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 o 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.3rd QUARTER REPORT ON FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATIONTELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIESMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONSAND FINANCIAL CONDITION
Telephone and Data Systems, Inc. (“TDS” or the “Company”) is a diversified telecommunications company, providing high-quality telecommunications services to over 4.9 million wireless telephone and wireline telephone customer units. TDS’s business development strategy is to expand its existing operations through internal growth and acquisitions, and to explore and develop telecommunications businesses that management believes utilize TDS’s expertise in providing customer focused telecommunications services. The Company conducts substantially all of its wireless telephone operations through its 82.2%-owned subsidiary, United States Cellular Corporation (“U.S. Cellular”) and its 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, Management’s Discussion and Analysis of Results of Operations and Financial Condition and the description of the Company’s business included in Item 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.
On August 7, 2002, U.S. Cellular completed the acquisition of all of the equity interest in Chicago 20MHz, LLC (“Chicago 20MHz”), including the assets and certain liabilities of Chicago 20MHz, from PrimeCo Wireless Communications LLC (“PrimeCo”). Chicago 20MHz operates the PrimeCo wireless system in the Chicago Major Trading Area (“MTA”). The purchase price was approximately $607 million subject to certain working capital and other adjustments. The financial statements include the assets and liabilities of Chicago 20MHz and the results of operations since August 7, 2002. See U.S. Cellular Operations – Acquisition of Chicago 20MHz.
Operating Revenuesincreased 14% ($273.2 million) during the first nine months of 2002 primarily as a result of a 17% increase in customer units served from internal growth and acquisitions. U.S. Cellular’s operating revenues increased 13% ($187.6 million) as customer units served increased by 564,000 or 17%, since September 30, 2001, to 3,943,000. The acquisition of Chicago 20MHz increased customer units by 305,000 and revenues by $28.2 million. TDS Telecom operating revenues increased 17% ($85.6 million) as equivalent access lines increased by 144,800, or 17%, since September 30, 2001, to 987,500 through internal growth (117,000) and acquisitions (27,800). Growth in the competitive local exchange operations increased revenue by $40.1 million, and the effect of acquisitions in 2002 and 2001 increased revenue by $32.7 million.
Operating Expensesrose 18% ($281.6 million) in the first nine months of 2002 reflecting growth in operations. U.S. Cellular’s operating expenses increased 16% ($188.8 million). The acquisition of Chicago 20MHz increased operating expenses by $33.6 million. TDS Telecom’s expenses increased 22% ($92.8 million).
Operating Income decreased 3% ($8.3 million) to $322.8 million in the first nine months of 2002 from $331.2 million in 2001. TDS adopted Statement of Financial Accounting Standards
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("SFAS") No. 142 effective January 1, 2002, and ceased the amortization of license costs and goodwill on that date. TDS also determined that no impairment charge was required upon the completion of the initial impairment review required by SFAS No. 142. For the nine months ended September 30, 2001, amortization of license costs and goodwill included in U.S. Cellular's and TDS Telecom's depreciation and amortization captions totaled $27.1 million and $5.1 million, respectively. Excluding license cost and goodwill amortization in 2001, operating income decreased 11% ($40.5 million). The decline in operating income reflects increased bad debts expense as a result of the WorldCom and Global Crossing bankruptcies ($10.7 million), increased bad debts on customer receivables ($18.1 million), and a write-off of certain analog radio equipment ($15.0 million).
U.S. Cellular's operating income decreased 1% ($1.2 million) in the first nine months of 2002. Excluding license cost and goodwill amortization in 2001, U.S. Cellular's operating income decreased 10% ($28.3 million) to $243.6 million in the first nine months of 2002 from $271.9 million in 2001 and its operating income margin, as a percentage of service revenues, decreased to 16.0% in 2002 from 19.9% in 2001. The decrease in U.S. Cellular's operating income was primarily due to increased bad debts ($18.1 million) and the additional depreciation expense recorded to write-off certain analog radio equipment ($15.0 million). The Chicago 20MHz acquisition contributed an operating loss of $5.3 million in 2002.
TDS Telecom’s operating income decreased 8% ($7.1 million) in the first nine months of 2002. Excluding license cost and goodwill amortization in 2001, TDS Telecom’s operating income decreased 13% ($12.2 million) to $79.2 million in the first nine months of 2002 from $91.4 million in 2001 and its operating margin declined to 13.5% in 2002 from 18.2% in 2001. The decrease in TDS Telecom’s operating income and margin was primarily due to increased reserves for uncollectible receivables related to the WorldCom and Global Crossing bankruptcy filings ($10.7 million) and increased operating losses from expanding the competitive local exchange business ($17.3 million).
Investment and Other Income (Expense) totaled $(1,759.5) million in 2002 and $(596.8) million in 2001.
Dividend and interest income increased $40.3 million to $52.4 million in the first nine months of 2002. The increase primarily relates to a $45.3 million dividend the Company recorded on its investment in Deutsche Telekom, offset somewhat by a $6.8 million reduction in interest income. This year is the first year that TDS has been a record holder on Deutsche Telekom’s annual dividend declaration date.
(Loss) on marketable securities and other investments totaled $(1,846.6) million in the first nine months of 2002 and $(644.9) million in the first nine months of 2001. Management determined that the decline in value of marketable securities relative to its cost basis was other than temporary in 2002 and charged a $1,756.5 million loss to the statement of operations. The loss primarily includes a loss of $1,363.3 million recognized by TDS on its investment in Deutsche Telekom ordinary shares and a loss of $308.1 million on the investment in Vodafone AirTouch plc American Depository Receipts ("ADRs").
TDS has notes receivable from Airadigm Communications, Inc. and Kington Management Corporation aggregating $100.6 million relating to the funding of Airadigm’s operations and the purchase by Kington of certain of U.S. Cellular’s minority interests in 2000. The values of the notes are directly related to the values of certain assets and contractual rights of Airadigm and the value of the minority cellular market interests. As a result of changes in business strategies and other events, a review of the Airadigm business plan and a review of the fair market value analysis of the cellular markets, including third party fair value analysis, management concluded that the notes receivable are impaired. Accordingly TDS established a valuation allowance to reduce the notes receivable by $90.1 million in the third quarter of 2002.
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In May 2001, TDS realized a pre-tax loss of $644.9 million as a result of the merger between VoiceStream Wireless Corporation and Deutsche Telekom AG. The loss was due to the decline in the market price of VoiceStream common stock between the time that TDS acquired the stock on May 4, 2000 and the merger on May 31, 2001.
Investment Income, net, decreased $5.7 million to $32.1 million in the first nine months of 2002. 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.
TDS adopted SFAS No. 145 in the second quarter of 2002. TDS no longer reports gains and losses from the extinguishment of debt as an extraordinary item. U.S. Cellular reported the conversion of liquid yield option notes (“LYONs”) for cash as extraordinary losses in 2001. Losses on extinguishment of debt, net of minority interest, totaling $5.7 million, or $0.10 per diluted share, reported as an extraordinary loss in 2001, have been reclassified into other (expense), net and minority interest.
Interest Expenseincreased 19% ($14.6 million) in the first nine months of 2002. The increase in interest expense is primarily due to the issuance of $500 million of 7.6% Series A Notes in December 2001 ($28.5 million) offset by a decrease in average short-term debt balances and related interest expense ($11.0 million), a $116.5 million reduction in medium-term notes ($6.3 million), and a reduction in LYONs interest expense ($1.0 million). Interest expense in 2002 also includes $2.0 million related to variable prepaid forward contracts (“forward contracts”) and $2.4 million related to the 30-year, 9% Series A Notes issued by U.S. Cellular in conjunction with the acquisition of Chicago 20MHz. See Note 6 - Derivatives and Note 8 - Long-term Debt, for an explanation of the forward contracts.
Income Tax Expense (Benefit) totaled $(588.3) million in 2002, a change of $455.0 million from $(133.3) million in 2001. A tax benefit of $718.8 million was recognized in 2002 related to the other than temporary loss on marketable securities and other investments. A tax benefit of $259.7 million was recognized in 2001 related to the loss on the VoiceStream/Deutsche Telekom merger. The effective tax (benefit) rate was (38.0)% in 2002 and (36.9)% in 2001. The effective tax rate excluding the effects of loss on marketable securities and other investments was 43.6% in 2002 and 44.6% in 2001.
Minority Share of (Income) Loss 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 2002 was reduced by $29.8 million due to U.S. Cellular’s loss on marketable securities and other investments in 2002.
Nine Months Ended September 30, -------------------- 2002 2001 Change -------- -------- -------- (Dollars in thousands) Minority Share of (Income) Loss U.S. Cellular Minority Public Shareholders' $ 5,890 $(25,301) $ 31,191 Minority Shareholders' or Partners' (5,013) (6,161) 1,148 -------- -------- -------- 877 (31,462) 32,339 Other (22) (93) 71 -------- -------- -------- $ 855 $(31,555) $ 32,410 ======== ======== ========
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Net Income (Loss) Available to Common totaled $(958.6) million, or $(16.35) per diluted share, in the first nine months of 2002, compared to $(260.3) million, or $(4.44) per diluted share, in the first nine months of 2001. Net income (loss) available to common includes significant losses from marketable securities and other investments as well as certain other income and expense items affecting the comparability of operating results. Income from operations, excluding the Deutsche Telekom dividend recorded in 2002, losses on marketable securities and other investments, amortization of license costs and goodwill in 2001, and losses on conversions of LYONs, was $111.7 million, or $1.89 per diluted share in 2002 compared to $152.4 million, or $2.59 per diluted share in 2001. The decline is primarily due to additional operating losses from the developing CLEC business, additional bad debt expense from WorldCom and Global Crossing bankruptcies as well as an increase in bad debts on customer receivables, an increase in depreciation expense relating to the write-off of certain analog radio equipment and an increase in interest expense. A summary of net income (loss) available to common and diluted earnings per share is shown below.
Nine Months Ended September 30, ------------- 2002 2001 ----------- ----------- (Dollars in thousands, except per share amounts) Net Income (Loss) from: Operations $ 111,681 $ 152,374 Deutsche Telekom dividend 27,659 -- Loss on marketable securities and other investments (1,097,958) (385,223) License and goodwill amortization -- (21,786) Loss on conversion of LYONs -- (5,697) ----------- ----------- $ (958,618) $ (260,332) =========== =========== Diluted Earnings Per Share from: Operations $ 1.89 $ 2.59 Deutsche Telekom dividend .47 -- Loss on marketable securities and other investments (18.71) (6.56) License and goodwill amortization -- (.37) Loss on conversion of LYONs -- (.10) ----------- ----------- $ (16.35) $ (4.44) =========== ===========
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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 wireless markets throughout the United States. The number of customer units served increased by 564,000, or 17%, since September 30, 2001, to 3,943,000. The Chicago 20MHz acquisition increased customer units by 305,000 in the third quarter of 2002.
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- (Dollars in thousands) Operating Revenue Retail service $ 443,290 $ 360,689 $1,217,387 $1,044,876 Inbound roaming 74,243 77,790 190,910 209,144 Long-distance and other 43,707 40,839 115,209 110,419 ---------- ---------- ---------- ---------- Service Revenue 561,240 479,318 1,523,506 1,364,439 Equipment Sales 36,331 21,706 80,195 51,643 ---------- ---------- ---------- ---------- 597,571 501,024 1,603,701 1,416,082 ---------- ---------- ---------- ---------- Operating Expenses System operations 136,367 119,160 362,426 320,596 Marketing and selling 100,877 74,363 264,032 213,667 Cost of equipment sold 51,595 31,721 118,550 93,737 General and administrative 141,161 105,817 363,066 321,663 Depreciation 93,355 61,520 228,289 174,437 Amortization 9,521 15,766 23,748 47,196 ---------- ---------- ---------- ---------- 532,876 408,347 1,360,111 1,171,296 ---------- ---------- ---------- ---------- Operating Income 64,695 92,677 243,590 244,786 Add Amortization of goodwill and license costs -- 9,126 -- 27,144 ---------- ---------- ---------- ---------- Operating Income, as adjusted $ 64,695 $ 101,803 $ 243,590 $ 271,930 ========== ========== ========== ==========
Operating revenue increased 13% ($187.6 million) and service revenues increased 12% ($159.1 million) in the first nine months of 2002 due primarily to the increase in customer units. The Chicago 20MHz acquisition increased operating revenues by $28.2 million and total service revenues by $26.4 million. Total average monthly service revenue per customer increased slightly ($0.36) to $47.02 in the first nine months of 2002 from $46.66 in 2001. Total average monthly service revenue per customer, excluding the Chicago 20MHz customers, was $47.03 in 2002.
Retail service revenue (charges to U.S. Cellular's customers for local systems usage and usage of systems other than their local systems) increased 17% ($172.5 million) in the first nine months of 2002 due primarily to the 17% customer growth. The Chicago 20MHz acquisition added $25.3 million to retail service revenue. Average local minutes of use per retail customer increased to 280 in 2002 (274 excluding Chicago 20MHz) from 208 in 2001, while average local retail revenue per minute continued to decline in 2002. The increase in monthly local retail minutes of use was driven by U.S. Cellular's focus on designing incentive programs and rate plans to stimulate overall usage. Average monthly retail service revenue per customer, including the Chicago 20MHz customers, increased 5% ($1.84) to $37.57 in 2002 from $35.73 in 2001. Average monthly retail service revenue per customer excluding the Chicago 20MHz customers was $37.45 in 2002.
Inbound roaming revenue (charges to customers of other systems who use U.S. Cellular's wireless systems when roaming) decreased 9% ($18.2 million) in the first nine months of 2002. The decline in inbound roaming revenue in 2002 was a result of a decrease in revenue per roaming minute of use partially offset by an increase in roaming minutes used. Management anticipates that the rate of growth in inbound roaming minutes of use will be reduced due to
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newer customers roaming less than existing customers, reflecting further penetration of the consumer market. In addition, as wireless operators expand service in U.S. Cellular's markets, roaming partners could switch their business to these operators. It is also anticipated that average inbound revenue per minute of use will continue to decline, reflecting the general downward trend in negotiated rates.
Operating expenses increased 16% ($188.8 million) during the first nine months of 2002. The Chicago 20MHz acquisition increased operating expenses by $33.6 million. The remaining increase is primarily related to increased costs to provide service and expand the customer base, increased general and administrative expense, and increased depreciation.
System operations expenses (costs to provide service) increased 13% ($41.8 million) and represented 24% of service revenues in 2002 and 2001, respectively. System operations expenses include customer usage expenses and maintenance, utility and cell site expenses. This increase was primarily due to an increase in the cost of minutes used on the systems ($19.4 million), an increase in the cost of maintaining the network ($12.3 million), the acquisition of Chicago 20MHz ($5.4 million) and an increase in the costs associated with customer roaming on other companies systems ($4.7 million). Management expects system operations expenses to increase over the next few years, driven by increases in the number of cell sites and increase in minutes of use on the U.S. Cellular system and on other systems when roaming. The number of cell sites increased to 3,750 at September 30, 2002 from 2,804 at September 30, 2001.
Management anticipates that the integration of Chicago 20MHz into its operations will result in an 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. Such a shift in minutes of use should reduce U.S. Cellular's per minute cost of usage in the future.
Costs to expand the customer base consist of marketing and selling expenses and the cost of equipment sold. These expenses, less equipment sales revenue, represent the cost to acquire a new customer. Cost per gross customer addition increased to $365 in 2002 ($363 excluding the effect of Chicago 20MHz) from $311 in 2001 primarily due to the increase in marketing and selling expenses. Gross customer activations were 829,000 (809,000 excluding Chicago 20MHz) in 2002 compared to 823,000 in 2001.
Marketing and selling expenses increased 24% ($50.4 million) in the first nine months of 2002. The increase in 2002 was primarily due to enhancements made to U.S. Cellular's merchandise management and telesales processes and the development of data services strategies ($18.6 million), commissions and related payments to U.S. Cellular personnel and third party agents ($9.7 million), increases in advertising costs related to certain pricing promotions implemented in the second quarter of 2002 ($7.2 million) and the acquisition of Chicago 20MHz ($6.9 million). Also, during the second half of 2001, the Company changed certain agent compensation plans to reduce the base commission payment and include future residual payments to agents. Such residual payments recognize the agent's role in providing ongoing customer support, promote agent loyalty and encourage agent sales to customers who are more likely to have greater usage and remain customers for a longer period of time. As a greater percentage of the Company's customer base becomes activated by agents receiving residual payments, it is possible that the Company's aggregate residual payments to agents may grow by a larger percentage than its customers.
Equipment sales revenue increased 55% ($28.6 million) in the first nine months of 2002 while cost of equipment sold increased 27% ($24.8 million). Chicago 20MHz contributed $1.8 million in equipment sales revenue and $3.8 million in cost of equipment sold. 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. 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
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pass along quantity discounts.
General and administrative expenses increased 13% ($41.4 million) and represented 24% of service revenues in 2002 and 2001. The increase in administrative expenses reflects a $18.1 million increase in bad debt expense due to the downturn in the economy over the past 15 months and an increase of $6.1 million in customer retention expenses. In addition, customer service-related expenses increased as a result of the 17% growth in the customer base. Chicago 20MHz added $10.6 million to general and administrative expenses. Management 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.
Depreciation expense increased 31% ($53.9 million) in 2002 primarily due to the increase in average fixed assets since September 30, 2001 and $4.8 million of depreciation expense related to Chicago 20MHz. In addition, depreciation expense increased $15.0 million in 2002 to reflect the write-off of certain analog radio equipment based on fixed asset inventory reviews performed in 2002. Increased fixed asset balances in 2002 resulted from the addition of new cell sites built to improve coverage and capacity in U.S. Cellular's markets, the addition of digital radio channels to the network to accommodate increased usage, upgrades to provide digital service in more service areas, the commencement of the migration to a single digital platform and investments in billing and office systems.
Amortization expense decreased 50% ($23.4 million) as a result of the implementation of SFAS No. 142. U.S. Cellular determined that licenses have indefinite lives and no longer amortizes the intangible asset. No impairment charge was required upon the completion of the initial impairment review. Amortization of license costs and goodwill totaled $27.1 million in 2001. Chicago 20 MHz added an additional $2.1 million to amortization expense.
Operating income decreased slightly ($1.2 million) to $243.6 million in the first nine months of 2002. Operating income, excluding license costs and goodwill amortization in 2001, decreased 10% ($28.3 million) in the first nine months of 2002. Operating margin, as a percent of service revenue, decreased to 16.0% in 2002 compared to 17.9% (19.9% excluding license cost and goodwill amortization) in 2001. The Chicago 20MHz market had an operating loss of $5.3 million in August and September of 2002. The decrease in operating income reflects increased marketing and selling expenses and depreciation offset somewhat by increases in revenue and the reduction in license cost and goodwill amortization.
U.S. Cellular expects each of the above factors to continue to have an effect on operating income and operating margins for the remainder of 2002. 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 and operating margins to fluctuate over the next several quarters.
Related to U.S. Cellular's acquisition and subsequent transition of the Chicago 20MHz operations, including the recent brand launch, U.S. Cellular plans to incur additional expenses during the remainder of 2002 and in 2003 as it begins to compete in the Chicago market. All expense categories will be affected by the launch of the Chicago market, and there is no assurance that the expenses incurred will result in any increase in revenues over the launch period. As a result, U.S. Cellular's operating income and operating margins may decrease during the remainder of 2002 and during 2003.
Management expects service revenues to continue to grow during the remainder of 2002 and in 2003; however, management anticipates that average monthly service revenue per customer may decrease as retail service and inbound roaming revenue per minute of use decline. Management continues to believe seasonal trends exist in both service revenue, which tends to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth, which may cause operating income to vary from quarter to quarter.
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Competitors licensed to provide wireless services have initiated service in many of U.S. Cellular’s markets over the past several years. U.S. Cellular expects other wireless operators to continue deployment of their network throughout all of its service areas during 2002 and 2003. 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 effect of additional wireless competition has significantly slowed U.S. Cellular customer growth in certain of its markets. Coupled with the downturn in the nation's economy, the effect of increased competition has caused U.S. Cellular's customer growth in these markets to be slower than expected over the past 15 months. Management anticipates that overall customer growth for U.S. Cellular will continue to 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.
On August 7, 2002, U.S. Cellular completed the acquisition of Chicago 20MHz, representing 13.2 million population equivalents (POPs), for approximately $607 million subject to certain working capital and other adjustments. U.S. Cellular financed the purchase using its revolving lines of credit, $175 million in 9% Series A Notes due 2032 and proceeds from a $105 million loan from TDS. See "Liquidity - Financing of Acquisition of Chicago 20MHz."
The Chicago MTA is the fourth largest MTA in the United States. The markets that comprise the Chicago MTA are adjacent to the Iowa, Illinois, Wisconsin and Indiana markets of U.S. Cellular's Midwest cluster, which is its largest market cluster. Of the total Chicago MTA population of 13.2 million, approximately 81% was not previously covered by U.S. Cellular's current licenses. There is a strong community of interest between U.S. Cellular's existing markets and the Chicago 20MHz markets. The Chicago MTA is the single largest roaming destination of U.S. Cellular's current customers.
Chicago 20MHz owns licenses covering 18 Basic Trading Areas ("BTAs"), that comprise the Chicago MTA. The Chicago MTA includes, among others, the Chicago, Bloomington-Normal, Champaign-Urbana, Decatur-Effingham, Peoria, Rockford and Springfield BTAs in Illinois, the South Bend and Fort Wayne BTAs in Indiana and the Benton Harbor BTA in Michigan. The Chicago 20MHz network currently covers approximately 73% of the population in the licensed area.
Chicago 20MHz utilizes Code Division Multiple Access ("CDMA") technology in a network which serves the Chicago MTA with over 500 cell sites. Chicago 20MHz currently serves approximately 305,000 customers, representing a penetration rate of approximately 2.3% based on 2001 Claritas population estimates for the licensed area of Chicago 20MHz.
Chicago 20MHz utilizes both direct and indirect distribution channels, with direct distribution provided through 34 stores and kiosks, and indirect distribution through approximately 600 authorized agents. In addition, Chicago 20MHz has approximately 720 replenishment locations for prepaid customers. U.S. Cellular launched its "U.S. Cellular" brand in the Chicago 20MHz licensed area in the fourth quarter of 2002.
At September 30, 2002, Chicago 20MHz had approximately 500 employees, none of whom is represented by labor unions.
Chicago 20MHz competes in the Chicago MTA directly against larger and more established wireless service providers, as it does in many of its other markets. The other wireless carriers competing in all or part of the Chicago MTA include Cingular, Verizon Wireless, AT&T Wireless, Sprint PCS, Nextel and T-Mobile. These competitors provide wireless services on a substantially national basis. As a result, they have customer bases substantially greater than Chicago 20MHz, which is only a local competitor, and also greater than U.S. Cellular, which is a
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regional competitor, and have financial resources that are substantially greater than Chicago 20MHz and U.S. Cellular.
For the twelve months ended December 31, 2001, Chicago 20MHz had net revenues of $232 million, an operating loss of $26 million and a net loss of $27 million.
For the portion of the third quarter subsequent to August 7, the date of acquisition, Chicago20MHz contributed $26.4 million of service revenue, with an average revenue per customer of $46.83, $1.8 million of equipment sales revenue and $5.3 million of operating loss to U.S. Cellular's operating results. Subsequent to the acquisition, Chicago 20MHz lost 15,000 net customers and ended the quarter with 305,000 customers.
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TDS operates its wireline telephone business through TDS Telecommunications Corporation ("TDS Telecom"), a wholly owned subsidiary. Total equivalent access lines served by TDS Telecom increased by 144,800, or 17%, since September 30, 2001 to 987,500.
TDS Telecom's incumbent local exchange carrier ("ILEC") subsidiaries served 714,400 equivalent access lines at September 30, 2002, a 6% (38,600 lines) increase over the 675,800 equivalent access lines at September 30, 2001. Acquisitions added 27,800 lines while internal growth added 10,800 lines. Acquisitions include the effect of the two telephone acquisitions in 2002 and the acquisition of Chorus Communications in September of 2001 and another small telephone company in October 2001.
TDS Telecom's competitive local exchange carrier ("CLEC") subsidiaries served 273,100 equivalent access lines at September 30, 2002, a 64% (106,200 lines) increase over the 166,900 equivalent access lines at September 30, 2001.
Access line equivalents are derived by converting each high capacity data line to the estimated equivalent, in terms of capacity, number of switched access lines. The historical statistics for the ILECs, which had been based on access lines, have been adjusted upward to an equivalent number of access lines. The change to equivalent access line reporting was made to account for an increasing use of data lines.
Operating revenue increased 17% ($85.6 million) in the first nine months of 2002, reflecting primarily customer growth in local telephone operations, including acquisitions, growth in services such as long distance resale and expansion of competitive local exchange activities.
Operating expenses increased 22% ($92.7 million) during 2002 reflecting primarily growth in expenses related to services such as long distance resale, ILEC acquisitions, continued expenses from expansion of competitive local exchange activities and uncollectible accounts from long distance providers that filed for bankruptcy.
Operating income decreased 8% ($7.1 million) to $79.2 million in the first nine months of 2002. Operating income, excluding goodwill amortization in 2001, decreased 13% ($12.2 million) in the first nine months of 2002. The decline in operating income resulted primarily from losses incurred from the expansion of competitive local exchange operations ($8.5 million, excluding bad debts), the increase in retail (residential and business) bad debts in CLEC operations ($6.3 million) and the write-off of uncollectible receivables related to the bankruptcy filing of two long distance providers ($10.7 million) offset by improved local telephone operations operating results.
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Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- (Dollars in thousands)Local Telephone OperationsOperating Revenue Local service $ 49,324 $ 45,251 $ 143,599 $ 132,003 Network access and long-distance 88,139 79,484 257,108 231,562 Miscellaneous 21,498 19,753 62,826 54,084 --------- --------- --------- --------- 158,961 144,488 463,533 417,649 --------- --------- --------- --------- Operating Expenses Operating expenses, excluding depreciation and amortization 80,206 70,582 240,603 203,833 Depreciation and Amortization 32,907 33,496 97,409 98,468 --------- --------- --------- --------- 113,113 104,078 338,012 302,301 --------- --------- --------- --------- Local Telephone Operating Income $ 45,848 $ 40,410 $ 125,521 $ 115,348 --------- --------- --------- ---------Competitive Local Exchange OperationsOperating Revenue $ 45,998 $ 30,157 $ 125,514 $ 85,404 --------- --------- --------- --------- Operating Expenses Operating expenses excluding Depreciation and amortization 52,906 40,284 150,512 102,920 Depreciation and Amortization 7,426 4,541 21,298 11,466 --------- --------- --------- --------- 60,332 44,825 171,810 114,386 --------- --------- --------- --------- Competitive Local Exchange Operating (Loss) $ (14,334) $ (14,668) $ (46,296) $ (28,982) --------- --------- --------- --------- Intercompany revenues (643) (660) (1,850) (1,456) Intercompany expenses (643) (660) (1,850) (1,456) --------- --------- --------- ---------Operating Income 31,514 25,742 79,225 86,366 Add amortization and goodwill -- 1,693 -- 5,098 --------- --------- --------- ---------Operating Income, as adjusted $ 31,514 $ 27,435 $ 79,225 $ 91,464 ========= ========= ========= =========
Local Telephone OperationsOperating revenues increased 11% ($45.9 million) in 2002. Acquisitions increased revenues by $32.7 million. Revenues from reselling long distance service increased network access and long distance revenues by $8.7 million in 2002. As of September 30, 2002, TDS Telecom was providing long distance service to 189,200 customers compared to 112,300 customers at September 30, 2001. Data transmission service revenues, which include Internet and DSL, increased by $5.4 million in 2002. Average monthly revenue per equivalent access line increased 1% ($0.46) to $74.08 in 2002 from $73.62 in 2001.
Operating expensesincreased by 12% ($35.7 million) in 2002. Operating expenses, excluding depreciation and amortization, increased by 18% ($36.8 million) in 2002. Acquisitions increased cash operating expenses by $19.7 million in 2002. The cost of providing long-distance service to an increased customer base increased expenses by $6.0 million. Bad debt expense, net of NECA pool recoveries, increased by $8.2 million in 2002 related to the bankruptcy filings of WorldCom and Global Crossing. Depreciation and amortization decreased 1% ($1.1 million) in 2002. Acquisitions increased depreciation expense by $6.7 million. In accordance with SFAS No. 142, TDS Telecom no longer amortizes telephone franchise costs (goodwill). No impairment charge was required upon the completion of the initial impairment review. Amortization expense of goodwill amounted to $5.1 million in the first nine months of 2001.
Operating income,increased 9% ($10.2 million) to $125.5 million in the first nine months of 2002. Operating income, excluding goodwill amortization in 2001,increased 4% ($5.1 million). Acquisitions contributed $6.3 million to this increase. Excluding the write-off of receivables due from companies which have filed bankruptcy during the first nine months of 2002, management
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expects operating income should remain fairly stable or increase slightly in the near term with expense increases due to inflation and additional revenue and expenses from new or expanded product offerings. Total long distance access minutes of use declined by 2.1% during the first nine months of 2002 compared to the first nine months of 2001. Minutes in the third quarter of 2002 as compared to the same period in 2001 were flat. Slower growth in internal equivalent access lines and the decrease in long distance access minutes of use are due primarily to a weaker economy, the use of high capacity lines, DSL implementation and wireless, email and broadband substitution.
Competitive Local Exchange OperationsOperating revenuesincreased 47% ($40.1 million) in 2002 as equivalent access lines served increased by 64% (106,200 lines) to 273,100 at September 30, 2002 from 166,900 at September 30, 2001.
Operating expensesincreased 50% ($57.4 million) in 2002 due primarily to the costs incurred to grow and serve the customer base and expand competitive local exchange operations. Operating expenses include a $2.5 million charge relating to the WorldCom and Global Crossing bankruptcies in 2002 and an increase in retail bad debts of $6.3 million.
Operating lossincreased $(17.3) million to $(46.3) million. TDS Telecom expects operating losses to continue in its competitive local exchange business as it continues to grow the customer base in each of its markets.
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Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001Except as otherwise stated below, the changes in the three month period are due to reasons generally the same as explained above for the nine month period.
Operating Revenuesincreased 19% ($126.9 million) during the third quarter of 2002. U.S. Cellular revenues increased 19% ($96.5 million) in 2002. The Chicago 20MHz acquisition increased operating revenues by $28.2 million in the third quarter of 2002. Retail service revenue increased 23% ($82.6 million) in the third quarter of 2002, while inbound roaming revenue decreased 5% ($3.5 million). Average monthly service revenue per customer was $49.31 in the third quarter of 2002 and $47.92 in 2001, primarily due to the increase in average retail service per customer to $38.95 from $36.06. Average monthly service revenue per customer, excluding the Chicago 20MHz acquisition, was $49.44 and retail service revenue per customer was $38.64. TDS Telecom revenues increased 17% ($30.3 million) in the third quarter of 2002 due to the growth in ILEC operations ($14.5 million) and growth in CLEC operations ($15.8 million). Acquisitions accounted for $11.5 million of the ILEC growth. Average monthly revenue per ILEC access line decreased to $74.39 in the third quarter of 2002 from $75.12 in 2001.
Operating Expensesrose 27% ($149.1 million) during the third quarter of 2002 for reasons generally the same as the first nine months.
U.S. Cellular expenses increased 31% ($124.5 million). The Chicago 20MHz acquisition increased expenses by $33.6 million. System operations expense increased 14% ($17.2 million). Marketing and selling expenses, including cost of equipment sold, increased 44% ($46.4 million). Cost per gross customer addition increased to $346 ($340 excluding Chicago 20MHz) in the third quarter of 2002 from $285 in 2001. Gross customer activations increased to 336,000 (316,000 excluding Chicago 20MHz) in the third quarter of 2002 from 296,000 in 2001. General and Administrative expense increased 33% ($35.3 million). Depreciation expense increased 52% ($31.8 million) while amortization expense decreased 40% ($6.2 million). Depreciation expense increased $15.0 million in 2002 to reflect the write-off of certain analog radio equipment based on fixed asset inventory reviews performed in 2002.
TDS Telecom expenses increased 17% ($24.6 million) due to growth in ILEC operations ($9.0 million) and in CLEC operations ($15.5 million) for reasons generally the same as the first nine months. Acquisitions increased ILEC expenses by $9.0 million.
Operating Incomedecreased 19% ($22.2 million) to $96.2 million in the third quarter of 2002. Excluding license cost and goodwill amortization, operating income decreased 26% ($33.0 million) in the third quarter of 2002. U.S. Cellular’s operating income decreased 30% ($28.0 million). The decrease in U.S. Cellular’s operating income relates to the increase in bad debt expense, the additional depreciation expense recorded to write-off certain analog radio equipment and the results of Chicago 20MHz, offset somewhat by ceasing amortization on license costs and goodwill. TDS Telecom’s operating income increased 22% ($5.8 million). The increase at TDS Telecom reflects improved ILEC operating results and the effects of acquisitions.
Investment and Other Income (Loss) totaled $(72.0) million in 2002 and $23.3 million in 2001.
(Loss) on marketable securities and other investments totaled $(90.1) million in the third quarter of 2002 as TDS established a valuation allowance to reduce the value of notes receivable related to Airadigm Communications, Inc. and to the sales in 2000 of certain minority interests. There was no gain or loss in the third quarter of 2001.
Interest Expenseincreased 50% ($11.2 million) to $33.5 million in the third quarter of 2002. The increase in interest expense is primarily due to the issuance of $500 million of 7.6% Series A Notes in December 2001 ($9.5 million) offset by a $51 million reduction in medium-term notes
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($1.2 million), a decrease in average short-term debt balances and related interest expense ($0.6 million), and a reduction in LYONs interest expense ($0.1 million). Interest expense in 2002 also includes $2.0 million related to the forward contracts and $2.4 million related to the 30-year, 9% Series A Notes issued by U.S. Cellular in conjunction with the acquisition of Chicago 20MHz. See Note 6 - Derivatives and Note 8 - Long-term Debt, for an explanation of the forward contracts.
Income Tax Expense (Benefit) totaled a benefit of $(0.4) million in 2002, and an expense of $50.5 million in 2001. The effective tax (benefit) rate was (2.6%) in 2002 and 44.6% in 2001. The effective tax rate excluding the effects of loss on marketable securities and other investments was 43.2% in 2002 and 44.6% in 2001.
Minority Share of (Income) Loss changed $6.8 million in the third quarter of 2002. U.S. Cellular’s minority public shareholders’ share of income in 2002 was reduced by $3.9 million due to the writedown of $34.2 million of notes receivable in 2002.
Three Months Ended September 30, ------------------- 2002 2001 Change -------- -------- -------- (Dollars in thousands) Minority Share of (Income) Loss U.S. Cellular Minority Public Shareholders' $ (2,164) $ (9,578) $ 7,414 Minority Shareholders' or Partners' (2,287) (1,634) (653) -------- -------- -------- (4,451) (11,212) 6,761 Other 2 (51) 53 -------- -------- -------- $ (4,449) $(11,263) $ 6,814 ======== ======== ========
Net Income (Loss) Available to Common totaled $(19.6) million, or $(0.33) per diluted share, in the third quarter of 2002, compared to $51.4 million, or $0.87 per diluted share, in the third quarter of 2001. Income from operations, excluding losses on marketable securities and other investments, amortization of license costs and goodwill in 2001, and losses on conversions of LYONs, was $33.9 million, or $0.58 per diluted share in 2002 compared to $60.7 million, or $1.02 per diluted share in 2001. The decline is primarily due to operating losses from the developing CLEC business, additional bad debt expense, and an increase in depreciation expense. A summary of net income (loss) from continuing operations and diluted earnings per share from operations and gains (losses) is shown below.
Three Months Ended September 30, ------------------- 2002 2001 -------- -------- (Dollars in thousands, except per share amounts) Net Income (Loss) from: Operations $ 33,939 $ 60,690 Loss on marketable securities and Other investments (53,555) -- License and goodwill amortization -- (7,858) Loss on conversion of LYONs -- (1,448) -------- -------- $(19,616) $ 51,384 ======== ======== Diluted Earnings Per Share from: Operations $ 0.58 $ 1.02 Losses on marketable securities and Other investments (0.91) -- License and goodwill amortization -- (0.13) Loss on conversion of LYONs -- (0.02) -------- -------- $ (0.33) $ 0.87 ======== ========
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SFAS No. 143, “Accounting for Asset Retirement Obligations” was issued in June 2001, and will become effective for the Company beginning January 1, 2003. SFAS No. 143 requires entities to record the fair value of a liability for legal obligations associated with an asset retirement in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. The Company is currently reviewing the requirements of this new standard and has not yet determined the impact, if any, on the Company’s financial position or results of operations.
SFAS No. 145 “Rescission of SFAS No. 4, 44, and 64 and Technical Corrections” was issued in April 2002. The Company elected to adopt SFAS No. 145 early, in the second quarter of 2002, and as a result no longer reports gains and losses from extinguishment of debt as an extraordinary item. Prior year losses on the retirement of LYONs debt of $1.4 million and $5.7 million, net of tax and minority interest for the three and nine months ended, respectively, previously reported as an extraordinary item, have been reclassified to Other income (expense), net in the Company’s statement of operations, to conform with SFAS No. 145.
SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” was issued in June 2002 and will become effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity’s commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. The Company will apply this new standard on exit or disposal activities, if any, initiated after December 31, 2002.
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Cash Flows From Operating Activities. U.S. Cellular and TDS Telecom are generating substantial internal funds from operations. Cash flows from operating activities totaled $624.5 million in the first nine months of 2002 compared to $512.7 million in 2001.
Income from operations excluding all noncash items and including the change in accrued taxes increased $76.5 million to $643.2 million in the first nine months of 2002. Changes in assets and liabilities from operations, excluding the change in accrued taxes, required $18.7 million in 2002 and $54.1 million in 2001 reflecting primarily timing differences in the payment of accounts payable and the receipt of accounts receivable.
Cash Flows From Investing Activities. TDS makes substantial investments each year to acquire, construct, operate and upgrade modern high-quality communications networks and facilities as a basis for seeking to create long-term value for shareowners. Cash flows from investing activities required $1,033.2 million in the first nine months of 2002 and $299.3 million in 2001.
Cash expenditures for capital additions required $565.7 million in 2002 and $521.5 million in 2001. The primary purpose of TDS’s construction and expansion expenditures is to provide for customer growth, to provide for increasing customer usage of the network, 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 $449.0 million in 2002 and $377.7 million in 2001 representing expenditures to construct cell sites, to add digital radio channels, to replace retired assets, to improve business systems, to change out analog equipment for digital equipment and to migrate to a single digital equipment platform. TDS Telecom’s capital expenditures for its local telephone operations totaled $81.0 million in 2002 and $64.4 million in 2001 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 $35.7 million in 2002 and $79.4 million in 2001 for switching and other network facilities. Capital expenditures for the competitive local exchange operations have decreased in 2002 due to the completion of expansion construction in the Michigan and Illinois markets.
Cash used for acquisitions, excluding cash acquired, totaled $528.6 million in 2002 and $338.9 million in 2001. TDS’s acquisitions include primarily the purchase of controlling interests in wireless markets and telephone properties, minority interests that increased the ownership of majority-owned markets and wireless spectrum.
On August 7, 2002, U.S. Cellular completed the acquisition of Chicago 20MHz. U.S. Cellular paid $430.4 million in cash, net of cash acquired, and issued $175 million of 9% Notes due in 2032 to PrimeCo. U.S. Cellular financed the cash portion of the purchase price by using its revolving lines of credit and a $105 million loan from TDS. The purchase price is subject to certain working capital adjustments. The Company also acquired two telephone companies ($77.2 million), three PCS licenses ($18.0 million) and additional minority interest in majority owned markets ($3.0 million) in 2002. In 2001, the Company acquired Chorus Communications Group, Ltd. ($200.8 million), interests in sixteen PCS markets ($78.2 million), a majority interest in a cellular market ($56.2 million), an interest in a small printing company ($3.5 million) and additional minority interests in majority owned markets ($0.2 million). The PCS licenses were acquired on U.S. Cellular’s behalf and through joint ventures. The interests acquired through joint ventures are 100% owned by the joint ventures, and U.S. Cellular is considered to have the controlling financial interest in these joint ventures for financial reporting purposes.
U.S. Cellular received a cash refund of $47.6 million on its FCC deposits in 2002. Cash totaling $570.0 million was received by TDS from the merger of Deutsche Telekom and VoiceStream along with 131.5 million Deutsche Telekom AG ordinary shares in 2001.
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Cash Flows From Financing Activities. Cash flows from financing activities provided $704.7 million in the first nine months of 2002 and required $250.8 million in 2001. In 2002, the Company received $680.4 million from forward contracts related to its investments in Deutsche Telekom, Vodafone and VeriSign. A portion of the proceeds from the Deutsche Telekom and VeriSign forward contracts were used by TDS to pay down TDS’s short-term debt. The remaining cash from the Deutsche Telekom forward contract is currently in cash and cash equivalents and will be used to pay down long-term debt and for other corporate purposes. U.S. Cellular used the proceeds from the Vodafone forward contract to pay down U.S. Cellular’s short-term debt. Notes Payable balances increased $116.1 million in 2002 and declined by $57.9 million in 2001. The proceeds received from the VoiceStream/Deutsche Telekom merger were used to reduce notes payable in 2001. TDS paid $51.0 million in the first nine months of 2002 and $65.5 million in 2001 to retire Medium-term Notes that were called at their principal face amount. Dividends paid on Common and Preferred Shares, excluding dividends reinvested, totaled $25.8 million in 2002 and $24.1 million in 2001.
No TDS or U.S. Cellular common shares were repurchased in 2002. During the first nine months of 2001, cash required for the repurchase of TDS common shares (324,600 shares for an aggregate price of $30.3 million) and the settlement of late December 2000 repurchases totaled $39.4 million. During the first nine months of 2001, cash required for the repurchase of U.S. Cellular common shares (322,600 shares for an aggregate price of $15.8 million) and the settlement of late December 2000 repurchases totaled $25.8 million. In 2001, U.S. Cellular retired LYONs securities with a carrying value of $49.4 million for cash totaling $30.1 million ($0.6 million was included in accounts payable at September 30, 2001) and 550,000 U.S. Cellular Common Shares.
Management believes that internal cash flow, existing cash and cash equivalents, funds available from line of credit arrangements and funds available from potential future monetization of marketable securities provide sufficient financial resources to finance its near-term capital, business development and expansion expenditures. TDS and its subsidiaries may 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 only 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 its 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 and acquisition programs.
At September 30, 2002, 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.
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TDS and its subsidiaries had cash and cash equivalents totaling $436.8 million at September 30, 2002. The large cash balance is due to the receipt of cash from the Deutsche Telekom forward contracts at the end of the third quarter. TDS anticipates using the cash to reduce outstanding debt and for general corporate purposes.
TDS and its subsidiaries have $1,425 million of revolving credit facilities available for general corporate purposes as well as an additional $87 million of bank lines of credit. As of September 30, 2002, TDS and its subsidiaries had $380 million of borrowings outstanding against the revolving credit facilities.
TDS had a $600 million revolving credit facility for general corporate purposes at September 30, 2002, all of which was unused. 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 September 30, 2002 (for a rate of 2.11% based on the LIBOR rate at September 30, 2002).
TDS also had $87 million of additional bank lines of credit for general corporate purposes at September 30, 2002, all of which were 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 (4.75% at September 30, 2002).
U.S. Cellular had a $500 million bank revolving line of credit ("1997 Revolving Credit Facility") for general corporate purposes at September 30, 2002, $120 million of which was unused. The revolving credit facility expires in August 2004. 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 19.5 basis points as of September 30, 2002 (for a rate of 2.01% based on the LIBOR rate at September 30, 2002).
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 September 30, 2002, all 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 September 30, 2002 (for a rate of 2.36% based on the LIBOR rate at September 30, 2002).
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 credit rating could adversely affect its ability to renew existing, or obtain access to new, credit facilities in the future. However, 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 to represent certain matters at the time of each borrowing. At September 30, 2002, TDS and U.S. Cellular were in compliance with all covenants and other requirements set forth in the credit agreements.
U.S. Cellular issued $175 million of 9% Series A Notes due 2032 to PrimeCo in connection with the purchase of Chicago 20MHz. Interest is payable quarterly. The notes are callable by U.S. Cellular after five years at the principal amount plus accrued but unpaid interest. In connection with the purchase of Chicago 20MHz from PrimeCo, U.S. Cellular entered into an agreement pursuant to which U.S. Cellular provided PrimeCo and transferees of PrimeCo rights to have such notes registered with the SEC for resale. U.S. Cellular filed the registration statement on August 29, 2002. This registration statement will be amended due to the purchase of a portion of the Series A Notes as described in the following paragraph.
In November 2002, U.S. Cellular sold $115 million of 8.75% Senior Notes due November 7,
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2032. Interest is payable quarterly. The notes are callable by U.S. Cellular after five years at the principal amount plus accrued but unpaid interest. The net proceeds of the notes are being used to purchase a portion of the 9% Series A Notes that were issued to PrimeCo. The issuance of the $115 million notes was a takedown from the $500 million shelf registration statement on Form S-3 filed in May of 2002. U.S. Cellular has also granted the underwriters an option, exercisable until November 30, 2002, to purchase up to an additional $17.25 million of the 8.75% Senior Notes. The underwriters have exercised the option to acquire an additional $15 million of the 8.75% Senior Notes.
U.S. Cellular's capital additions budget for 2002 totals approximately $720-$740 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 initial steps toward the migration to a single digital platform - CDMA technology, to satisfy certain regulatory requirements for specific services such as enhanced 911 and wireless number portability, and to enhance billing and office systems. The conversion to CDMA is expected to be completed during 2004, at an approximate cost of $400-$450 million, during the period from 2002 through 2004. The estimated capital additions in 2002 include $130-$145 million related to the conversion. Approximately $50 million of the conversion expenditures were moved into 2002 from 2003 to enable U.S. Cellular to migrate some service areas to the new platform sooner and to minimize U.S. Cellular's investment in infrastructure and handsets related to the old platform. Customers in the areas converted to CDMA in 2002 will be able to use U.S. Cellular's Chicago 20MHz network instead of roaming in third-party networks, potentially reducing system operations expense. At September 30, 2002, the remaining amount of the 2002 capital budget approximated $271 - $291 million. U.S. Cellular plans to finance its cellular construction program using primarily internally generated cash and short-term debt. U.S. Cellular's operating cash flow totaled $647.1 million for the twelve months ended September 30, 2002, up 12% ($67.6 million) from the twelve months ended September 30, 2001.
U.S. Cellular expects to incur approximately $90 million in capital expenditures during the first 12 months following the Chicago 20MHz acquisition, to improve coverage in the Chicago 20MHz network, including an upgrade of the current CDMA system to 1XRTT, and to enhance its marketing distribution in the Chicago market, including opening new retail and agent locations. Included in U.S. Cellular's 2002 capital additions budget above is approximately $50 million of this $90 million related to the Chicago market.
TDS Telecom’s capital additions budget for 2002 approximates $175-$195 million. The incumbent local telephone companies are expected to spend approximately $125 - $135 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 $50-$60 million to build switching and other network facilities to meet the needs of a growing customer base and to expand their markets. At September 30, 2002, the remaining amount of the 2002 capital budget approximated $44 - $54 million for local telephone companies and $14 - $24 million for the competitive local exchange companies. TDS Telecom plans to finance its construction program using primarily internally generated cash. TDS Telecom’s operating cash flow totaled $269.9 million for the twelve months ended September 30, 2002, up 2% ($6.1 million) from the twelve months ended September 30, 2001.
TDS reviews attractive opportunities to acquire additional telecommunications companies and wireless spectrum, which it believes will add value to the business.
On November 1, 2000, the United States Bankruptcy Court for the Western District of Wisconsin confirmed a plan of financial reorganization for Airadigm Communications, Inc., a Wisconsin-based wireless service provider. Under the terms of the plan of reorganization, TDS and an unrelated entity have provided funding to meet certain obligations of Airadigm. Airadigm continues to operate as an independent company providing wireless services. Pursuant to the plan of reorganization, under certain circumstances and subject to the FCC’s rules and
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regulations, TDS and the unrelated entity, or their respective designees, were permitted to acquire certain PCS licenses for areas of Wisconsin and Iowa as well as other Airadigm assets. In October 2002, TDS terminated its right to purchase licenses and assets from Airadigm. TDS has the right to foreclose on certain assets of Airadigm and cease its operations at any time. TDS is evaluating the desirability of providing additional funding on a month to month basis. See Application of Critical Accounting Policies, Valuation of Notes Receivable, below, for more information on Airadigm.
U.S. Cellular is a limited partner in a joint venture that was a successful bidder for 17 licenses in 13 markets in the January 2001 FCC spectrum auction ("Auction 35"). The cost for the 17 licenses totaled $283.9 million. Legally the general partner controls the joint venture; however, the Company has included the joint venture in its consolidated financial statements because U.S. Cellular is considered to have controlling financial interest for financial reporting purposes under GAAP. In 2001, the joint venture acquired 5 of such licenses in 4 markets for a total of $4.1 million and had deposits with the FCC totaling $56.1 million for the remaining licenses. In May 2002, the FCC refunded 85% of the deposits, or $47.6 million, and retained the remaining $8.5 million of deposits pending the outcome of the proceedings discussed below.
On September 12, 2002, the FCC issued a public notice (“WT Docket 02-276”) seeking comment on whether it should consider refunding the remainder of the deposits as well as permit the winning bidders in Auction 35 to dismiss some or all of their applications. The FCC also sought comment on whether winning bidders who elected to “opt-out” of certain applications should be barred from participating in any subsequent reauction with respect to those licenses. The pleading cycle in WT Docket 02-276 ended on October 21, 2002 and the FCC has indicated its intention of issuing an order soon thereafter. The remaining deposits are classified as a current asset at September 30, 2002. Subject to the final outcome of such proceedings, or the earlier decision of the FCC in WT Docket 02-276 and the election by the joint venture to opt-out of all of its applications, the joint venture’s portion of the funding could range from zero up to an aggregate of an additional $271.3 million. At this time, the joint venture has made no decision as to whether it will exercise any opt-out rights, even if the FCC were to grant such rights. In addition, U.S. Cellular has agreed to loan the general partner up to $20 million that could be used by the general partner to fund its investment in the licenses.
With respect to the remaining 12 licenses in 9 markets, such licenses had been reauctioned by the FCC after defaults by winning bidders in a prior auction and were made subject by the FCC to the final outcome of certain legal proceedings initiated by the prior winning bidders. Following the reauction, one of the prior winning bidders obtained a court ruling that the FCC’s actions were illegal. In response to a request of the U.S. Department of Justice and the FCC, the U.S. Supreme Court agreed to review this court ruling and oral arguments were heard on October 8, 2002. In the event the prior winning bidder is successful in this litigation, the joint venture would receive a refund of its remaining deposit of $8.5 million made to the FCC for such 12 licenses. The joint venture’s financial requirements would then be limited to the 5 licenses in 4 markets that it acquired in 2001. If the FCC is successful in this litigation or the matter is otherwise resolved in a manner that will permit the joint venture to acquire the remaining licenses, the joint venture could be required to pay to the FCC the balance of the auction price for such licenses. The joint venture could then have significant financial requirements to build out such markets. The exact nature of U.S. Cellular’s financial commitment going forward will be determined as the joint venture evaluates its alternatives as a result of any Order issued in WT Docket 02-276 and develops its long-term business and financing plans.
TDS and U.S. Cellular have no current plans to repurchase their common shares. However, as 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. The repurchase programs are intended to create value for the shareholders. The repurchases of common shares will be funded by internal cash flow, supplemented by short-term borrowings and other sources.
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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 maintains a portfolio of available-for-sale marketable equity securities. The market value of these investments aggregated $1,270.8 million at September 30, 2002. The Company has forward contracts, which may be settled in shares of the respective marketable equity security or in cash at the expiration of the forward contract, in connection with $521.0 million of the Company’s portfolio. With respect to the marketable securities not subject to forward contracts, TDS may sell or transfer shares in public or private transactions and/or may enter into privately negotiated derivative transactions to hedge the market risk of some or all of its positions in the securities depending on market conditions and other factors.
In October and November of 2002, the Company entered into forward contracts relating to Vodafone ADRs and ordinary shares of Deutsche Telekom. The forward contracts are similar to the other forward contracts that the Company has entered into. See – Market Risk below and Note 6 Derivatives for the explanation of the similar forward contracts. The table below summarizes certain facts surrounding the forward contracts entered from October 1, 2002 through November 11, 2002.
Collar --------------------- Downside Upside Proceeds Limit Potential Security Shares (000s) (Floor) (Ceiling) ---------- ---------- -------- ------- --------- Vodafone 2,700,545 $ 41,182 $ 15.25 $ 20.92 Deutsche Telekom 30,000,000 332,133 $ 11.37 $ 13.64 -------- $373,315 ========
TDS is subject to market rate risks due to fluctuations in interest rates and market prices of marketable equity securities. The majority of TDS’s debt 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. As of September 30, 2002, 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 $1,270.8 million at September 30, 2002 and $2,700.2 million at December 31, 2001. As of September 30, 2002, the net unrealized holding loss, net of tax and minority interest, included in accumulated other comprehensive loss totaled $167.7 million. In 2002, TDS recognized, in the statement of operations, a loss of $1,044.4 million, net of tax and minority interest, related to investments in marketable securities as a result of management’s determination that unrealized losses with respect to the investments were “other than temporary.” 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 statement of operations.
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The Company has entered into a number of variable prepaid forward contracts (“forward contracts”) related to the marketable equity securities that it holds. See Footnote 6 – Derivatives, for a description of the forward contracts. The risk management objective of the forward contracts is to hedge the value of the marketable equity securities to protect the value of the marketable equity securities from losses due to decrease in the market prices of the securities (“downside risk”) while retaining a share of gains from increases in the market prices of such securities (“upside potential”). The forward contracts may be settled in shares of the respective marketable equity security or in cash upon expiration of the forward contract. If shares are delivered in the settlement of the forward contract, the Company would incur a current tax liability at the time of delivery for the difference between the tax basis of the marketable equity securities and the maturity value of the forward contracts. TDS may enter into further monetizations depending on market conditions and other factors.
The following table summarizes certain facts surrounding the contracted securities as of September 30, 2002.
Collar -------------------- Downside Upside Loan Derivative Proceeds Limit Potential Amount Asset Security Shares (000s) (Floor) (Ceiling) (000s) (000s) -------- ------ -------- ------- --------- ------- --------- VeriSign 2,361,333 $ 18,927 8.82 11.46 $ 20,819 $ 6,942 Vodafone 10,245,370 159,856 15.60 23.29 159,856 35,961 Deutsche Telekom 45,492,175 501,577 11.36 13.63 516,892 163,545 -------- -------- ------- $680,360 $697,567 $206,448 ======== ======== ========
The principal amount of the forward contracts is accounted for as a loan. The collar portions of the forward contracts are accounted for as derivative instruments. The collars could be adjusted for any changes in dividends on the contracted shares.
The following analysis presents the hypothetical change in the fair value of our marketable equity securities and derivative instruments at September 30, 2002, assuming the same hypothetical price fluctuations of plus and minus 10%, 20% and 30%.
Valuation of investments September 30, Valuation of investments assuming indicated decrease 2002 assuming indicated increase --------------------------------- ---------------------------- ($ in millions) -30% -20% -10% Fair Value +10% +20% +30% - --------------- ---- ---- ---- ---------- ---- ---- ---- Marketable Equity Securities $ 889.6 $ 1,016.7 $1,143.8 $ 1,270.8 $1,397.9 $1,524.9 $1,652.0 Derivative Instruments (1) $ 309.6 $ 263.0 $ 216.3 $ 206.4 $ 122.3 $ 75.0 $ 27.4 (1) Represents change in the fair value of the derivative instruments assuming the indicated increase or decrease in the underlying securities.
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, 2001.
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
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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.
Valuation of Notes ReceivableU.S. Cellular holds notes receivable aggregating $45.8 million from Kington Management Corporation ("Kington") that are due in June 2005. These notes relate to the purchase by Kington of two of U.S. Cellular's minority interests in 2000. The value of the notes is directly related to the future fair market value of the related interests. An independent third party valuation of one of the wireless minority interests sold to Kington and a recent transaction involving an unrelated party holding an interest in the same market as the other wireless minority interest sold to Kington indicated a lower market value for these wireless minority interests, and therefore a lower value of the notes. Management concluded that the notes receivable were impaired and established a valuation allowance against the notes. A loss of $34.2 million was charged to the statement of operations in the third quarter of 2002 and was included in the caption (Loss) on marketable securities and other investments. Following this writedown, the carrying value of such notes receivable at September 30, 2002 was $11.6 million. If or when the market values for the related cellular interest will recover is unclear. There may continue to be substantial variability in the future market values of these interests and risk of decline in the value of the notes. Management will continue to review the valuation on a periodic basis.
On November 1, 2000, the United States Bankruptcy Court for the Western District of Wisconsin confirmed a plan of financial reorganization for Airadigm Communications, Inc., a Wisconsin-based wireless service provider. Under the terms of the plan of reorganization, TDS and an unrelated entity have provided funding to meet certain obligations of Airadigm. Airadigm continues to operate as an independent company providing wireless services. Pursuant to the plan of reorganization, under certain circumstances and subject to the FCC’s rules and regulations, TDS and the unrelated entity, or their respective designees, were permitted to acquire certain PCS licenses for areas of Wisconsin and Iowa as well as other Airadigm assets. As of September 30, 2002, TDS had provided funding of $54.8 million to Airadigm that TDS has recorded as notes receivable and had capitalized $1.1 million in other costs associated with Airadigm.
During the third quarter, TDS reviewed the value of Airadigm’s current and contractual assets, Airadigm’s business plan and the facts and circumstances surrounding the investment and concluded that the note receivable was impaired and established a valuation allowance for the amount of the loan. A loss of $55.9 million was charged to the statement of operations in the third quarter of 2002 and was included in the caption (Loss) on marketable securities and other investments. Following this action, the carrying values of such notes receivable and other capitalized costs at September 30, 2002 have been reduced to zero. In October 2002, TDS terminated its right to purchase licenses and assets from Airadigm. TDS has the right to foreclose on certain assets of Airadigm and cease its operations at any time. TDS is evaluating the desirability of providing additional funding on a month to month basis.
Marketable Equity Securities The Company holds a substantial amount of marketable securities that are publicly traded and can have volatile share prices. These investments are classified as available-for-sale and are stated at fair value based on quoted market prices. The marketable securities are marked to market each period with the unrealized gain or loss in value of the securities reported as Other Comprehensive Income, net of income taxes and minority interest, which is included in the
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stockholders' equity section of the balance sheet.
The market values of marketable securities may fall below the accounting cost basis of such securities. Generally accepted accounting principles require management to determine whether a decline in fair value below the accounting cost basis is other than temporary. If management determined that the decline in value of the marketable securities was “other than temporary,” the unrealized loss included in other comprehensive income would be recognized and recorded as a loss in the statement of operations.
Factors that management reviews in determining an other than temporary decline include whether there has been a significant change in the financial condition, operational structure or near-term prospects of the issuer; how long and how much the security has been below historical cost; and whether TDS has the intent and ability to retain its investment in the issuer’s securities to allow the market value to return to historical cost levels. TDS is in the same industry classification as the issuers of its marketable securities enhancing the Company’s ability to evaluate the effects of any changes in industry-specific factors which may affect the determination of whether a decline in market values of its marketable securities is other than temporary. In the first and second quarters of 2002, based on a review of such factors, management determined that a decline in the value of marketable equity securities relative to their respective accounting cost basis was other than temporary and charged an aggregate $1,756.5 million loss to the statement of operations ($1,044.4 net of tax and minority interest) and reduced the accounting cost basis of such marketable equity securities by a respective amount.
As of September 30, 2002, the aggregate market value of the marketable equity securities totaled $1,270.8 million, the aggregate cost basis was $1,546.7 million, and the unrealized loss included in accumulated other comprehensive income was $167.7 million (net of tax and minority interest of $108.2 million.) At September 30, 2002, the Company had forward contracts maturing in 2007 in connection with $521.0 million of the Company’s marketable equity security portfolio, hedging the market price risk with respect to the contracted securities. The downside risk is hedged at or above the accounting cost basis thereby eliminating the other than temporary risk on these contracted securities. With respect to the non-hedged marketable equity securities at September 30, 2002, the unrealized loss included in accumulated other comprehensive income was $97.0 million, net of tax and minority interest of $62.0 million. At September 30, 2002, based on a review of the factors described above, management concluded that unrealized loss in accumulated other comprehensive income was not other than temporary and no charge to the statement of operations was necessary. There can be no assurance that upon review of such factors at a later date a material loss will not be recognized in the statement of operations.
License Costs and Goodwill As of September 30, 2002, the Company reported $1,040.8 million of wireless license costs, net of accumulated amortization and $1,089.5 million of goodwill, net of accumulated amortization, as a result of the acquisitions of wireless licenses and markets, and the acquisition of operating telephone companies. TDS adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002. With the implementation of SFAS No. 142, the Company assessed its recorded balances of cellular license costs and goodwill for potential impairment. The Company completed its initial impairment assessments in the first quarter of 2002. No impairment charge was necessary upon the completion of the initial impairment review. After the initial impairment review, 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
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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 shall be 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 management estimating future cash flows, selecting the appropriate discount rate, and estimating other factors and inputs, and generally result in a range of values. There can be no assurance that these estimates incorporate all known and unknown risks, uncertainties and other factors necessary to arrive at an estimated fair value.
Allocation of Chicago 20MHz Purchase PriceIn connection with the purchase of Chicago 20MHz, the Company allocated the total acquisition costs to all tangible and intangible assets acquired and all liabilities assumed, with the excess purchase price over the fair value of net assets acquired recorded to goodwill. An independent appraiser provided a preliminary valuation of Chicago 20MHz’s assets. The following table summarizes the estimated fair values of the Chicago 20MHz assets acquired and liabilities assumed at the date of acquisition.
August 7, 2002-------------------------------------------------------- (Dollars in millions) Current assets $ 31.6 Property, plant and equipment 239.3 Other assets 0.1 Customer list 43.4 Licenses 163.5 Goodwill 150.0 ------------ Total assets acquired $ 627.9 ------------ Current liabilities (19.0) Non-current liabilities (1.6) ------------ Total liabilities acquired $ (20.6) ------------ Purchase price $ 607.3 ============
It is expected that the allocation will need to be revised as the Company obtains additional information relating to the valuation and finalizes the working capital and other adjustments. Management is not currently aware of any matter that would require a material adjustment to the purchase price.
Income TaxesThe preparation of the consolidated financial statements requires the Company to calculate its provision for income taxes. This process involves estimating the actual current tax expense together with assessing temporary differences resulting from differing 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, a valuation allowance must be established. Management judgment is required in determining the
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provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of September 30, 2002 are as follows:
September 30, 2002 (dollars in millions) ------------ Deferred Tax Asset State net operating loss carryforwards $ 39.7 Notes receivable valuation 32.6 Other 5.6 ---------- 77.9 Less valuation allowance (31.0) ---------- Total Deferred Tax Asset 46.9 ---------- Deferred Tax Liability Marketable equity securities 552.2 Property, plant and equipment 259.2 Licenses 132.0 Other 62.4 ---------- Total Deferred Tax Liability 1,005.8 ---------- Net Deferred Income Tax Liability $ 958.9 ==========
The valuation allowance relates to state net operating loss carry forwards that are expected to expire before they can be utilized.
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 tax years through 1996. The Company expects to pay $59.6 million, including interest, to the IRS in the fourth quarter of 2002 related to the most recent audit. The $56.9 million liability was included in Accrued taxes on the September 30, 2002 balance sheet and was provided for in the income tax provisions in prior periods.
Initial Adoption of Accounting Policies
During 2002, TDS began utilizing derivative financial instruments to reduce market risks due to fluctuations in market prices of marketable equity securities. Prior to 2002 the Company had no significant derivative financial instruments. The Company does not hold or issue derivative financial instruments for trading purposes. The Company recognizes all derivatives as either assets or liabilities in the statement of financial condition and measures those instruments at fair value. Changes in fair value of those instruments will be reported in earnings or other comprehensive income depending on the use of the derivative and whether it qualifies for hedge accounting. The accounting for gains and losses associated with changes in the fair value of the derivative and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of the hedged item or cash flows of the asset or liability hedged. Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities," (as amended) establishes the accounting and reporting standards for derivative instruments and hedging activities.
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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 Assistant General Counsel of TDS and an Assistant Secretary of TDS and certain subsidiaries of TDS; and Stephen P. Fitzell, the Assistant General Counsel and/or an Assistant Secretary of certain subsidiaries of TDS. In addition, prior to August 1, 2002, another partner of Sidley Austin Brown & Wood at the time, Michael G. Hron, was the General Counsel and an Assistant Secretary of TDS, U.S. Cellular and TDS Telecom, and the Secretary or an Assistant Secretary of certain other TDS subsidiaries.
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:
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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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TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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September 30, December 31, 2002 2001 ----------- ----------- (Dollars in thousands) Available-for-sale marketable equity securities Aggregate fair value $ 1,270,805 $ 2,700,230 Accounting cost basis* 1,546,659 3,303,106 ----------- ----------- Gross holding losses (275,854) (602,876) Tax effect 108,019 236,331 ----------- ----------- (167,835) (366,545) Derivative accounting adjustments, net of tax 117,220 -- Minority share of unrealized holding losses (780) 14,028 Equity method unrealized gains 615 397 ----------- ----------- Unrealized holding losses, net of tax $ (50,780) $ (352,120) =========== ===========
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TDS Telecom U.S ----------------------- (Dollars in thousands) Cellular ILEC CLEC Other(1) Total ----------- ----------- ----------- ----------- ----------- Beginning Balance July 1, 2002 $ 473,975 $ 374,253 $ 29,440 $ 34,538 $ 912,206 Net additions 155,566 20,356 -- 1,362 177,284 ----------- ----------- ----------- ----------- ----------- Ending Balance September 30, 2002 $ 629,541 $ 394,609 $ 29,440 $ 35,900 $ 1,089,490 =========== =========== =========== =========== =========== Beginning Balance July 1, 2001 $ 480,914 $ 207,085 $ 7,324 $ 35,075 $ 730,398 Net additions 662 146,740 22,229 -- 169,631 Amortization (3,753) (1,654) (57) (268) (5,732) ----------- ----------- ----------- ----------- ----------- Ending Balance September 30, 2001 $ 477,823 $ 352,171 $ 29,496 $ 34,807 $ 894,297 =========== =========== =========== =========== =========== TDS Telecom U.S ----------------------- (Dollars in thousands) Cellular ILEC CLEC Other(1) Total ----------- ----------- ----------- ----------- ----------- Beginning Balance January 1, 2002 $ 473,975 $ 332,848 $ 29,440 $ 34,538 $ 870,801 Net additions 155,566 61,761 -- 1,362 218,689 ----------- ----------- ----------- ----------- ----------- Ending Balance September 30, 2002 $ 629,541 $ 394,609 $ 29,440 $ 35,900 $ 1,089,490 =========== =========== =========== =========== =========== Beginning Balance January 1, 2001 $ 400,967 $ 210,320 $ 7,436 $ 35,612 $ 654,335 Net additions 86,871 146,831 22,229 -- 255,931 Amortization (10,015) (4,980) (169) (805) (15,969) ----------- ----------- ----------- ----------- ----------- Ending Balance September 30, 2001 $ 477,823 $ 352,171 $ 29,496 $ 34,807 $ 894,297 =========== =========== =========== =========== =========== (1)Other consists of goodwill related to an investment in a cellular market owned by an ILEC subsidiary.
Three Months Ended Nine Months Ended September 30, September 30, -------------------- ----------------------- 2002 2001 2002 2001 --------- --------- --------- --------- (Dollars in thousands, except per share amounts) Net Income (Loss) $ (19,511) $ 51,496 $(958,295) $(259,987) Amortization, net of tax and minority interest effect of: License costs -- 3,609 -- 10,615 Goodwill -- 3,853 -- 10,061 Equity method goodwill -- 399 -- 1,110 --------- --------- --------- --------- Adjusted Net Income (Loss) $ (19,511) $ 59,357 $(958,295) $(238,201) ========= ========= ========= ========= Basic earnings per share: Net Income (Loss) $ (0.33) $ 0.88 $ (16.35) $ (4.44) Amortization, net of tax and minority interest -- 0.13 -- 0.37 --------- --------- --------- --------- Adjusted Earnings per Share $ (0.33) $ 1.01 $ (16.35) $ (4.07) ========= ========= ========= ========= Diluted Earnings Per Share: Net Income (Loss) $ (0.33) $ 0.87 $ (16.35) $ (4.44) Amortization, net of tax and minority interest -- 0.13 -- 0.37 ---------- --------- --------- --------- Adjusted Earnings per Share $ (0.33) $ 1.00 $ (16.35) $ (4.07) ========== ========= ========= =========
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Collar (per Share) -------------------- Downside Upside Loan Derivative Proceeds Limit Potential Amount Asset Security Shares (000s) (Floor) (Ceiling) (000s) (000s) -------- ------ -------- ------- --------- ------- --------- VeriSign 2,361,333 $ 18,927 8.82 11.46 $ 20,819 $ 6,942 Vodafone 10,245,370 159,856 15.60 23.29 159,856 35,961 Deutsche Telekom 45,492,175 501,577 11.36 13.63 516,892 163,545 -------- -------- ------- $680,360 $697,567 $206,448 ======== ======== ========
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Nine Months Ended September 30, ------------------------ 2002 2001 ----------- ----------- (Dollars in thousands) Accumulated Other Comprehensive Income (Loss) Balance, beginning of period $ (352,120) $ (178,344) ----------- ----------- Add (Deduct): Net unrealized gains (losses) on Marketable equity securities (1,429,504) (1,096,776) Income tax effect 557,913 438,163 ----------- ----------- (871,591) (658,613) Equity method unrealized gains 218 397 Unrealized gain on derivatives instruments 117,220 -- Minority share of unrealized (gains) losses 11,090 15,396 ----------- ----------- Net unrealized gains (losses) (743,063) (642,820) ----------- ----------- (Deduct) Add: Recognized loss 1,756,526 644,929 Income tax effect (686,223) (259,707) Minority share of loss (25,900) -- ----------- ----------- 1,044,403 385,222 ----------- ----------- Net change in unrealized gains (losses) included In comprehensive income 301,340 (257,598) ----------- ----------- Balance, end of period $ (50,780) $ (435,942) =========== =========== Accumulated Unrealized Gain on Derivative Instruments Balance, beginning of period $ -- $ -- Add (Deduct): Unrealized gain on derivative instruments 117,220 -- ----------- ----------- Balance, end of period $ 117,220 $ -- =========== =========== Three Months Ended Nine Months Ended September 30, September 30, -------------------- --------------------- 2002 2001 2002 2001 --------- --------- --------- --------- Comprehensive Income (Loss) (Dollars in thousands) Net Income (Loss) $ (19,511) $ 51,496 $(958,295) $(259,987) Net change in unrealized gains (losses) on marketable equity securities and derivative instruments (30,370) (536,234) 301,340 (257,598) --------- --------- --------- --------- Comprehensive Income (Loss) $ (49,881) $(484,738) $(656,955) $(517,585) ========= ========= ========= =========
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Three Months Ended Nine Months Ended September 30, September 30, ------------------ -------------------- 2002 2001 2002 2001 --------- --------- --------- --------- (Dollars in thousands, except per share amounts) Net Income (Loss) $ (19,511) $ 51,496 $(958,295) $(259,987) Preferred Dividend Requirement (105) (112) (323) (345) --------- --------- --------- --------- Net income (loss) Available to Common Used in Basic Earnings Per Share $ (19,616) $ 51,384 $(958,618) $(260,332) ========= ========= ========= ========= Weighted Average Number of Common Shares Used in Basic Earnings per Share 58,660 58,711 58,633 58,694 ========= ========= ========= ========= Basic Earnings per Share $ (0.33) $ 0.88 $ (16.35) $ (4.44) ========= ========= ========= ========= Three Months Ended Nine Months Ended September 30, September 30, ------------------ -------------------- 2002 2001 2002 2001 --------- --------- --------- --------- Net Income (Loss) Available to Common Used in Basic Earnings (Loss) Per Share $ (19,616) $ 51,384 $(958,618) $(260,332) Reduction in Preferred Dividends if Preferred Shares Converted into Common Shares -- 103 -- -- Minority Income Adjustment -- (143) -- -- --------- --------- --------- --------- Net Income (Loss) Available to Common Used in Diluted Earnings (Loss) Per Share $ (19,616) $ 51,344 $(958,618) $(260,332) ========= ========= ========= ========= Weighted Average Number of Common Shares Used in Basic Earnings (Loss) Per Share 58,660 58,711 58,633 58,694 Effect of Dilutive Securities Common Shares Outstanding if Preferred Shares Converted -- 238 -- -- Stock Options -- 344 -- -- --------- --------- --------- --------- Weighted Average Number of Common Shares Used in Diluted Earnings (Loss) Per Share 58,660 59,293 58,633 58,694 ========= ========= ========= ========= Diluted Earnings Per Share $ (0.33) $ 0.87 $ (16.35) $ (4.44) ========= ========= ========= =========
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Three Months Ended Nine Months Ended September 30, September 30, ---------------- --------------- 2002 2001 2002 2001 ------- ------ ----- ------- Effective Tax Rate From: (Dollars in thousands, except per share amounts) Operations excluding Losses on marketable securities and Other investments 43.2% 44.6% 43.6% 44.6% Losses on marketable securities and Other investments (36.2%) -- (38.9%) (40.3%) Net income (2.6%) 44.6% (38.0%) (36.9%)
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August 7, 2002- -------------------------------------------------------------------------------- (Dollars in thousands) Current assets $ 31,675 Property, plant and equipment 239,262 Other Assets 80 Customer list 43,400 Licenses 163,500 Goodwill 149,989 --------- Total assets acquired $ 627,906 --------- Current liabilities (19,063) Non-current liabilities (1,593) --------- Total liabilities acquired $ (20,656) --------- Purchase price $ 607,250 Notes issued to PrimeCo (175,000) Capitalized transaction costs 1,750 Chicago 20MHz cash at date of acquisition (3,581) --------- Cash required, excluding cash at date of acquisition $ 430,419 =========
Nine Months Ended September 30, 2002 -------- (Dollars in thousands) Current assets, excluding cash acquired $ 6,454 Property, plant and equipment 25,544 Cellular licenses 18,010 Goodwill - U.S. Cellular 3,827 Goodwill - TDS Telecom 60,936 Other Assets 2,068 Current liabilities (5,474) Long-term debt (9,767) Deferred credits (1,752) Other liabilities (1,627) -------- Decrease in cash due to other acquisitions $ 98,219 ========
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Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ 2002 2001 2002 2001 ----------- ----------- ---------- ------------ Operating revenues $ 818,460 $ 747,334 $ 2,316,988 $ 2,148,464 Net income (23,599) 39,623 (985,757) (296,230) Earnings per share - basic and diluted $ (0.40) $ 0.67 $ (16.82) $ (5.05)
Nine Months Ended September 30, -------------------------- 2002 2001 --------- ------- (Dollars in thousands) Interest Paid $88,998 $82,260 Income Taxes Paid $15,861 $45,708
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Three Months Ended or at September 30, 2002 TDS Telecom - ---------------------------- U.S. ---------------- (Dollars in thousands) Cellular ILEC CLEC All Other(1) Total ----------- ----------- ----------- ----------- ----------- Operating revenues $ 597,571 $ 158,961 $ 45,998 $ (643) $ 801,887 Operating cash flow(2) 167,571 78,755 (6,908) -- 239,418 Depreciation and amortization expense(3) 102,876 32,907 7,426 -- 143,209 Operating income (loss) 64,695 45,848 (14,334) -- 96,209 Significant noncash items: Investment income, net 12,965 125 -- 247 13,337 Gain (loss) on marketable securities and other investments (34,209) -- -- (55,862) (90,071) Marketable securities 131,767 -- -- 1,139,038 1,270,805 Investment in unconsolidated entities 162,211 48,956 -- 25,545 236,712 Total assets 4,433,097 1,705,284 235,486 1,610,271 7,984,138 Capital expenditures $ 192,256 $ 36,484 $ 9,653 $ -- $ 238,393 Three Months Ended or at September 30, 2001 TDS Telecom - ---------------------------- U.S. ---------------- (Dollars in thousands) Cellular ILEC CLEC All Other(1) Total ----------- ----------- ----------- ----------- ----------- Operating revenues $ 501,024 $ 144,488 $ 30,157 $ (660) $ 675,009 Operating cash flow(2) 169,963 73,906 (10,127) -- 233,742 Depreciation and amortization expense(3) 77,286 33,496 4,541 -- 115,323 Operating income (loss) 92,677 40,410 (14,668) -- 118,419 Significant noncash items: Investment income, net 14,145 369 -- 6,143 20,657 Gain (loss) on marketable securities and other investments -- -- -- -- -- Marketable securities 234,000 -- -- 2,221,097 2,455,097 Investment in unconsolidated entities 149,850 25,307 -- 25,937 201,094 Total assets 3,596,746 1,477,135 193,848 2,349,281 7,617,010 Capital expenditures $ 125,589 $ 28,591 $ 23,303 $ -- $ 177,483
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Nine Months Ended or at September 30, 2002 TDS Telecom - ---------------------------- U.S. ---------------- (Dollars in thousands) Cellular ILEC CLEC All Other(1) Total ----------- ----------- ----------- ----------- ----------- Operating revenues $ 1,603,701 $ 463,533 $ 125,514 $ (1,850) $ 2,190,898 Operating cash flow(2) 495,627 222,930 (24,998) -- 693,559 Depreciation and amortization expense(3) 252,037 97,409 21,298 -- 370,744 Operating income (loss) 243,590 125,521 (46,296) -- 322,815 Significant noncash items: Investment income, net 30,731 736 -- 677 32,144 Gain (loss) on marketable securities and other investments (278,909) -- -- (1,567,688) (1,846,597) Marketable securities 131,767 -- -- 1,139,038 1,270,805 Investment in unconsolidated entities 162,211 48,956 -- 25,545 236,712 Total assets 4,433,097 1,705,284 235,486 1,610,271 7,984,138 Capital expenditures $ 449,030 $ 80,946 $ 35,703 $ -- $ 565,679 Nine Months Ended or at September 30, 2001 TDS Telecom - ---------------------------- U.S. ---------------- (Dollars in thousands) Cellular ILEC CLEC All Other(1) Total ----------- ----------- ----------- ----------- ----------- Operating revenues $ 1,416,082 $ 417,649 $ 85,404 $ (1,456) $ 1,917,679 Operating cash flow(2) 466,419 213,816 (17,516) -- 662,719 Depreciation and amortization expense(3) 221,633 98,468 11,466 -- 331,567 Operating income (loss) 244,786 115,348 (28,982) -- 331,152 Significant noncash items: Investment income, net 30,773 726 -- 6,333 37,832 Gain (loss) on marketable securities and other investments -- -- -- (644,929) (644,929) Marketable securities 234,000 -- -- 2,221,097 2,455,097 Investment in unconsolidated entities 149,850 25,307 -- 25,937 201,094 Total assets 3,596,746 1,477,135 193,848 2,349,281 7,617,010 Capital expenditures $ 377,721 $ 64,369 $ 79,371 $ -- $ 521,461
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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.
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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 2002 Third Quarter Form 10-Q