal income taxes as if they filed a separate return. Any income tax benefits used on a consolidated basis not used by the business units are recorded by TDS, the parent company. TDS and the business units have tax allocation agreements and policies under which the business units are able to carry forward any losses and credits and use them to offset any future income tax liability to TDS. The table below summarizes the results of operations of the business units and gains (along with the related impact of income taxes and minority interest) on net income available to common and diluted earnings per share. <TABLE> <CAPTION> Six Months Ended June 30, ------------------------- 1998 1997 ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> Net Income Available to Common U.S. Cellular $ 37,726 $ 38,241 TDS Telecom 11,341 15,742 Aerial (145,382) (64,327) Parent and Other 38,343 21,824 Gains 117,607 4,007 -------- -------- $ 59,635 $ 15,487 ======== ======== Diluted Earnings Per Share U.S. Cellular $ .62 $ .63 TDS Telecom .19 .26 Aerial (2.39) (1.06) Parent and Other .63 .35 Gains 1.92 .07 -------- --------- $ .97 $ .25 ======== ========= </TABLE> Operating Revenues increased 36% ($221.7 million) during the first half of 1998 primarily as a result of a 49% increase in customer units served. U.S. Cellular generated 60% ($133.1 million) of the total increase in revenues as customer units increased by 659,000 units, or 52%, for the twelve months ended June 30, 1998, to 1,922,000 units. Aerial generated 27% ($60.3 million) of the increase as it added 176,000 units for the twelve month period ended June 30, 1998, to 204,000 units. TDS Telecom generated 13% ($28.3 million) of the total increase in revenues. Access lines increased 8% for the twelve month period ended June 30, 1998 to 537,500 access lines. U.S. Cellular revenues increased 33% ($133.1 million) in 1998. Local retail revenue increased 41% ($108.0 million) in the first half of 1998 due primarily to the 52% customer growth. Average 3
local minutes of use per retail customer decreased by 4% to 102 in 1998 from 106 in 1997, while average local retail revenue per minute totaled $.33 in 1998 compared to $.35 in 1997. U.S. Cellular's use of pricing and other incentive programs that encourage lower-priced weekend and off-peak usage, in order to stimulate overall usage, resulted in a lower average revenue per minute of use in 1998. Inbound roaming revenue (charges to customers of other systems who use U.S. Cellular's cellular systems when roaming) increased less than 1% ($300,000) in the first half of 1998. The lack of substantial growth in inbound roaming revenue is in part a result of the exchange with BellSouth Corporation ("BellSouth"). Prior to the BellSouth exchange, revenue from BellSouth customers traveling into the Company's service areas was reported as inbound roaming revenue. For periods after the exchange, this revenue is eliminated as an intracompany transaction. In addition, increased roaming minutes used was offset by negotiated reductions in roaming rates. While minutes of use increased by 35%, average inbound roaming revenue per minute declined by 22% to $.68 in 1998 from $.88 in 1997. Total average monthly service revenue per customer decreased 15% ($8.53) to $47.50 in the first half of 1998 from $56.03 in 1997. Average monthly local retail revenue per customer declined 9% ($3.39) to $33.82 in 1998 from $37.21 in 1997 due primarily to competitive pressures, incentive programs being offered, consumer market penetration and the effects of acquisitions. The recently acquired markets produced a lower amount of revenue per customer, thereby reducing the average retail revenue per customer. Average monthly inbound roaming revenue per customer declined 36% ($5.21) to $9.45 in 1998 compared to $14.66 in 1997. This decrease is related to the decrease in roaming revenue per minute, the faster growth of U.S. Cellular's customer base as compared to the growth of inbound roaming revenues and the elimination of certain inbound roaming revenues between U.S. Cellular's existing markets and the acquired markets. TDS Telecom revenues increased 13% ($28.3 million) in 1998 due to growth in telephone operations ($20.7 million) and growth in other services ($8.3 million). Telephone operations revenues increased primarily as a result of the recovery of increased costs of providing long-distance services ($6.1 million), increased network usage ($3.8 million), effects of acquisitions ($3.8 million), increased sale of customer premise equipment ($2.9 million), internal access line growth of 6% since June 30, 1997 ($2.2 million) and increased sales of custom calling and advanced feature sales ($2.0 million). The number of telephone access lines increased by 8% (6% from internal growth and 2% from acquisitions) to 537,500 at June 30, 1998 from 500,000 at June 30, 1997. Average monthly revenue per access line increased by 3% to $69.41 for the first half of 1998 from $67.30 in 1997. The other services increase was primarily driven by increases in revenues in the LAN wiring business of $5.7 million and from the Internet access provider of $1.9 million. TDS Telecom's competitive local exchange carrier ("CLEC") began operations in the first half of 1998 resulting in revenues of $800,000. Aerial revenues totaled $67.4 million in 1998, consisting of service revenue of $52.9 million and equipment sales revenues of $14.5 million. Average revenue per customer was approximately $52.93 in the first half of 1998. Aerial added 79,000 customer units in the first half of 1998 and had 204,000 customers in service at June 30, 1998. Operating Expenses rose 53% ($297.7 million) in the first half of 1998 due primarily to added expenses at Aerial for the development of its markets and added expenses to serve the growing customer base at U.S. Cellular and Aerial. Aerial generated 49% ($145.4 million) of the total 4
increase in operating expenses, while U.S. Cellular generated 39% ($115.4 million) and TDS Telecom generated 12% ($36.9 million) of the total increase. U.S. Cellular expenses increased 34% ($115.4 million) during 1998. System operations expenses increased 29% ($20.0 million) in 1998 as a result of increases in customer usage expenses and costs associated with the growing number of cell sites within U.S. Cellular's systems. Customer usage expenses grew 37% ($16.2 million) primarily due to the increase in net outbound roaming expense and the increase in minutes used on U.S. Cellular's systems. Net outbound roaming usage expense increased primarily as a result of U.S. Cellular offering its customers increasingly larger service footprints in which their calls are billed at local rates. In certain cases these service areas include other operators' service areas. U.S. Cellular pays roaming rates to the other carriers for calls U.S. Cellular's customers make in these areas, while charging those customers a local rate which is usually lower than the roaming rate. Maintenance, utility and cell site expenses increased 15% ($3.9 million) reflecting primarily the increase in the number of cell sites to 1,864 in 1998 from 1,485 in 1997. Marketing and selling expenses increased 24% ($27.8 million), reflecting increased advertising and costs incurred to add new customers, including a $5.3 million increase in cost of equipment sold. Cost per gross customer addition declined to $309 in 1998 from $325 in 1997 while gross customer activations increased to 403,000 in 1998 from 321,000 in 1997. General and administrative expenses increased 37% ($33.5 million) due to the growing customer base and an expansion of local office and corporate staff necessitated by U.S. Cellular's growth. Depreciation and amortization increased 55% ($34.1 million) primarily due to the 36% increase in average fixed assets since June 30, 1997 as well as a reduction in useful lives of certain assets beginning in 1998 which increased depreciation expense by $10.3 million. TDS Telecom expenses increased 23% ($36.9 million) during 1998 due to growth in telephone operations ($22.4 million) and in other services ($15.3 million). Telephone operations increased primarily due to increased depreciation and amortization ($4.6 million), increased costs to support and maintain information systems ($4.0 million), the effects of acquisitions ($3.5 million), increased sales of customer premise equipment ($3.0 million) and increased costs of maintaining the centralized network management center and other network administration ($2.9 million). The remaining increase is primarily due to growth in internal operations, including wage and salary increases, staffing and inflation. Other services increased primarily due to the growth in the LAN wiring business of $7.8 million, development activities at a start-up competitive local exchange carrier of $4.8 million and growth at the Internet access provider of $1.9 million. Aerial's expenses increased to $204.2 million in 1998 from $58.8 million in 1997, reflecting Aerial's launch of service between March and June of 1997 and the subsequent significant efforts to build its customer base. Expenses incurred in the first quarter of 1997 prior to the launch of service totaled $21.6 million and were reported as PCS Development Costs as part of Investment and Other Income (Expense). For the first six months of 1998, system operations expenses totaled $32.6 million reflecting the costs of operating Aerial's network, primarily cell site expenses, landline interconnection charges and wages. Marketing and selling expenses incurred to add new customers totaled $35.4 million while cost of equipment sold totaled $43.4 million. General and administrative expenses totaled $28.2 million reflecting the expenses associated with the management and operating teams as well as overhead expenses. Customer service expenses totaled $23.7 million primarily for the staffing to support the PCS markets and bad debt expense. Depreciation and amortization totaled $40.9 million. 5
Operating Income was a $(22.6) million loss in the first half of 1998 compared to $49.3 million income in 1997 reflecting the increase in Aerial's losses as its markets were in operation only in the second quarter of 1997 compared to the first half of 1998. Aerial incurred an operating loss of $136.8 million in the first half of 1998 which offset the U.S. Cellular and TDS Telecom operating income. U.S. Cellular's operating income increased 27% to $83.3 million in the first half of 1998; however, U.S. Cellular's operating income margin decreased to 15.6% in 1998 from 16.3% in 1997 due to increased depreciation expense in 1998. TDS Telecom's operating income declined $8.6 million to $42.3 million reflecting $6.9 million of additional operating losses from new business ventures as anticipated, primarily the CLEC business and the LAN wiring business, and a $1.6 million decrease in telephone operating income. TDS Telecom's operating margin decreased to 17.5% in 1998 from 23.9% in 1997 due to the impact of new business ventures and higher operating costs of depreciation on improvements to the telephone network and cash expenditures to develop programs which will improve customer satisfaction and provide long-term benefits in future cost avoidance. <TABLE> <CAPTION> Six Months Ended June 30, ------------------------------------- 1998 1997 Change --------- ---------- ----------- (Dollars in thousands) <S> <C> <C> <C> Operating Income (Loss) from Ongoing Operations U.S. Cellular $ 83,292 $ 65,599 $ 17,693 TDS Telecom 42,313 50,869 (8,556) Aerial (136,775) (51,633) (85,142) --------- --------- --------- (11,170) 64,835 (76,005) American Paging Operating (Loss) (11,406) (15,540) 4,134 --------- --------- --------- Operating Income (Loss) $ (22,576) $ 49,295 $ (71,871) ========= ========= ========= </TABLE> TDS completed the transfer of substantially all of the assets and certain, limited liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC effective March 31, 1998. American Paging's revenues are netted against its expenses with the resulting operating loss reported as American Paging Operating (Loss). American Paging's revenues totaled $17.8 million and expenses totaled $29.2 million for the three month period ended March 31, 1998. Effective in the second quarter of 1998, TDS followed the equity method of accounting for its interest in TSR Wireless Holdings, LLC and reported these results as a component of Investment and Other Income (Expense). American Paging's revenues totaled $24.2 and $48.8 million for the three and six months ended June 30, 1997, respectively, and operating expenses totaled $31.4 million and $64.4 million, respectively, for the same periods. Investment and Other Income (Expense) totaled $242.9 million in 1998 and $24.8 million in 1997. Gain on Sale of Cellular Interests and Other Investments totaled $232.0 million in the first half of 1998 and $10.6 million in 1997, as the Company has sold or traded certain non-strategic minority cellular interests. PCS Development Costs totaled $21.6 million in 1997 reflecting the costs prior to the launch of PCS service in Aerial's markets in the second quarter of 1997. Cellular Investment Income, the Company's share of income of cellular markets in which the Company has a minority interest and follows the equity method of accounting, decreased 39% ($14.0 million) in the first half of 1998 primarily due to the transfer of minority interests to 6
BellSouth in 1997 and the sale of minority interests to AirTouch Communications, Inc. ("AirTouch") in 1998. Cellular investment income is net of amortization of license costs relating to these minority interests. Minority Share of Income includes the minority shareholders' share of U.S. Cellular's and Aerial's net income or loss, the minority partners' share of U.S. Cellular's operating markets and other minority shareholders' and partners' share of subsidiaries' net income or loss. The increase in U.S. Cellular's minority share of income in the first half of 1998 is primarily due to gains from the sale of cellular interests, which contributed $(22.0) million of the $(30.8) million of U.S. Cellular's minority shareholders' share of income. <TABLE> <CAPTION> Six Months Ended June 30, -------------------------------- 1998 1997 Change -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> Minority Share of (Income) Loss United States Cellular Minority Shareholders' Share $(30,753) $ (9,563) $(21,190) Minority Partners' Share (2,695) (7,248) 4,553 -------- -------- -------- (33,448) (16,811) (16,637) Aerial Communications 31,014 13,488 17,526 Telephone Subsidiaries and Other (2,535) (869) (1,666) -------- -------- -------- $ (4,969) $ (4,192) $ (777) ======== ======== ======== </TABLE> Interest Expense increased $29.2 million to $62.9 million in the first half of 1998 primarily due to a reduced amount of capitalized interest ($10.6 million), the increase in short-term debt ($5.2 million), the increase in U.S. Cellular's long-term debt ($8.7 million) and the increase in Aerial's long-term debt ($4.4 million). The Company capitalized $132,000 of interest in the first half of 1998 and $10.7 million in 1997 related to qualifying license and construction costs. Minority Interest in Income of Subsidiary Trust totaled $11.1 million in the first half of 1998. This preferred dividend requirement is the result of the issuance of Company-Obligated Mandatorily Redeemable Preferred Securities ("Trust Originated Preferred Securities") in November 1997 and February 1998. Income Tax Expense increased $61.9 million in 1998 to $85.8 million primarily due to the significant gains on the sale of cellular interests and other investments. Net Income Available to Common increased $44.1 million to $59.6 million in the first half of 1998 from $15.5 million in the first half of 1997. The gains from the sale of cellular interests and other investments totaled $117.6 million in 1998 and $4.0 million in 1997. Earnings Per Common Share - Diluted was $.97 in the first half of 1998 and $.25 in the first half of 1997. Gains from the sale of cellular interests and other investments contributed $1.92 per share in 1998 and $.07 per share in 1997. Management believes operating expenses tend to be higher in the fourth quarter, particularly at U.S. Cellular, due to increased marketing activities and customer growth. This seasonality may cause operating income to be lower in the fourth quarter. PCS competitors have initiated 7
service in certain of U.S. Cellular's markets over the past two years. U.S. Cellular expects PCS competitors to complete initial deployment of PCS in portions of all of its market clusters by the end of 1998. U.S. Cellular has increased its advertising to promote the United States Cellular brand and to distinguish its service from other wireless communications providers. U.S. Cellular's management continues to monitor other wireless communications providers' strategies to determine what effects additional competition will have on U.S. Cellular's future strategies and results. TDS anticipates that Aerial will continue to incur operating losses and generate negative cash flow as it continues to build its customer base reducing TDS's cash flow, operating and net income during 1998. Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997 Telephone and Data Systems, Inc. reported net income (loss) available to common of $(14.1) million, or $(.23) per diluted share, in the second quarter ended June 30, 1998, compared to $6.4 million, or $.11 per diluted share in 1997. Net income (loss) included significant gains from the sale of cellular interests and other investments totaling $5.1 million, or $.09 per share, in 1998, compared to $4.0 million, or $.07 per share, in 1997. Net income from U.S. Cellular, excluding gains, decreased to $21.9 million, or $.36 per share, in 1998, from $23.3 million, or $.39 per share, in 1997. Net income from TDS Telecom, excluding gains, decreased to $6.1 million, or $.10 per share, in 1998 from $6.8 million, or $.11 per share, in 1997. Aerial's activities reduced net income by $73.7 million, or $1.21 per share, in 1998 compared to $45.8 million, or $.76 per share in 1997. Net income from Parent and Other increased to $26.5 million, or $.43 per share, in 1998 from $18.1 million, or $.30 per share, in 1997 due primarily to increase in the tax benefit associated with Aerial's losses. The table below summarizes the results of operations of the business units and gains (along with the related impact of income taxes and minority interest) on net income available to common and earnings per share - diluted. <TABLE> <CAPTION> Three Months Ended June 30, --------------------------- 1998 1997 ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> Net Income (Loss) Available to Common U.S. Cellular $ 21,871 $ 23,294 TDS Telecom 6,138 6,821 Aerial (73,701) (45,837) Parent and Other 26,474 18,066 Gains 5,123 4,007 ------------- ------------- $ (14,095)$ 6,351 ============= ============= Diluted Earnings Per Share U.S. Cellular $ .36 $ .39 TDS Telecom .10 .11 Aerial (1.21) (.76) Parent and Other .43 .30 Gains .09 .07 ------------- ------------- $ (.23)$ .11 ============= ============= </TABLE> 8
Operating Revenues increased 36% ($119.8 million) during the second quarter of 1998 for reasons generally the same as the first six months. U.S. Cellular revenues increased 33% ($72.5 million) in 1998. Local retail revenue increased 42% ($58.9 million) in the second quarter of 1998, while inbound roaming revenue decreased 1% ($600,000). Average monthly service revenue per customer was $50.16 in the second quarter of 1998 and $58.41 in 1997. TDS Telecom revenues increased 16% ($17.7 million) in the second quarter of 1998 due to the growth in telephone operations ($12.1 million) and growth in other operations ($6.1 million). Average monthly revenue per access line increased to $70.28 in the second quarter of 1998 from $67.34 in 1997. Aerial revenues totaled $36.7 million in the second quarter of 1998 consisting of service revenues of $28.9 million and revenue from units sold to customers of $7.8 million. Operating Expenses rose 41% ($129.6 million) during the second quarter of 1998 for reasons generally the same as the first six months. U.S. Cellular expenses increased 37% ($64.5 million). System operations expense increased 38% ($14.3 million). Marketing and selling expenses, including cost of equipment sold, increased 22% ($12.8 million). Cost per gross customer addition decreased to $305 in the second quarter of 1998 from $327 in 1997. General and Administrative expense increased 39% ($18.4 million). Depreciation and amortization expense increased 60% ($19.0 million). TDS Telecom expenses increased 24% ($19.6 million) due to growth in telephone operations ($10.9 million) and in other operations ($9.2 million) for reasons generally the same as the first six months. Aerial's operating expenses totaled $104.2 million as the markets were in service for the full quarter. Operating Income decreased 36% ($2.7 million) in the second quarter of 1998. Aerial's operating loss increased by $15.8 million as all of Aerial's markets were in operation for the full quarter in 1998 while the launch of service occurred in the markets between March and June of 1997. U.S. Cellular's operating income increased $8.0 million reflecting continued growth in customers and revenues. TDS Telecom's operating income decreased $2.0 million reflecting the anticipated impact of new business ventures and cash expenditures to improve the network and customer satisfaction, and avoid costs in the future. The results of American Paging were not included in operating income in the second quarter of 1998 reflecting the transfer to TSR Wireless Holdings, LLC at the end of the first quarter of 1998. TDS's investment in TSR Wireless Holdings, LLC is reported under the equity method as a component of Investment and Other Income (Expense). <TABLE> <CAPTION> Three Months Ended June 30, ------------------------------- 1998 1997 Change ------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> Operating Income (Loss) from Ongoing Operations U.S. Cellular $ 50,137 $ 42,154 $ 7,983 TDS Telecom 21,998 23,962 (1,964) Aerial (67,462) (51,633) (15,829) -------- -------- -------- 4,673 14,483 (9,810) American Paging Operating (Loss) -- (7,129) 7,129 -------- -------- -------- Operating Income (Loss) $ 4,673 $ 7,354 $ (2,681) ======== ======== ======== </TABLE> Investment and Other Income totaled $19.0 million in 1998 and $29.4 million in 1997. Gain on Sale of Cellular Interests and Other Investments totaled $10.5 million in the second quarter of 1998 compared to $10.6 million in 1997 as the Company has sold or traded certain non- strategic cellular interests and sold other investments. Cellular Investment Income decreased 54% ($9.7 million) to $8.2 million, reflecting the transfer of minority interests to BellSouth in the fourth quarter of 1997 and the sale of minority interests to AirTouch in 1998. 9
Minority Share of Income decreased $8.0 million in the second quarter of 1998 due primarily to the increase in Aerial's net loss allocated to its minority shareholders. <TABLE> <CAPTION> Three Months Ended June 30, -------------------------------- 1998 1997 Change -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> Minority Share of (Income) Loss United States Cellular Minority Shareholders' Share $ (6,219) $ (6,042) $ (177) Minority Partners' Share (1,513) (4,383) 2,870 -------- -------- -------- (7,732) (10,425) 2,693 Aerial 15,773 9,639 6,134 Telephone Subsidiaries and Other (1,457) (647) (810) -------- -------- -------- $ 6,584 $ (1,433) $ 8,017 ======== ======== ======== </TABLE> Interest Expense increased $11.4 million to $31.3 million in the second quarter of 1998 for reasons generally the same as the first six months. Minority Interest in Income of Subsidiary Trust totaled $6.2 million in the second quarter of 1998. This preferred dividend requirement is the result of the issuance of Trust Originated Preferred Securities in November 1997 and February 1998. Income Tax Expense decreased $10.2 million to $(100,000) in the second quarter of 1998 compared with 1997 as pretax income decreased. Net Income (Loss) Available to Common decreased $20.4 million to $(14.1) million in the second quarter of 1998 from $6.4 million in 1997. Earnings Per Common Share-Diluted was $(.23) in 1998 and $.11 in 1997. FINANCIAL RESOURCES AND LIQUIDITY TDS and its subsidiaries operate relatively capital-intensive businesses. Rapid growth has caused expenditures for construction, expansion and acquisition programs to exceed internally generated cash flow. Accordingly, TDS has obtained substantial funds from external sources to finance the build-out of PCS markets, to fund acquisitions and for general corporate purposes. Although increasing internal cash flow from U.S. Cellular and steady internal cash flow from TDS Telecom have reduced the need for external financing, Aerial's working capital, operating expenses and construction activities will require substantial additional funds from external sources. Cash Flows From Operating Activities. Cash flows from operating activities totaled $105.9 million in the first half of 1998 compared to $106.7 million in 1997. U.S. Cellular and TDS Telecom generated substantial internal funds. The launch of Aerial's operations required substantial funds reducing cash flows from operating activities in 1998. U.S. Cellular's operating cash flow (operating income plus depreciation and amortization) totaled $179.0 million in the first half of 1998 (up 41%) while TDS Telecom's operating cash flow totaled $97.0 million (down 2%). Aerial's start-up activities resulted in an operating cash outflow of $95.8 million for the first half of 1998. Cash flows for other operating activities (investment and other income, interest and 10
income tax expense, and changes in working capital and other assets and liabilities) required $70.7 million in the first half of 1998 and $73.7 million in 1997. <TABLE> <CAPTION> Six Months Ended June 30, ----------------------------------- 1998 1997 Change ---- ---- ------ (Dollars in thousands) <S> <C> <C> <C> Operating cash flow U.S. Cellular $ 179,001 $ 127,191 $ 51,810 TDS Telecom 96,957 99,334 (2,377) Aerial (95,835) (45,750) (50,085) American Paging (3,511) (395) (3,116) --------- --------- --------- 176,612 180,380 (3,768) Other operating activities (70,726) (73,707) 2,981 --------- --------- --------- $ 105,886 $ 106,673 $ (787) ========= ========= ========= </TABLE> Cash Flows from Financing Activities. TDS has used short-term debt to finance its PCS operations, for acquisitions and for general corporate purposes. TDS has taken advantage of attractive opportunities from time-to-time to reduce short-term debt with proceeds from long-term debt and equity sales, and sales of non-strategic assets. Cash flows from financing activities totaled $101.4 million in the first half of 1998 compared to $244.0 million in 1997. TDS received $144.9 million on the sale of 8.04% Trust Originated Preferred Securities providing most of the Company's external financing during the first half of 1998. The proceeds were used to reduce notes payable balances. Increases in short-term debt provided most of the Company's external financing requirements during the first half of 1997. The 1997 borrowings were used primarily to fund expenditures for PCS construction and development activities and for stock repurchases. In the first half of 1998, TDS expended $9.1 million for the purchase of American Paging common shares pursuant to a tender offer. In the first half of 1997, TDS purchased 1,798,100 TDS Common Shares for $68.5 million and 350,000 U.S. Cellular Common Shares for $9.8 million. Cash Flows From Investing Activities. TDS makes substantial investments each year to acquire, construct, operate and maintain modern high-quality communications networks and facilities as a basis for creating long-term value for shareowners. Cash flows from investing activities required $166.3 million in the first half of 1998 compared to $372.7 million in 1997. Capital expenditures required $250.5 million in 1998 and $393.2 million in 1997. Aerial's capital expenditures have decreased in 1998 because it has completed its initial build out program. Acquisitions, net of cash acquired, required $43.4 million in 1998 and $36.6 million in 1997. The sales of non-strategic cellular interests and other investments provided $96.8 million in 1998 and $21.4 million in 1997, reducing total cash flows required for investing activities. The primary purpose of TDS's construction and expansion program is to provide for significant customer growth, to upgrade service, to expand into new communication areas, and to take advantage of service-enhancing and cost-reducing technological developments. Capital expenditures totaled $250.5 million in the first half of 1998 consisting primarily of $137.0 million for cellular plant and equipment, $62.4 million for telephone plant and equipment and $48.1 11
million for PCS property and equipment. Capital expenditures totaled $393.2 million in 1997 consisting primarily of $161.1 million for cellular plant and equipment, $54.8 million for telephone plant and equipment and $157.7 million for PCS property and equipment. LIQUIDITY TDS anticipates that the aggregate resources required for 1998 will include approximately $560 million for capital spending, consisting of $330 million for cellular capital additions, $140 million for telephone capital additions and $90 million for PCS capital additions. In addition, Aerial's working capital and operating expenses will require an estimated $255 million. The Company anticipates financing these expenditures with internally generated funds, short- and long-term financing, and an equity investment by a minority investor in Aerial. U.S. Cellular plans to finance its cellular construction program using primarily internally generated cash supplemented by short-term financing. U.S. Cellular's operating cash flow totaled $313.7 million for the twelve months ended June 30, 1998, up 37% ($83.9 million) from 1997. U.S. Cellular had $500 million of bank lines of credit for general corporate purposes at June 30, 1998, all of which was unused. These line of credit agreements provide for borrowings at the London InterBank Offered Rate ("LIBOR") plus 26.5 basis points. TDS Telecom plans to finance its construction program using primarily internally generated cash supplemented by long-term financing from federal government programs and short-term financing. Operating cash flow totaled $194.3 million for the twelve months ended June 30, 1998, down 3% ($6.4 million) from 1997. At June 30, 1998, TDS Telecom telephone subsidiaries had $114.7 million in unadvanced loan funds from federal government programs to finance the telephone construction program. Aerial plans to finance its construction expenditures and working capital requirements with short-term financing, vendor financing and an equity investment by a minority investor. In June, Aerial and Nokia Telecommunications, Inc. ("Nokia") entered into a new credit agreement in which Nokia will provide up to an aggregate $150 million in financing to Aerial for the purchase of network infrastructure equipment and services from Nokia. Aerial may borrow up to $75 million prior to June 30, 1999 and an additional $75 million between June 30, 1999 and June 30, 2000. Also in June, Sonera Corporation ("Sonera" formerly Telecom Finland) and Aerial announced an agreement for Sonera to make a $200 million investment in a wholly-owned subsidiary of Aerial, subject to regulatory approval. TDS and its subsidiaries had cash and temporary investments totaling $106.2 million and longer-term cash investments totaling $16.5 million at June 30, 1998. These investments are primarily the result of telephone operations' internally generated cash. While certain regulated telephone subsidiaries' debt agreements place limits on intercompany dividend payments, these restrictions are not expected to affect the Company's ability to meet its cash obligations. TDS and its subsidiaries also have access to a variety of external capital sources. TDS had $650 million of bank lines of credit for general corporate purposes at June 30, 1998. Unused amounts of such lines totaled $138 million. These line of credit agreements provide for borrowings at negotiated rates up to the prime rate. Management believes that TDS's internal cash flows and funds available from cash and cash 12
equivalents, lines of credit, and longer-term financing commitments provide sufficient financial flexibility. However, the timing and amounts of capital expenditures and acquisitions as well as working capital requirements and amounts needed for general corporate purposes may vary throughout the year. There can be no assurance that sufficient funds will be available to the Company on terms or at prices acceptable to the Company. If sufficient funding is not made available to the Company on terms and prices acceptable to the Company, the Company would have to reduce its construction, development and acquisition programs. TDS and its subsidiaries anticipate accessing public and private capital markets to issue debt and equity securities when capital requirements, financial market conditions and other factors warrant. In July 1998, TDS sold $200 million of 7.0% Notes due August 1, 2006. The net proceeds were used to reduce notes payable balances. Tracking Stock Proposal At a Special Meeting on April 27, 1998, Shareholders of the Company approved the "Tracking Stock Proposal" and two related proposals which would, among other things, change the state of incorporation of TDS from Iowa to Delaware and permit TDS to issue shares of tracking stock which are intended to reflect the performance of the Company's interest in its three principal business units: TDS Telecom, U.S. Cellular and Aerial. The reincorporation of TDS into Delaware occurred on May 22, 1998. In connection with the Tracking Stock Proposal, TDS had made offers to each of U.S. Cellular and Aerial to acquire the common stock of such corporations which TDS does not own, in exchange for tracking stock of TDS which would be intended to reflect the separate performance of U.S. Cellular and Aerial, respectively. U.S. Cellular's special committee has held meetings with the representatives of TDS relating to the TDS offer. Aerial's special committee has recommended the Aerial Board of Directors reject the TDS offer. TDS is attempting to seek to negotiate agreements with the special committees of U.S. Cellular and Aerial to acquire the U.S. Cellular and Aerial Common Shares that it does not own on mutually acceptable terms. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT This Management's Discussion and Analysis of Financial Condition and Results of Operations contain "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995, that are based on current expectations, estimates and projections. Statements that are not historical facts, including statements about the Company's beliefs and expectations are forward-looking statements. These statements contain potential risks and uncertainties and, therefore, actual results may differ materially. TDS undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Important factors that may affect these projections or expectations include, but are not limited to: changes in the overall economy; changes in competition in markets in which TDS operates; advances in telecommunications technology; changes in the telecommunications regulatory environment; pending and future litigation; availability of future financing; start-up of PCS operations; and unanticipated changes in growth in cellular customers, penetration rates, churn rates and the mix of products and services offered in our markets. Readers should evaluate any statements in light of these important factors. 13
<TABLE> TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Unaudited <CAPTION> Three Months Ended Six Months Ended June 30, June 30, ---------------------- ---------------------- 1998 1997 1998 1997 --------- --------- --------- --------- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> OPERATING REVENUES U.S. Cellular $ 290,108 $ 217,579 $ 535,265 $ 402,163 TDS Telecom 125,054 107,374 241,269 212,945 Aerial 36,688 7,143 67,434 7,143 --------- --------- --------- --------- 451,850 332,096 843,968 622,251 --------- --------- --------- --------- OPERATING EXPENSES U.S. Cellular 239,971 175,425 451,973 336,564 TDS Telecom 103,056 83,412 198,956 162,076 Aerial 104,150 58,776 204,209 58,776 --------- --------- --------- --------- 447,177 317,613 855,138 557,416 --------- --------- --------- --------- Operating Income (Loss) from Ongoing Operations 4,673 14,483 (11,170) 64,835 American Paging Operating (Loss) -- (7,129) (11,406) (15,540) --------- --------- --------- --------- OPERATING INCOME 4,673 7,354 (22,576) 49,295 --------- --------- --------- --------- INVESTMENT AND OTHER INCOME Interest and dividend income 3,025 3,478 6,462 6,896 Cellular investment income, net of license cost amortization 8,241 17,920 21,846 35,840 Gain on sale of cellular interests and other investments 10,516 10,598 231,958 10,598 PCS development costs -- -- -- (21,614) Other (expense), net (9,354) (1,129) (12,403) (2,766) Minority share of income 6,584 (1,433) (4,969) (4,192) --------- --------- --------- --------- 19,012 29,434 242,894 24,762 --------- --------- --------- --------- INCOME BEFORE INTEREST AND INCOME TAXES 23,685 36,788 220,318 74,057 Interest expense 31,272 19,880 62,885 33,694 Minority interest in income of subsidiary trust 6,203 -- 11,099 -- --------- --------- --------- --------- INCOME BEFORE INCOME TAXES (13,790) 16,908 146,334 40,363 Income tax expense (113) 10,087 85,841 23,925 --------- --------- --------- --------- NET INCOME (13,677) 6,821 60,493 16,438 Preferred Dividend Requirement (418) (470) (858) (951) --------- --------- --------- --------- NET INCOME AVAILABLE TO COMMON $ (14,095) $ 6,351 $ 59,635 $ 15,487 ========= ========= ========= ========= WEIGHTED AVERAGE COMMON SHARES (000s) 60,984 60,051 60,867 60,617 EARNINGS PER COMMON SHARE-Basic $ (.23) $ .11 $ .98 $ .26 ========= ========= ========= ========= EARNINGS PER COMMON SHARE-Diluted $ (.23) $ .11 $ .97 $ .25 ========= ========= ========= ========= DIVIDENDS PER COMMON AND SERIES A COMMON SHARE $ .11 $ .105 $ .22 $ .21 ========= ========= ========= ========= <FN> The accompanying notes to financial statements are an integral part of these statements. </FN> </TABLE> 14
<TABLE> TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited <CAPTION> Six Months Ended June 30, ---------------- 1998 1997 ---- ---- (Dollars in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 60,493 $ 16,438 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 199,188 131,806 Deferred taxes 80,362 5,483 Investment income (21,704) (37,993) Minority share of income 4,969 4,192 Gain on sale of cellular interests and other investments (231,958) (10,598) Noncash interest expense 17,541 11,712 Other noncash expense 8,831 11,475 Change in accounts receivable (25,211) (26,795) Change in materials and supplies 15,553 (7,581) Change in accounts payable (13,569) 553 Change in accrued taxes 10,857 11,904 Change in other assets and liabilities 534 (3,923) ---------- --------- 105,886 106,673 ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Long-term debt borrowings 955 7,935 Repayments of long-term debt (8,833) (20,435) Change in notes payable (15,321) 346,604 Trust preferred securities 144,893 -- Dividends paid (14,043) (13,652) Repurchase of Common Shares -- (68,523) Purchase of subsidiary common stock (9,103) (9,801) Other financing activities 2,830 1,879 ---------- --------- 101,378 244,007 ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures (250,501) (393,232) Investments in and advances to cellular minority partnerships (3,561) (6,167) Distributions from partnerships 12,464 24,028 Investments in PCS licenses -- (5,073) Proceeds from investment sales 96,793 21,384 Other investing activities (3,201) 3,291 Acquisitions, net of cash acquired (43,394) (36,606) Change in temporary investments and marketable securities 25,116 19,628 ---------- --------- (166,284) (372,747) ---------- --------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS 40,980 (22,067) CASH AND CASH EQUIVALENTS - Beginning of period 51,008 57,633 ---------- --------- End of period $ 91,988 $ 35,566 ========== ========= <FN> The accompanying notes to financial statements are an integral part of these statements. </FN> </TABLE> 15
<TABLE> TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS <CAPTION> (Unaudited) June 30, 1998 December 31, 1997 ------------- ----------------- (Dollars in thousands) <S> <C> <C> CURRENT ASSETS Cash and cash equivalents $ 91,988 $ 51,008 Temporary investments 14,243 24,559 Accounts receivable from customers and others 264,528 247,298 Materials and supplies, at average cost, and other current assets 61,306 85,419 ---------- ---------- 432,065 408,284 ---------- ---------- INVESTMENTS Cellular license acquisition costs, net 1,224,441 1,190,917 Cellular minority interests 94,377 138,367 PCS license acquisition costs, net 315,917 319,918 Franchise costs and other costs in excess of the underlying book value of subsidiaries, net 183,972 180,669 Marketable equity securities 308,395 1,621 Other investments 183,729 141,092 ---------- ---------- 2,310,831 1,972,584 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT Cellular telephone, net 940,236 940,253 Telephone, net 846,383 830,767 PCS, net 615,445 604,104 Radio paging, net -- 43,230 Other, net 40,186 47,299 ---------- ---------- 2,442,250 2,465,653 ---------- ---------- OTHER ASSETS AND DEFERRED CHARGES 147,763 125,080 ---------- ---------- TOTAL ASSETS $5,332,909 $4,971,601 ========== ========== <FN> The accompanying notes to financial statements are an integral part of these statements. </FN> </TABLE> 16
<TABLE> TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY <CAPTION> (Unaudited) June 30, 1998 December 31, 1997 ------------- ----------------- (Dollars in thousands) <S> <C> <C> CURRENT LIABILITIES Current portion of long-term debt and preferred shares $ 15,896 $ 16,115 Notes payable 512,266 527,587 Accounts payable 212,387 239,783 Advance billings and customer deposits 31,364 33,640 Accrued interest 18,735 18,284 Accrued taxes 18,908 6,961 Accrued compensation 24,501 23,386 Other current liabilities 36,217 40,129 ----------- ----------- 870,274 905,885 ----------- ----------- DEFERRED LIABILITIES AND CREDITS 343,429 235,646 ----------- ----------- LONG-TERM DEBT, excluding current portion 1,313,596 1,264,218 ----------- ----------- REDEEMABLE PREFERRED SHARES, excluding current portion 175 180 ----------- ----------- MINORITY INTEREST in subsidiaries 407,892 416,566 ----------- ----------- COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES of Subsidiary Trust Holding Solely Company Subordinated Debentures (a) 300,000 150,000 ----------- ----------- NONREDEEMABLE PREFERRED SHARES 26,246 30,987 ----------- ----------- COMMON STOCKHOLDERS' EQUITY (Note 3) Common Shares - par value $.01 and $1.00, respectively 549 54,443 Series A Common Shares - par value $.01 and $1.00, respectively 69 6,936 Common Shares issuable (12,584 and 10,480 shares, respectively) 549 499 Capital in excess of par value 1,731,461 1,663,749 Unrealized gains on securities 49,428 683 Treasury Shares, at cost (768,317 and 794,576 shares, respectively) (29,700) (30,682) Retained earnings 318,941 272,491 ----------- ----------- 2,071,297 1,968,119 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,332,909 $ 4,971,601 =========== =========== <FN> (a) As described in Note 5, 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. The accompanying notes to financial statements are an integral part of these statements. </FN> </TABLE> 17
TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures 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 the Company's latest annual report on Form 10-K. The accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring items) necessary to present fairly the financial position as of June 30, 1998 and December 31, 1997, and the results of operations and cash flows for the six months ended June 30, 1998 and 1997. The results of operations for the six months ended June 30, 1998 and 1997, are not necessarily indicative of the results to be expected for the full year. 2. Tracking Stock Proposal At a Special Meeting on April 27, 1998, Shareholders of the Company approved the "Tracking Stock Proposal" and two related proposals which would, among other things, change the state of incorporation of TDS from Iowa to Delaware and permit TDS to issue shares of tracking stock which are intended to reflect the performance of the Company's interest in its three principal business units: TDS Telecom, U.S. Cellular and Aerial. The reincorporation of TDS into Delaware occurred on May 22, 1998. In connection with the Tracking Stock Proposal, TDS had made offers to each of U.S. Cellular and Aerial to acquire the common stock of such corporations which TDS does not own, in exchange for tracking stock of TDS which would be intended to reflect the separate performance of U.S. Cellular and Aerial, respectively. U.S. Cellular's special committee has held meetings with the representatives of TDS relating to the TDS offer. Aerial's special committee has recommended the Aerial Board of Directors reject the TDS offer. TDS is attempting to seek to negotiate agreements with the special committees of U.S. Cellular and Aerial to acquire the U.S. Cellular and Aerial Common Shares that it does not own on mutually acceptable terms. 3. Common Stockholder's Equity In connection with the reincorporation of TDS into Delaware, each issued, Iowa Preferred Share no par value and each issued Iowa Common Share and Series A Common Share, $1 par value was converted into a Delaware Preferred Share, $.01 par value and Delaware Common Share and Series A Common Share, $.01 par value. The June 30, 1998 amounts for Common Shares, Series A Common Shares, and Capital in excess of par value have 18
been adjusted to reflect the change in par value. 4. American Paging Merger TDS completed the transfer of substantially all of the assets and certain, limited liabilities of American Paging, Inc. to TSR Wireless Holdings, LLC pursuant to a previously announced asset contribution agreement on April 7, 1998. American Paging's revenues totaled $17.8 million and expenses totaled $29.2 million for the three month period ended March 31, 1998. Effective in the second quarter of 1998, TDS applied the equity method of accounting for its interest in TSR Wireless Holdings, LLC and reported these results as a component of Investment and Other Income (Expense). American Paging's revenues totaled $24.2 million and $48.8 million for the three and six month periods ended June 30, 1997, respectively, and expenses totaled $31.4 million and $64.4 million, respectively, for the same periods of 1997. 5. Marketable Equity Securities The following table lists the Company's marketable equity securities at June 30, 1998. <TABLE> <CAPTION> Cumulative Net Fair Market Original Unrealized Tax Unrealized Value Cost Gain Effect Gain ----------- -------- ---------- ------- ---------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Investment in Air Touch $302,542 $229,562 $ 72,980 $ 26,428 $ 46,552 Other 5,853 979 4,874 1,998 2,876 -------- -------- -------- -------- -------- $308,395 $230,541 $ 77,854 $ 28,426 $ 49,428 ======== ======== ======== ======== ======== </TABLE> The cumulative unrealized gain, net of taxes, is included in Common Shareholders' Equity. 6. Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Company Subordinated Debentures In February 1998, TDS Capital II, a subsidiary trust (the "Trust") of TDS, issued 6,000,000 of its 8.04% Company-Obligated Mandatorily Redeemable Preferred Securities (the "Preferred Securities") at $25 per Preferred Security. Net proceeds from the issuance totaled $144.9 million and were used to retire short-term debt. The sole asset of TDS Capital II is $154.6 million principal amount of TDS's 8.04% Subordinated Debentures due March 31, 2038 or such date to which the maturity is extended by TDS, but in no event later than March 31, 2047. There is a full and unconditional guarantee by TDS of the Trust's obligations under the Preferred Securities issued by the Trust. However, TDS's obligations are subordinate and junior in right of payment to certain other indebtedness of TDS. TDS has the right to defer payment of interest on the Subordinated Debentures by extending the interest payment period, at any time, for up to 20 consecutive quarters. If interest payment on the Subordinated Debentures are so deferred, distributions on the Preferred Securities will also be deferred. During any deferral, distributions will continue to accrue with interest thereon. In addition, during any such deferral, TDS may not declare or pay any dividend or other distribution on, or redeem 19
or purchase, any of its common stock. The Subordinated Debentures are redeemable by TDS, in whole or in part, from time to time, on or after March 31, 2003, or, in whole but not in part, at any time in the event of certain income tax circumstances. If the Subordinated Debentures are redeemed, the Trust must redeem Preferred Securities on a pro rata basis having an aggregate liquidation amount equal to the aggregate principal amount of the Subordinated Debentures so redeemed. In the event of the dissolution, winding up or termination of the Trust the holders of Preferred Securities will be entitled to receive, for each Preferred Security, a liquidation amount of $25 plus accrued and unpaid distributions thereon to the date of payment, unless, in connection with the dissolution, winding up or termination, Subordinated Debentures are distributed to the holders of the Preferred Securities. The Preferred Securities are accounted for and reported in the Company's financial statements in the same manner as the 8.5% Trust Originated Preferred Securities issued by TDS Capital I in 1997. 7. Long-term Debt Aerial sold $220 million principal amount at maturity of 10-year zero coupon 8.05% yield to maturity debt in February 1998 at an issue price of $100 million. The unsecured notes are due in 2008 and there is no periodic payment of interest. The proceeds were paid to Aerial's equipment vendor in satisfaction of all then outstanding obligations and future obligations up to $100 million. The notes are fully and unconditionally guaranteed by TDS. The notes are subject to optional redemption beginning in 2003 at redemption prices which reflect original issue discount accrued since issuance. On June 30, 1998, Aerial and Nokia Telecommunications Inc. ("Nokia") entered into an agreement (the "1998 Credit Agreement") in which Nokia will provide up to an aggregate $150 million in financing to Aerial for the purchase of network infrastructure equipment and services from Nokia. Loans under the 1998 Credit Agreement are to be made available in two $75 million tranches. With respect to Tranche A, Aerial may borrow up to $75 million until June 30, 1999. Tranche A loans mature on June 30, 1999, however, the maturity date of Tranche A loans may be extended to June 30, 2000, upon written notice and payment of an extension fee by Aerial to Nokia. A second $75 million ("Tranche B") becomes available commencing on June 30, 1999, and ending on June 30, 2000, the maturity date of Tranche B loans. Interest under the 1998 Credit Agreement is payable monthly at a per annum rate equal to the 30 day London Interbank Offered Rate ("LIBOR") plus 0.25% (the "Eurodollar margin"). The Eurodollar margin on any Tranche A loans with an extended maturity date is subject to adjustment based on ratings for TDS long-term senior unsecured debt. The obligations of Aerial under the 1998 Credit Agreement are fully and unconditionally guaranteed by TDS. 8. Minority Investor On June 1, 1998, the Company, Aerial and Sonera Corporation ("Sonera"), formerly Telecom Finland Ltd., signed a definitive purchase agreement under which Sonera will make a $200 million investment in Aerial Operating Co., Inc. ("AOC"), a wholly-owned subsidiary of 20
the Aerial. Upon closing, Sonera will purchase approximately 2.4 million shares of common stock of AOC at a purchase price of approximately $83 per share representing a 19.423% equity interest in AOC. The Aerial equivalent price per share and Aerial equivalent equity ownership percentage for Sonera are subject to adjustment based on Aerial's 20-day average stock price during the three years commencing the day of closing. Depending on the stock price, Sonera's equivalent equity ownership amount in Aerial could range from 18.452% based on a low price of $12.33 per equivalent Aerial share to 14.329% based on a high price of $16.68 per equivalent Aerial share. In addition, after five years Sonera's equity in Aerial Operating Company becomes incrementally exchangeable for equity in Aerial Communications, Inc. or, in certain circumstances, incrementally exchangeable for equity in Telephone and Data Systems, Inc. or cash. The purchase agreement is subject to regulatory approval. 9. Gains from Sale of Cellular Interests and Other Investments Gains from the sale of cellular interest and other investments in 1998 primarily reflects gains recorded on the sale of the Company's minority interests in certain non-strategic markets to AirTouch Communications Inc. ("AirTouch") for AirTouch common shares and cash. 10. Other Comprehensive Income In 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS No. 130"), which requires companies to report all of the changes in shareholder's equity, except those resulting from investment by owners or distribution to owners ("Comprehensive Income"). The Company's Comprehensive Income includes Net Income and Unrealized Gains from Marketable Equity Securities that are classified as "available-for-sale". The following table summarizes the Company's Comprehensive Income. <TABLE> <CAPTION> Six Months Ended June 30, ------------------- 1998 1997 -------- -------- (Dollars in thousands) <S> <C> <C> Net Income $ 60,493 $ 16,438 Other Comprehensive Income - Unrealized gains on securities, net of tax of $27,960 48,745 -- -------- -------- $109,238 $ 16,438 ======== ======== </TABLE> 11. Earnings Per Share The Company adopted SFAS No. 128, "Earnings per Share," effective December 31, 1997. Earnings per Common Share for June 30, 1997 has been restated to conform to current period presentation. The amounts used in computing Earnings per Common Share and the effect on income and 21
the weighted average number of Common and Series A Common Shares of dilutive potential common stock are as follows: <TABLE> <CAPTION> June 30, 1998 June 30, 1997 --------------------------------- (Dollars and shares in thousands) <S> <C> <C> Net Income $ 60,493 $ 16,438 Less: Preferred Dividends (858) (952) -------- -------- Net Income Available to Common used in Earnings per Share-Basic 59,635 15,486 Reduction in preferred dividends if Preferred Shares converted into Common Shares 292 -- Minority income adjustment (78) (55) -------- -------- Net Income Available to Common used in Earnings per Share-Diluted $ 59,849 $ 15,431 ======== ======== Weighted Average Number of Common Shares used in Earnings per Share-Basic 60,867 60,617 Effect of Dilutive Securities: Common Shares outstanding if Preferred Shares converted 483 -- Stock options and stock appreciation rights 134 134 Common Shares issuable 13 19 -------- -------- Weighted Average Number of Common Shares used in Earnings per Share-Diluted 61,497 60,770 ======== ======== </TABLE> For 1998 and 1997, respectively, Preferred Shares convertible into 419,000 and 946,000 Common Shares were not included in computed diluted Earnings per Common Share because their effects were antidilutive. The minority income adjustment reflects the additional minority share of U.S. Cellular's income computed as if all of U.S. Cellular's issuable securities were outstanding. 12. Acquisition Effects Assuming that acquisitions accounted for as purchases during the period January 1, 1997, to June 30, 1998, had taken place on January 1, 1997, unaudited pro forma results of operations from continuing operations would have been as follows: <TABLE> <CAPTION> Six Months Ended June 30, ----------------------------- 1998 1997 -------------- ------------- (Dollars in thousands, except per share amounts) <S> <C> <C> Operating revenues $ 844,926 $ 664,142 Net income 60,586 23,555 Earnings per share - Basic .98 .37 Earnings per share - Diluted $ .97 $ .36 </TABLE> 22
13. Supplemental Cash Flow Information Cash and cash equivalents include cash and those short-term, highly liquid investments with original maturities of three months or less. Those investments with original maturities of more than three months to twelve months are classified as temporary investments. Temporary investments are stated at cost, which approximates market. Those investments with original maturities of more than 12 months are classified as marketable securities and are stated at amortized cost. TDS acquired certain cellular licenses, operating companies and telephone companies in 1998. In conjunction with these acquisitions, the following assets were acquired and liabilities assumed and Common Shares issued. <TABLE> <CAPTION> Six Months Ended June 30, ------------------- 1998 1997 ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> Property, plant and equipment $ 13,271 $ -- Cellular licenses 27,563 36,719 Equity method investment in cellular interests (4,222) -- Franchise costs 5,477 -- Long-term debt (4,634) -- Deferred credits (991) -- Other assets and liabilities, excluding cash and cash equivalents 3,790 -- Decrease in Minority interest 13,168 (113) Common Shares issued (10,028) -- -------- -------- Decrease in cash due to acquisitions $ 43,394 $ 36,606 ======== ======== </TABLE> The following table summarizes interest and income taxes paid, and other noncash transactions. <TABLE> <CAPTION> Six Months Ended June 30, ------------------ 1998 1997 ---- ---- (Dollar in thousands) <S> <C> <C> Interest Paid $43,088 $32,102 Income Taxes Paid (net of income tax refund received of $10,000 in 1998) 1,697 6,818 Common Shares issued by TDS for conversion of TDS Preferred Stock $ 4,741 $ 338 </TABLE> 14. Subsequent Event In July 1998, TDS sold $200 million of 7.0% Notes due August 1, 2006. The net proceeds were used to reduce notes payable balances. 23
15. Business Segment Information The following tables summarize business segment information for the three and six months ended or at June 30, 1998, and 1997. <TABLE> CELLULAR OPERATIONS <CAPTION> Three Months Ended or at Six Months Ended or at June 30, June 30, ------------------------ ---------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Operating Revenues Local service $ 198,222 $ 139,285 $ 368,307 $ 260,312 Inbound roaming 56,675 57,244 102,881 102,584 Long-distance and other 35,211 21,050 64,077 39,267 ----------- ----------- ----------- ----------- 290,108 217,579 535,265 402,163 ----------- ----------- ----------- ----------- Operating Expenses System operations 52,367 38,048 89,310 69,277 Marketing and selling 51,328 41,088 101,329 78,890 Cost of equipment sold 20,357 17,763 41,105 35,757 General and administrative 65,477 47,095 124,520 91,048 Depreciation 40,878 22,722 76,798 44,231 Amortization 9,564 8,709 18,911 17,361 ----------- ----------- ----------- ----------- 239,971 175,425 451,973 336,564 ----------- ----------- ----------- ----------- Operating Income $ 50,137 $ 42,154 $ 83,292 $ 65,599 =========== =========== =========== =========== Additions to property, plant and equipment $ 67,899 $ 107,996 $ 136,992 $ 161,058 Identifiable assets $ 2,828,377 $ 2,279,433 $ 2,828,377 $ 2,279,433 </TABLE> <TABLE> AERIAL OPERATIONS <CAPTION> Three Months Ended or at Six Months Ended or at June 30, June 30, ------------------------ ---------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Operating Revenues $ 36,688 $ 7,143 $ 67,434 $ 7,143 ----------- ----------- ----------- ----------- Operating Expenses Systems operations 17,593 4,876 32,609 4,876 Marketing and selling 17,974 15,958 35,406 15,958 Cost of equipment sold 20,573 14,972 43,393 14,972 General and administrative 14,014 14,723 28,210 14,723 Customer service 12,752 2,364 23,651 2,364 Depreciation 19,356 5,161 37,163 5,161 Amortization 1,888 722 3,777 722 ----------- ----------- ----------- ----------- 104,150 58,776 204,209 58,776 ----------- ----------- ----------- ----------- Operating (Loss) $ (67,462) $ (51,633) $ (136,775) $ (51,633) =========== =========== =========== =========== Additions to property, plant and equipment $ 18,376 $ 73,094 $ 48,061 $ 157,702 Identifiable assets $ 957,398 $ 814,823 $ 957,398 $ 814,823 </TABLE> 24
<TABLE> TDS TELECOM OPERATIONS <CAPTION> Three Months Ended or at Six Months Ended or at June 30, June 30, ------------------------ ---------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Telephone Operations Operating Revenues Local Service $ 33,570 $ 30,491 $ 66,121 $ 60,352 Network access and long distance 64,171 56,717 125,017 113,309 Miscellaneous 14,645 13,104 28,542 25,283 ----------- ----------- ----------- ----------- 112,386 100,312 219,680 198,944 ----------- ----------- ----------- ----------- Operating Expenses Network operations 22,455 17,770 43,133 35,800 Depreciation and amortization 26,606 23,811 52,613 47,104 Customer operations 17,359 16,290 34,868 31,187 Corporate and other 19,944 17,607 38,892 33,063 ----------- ----------- ----------- ----------- 86,364 75,478 169,506 147,154 ----------- ----------- ----------- ----------- Telephone Operating Income 26,022 24,834 50,174 51,790 ----------- ----------- ----------- ----------- Other Operations Revenues 13,389 7,290 22,789 14,461 Expenses 17,413 8,162 30,650 15,382 ----------- ----------- ----------- ----------- Other Operating Income (4,024) (872) (7,861) (921) ----------- ----------- ----------- ----------- Intercompany Eliminations Revenues (721) (228) (1,200) (460) Expenses (721) (228) (1,200) (460) ----------- ----------- ----------- ----------- Operating Income $ 21,998 $ 23,962 $ 42,313 $ 50,869 =========== =========== =========== =========== Additions to property, plant and equipment $ 31,693 $ 30,934 $ 62,432 $ 54,838 Identifiable assets $ 1,324,580 $ 1,174,508 $ 1,324,580 $ 1,174,508 </TABLE> <TABLE> OTHER OPERATIONS <CAPTION> Three Months Ended or at Six Months Ended or at June 30, June 30, ------------------------ ---------------------- 1998 1997 1998 1997 ---- ---- ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> Additions to property, plant and equipment $ 7,219 $ 12,184 $ 3,016 $ 19,634 Identifiable Assets $ 222,554 $ 237,364 $ 222,554 $ 237,364 </TABLE> 25
PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ At a Special Meeting of Shareholders of TDS held on April 27, 1998, the following numbers of votes were cast for the matters indicated: 1. Approval of a proposal to authorize three tracking stocks for the Company's principal business units and to reincorporate the Company from Iowa to Delaware (the "Tracking Stock Proposal"): <TABLE> <CAPTION> Broker For Against Abstain Non-vote ---------- ---------- --------- -------- <S> <C> <C> <C> <C> Common Shares 31,875,787 7,168,674 2,443,881 175 Series A Common Shares 65,472,510 0 0 0 Preferred Shares, issued before 10/31/98 6,464 16 0 0 Preferred Shares, issued after 10/31/98 172,918 12 6 0 ---------- ---------- ---------- ---------- Total 97,527,679 7,168,702 2,443,887 175 ========== ========== ========== ========== </TABLE> 2. Approval of Amendment and Adjustment of Existing Plans as a result of the Tracking Stock Proposal: <TABLE> <CAPTION> Broker For Against Abstain Non-vote ---------- --------- --------- -------- <S> <C> <C> <C> <C> Common Shares 34,747,220 4,130,609 2,490,888 119,800 Series A Common Shares 65,472,510 0 0 0 Preferred Shares, issued before 10/31/98 6,464 16 0 0 Preferred Shares, issued after 10/31/98 172,851 12 73 0 ----------- ----------- ----------- ----------- Total 100,399,045 4,130,637 2,490,961 119,800 =========== =========== =========== =========== </TABLE> 26
3. Approval of the Company's 1998 Long-Term Incentive Plan: <TABLE> <CAPTION> Broker For Against Abstain Non-vote ---------- --------- --------- -------- <S> <C> <C> <C> <C> Common Shares 33,059,234 5,795,852 2,513,454 119,977 Series A Common Shares 65,472,300 210 0 0 Preferred Shares, issued before 10/31/98 6,464 16 0 0 Preferred Shares, issued after 10/31/98 172,851 12 73 0 ---------- ---------- ---------- ---------- Total 98,710,849 5,796,090 2,513,527 119,977 ========== ========== ========== ========== </TABLE> Item 6. Exhibits and Reports on Form 8-K. - ----------------------------------------- (a) Exhibit 11 - Computation of earnings per common share is included herein as footnote 11 to the financial statements. (b) Exhibit 12 - Statement regarding computation of ratios. (c) Exhibit 27 - Financial Data Schedule (d) Reports on Form 8-K filed during the quarter ended June 30, 1998: TDS filed a Current Report on Form 8-K on April 20, 1998 dated April 17, 1998, which included a news release that announced the Company intends to submit a proposal to shareholders at the TDS 1998 Annual Meeting to consider certain amendments to the proposed charter of the new TDS Delaware corporation, which the Board of Directors believes would improve the corporate governance provisions of the Tracking Stock Proposal. TDS filed a Current Report on Form 8-K on April 23, 1998, dated April 21, 1998, which included a news release that announced the Company's first quarter 1998 financial results. TDS filed a Current Report on Form 8-K on April 28, 1998, dated February 10, 1998, which included certain documents related to the sale of 6,000,000 8.04% Trust Originated Preferred Securities. TDS filed a Current Report on Form 8-K on April 28, 1998, dated April 27, 1998, which included a news release that announced that shareholders approved the Company's Tracking Stock Proposal as well as two other related proposals. TDS filed a Current Report on Form 8-K on May 22, 1998, dated May 22, 1998, which announced the merger and reincorporation of TDS from Iowa to Delaware and included the Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware and the Restated Bylaws of the Company. 27
TDS filed a Current Report on Form 8-K on June 5, 1998, dated May 22, 1998, which included the opinion letters of Credit Suisse First Boston and Salomon Smith Barney with respect to the proposal by TDS set forth in the Proxy Statement / Prospectus dated March 24, 1998, as amended on April 20, 1998. The Current Report also included an amendment to the Voting Trust Agreement to be governed by the laws of the state of Delaware. TDS filed a Current Report on Form 8-K on June 15, 1998, dated June 12, 1998, which included a news release that announced that the Company has withdrawn its planned offering of 13,500,000 shares of TDS Telecommunications Group Common Shares, a class of common stock of TDS which would track the performance of the TDS Telecom Group. TDS filed a Current Report on Form 8-K on June 16, 1998, dated June 1, 1998, which included a news release of Aerial Communications, Inc., an 83% owned subsidiary of TDS, and the Purchase Agreement between TDS, Aerial, APT Operating Co., Inc. and Sonera Corporation related to Sonera's $200 million investment in APT Operating Co., Inc., a wholly owned subsidiary of Aerial. 28
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 August 10, 1998 MURRAY L. SWANSON ----------------------------- ------------------------- Murray L. Swanson, Executive Vice President-Finance (Chief Financial Officer) Date August 10, 1998 GREGORY J. WILKINSON ------------------------------ -------------------------- Gregory J. Wilkinson, Vice President and Controller (Principal Accounting Officer) 29