Filed Pursuant to Rule 424(b)(3)

Registration Nos.    033-08857-99

033-59435-99

333-125001

 

PROSPECTUS SUPPLEMENT

 

to

 

PROSPECTUS DATED MARCH 12, 2008

 

The attached quarterly report on Form 10-Q for the period ended March 31, 2008 was filed by the registrant with the Securities and Exchange Commission, and should be read in conjunction with the Prospectus dated March 12, 2008.

 

The date of this Prospectus Supplement is May 7, 2008

 

 



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2008

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                              to                                                  

 

Commission File Number 001-14157

 

TELEPHONE AND DATA SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

36-2669023

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

30 North LaSalle Street, Chicago, Illinois  60602

(Address of principal executive offices)  (Zip Code)

 

Registrant’s telephone number, including area code: (312) 630-1900

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x

 

Accelerated filer  o

Non-accelerated filer  o

 (Do not check if a smaller reporting company)

 

Smaller reporting company  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   o  No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at March 31, 2008

Common Shares, $.01 par value

 

53,164,628 Shares

Special Common Shares, $.01 par value

 

57,234,617 Shares

Series A Common Shares, $.01 par value

 

6,442,058 Shares

 

 



 

Telephone and Data Systems, Inc.

 

Quarterly Report on Form 10-Q

For the Period Ended March 31, 2008

 

Index

 

 

 

 

 

Page No.

 

 

 

 

 

Part I.          Financial Information

 

3

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

 

 

 

 

Consolidated Statements of Operations Three Months Ended March 31, 2008 and 2007

 

3

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows Three Months Ended March 31, 2008 and 2007

 

4

 

 

 

 

 

 

 

Consolidated Balance Sheets March 31, 2008 and December 31, 2007

 

5

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

7

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and  Overview

 

25

 

 

Results of Operations – Consolidated

 

28

 

 

Results of Operations – Wireless

 

31

 

 

Results of Operations – Wireline

 

37

 

 

Recent Accounting Pronouncements

 

42

 

 

Financial Resources

 

43

 

 

Liquidity and Capital Resources

 

45

 

 

Application of Critical Accounting Policies and Estimates

 

49

 

 

Safe Harbor Cautionary Statement

 

50

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

54

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

56

 

 

 

 

 

Part II.         Other Information

 

58

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

58

 

 

 

 

 

 

Item 1A.

Risk Factors

 

58

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

58

 

 

 

 

 

 

Item 5.

Other Information

 

59

 

 

 

 

 

 

Item 6.

Exhibits

 

60

 

 

 

 

 

Signatures

 

 

 

 



 

Part I.  Financial Information

 

Item 1.  Financial Statements

 

Telephone and Data Systems, Inc.

 

Consolidated Statements of Operations

 

Unaudited

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars and shares in thousands,

 

 

 

except per share amounts)

 

 

 

 

 

 

 

Operating Revenues

 

$

1,249,101

 

$

1,156,557

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

Cost of services and products (excluding Depreciation, amortization and accretion expense reported below)

 

442,383

 

402,033

 

Selling, general and administrative expense

 

463,299

 

420,417

 

Depreciation, amortization and accretion expense

 

186,158

 

188,005

 

Loss on asset disposals, net

 

3,652

 

3,305

 

Total Operating Expenses

 

1,095,492

 

1,013,760

 

 

 

 

 

 

 

Operating Income

 

153,609

 

142,797

 

 

 

 

 

 

 

Investment and Other Income (Expense)

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

21,470

 

23,696

 

Interest and dividend income

 

9,746

 

16,196

 

Interest expense

 

(41,380

)

(57,801

)

Gain (loss) on investments and financial instruments

 

(3,490

)

255,870

 

Other, net

 

(199

)

(2,224

)

Total Investment and Other Income (Expense)

 

(13,853

)

235,737

 

 

 

 

 

 

 

Income Before Income Taxes and Minority Interest

 

139,756

 

378,534

 

Income tax expense

 

49,251

 

141,238

 

Income Before Minority Interest

 

90,505

 

237,296

 

Minority share of income, net of tax

 

(17,018

)

(17,971

)

Net Income

 

73,487

 

219,325

 

Preferred dividend requirement

 

(13

)

(13

)

Net Income Available To Common

 

$

73,474

 

$

219,312

 

 

 

 

 

 

 

Basic Weighted Average Shares Outstanding

 

117,570

 

116,837

 

Basic Earnings Per Share (Note 7)

 

$

0.62

 

$

1.88

 

 

 

 

 

 

 

Diluted Weighted Average Shares Outstanding

 

118,191

 

118,383

 

Diluted Earnings Per Share (Note 7)

 

$

0.62

 

$

1.85

 

 

 

 

 

 

 

Dividends Per Share

 

$

0.1025

 

$

0.0975

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



 

Telephone and Data Systems, Inc.

 

Consolidated Statements of Cash Flows

 

Unaudited

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Cash Flows from Operating Activities

 

 

 

 

 

Net income

 

$

73,487

 

$

219,325

 

Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Depreciation, amortization and accretion

 

186,158

 

188,005

 

Bad debts expense

 

20,405

 

12,255

 

Stock-based compensation expense

 

3,116

 

4,651

 

Deferred income taxes

 

(102,540

)

81,841

 

(Gain) loss on investments and financial instruments

 

3,490

 

(255,870

)

Equity in earnings of unconsolidated entities

 

(21,470

)

(23,696

)

Distributions from unconsolidated entities

 

7,047

 

2,321

 

Minority share of income

 

17,018

 

17,971

 

Loss on asset disposals, net

 

3,652

 

3,305

 

Noncash interest expense

 

5,319

 

5,378

 

Other noncash expense

 

189

 

 

Excess tax benefit from stock awards

 

(1,138

)

(1,522

)

Changes in assets and liabilities

 

 

 

 

 

Change in accounts receivable

 

(10,156

)

20,262

 

Change in inventory

 

(15,485

)

15,785

 

Change in accounts payable

 

(14,529

)

(27,048

)

Change in customer deposits and deferred revenues

 

6,162

 

12,648

 

Change in accrued taxes

 

149,349

 

55,355

 

Change in accrued interest

 

5,807

 

5,403

 

Change in other assets and liabilities

 

(46,882

)

(49,901

)

 

 

268,999

 

286,468

 

 

 

 

 

 

 

Cash Flows from Investing Activities

 

 

 

 

 

Additions to property, plant and equipment

 

(132,465

)

(130,717

)

Cash paid for acquisitions

 

(107,685

)

(18,237

)

Cash received from divestitures

 

6,838

 

279

 

Proceeds from sale of investments

 

48,619

 

 

Other investing activities

 

371

 

2,246

 

 

 

(184,322

)

(146,429

)

 

 

 

 

 

 

Cash Flows from Financing Activities

 

 

 

 

 

Issuance of notes payable

 

 

25,000

 

Issuance of long-term debt

 

 

454

 

Repayment of long-term debt

 

(928

)

(848

)

TDS Common Shares and Special Common Shares reissued for benefit plans, net of tax payments

 

1,103

 

7,040

 

U.S. Cellular Common Shares reissued for benefit plans, net of tax payments

 

(2,526

)

5,558

 

Excess tax benefit from stock awards

 

1,138

 

1,522

 

Repurchase of TDS Special Common Shares

 

(40,584

)

 

Repurchase of U.S. Cellular Common Shares

 

(6,201

)

 

Dividends paid

 

(13

)

(11,399

)

Distributions to minority partners

 

(2,588

)

(2,519

)

Other financing activities

 

1,262

 

(1,769

)

 

 

(49,337

)

23,039

 

 

 

 

 

 

 

Net Increase in Cash and Cash Equivalents

 

35,340

 

163,078

 

 

 

 

 

 

 

Cash and Cash Equivalents -

 

 

 

 

 

Beginning of period

 

1,174,446

 

1,013,325

 

End of period

 

$

1,209,786

 

$

1,176,403

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



 

Telephone and Data Systems, Inc.

 

Consolidated Balance Sheets

 

Assets

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

 

 

(Dollars in thousands)

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,209,786

 

$

1,174,446

 

Accounts receivable

 

 

 

 

 

Due from customers, less allowances of $15,104 and $16,326, respectively

 

368,337

 

379,558

 

Other, principally connecting companies, less allowances of $5,670 and $5,297, respectively

 

141,044

 

150,863

 

Marketable equity securities

 

969,311

 

1,917,893

 

Inventory

 

128,771

 

115,818

 

Prepaid expenses

 

92,890

 

77,155

 

Other current assets

 

23,872

 

59,855

 

 

 

2,934,011

 

3,875,588

 

Investments

 

 

 

 

 

Licenses

 

1,824,144

 

1,516,629

 

Goodwill

 

684,164

 

679,129

 

Customer lists, net of accumulated amortization of $85,947 and $82,243, respectively

 

25,794

 

25,851

 

Investments in unconsolidated entities

 

224,282

 

206,418

 

Other investments

 

11,279

 

11,509

 

 

 

2,769,663

 

2,439,536

 

Property, Plant and Equipment

 

 

 

 

 

In service and under construction

 

8,174,705

 

8,064,229

 

Less accumulated depreciation

 

4,692,065

 

4,539,127

 

 

 

3,482,640

 

3,525,102

 

Other Assets and Deferred Charges

 

52,099

 

53,917

 

Total Assets

 

$

9,238,413

 

$

9,894,143

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



 

Telephone and Data Systems, Inc.

 

Consolidated Balance Sheets

 

Liabilities and Stockholders’ Equity

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Unaudited)

 

 

 

 

 

(Dollars in thousands)

 

Current Liabilities

 

 

 

 

 

Current portion of long-term debt

 

$

4,444

 

$

3,860

 

Forward contracts

 

669,226

 

1,005,512

 

Accounts payable

 

298,840

 

308,882

 

Customer deposits and deferred revenues

 

172,377

 

166,191

 

Accrued interest

 

24,264

 

18,456

 

Accrued taxes

 

153,245

 

40,439

 

Accrued compensation

 

61,806

 

91,703

 

Derivative liability

 

156,081

 

711,692

 

Deferred income tax liability

 

209,074

 

327,162

 

Other current liabilities

 

335,535

 

125,622

 

 

 

2,084,892

 

2,799,519

 

 

 

 

 

 

 

Deferred Liabilities and Credits

 

 

 

 

 

Net deferred income tax liability

 

570,747

 

555,593

 

Asset retirement obligation

 

177,527

 

173,468

 

Other deferred liabilities and credits

 

157,195

 

154,602

 

 

 

905,469

 

883,663

 

Long-Term Debt

 

 

 

 

 

Long-term debt, excluding current portion

 

1,635,373

 

1,632,226

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Minority Interest

 

665,701

 

651,537

 

 

 

 

 

 

 

Preferred Shares

 

860

 

860

 

 

 

 

 

 

 

Common Stockholders’ Equity

 

 

 

 

 

Common Shares, par value $.01 per share; authorized 100,000,000 shares; issued 56,581,000 and 56,581,000 shares, respectively

 

566

 

566

 

Special Common Shares, par value $.01 per share; authorized 165,000,000 shares; issued 62,946,000 and 62,946,000 shares, respectively

 

629

 

629

 

Series A Common Shares, par value $.01 per share; authorized 25,000,000 shares; issued and outstanding 6,442,000 and 6,442,000 shares, respectively

 

64

 

64

 

Capital in excess of par value

 

2,049,738

 

2,048,110

 

Treasury Shares at cost:

 

 

 

 

 

Common Shares, 3,416,000 and 3,433,000 shares, respectively

 

(119,598

)

(120,544

)

Special Common Shares, 5,711,000 and 4,712,000 shares, respectively

 

(245,177

)

(204,914

)

Accumulated other comprehensive income

 

9,180

 

511,776

 

Retained earnings

 

2,250,716

 

1,690,651

 

 

 

3,946,118

 

3,926,338

 

Total Liabilities and Stockholders’ Equity

 

$

9,238,413

 

$

9,894,143

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



 

Telephone and Data Systems, Inc.

 

Notes To Consolidated Financial Statements

 

1.              Basis of Presentation

 

The accounting policies of Telephone and Data Systems, Inc. (“TDS”) conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”).  The consolidated financial statements include the accounts of TDS and its majority-owned subsidiaries, including TDS’ 80.8%-owned wireless telephone subsidiary, United States Cellular Corporation (“U.S. Cellular”), TDS’ 100%-owned wireline telephone subsidiary, TDS Telecommunications Corporation (“TDS Telecom”) and TDS’ 80%-owned printing and distribution company, Suttle Straus, Inc.  In addition, the consolidated financial statements include all entities in which TDS has a variable interest that requires TDS to absorb a majority of the entity’s expected gains or losses, or both.  All material intercompany accounts and transactions have been eliminated.  Certain prior year amounts have been reclassified to conform to the 2008 financial statement presentation.

 

The consolidated financial statements included herein have been prepared by TDS, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. However, TDS believes that the disclosures included herein are adequate to make the information presented not misleading.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in TDS’ Annual Report on Form 10-K for the year ended December 31, 2007 (“Form 10-K”).

 

The accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring items unless otherwise disclosed) necessary to present fairly the financial position as of March 31, 2008 and December 31, 2007, the results of operations for the three months ended March 31, 2008 and 2007, and the cash flows for the three months ended March 31, 2008 and 2007.  The results of operations and cash flows for the three months ended March 31, 2008 are not necessarily indicative of the results to be expected for the full year.

 

2.              Summary of Significant Accounting Policies

 

Pension Plan

 

TDS sponsors a qualified noncontributory defined contribution pension plan. The plan provides benefits for the employees of TDS Corporate, TDS Telecom and U.S. Cellular.  Under this plan, pension benefits and costs are calculated separately for each participant and are funded currently.  Pension costs were $4.6 million and $3.6 million for the three months ended March 31, 2008 and March 31, 2007, respectively.

 

TDS also sponsors an unfunded non-qualified deferred supplemental executive retirement plan for certain employees which supplements the benefits under the qualified plan to offset the reduction of benefits caused by the limitation on annual employer contributions under the tax laws.

 

Other Postretirement Benefits

 

TDS sponsors two contributory defined benefit postretirement plans that cover most employees of TDS Corporate, TDS Telecom and the subsidiaries of TDS Telecom.  One plan provides medical benefits and the other plan provides life insurance benefits.

 

Net periodic benefit costs for the defined benefit postretirement plans include the following components:

 

7



 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Service Cost

 

$

499

 

$

609

 

Interest on accumulated benefit obligation

 

863

 

858

 

Expected return on plan assets

 

(948

)

(821

)

Amortization of:

 

 

 

 

 

Prior service cost

 

(207

)

(207

)

Net loss

 

242

 

340

 

Net postretirement cost

 

$

449

 

$

779

 

 

TDS expects to make contributions to the post-retirement plans in the second quarter of 2008.  The amount of contributions will be between $3.7 million and $4.5 million.

 

Amounts Collected from Customers and Remitted to Governmental Authorities

 

TDS records amounts collected from customers and remitted to governmental authorities net within a tax liability account if the tax is assessed upon the customer and TDS merely acts as an agent in collecting the tax on behalf of the imposing governmental authority.  If the tax is assessed upon TDS, the amounts collected from customers as recovery of the tax are recorded in Operating revenues and amounts remitted to governmental authorities are recorded in Selling, general and administrative expenses in the Consolidated Statements of Operations. The amounts recorded gross in Operating revenues that are billed to customers and remitted to governmental authorities totaled $36.8 million and $30.8 million for the three months ended March 31, 2008 and 2007, respectively.

 

Accounting for the Effects of Certain Types of Regulation

 

For the three months ended March 31, 2007, TDS Telecom’s incumbent local exchange carrier (“ILEC”) operations followed the accounting for regulated enterprises prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 71, Accounting for the Effects of Certain Types of Regulation (“SFAS 71”). This accounting recognized the economic effects of rate-making actions of regulatory bodies in the financial statements of TDS Telecom’s ILEC operations. In the third quarter of 2007, TDS Telecom discontinued the application of SFAS 71 for its ILEC operations. Therefore, TDS Telecom’s ILEC operations follow the provisions of SFAS 71 for the three months ended March 31, 2007, and do not follow such provisions for the three months ended March 31, 2008.  This accounting change did not have a material impact on the comparability of TDS’ consolidated financial statements for these periods.

 

Recent Accounting Pronouncements

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures related to the use of fair value measures in financial statements. SFAS 157 does not expand the use of fair value measurements in financial statements, but standardizes its definition and guidance in U.S. GAAP. SFAS 157 emphasizes that fair value is a market-based measurement and not an entity-specific measurement, based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS 157 establishes a fair value hierarchy from observable market data as the highest level to an entity’s own fair value assumptions about market participant assumptions as the lowest level. In February 2008, the FASB issued FSP FAS 157-2 to defer the effective date of SFAS 157 for all nonfinancial assets and liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until years beginning after November 15, 2008. TDS adopted SFAS 157 for its financial assets and liabilities effective January 1, 2008 (See Note 5 - Fair Value Measurements for more information related to TDS’ adoption of SFAS 157 for its financial assets and liabilities). TDS is currently reviewing the adoption requirements related to its nonfinancial assets and liabilities and has not yet determined the impact, if any, on its financial position or results of operations.

 

8



 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations—a replacement of FASB Statement No. 141 (“SFAS 141(R)”). SFAS 141(R) replaces FASB Statement No. 141, Business Combinations (“SFAS 141”). SFAS 141(R) retains the underlying concept of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method, a method that requires the acquirer to measure and recognize the acquiree on an entire entity basis and recognize the assets acquired and liabilities assumed at their fair values as of the date of acquisition. However, SFAS 141(R) changes the method of applying the acquisition method in a number of significant aspects, such as requiring the expensing of transaction costs previously capitalized and requiring the accrual at fair value of certain contractual and noncontractual contingencies.  SFAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after January 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. SFAS 141(R) amends SFAS No. 109, Accounting for Income Taxes, such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of SFAS 141(R) would also apply the provisions of SFAS 141(R). TDS is currently reviewing the requirements of SFAS 141(R) and has not yet determined the impact, if any, on its financial position or results of operations.

 

In December 2007, the FASB issued SFAS No.160, Consolidated Financial Statements, Including Accounting and Reporting of Noncontrolling Interests in Subsidiaries—a replacement of ARB No. 51 (“SFAS 160”). SFAS 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, as amended by FASB Statement No. 94, Consolidation of All Majority-Owned Subsidiaries, to establish new standards that will govern the accounting and reporting of (1) noncontrolling interests (commonly referred to as minority interests) in partially owned consolidated subsidiaries and (2) the loss of control of subsidiaries. It also establishes that once control of a subsidiary is obtained, changes in ownership interests in that subsidiary that do not result in a loss of control shall be accounted for as equity transactions, not as step acquisitions under SFAS 141. SFAS 160 is effective on a prospective basis for TDS’ 2009 financial statements, except for the presentation and disclosure requirements, which will be applied retrospectively. TDS is currently reviewing the requirements of SFAS 160 and has not yet determined the impact, if any, on its financial position or results of operations.

 

In March 2008, the FASB issued SFAS No.161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 expands the disclosure requirements for derivative instruments and hedging activities. The Statement specifically requires entities to provide enhanced disclosures addressing the following: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for TDS’ 2009 financial statements. TDS’ current derivative instruments are expected to mature prior to the effective date of SFAS 161, and therefore, TDS does not expect SFAS 161 to have an impact on its disclosures.

 

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). The intent of FSP FAS 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R) and other applicable accounting literature. FSP FAS 142-3 is effective for TDS’ 2009 financial statements. TDS does not anticipate that the adoption of FSP FAS 142-3 will have an impact on its financial position or results of operations.

 

9



 

3.              Acquisitions, Divestitures and Exchanges

 

TDS assesses its existing wireless and wireline interests on an ongoing basis with a goal of improving the competitiveness of its operations and maximizing its long-term return on investment. As part of this strategy, TDS reviews attractive opportunities to acquire additional operating markets, telecommunications companies and wireless spectrum.  In addition, TDS may seek to divest outright or include in exchanges for other wireless interests those markets and wireless interests that are not strategic to its long-term success.

 

Transactions Pending as of March 31, 2008:

 

TDS’ subsidiary, U.S. Cellular, participated in the Federal Communications Commission (“FCC”) auction of spectrum in the 700 megahertz band, known as Auction 73, indirectly through its interest in King Street Wireless, L.P. (“King Street Wireless”).  U.S. Cellular is a limited partner in King Street Wireless.  King Street Wireless qualified as a “designated entity” and was eligible for bid credits with respect to spectrum purchased in Auction 73.  As discussed in Note 4 – Variable Interest Entities, TDS consolidates King Street Wireless.

 

The FCC released the results of Auction 73 on March 20, 2008.  King Street Wireless was the provisional winning bidder for 152 licenses for an aggregate bid of $300.5 million, net of its designated entity discount of 25%.  This amount is recorded as a component of Licenses in TDS’ March 31, 2008 Consolidated Balance Sheet.  In January 2008, U.S. Cellular made capital contributions and advances to King Street Wireless and its general partner of $97.0 million.  King Street Wireless used the funding to pay the FCC an initial deposit of $97.0 million in January 2008 to allow it to participate in Auction 73.  During April 2008, U.S. Cellular made additional capital contributions and advances to King Street Wireless and its general partner of $203.5 million in cash.  This amount is recorded as a component of Other current liabilities in TDS’ March 31, 2008 Consolidated Balance Sheet.  King Street Wireless then paid this amount to the FCC in April 2008 to fulfill its remaining obligation ($300.5 million aggregate bid less $97.0 million deposit) for the licenses for which it was the provisional winning bidder in the auction. U.S. Cellular may agree to make additional capital contributions and/or advances to King Street Wireless and/or its general partner to provide additional funding for the development of such licenses.  U.S. Cellular may finance such amounts with a combination of cash on hand, borrowings under its revolving credit agreement and/or long-term debt.  There is no assurance that U.S. Cellular will be able to obtain additional financing on commercially reasonable terms or at all.  While the bidding in Auction 73 has ended, the FCC has not yet awarded any of the licenses to winning bidders nor is there any prescribed timeframe for the FCC to review the qualifications of the various winning bidders and award licenses.  The licenses expected to be awarded to King Street Wireless cover areas that overlap or are proximate or contiguous to areas covered by licenses that U.S. Cellular currently owns, operates and/or consolidates.

 

On March 21, 2008, U.S. Cellular entered into an agreement to acquire the remaining 50% ownership interest of North Carolina RSA 1 Partnership, a wireless market operator in which U.S. Cellular had previously owned a 50% non-operating, unconsolidated interest, for $7.0 million in cash, subject to a working capital adjustment.  The transaction is expected to close in the second quarter of 2008.

 

Transactions Completed as of March 31, 2008:

 

As previously disclosed, in October 2006, U.S. Cellular’s interest in Midwest Wireless Communications, LLC (“Midwest Wireless”) was sold to ALLTEL Corporation. In connection with the sale, U.S. Cellular became entitled to receive approximately $106.0 million in cash with respect to its interest in Midwest Wireless. On January 8, 2008, U.S. Cellular received a final distribution from the escrow of $6.3 million, plus interest of $0.5 million.  A gain and interest income of $6.3 million and $0.5 million, respectively, were recognized in the fourth quarter of 2007 related to this distribution.

 

As previously disclosed, on December 3, 2007, U.S. Cellular entered into an agreement to acquire six 12 megahertz lower C block 700 megahertz licenses in Maine for $5.0 million in cash. On March 28, 2008, U.S. Cellular completed this transaction.

 

10



 

As previously disclosed, on November 30, 2007, U.S. Cellular entered into an exchange agreement with Sprint Nextel Corporation which provided for U.S. Cellular to receive personal communication service (“PCS”) spectrum in eight licenses covering portions of four states (Oklahoma, West Virginia, Maryland and Iowa), in exchange for U.S. Cellular delivering PCS spectrum in eight licenses covering portions of Illinois.  In connection with the exchange, TDS recognized a pre-tax loss of $20.8 million during the fourth quarter of 2007.  This transaction closed on March 19, 2008.

 

As previously disclosed, on November 30, 2007, TDS Telecom entered into an agreement to acquire a telephone company in Indiana serving 750 access lines for $6.7 million in cash, including acquisition costs of $0.1 million.  On February 13, 2008, TDS Telecom completed this transaction.

 

TDS’ acquisitions for the three months ended March 31, 2008 and the allocation of the purchase price for each respective acquisition were as follows:

 

 

 

 

 

Allocation of Purchase Price

 

(Dollars in thousands)

 

Purchase
price

 

Goodwill(1)

 

Licenses

 

Customer
lists

 

Net tangible
assets/(liabilities)

 

U.S. Cellular Acquisitions

 

 

 

 

 

 

 

 

 

 

 

Auction 73 Licenses

 

$

300,479

 

$

 

$

300,479

 

$

 

$

 

Maine Licenses

 

5,000

 

 

5,000

 

 

 

Other

 

1,891

 

970

 

623

 

964

 

(666

)

 

 

 

 

 

 

 

 

 

 

 

 

Telecom Acquisitions

 

 

 

 

 

 

 

 

 

 

 

ILEC telephone company

 

6,712

 

1,923

 

 

499

 

4,290

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

314,082

 

$

2,893

 

$

306,102

 

$

1,463

 

$

3,624

 

 


(1)          None of the goodwill is deductible for tax purposes.

 

4.     Variable Interest Entities

 

As of March 31, 2008, TDS consolidates the following variable interest entities:

 

·                  King Street Wireless and King Street Wireless, Inc., the general partner of King Street Wireless

·                  Barat Wireless L.P. (“Barat Wireless”) and Barat Wireless, Inc., the general partner of Barat Wireless

·                  Carroll Wireless L.P. (“Carroll Wireless”) and Carroll PCS, Inc., the general partner of Carroll Wireless

 

These variable interest entities are consolidated pursuant to the guidelines of FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“FIN 46(R)”), as U.S. Cellular anticipates benefiting from or absorbing a majority of the variable interest entities’ expected gains or losses. Pending finalization of the variable interest entities’ permanent financing plans, and upon request by the variable interest entities, U.S. Cellular may agree to make additional capital contributions and advances to the variable interest entities.

 

See Note 3 - Acquisitions, Divestitures and Exchanges for further details on King Street Wireless.

 

U.S. Cellular is a limited partner in Barat Wireless, an entity which participated in the auction of wireless spectrum designated by the FCC as Auction 66. Barat Wireless was qualified to receive a 25% bid credit available to “very small businesses”, defined as businesses having annual gross revenues of less than $15 million. At the conclusion of the auction on September 18, 2006, Barat Wireless was the successful bidder with respect to 17 licenses for which it had bid $127.1 million, net of its bid credit. On April 30, 2007, the FCC granted Barat Wireless’ applications with respect to the 17 licenses for which it was the successful bidder. These 17 license areas cover portions of 20 states and are in markets which are either adjacent to or overlap U.S. Cellular licensed areas.

 

11



 

Barat Wireless is in the process of developing its long-term business and financing plans. As of March 31, 2008, U.S. Cellular has made capital contributions and advances to Barat Wireless and/or its general partner of $127.2 million; of this amount $127.1 million is included in Licenses in the Consolidated Balance Sheets. Barat Wireless used the funding to pay the FCC $127.1 million in 2006 to fulfill its obligation for the licenses purchased in Auction 66.

 

U.S. Cellular is a limited partner in Carroll Wireless, an entity which participated in the auction of wireless spectrum designated by the FCC as Auction 58. Carroll Wireless was qualified to bid on “closed licenses” that were available only to companies included under the FCC definition of “entrepreneurs,” which are small businesses that have a limited amount of assets and revenues. In addition, Carroll Wireless bid on “open licenses” that were not subject to restriction. With respect to these licenses, Carroll Wireless was qualified to receive a 25% bid credit available to “very small businesses” which were defined as having average annual gross revenues of less than $15 million. Carroll Wireless was a successful bidder for 16 licenses in Auction 58, which ended on February 15, 2005. The aggregate amount paid to the FCC for the licenses was $129.7 million, net of the bid credit to which Carroll Wireless was entitled. These licenses cover portions of 10 states and are in markets which are either adjacent to or overlap U.S. Cellular licensed areas.

 

Carroll Wireless is in the process of developing its long-term business and financing plans. As of March 31, 2008, U.S. Cellular has made capital contributions and advances to Carroll Wireless and/or its general partner of approximately $129.9 million; of this amount, $129.7 million is included in Licenses in the Consolidated Balance Sheets.

 

5.              Fair Value Measurements

 

Effective January 1, 2008, TDS adopted the provisions of SFAS 157 for its financial assets and liabilities. Also on January 1, 2008, TDS elected to adopt the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities - Including an amendment of FASB Statement No. 115
(“SFAS 159”), for certain assets and liabilities.

 

SFAS 157 Adoption

 

SFAS 157 defines “fair value”, establishes a framework for measuring fair value in the application of U.S. GAAP, and expands disclosures about fair value measurements.  SFAS 157 does not expand the use of fair value measurements in financial statements, but standardizes its definition and application in U.S. GAAP.  SFAS 157 provides that fair value is a market-based measurement and not an entity-specific measurement, based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price).  This pronouncement establishes a fair value hierarchy that contains three levels for inputs used in fair value measurements.  Level 1 inputs include quoted market prices for identical assets or liabilities in active markets.  Level 2 inputs include quoted market prices for similar assets and liabilities in active markets or quoted market prices for identical assets and liabilities in inactive markets.  Level 2 inputs must be observable either directly or indirectly for substantially the full term of the financial instrument.  Level 3 inputs are unobservable.

 

Although TDS believes the valuation methodologies being utilized are most appropriate for valuing a given asset or liability, different methodologies or assumptions could result in a different estimate of fair value at the measurement date.

 

TDS’ methods of determining or estimating fair value for financial assets and liabilities that are reported on a fair value basis subject to the provisions of SFAS 157 are as follows:

 

Marketable Equity Securities:

TDS and its subsidiaries hold marketable equity securities in Deutsche Telekom and Rural Cellular Corporation (“RCCC”).  These securities are publicly traded. Fair value for these securities is based upon quoted market prices for identical assets in active markets. Therefore, these inputs are considered Level 1 inputs in accordance with guidance set forth in SFAS 157.

 

TDS’ investment in RCCC is accounted for as an “available for sale” security under the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”).  Therefore, unrealized gains and losses on this investment are recorded as a component of Accumulated other comprehensive income.

 

12



 

Prior to the adoption of SFAS 159 on January 1, 2008 (see below), TDS’ investment in Deutsche Telekom was accounted for as an “available for sale” security under the provisions of SFAS 115, and therefore unrealized gains and losses on this investment were recorded as a component of Accumulated other comprehensive income for the three months ended March 31, 2007.  Subsequent to the adoption of SFAS 159, TDS’ investment in Deutsche Telekom was accounted for as a “trading” security under the provisions of SFAS 115, and therefore unrealized gains and losses on this investment were recorded as a component of (Gain) loss on investments and financial instruments for the three months ended March 31, 2008.

 

Derivative Liabilities:

 

TDS has variable prepaid forward contracts (“forward contracts”) in connection with its Deutsche Telekom marketable equity securities.  The collar component of these forward contracts represents a derivative instrument as defined by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”).  The fair value of these collars is estimated by applying option pricing models.  The inputs to these models include the current Deutsche Telekom stock price, collar ceiling strike price, collar floor strike price, risk-free interest rate, contractual dividend yield, contract term, and the estimated future volatility of the underlying Deutsche Telekom stock.  Cumulatively, these inputs are considered Level 2 inputs in accordance with the guidance set forth in SFAS 157.

 

The following table includes each major category of financial assets and liabilities that are reported on a fair value basis subject to SFAS 157 at March 31, 2008 and its classification within the fair value hierarchy:

 

 

 

Quoted prices in

 

 

 

 

 

active markets for

 

Significant other

 

 

 

identical assets

 

observable inputs

 

(Dollars in thousands)

 

(Level 1)

 

(Level 2)

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Marketable equity securities

 

$

969,311

 

$

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Derivative liability

 

$

 

$

156,081

 

 

SFAS 159 Adoption

 

SFAS 159 permits companies to choose to measure various financial instruments and certain other items at fair value.  Pursuant to the provisions of SFAS 159, at the date the option is elected, entities are required to record a cumulative-effect adjustment to beginning retained earnings.  In subsequent periods, for those instruments in which the fair value option is elected, unrealized gains and losses are recorded in the Statement of Operations.  On January 1, 2008, TDS adopted SFAS 159 for its investment in Deutsche Telekom AG Ordinary Shares, and also for the “collar” portions of the variable prepaid forward contracts related to such Deutsche Telekom stock.

 

TDS adopted SFAS 159 for these items in order to better align the financial statement presentation of the unrealized gains and losses attributable to these items with their underlying economics.  Specifically, prior to the adoption of SFAS 159 for these items, the Deutsche Telekom stock was subject to the recognition provisions of SFAS 115, which required that the unrealized gains and losses on such stock be recorded in Accumulated other comprehensive income, a balance sheet account.  Since the related collars did not qualify as cash flow hedges after June 2003, the changes in the fair value of the collars were reported in earnings in accordance with the requirements of SFAS 133 after this date.  As a result of adopting SFAS 159 for both the Deutsche Telekom stock and the related collars, unrealized gains and losses on both of these items will be recorded in earnings as a (Gain) loss on investments and financial instruments.  Such gains and losses are expected to substantially offset each other, and thus better reflect the economics of the collars, which were established in order to hedge the variability in the fluctuations of the fair value of the underlying Deutsche Telekom stock.

 

13



 

At March 31, 2008, in addition to the aforementioned investment in Deutsche Telekom, TDS’ investment in marketable equity securities included a $31.8 million investment in RCCC common stock.  TDS accounts for its RCCC common stock under the provisions of SFAS 115, as an “available-for-sale” security.  TDS did not elect to adopt the provisions of SFAS 159 for this investment since TDS does not have any collars or other derivative instruments that hedge the impact of changes in the market value of this RCCC stock.

 

As a result of the election of SFAS 159 for its Deutsche Telekom stock and related collars, TDS recorded an adjustment to increase the January 1, 2008 beginning retained earnings by $502.7 million, net of $291.2 of income taxes.  This amount reflects an unrealized gain attributable to the Deutsche Telekom stock of $647.3 million, net of income tax of $374.9 million, offset by an unrealized loss on the related collars of $144.6 million, net of income tax of $83.7 million.  The unrealized loss on the collars was attributable to the periods from inception to June 2003.  During such periods the collars qualified as cash flow hedges and the changes in the fair value were recorded as a component of Accumulated other comprehensive income.

 

There were no tax accounting implications to the Consolidated Balance Sheet or Statement of Operations upon TDS’ election of the fair value option for its Deutsche Telekom marketable equity securities and related collars other than to reclassify the related tax effects from Accumulated other comprehensive income to beginning retained earnings, as mentioned above.  On a recurring basis, as the Consolidated Statement of Operations reflects a benefit or detriment related to the increase or decrease in the value of these securities and collars, there will be deferred tax consequences.  For income tax purposes, no gain or loss is recognized until the securities are sold and until the collars are settled.

 

The following table summarizes the impact of the adoption of SFAS 159 as of January 1, 2008:

 

 

 

Balance Sheet prior

 

 

 

Balance Sheet

 

 

 

to the adoption

 

Net unrealized

 

after adoption

 

 

 

of SFAS 159

 

gain reclassified

 

of SFAS 159

 

 

 

on January 1, 2008

 

upon adoption

 

on January 1, 2008

 

Marketable equity securities

 

$

1,917,893

 

$

 

$

1,917,893

 

Derivative liabilities

 

711,692

 

 

711,692

 

Accumulated other comprehensive income

 

511,776

 

(502,677

)

9,099

 

Retained earnings

 

1,690,651

 

502,677

 

2,193,328

 

 

The following table details the (Gain) loss on investments and financial instruments included in the Statements of Operations for the three months ended March 31, 2008 and 2007:

 

 

 

March 31,

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Gain (loss) on marketable equity securities

 

 

 

 

 

Deutsche Telekom AG

 

$

(357,160

)

$

 

VeriSign, Inc.

 

 

2,527

 

 

 

(357,160

)

2,527

 

 

 

 

 

 

 

Gain (loss) on derivative instruments

 

 

 

 

 

Deutsche Telekom AG collars(1)

 

353,670

 

239,746

 

Vodafone Group Plc collars (1)

 

 

15,769

 

VeriSign, Inc. collars(1)

 

 

(2,172

)

 

 

353,670

 

253,343

 

Total

 

$

(3,490

)

$

255,870

 

 


(1)          These derivative instruments represent the collar portions of variable prepaid forward contracts that relate to each of these marketable equity security investments.  All forward contracts relating to the Vodafone Group and VeriSign shares were settled and the remaining shares disposed of in 2007.  See Note 10 - Marketable Equity Securities and Variable Prepaid Forward Contracts, for more information on the variable prepaid forward contracts.

 

14



 

6.              Income Taxes

 

The overall effective tax rate on income before income taxes and minority interest for the three months ended March 31, 2008 and 2007 was 35.2% and 37.3%, respectively. The decrease in the effective tax rate for the 2008 period was attributable to lower state income tax rates applicable to tax gains recorded in the first quarter of 2008.

 

7.              Earnings per Share

 

Basic earnings per share is computed by dividing Net income available to common by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing Net income available to common by the weighted average common shares adjusted to include the effect of potentially dilutive securities. Potentially dilutive securities include incremental shares issuable upon exercise of outstanding stock options and the vesting of restricted stock units.

 

The amounts used in computing earnings per share and the effect of potentially dilutive securities on income and the weighted average number of Common, Special Common and Series A Common Shares are as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars and shares in thousands,

 

 

 

except earnings per share)

 

Basic Earnings per Share:

 

 

 

 

 

Net income

 

$

73,487

 

$

219,325

 

Preferred dividend requirement

 

(13

)

(13

)

Net income available to common used in basic earnings per share

 

$

73,474

 

$

219,312

 

 

 

 

 

 

 

Diluted Earnings per Share:

 

 

 

 

 

Net income available to common used in basic earnings per share

 

$

73,474

 

$

219,312

 

Minority income adjustment (1)

 

(321

)

(529

)

Preferred dividend adjustment (2)

 

12

 

12

 

Net income available to common used in diluted earnings per share

 

$

73,165

 

$

218,795

 

 

 

 

 

 

 

Weighted average number of shares used in basic earnings per share:

 

 

 

 

 

Common Shares

 

53,208

 

51,975

 

Special Common Shares

 

57,920

 

58,417

 

Series A Common Shares

 

6,442

 

6,445

 

Weighted average number of shares used in basic earnings per share

 

117,570

 

116,837

 

Effects of Dilutive Securities:

 

 

 

 

 

Effects of preferred shares

 

50

 

44

 

Effects of stock options (3)

 

481

 

1,427

 

Effects of restricted stock units (4)

 

90

 

75

 

Weighted average number of shares used in diluted earnings per share

 

118,191

 

118,383

 

 

 

 

 

 

 

Basic Earnings per Share

 

$

0.62

 

$

1.88

 

 

 

 

 

 

 

Diluted Earnings per Share

 

$

0.62

 

$

1.85

 

 


(1)   The minority income adjustment reflects the additional minority share of U.S. Cellular’s income computed as if all of

 

15



 

U.S. Cellular’s issuable securities were outstanding.

(2)   The preferred dividend adjustment reflects the dividend reduction in the event any preferred series were dilutive, and therefore converted for shares.

(3)   Stock options exercisable into 335,867 Common Shares and 1,414,320 Special Common Shares for the three months ended March 31, 2008, and 224,722 Common Shares and 224,722 Special Common Shares for the three months ended March 31, 2007, were not included in computing Diluted Earnings per Share because their effects were antidilutive.

(4)   Restricted stock units issuable upon vesting into 466 Special Common Shares for the three months ended March 31, 2008 were not included in computing diluted earnings per share because their effects were antidilutive.  There were no antidilutive restricted stock units for the comparable period in 2007.

 

8.              Licenses and Goodwill

 

Changes in TDS’ licenses and goodwill are primarily the result of acquisitions, divestitures and impairment of its licenses, wireless markets and telephone companies. See Note 3 – Acquisitions, Divestitures and Exchanges for information regarding transactions which affected licenses and goodwill during the period.

 

 

 

U.S.

 

 

 

 

 

(Dollars in thousands)

 

Cellular(1)

 

TDS Telecom

 

Total

 

Licenses

 

 

 

 

 

 

 

Balance December 31, 2007

 

$

1,513,829

 

$

2,800

 

$

1,516,629

 

Acquisitions

 

306,102

 

 

306,102

 

U.S. Cellular Common Share repurchases (2)

 

1,413

 

 

1,413

 

Balance March 31, 2008

 

$

1,821,344

 

$

2,800

 

$

1,824,144

 

 

 

 

 

 

 

 

 

Balance December 31, 2006

 

$

1,517,607

 

$

2,800

 

$

1,520,407

 

Acquisitions

 

7,900

 

 

7,900

 

Balance March 31, 2007

 

$

1,525,507

 

$

2,800

 

$

1,528,307

 

 


(1)          U.S. Cellular’s balances include licenses allocated from TDS.

(2)          This adjustment is the allocation of value related to U.S. Cellular’s share buyback programs.  See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellular’s purchase of its Common Shares.

 

 

 

U.S.

 

 

 

 

 

 

 

(Dollars in thousands)

 

Cellular(1)

 

TDS Telecom

 

Other(2)

 

Total

 

Goodwill

 

 

 

 

 

 

 

 

 

Balance December 31, 2007

 

$

276,416

 

$

398,911

 

$

3,802

 

$

679,129

 

Acquisitions

 

970

 

1,923

 

 

2,893

 

U.S. Cellular Common Share repurchases(3)

 

2,142

 

 

 

2,142

 

Balance March 31, 2008

 

$

279,528

 

$

400,834

 

$

3,802

 

$

684,164

 

 

 

 

 

 

 

 

 

 

 

Balance December 31, 2006

 

$

246,920

 

$

398,652

 

$

2,281

 

$

647,853

 

Acquisitions

 

5,818

 

 

 

5,818

 

Balance March 31, 2007

 

$

252,738

 

$

398,652

 

$

2,281

 

$

653,671

 

 


(1)          U.S. Cellular’s balances include goodwill allocated from TDS.

(2)          Other consists of goodwill related to Suttle Straus.

(3)          This adjustment is the allocation of value related to U.S. Cellular’s share buyback programs.  See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellular’s purchase of its Common Shares.

 

16



 

9.              Customer Lists

 

Customer lists, which are intangible assets resulting from acquisitions or step acquisition allocation of value related to U.S. Cellular’s share buyback programs, are amortized using a combination of accelerated and straight-line methods over the remaining estimated life. The changes in the customer lists for the three months ended March 31, 2008 and 2007 were as follows:

 

 

 

U.S.

 

TDS

 

 

 

(Dollars in thousands)

 

Cellular(1)

 

Telecom

 

Total

 

Customer lists

 

 

 

 

 

 

 

Balance December 31, 2007

 

$

25,851

 

$

 

$

25,851

 

Acquisitions

 

964

 

499

 

1,463

 

Amortization

 

(3,703

)

 

(3,703

)

U.S. Cellular Common Share repurchases(2)

 

2,183

 

 

2,183

 

Balance March 31, 2008

 

$

25,295

 

$

499

 

$

25,794

 

 

 

 

 

 

 

 

 

Balance December 31, 2006

 

$

26,196

 

$

 

$

26,196

 

Acquisitions

 

1,560

 

 

1,560

 

Amortization

 

(3,773

)

 

(3,773

)

Balance March 31, 2007

 

$

23,983

 

$

 

$

23,983

 

 


(1)         U.S. Cellular’s balance include customer lists allocated from TDS.

(2)         This adjustment is the allocation of value related to U.S. Cellular’s share buyback programs.  See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellular’s purchase of its Common Shares.

 

Based on the Customer lists balance as of March 31, 2008, amortization expense for the remainder of 2008 and for the years 2009-2013 is expected to be $8.5 million, $7.7 million, $6.0 million, $3.0 million, $0.5 million and $0.1 million, respectively.

 

10.       Marketable Equity Securities and Variable Prepaid Forward Contracts

 

TDS holds marketable equity securities, which were obtained in connection with the sale of non-strategic investments.  Information regarding TDS’ marketable equity securities is summarized as follows:

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Marketable Equity Securities – Current Assets

 

 

 

 

 

Deutsche Telekom AG - 55,969,689 and 85,969,689 Ordinary Shares, respectively

 

$

937,492

 

$

1,886,175

 

Rural Cellular Corporation - 719,396 Common Shares

 

31,819

 

31,718

 

Aggregate fair value included in Current Assets

 

969,311

 

1,917,893

 

Accounting cost basis

 

938,140

 

864,643

 

Gross unrealized holding gains (1)

 

31,171

 

1,053,250

 

Equity method unrealized gains

 

387

 

387

 

Income tax (expense)

 

(11,435

)

(386,315

)

Minority share of unrealized holding gains

 

(1,949

)

(1,945

)

Unrealized holding gains, net of tax and minority share (1)

 

18,174

 

665,377

 

Derivative instruments, net of tax and minority share(1)

 

 

(144,583

)

Retirement plans, net of tax

 

(8,994

)

(9,018

)

Accumulated other comprehensive income

 

$

9,180

 

$

511,776

 

 


(1)         Upon the adoption of SFAS 159 on January 1, 2008, unrealized holding gains and losses related to the Deutsche Telekom AG Ordinary Shares and the collar portions of the variable prepaid forward contracts related to such shares (derivatives) were reclassified to retained earnings.  See Note 5 - Fair Value Measurements, for further details on the adoption of SFAS 159.

 

17



 

TDS entered into variable prepaid forward contracts (“forward contracts”) related to the Deutsche Telekom ordinary shares it holds. The economic hedge risk management objective of the forward contracts is to hedge the value of the marketable equity securities from losses due to decreases in the market prices of the securities while retaining a share of gains from increases in the market prices of such securities. The downside risk is hedged at or above the accounting cost basis of the securities.  As of December 31, 2007, such forward contracts were scheduled to mature during the period January 2008 to September 2008.  The principal amount of the forward contracts was accounted for as a loan. The forward contracts contain embedded collars that are bifurcated and accounted for as derivatives in accordance with SFAS 133.

 

The forward contracts related to 30 million Deutsche Telekom Ordinary Shares matured during the quarter ended March 31, 2008.  TDS elected to deliver a substantial majority of the 30 million Deutsche Telekom ordinary shares in settlement of the forward contracts relating to such Deutsche Telekom ordinary shares and disposed of the remaining Deutsche Telekom ordinary shares related to such forward contracts and realized $48.6 million of cash proceeds. Disposition of these 30 million shares through settlement and sale resulted in a current tax liability of $113.0 million.  After these forward contracts were settled in January and February 2008, TDS owns 55,969,689 Deutsche Telekom ordinary shares at March 31, 2008.  The forward contracts related to TDS’ 55,969,689 Deutsche Telekom ordinary shares are scheduled to mature between May and September 2008.  As a result of TDS adopting SFAS 159 as of January 1, 2008, no gain or loss was recognized upon the settlement in the quarter ended March 31, 2008.  Rather changes in the fair value of the Deutsche Telekom ordinary shares and the collar portion of the forward contracts related to such shares were recorded in Gain (loss) on investments and financial instruments from January 1, 2008 through the respective settlement dates. See Note 5 - Fair Value Measurements for details on TDS’ adoption of SFAS 159 and the impact on TDS’ financial statements.

 

The remaining Deutsche Telekom ordinary shares are classified as Current Assets and the related forward contracts and derivative liability are classified as Current Liabilities in the Consolidated Balance Sheet at March 31, 2008. Contracts aggregating $236.4 million require quarterly interest payments at the LIBOR rate plus 50 basis points (the three-month LIBOR rate was 2.69% at March 31, 2008). Contracts aggregating $438.0 million are structured as zero-coupon obligations with a weighted average effective interest rate of 4.4% per year. No interest payments are required for the zero-coupon obligations during the contract period.

 

Under the terms of the forward contracts, TDS will continue to own the contracted shares and will receive dividends paid on such contracted shares, if any. The forward contracts may be settled in Deutsche Telekom shares or in cash, pursuant to formulas that “collar” the price of the shares. The collars typically are adjusted contractually for any changes in dividends on the underlying shares. If the dividend increases, the collar’s upside potential typically is reduced. If the dividend decreases, the collar’s upside potential typically is increased. If TDS elects to settle in shares, it will be required to deliver the number of shares of the contracted security determined pursuant to the formula. If shares are delivered in the settlement of the forward contract, TDS would incur a current tax liability at the time of delivery based on the difference between the tax basis of the marketable equity securities delivered and the net amount realized through maturity. If TDS elects to settle in cash, it will be required to pay an amount in cash equal to the fair market value of the number of shares determined pursuant to the formula.

 

In April and May 2008, TDS settled or agreed to settle forward contracts related to 46,969,689 additional Deutsche Telekom ordinary shares. The forward contracts related to the 46,969,689 Deutsche Telekom shares were or will be settled prior to their scheduled maturity dates in May 2008 through September 2008.  See Note 17 — Subsequent Events, for details on the early settlement of such forward contracts.

 

TDS is required to comply with certain covenants under the forward contracts. TDS believes that it was in compliance as of March 31, 2008 with all covenants and other requirements set forth in its forward contracts.

 

18



 

On July 30, 2007, RCCC announced that Verizon Wireless agreed to purchase the outstanding shares of RCCC for $45 per share in cash. The acquisition is expected to close in 2008 and, therefore, the investment is classified as a Current Asset in TDS’ Consolidated Balance Sheet as of March 31, 2008. If the transaction closes, TDS will receive approximately $32.4 million in cash, recognize a $31.7 million pre-tax gain and cease to own any interest in RCCC.

 

11.       Investments in Unconsolidated Entities

 

Investments in unconsolidated entities consist of amounts invested in wireless and wireline entities in which TDS holds a minority interest. These investments are accounted for using either the equity or cost method.

 

TDS held a 5.5% ownership interest in the Los Angeles SMSA Limited Partnership (“LA Partnership”) as of March 31, 2008 and March 31, 2007, and recorded $15.8 million and $18.0 million, respectively, of equity income related to the LA Partnership in the three month periods then ended.  Such amounts are included in Equity in earnings of unconsolidated entities in the Consolidated Statements of Operations.

 

Based on data furnished to TDS by the managing partner the following table summarizes the operating results of the LA Partnership:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

Revenues

 

$

949,000

 

$

904,000

 

Operating expenses

 

652,000

 

584,000

 

Operating income

 

297,000

 

320,000

 

Other income

 

7,000

 

8,000

 

Net income

 

$

304,000

 

$

328,000

 

 

12.       Commitments and Contingencies

 

Indemnifications

 

TDS enters into agreements in the normal course of business that provide for indemnification of counterparties. These agreements include certain asset sales and financings with other parties. The terms of the indemnifications vary by agreement. The events or circumstances that would require TDS to perform under these indemnities are transaction specific; however, these agreements may require TDS to indemnify the counterparty for costs and losses incurred from litigation or claims arising from the underlying transaction. TDS is unable to estimate the maximum potential liability for these types of indemnifications as the amounts are dependent on the outcome of future events, the nature and likelihood of which cannot be determined at this time. Historically, TDS has not made any significant indemnification payments under such agreements.

 

Legal Proceedings

 

TDS is involved or may be involved from time to time in legal proceedings before the FCC, other regulatory authorities, and/or various state and federal courts. If TDS believes that a loss arising from such legal proceedings is probable and can be reasonably estimated, an amount is accrued in the financial statements for the estimated loss.  If only a range of loss can be determined, the best estimate within that range is accrued; if none of the estimates within that range is better than another, the low end of the range is accrued. The assessment of the expected outcomes of legal proceedings is a highly subjective process that requires judgments about future events. The legal proceedings are reviewed at least quarterly to determine the adequacy of accruals and related financial statement disclosures. The ultimate outcomes of legal proceedings could differ materially from amounts accrued in the financial statements.

 

19



 

13.       TDS Special Common and U.S. Cellular Common Share Repurchases

 

On March 2, 2007, the TDS Board of Directors authorized the repurchase of up to $250 million of TDS Special Common Shares from time to time through open market purchases, block transactions, private purchases or otherwise. This authorization will expire on March 2, 2010. During the three months ended March 31, 2008, TDS repurchased 1,041,016 Special Common Shares for $45.1 million, or an average of $43.28 per share pursuant to this authorization.  Of this amount, $40.6 million was paid in the first quarter of 2008, and $4.5 million was paid in April of 2008.  TDS did not repurchase any Special Common Shares in the first quarter of 2007.  As of March 31, 2008, TDS has purchased a total of $171.7 million of Special Common Shares under this authorization, and therefore may purchase up to $78.3 million in future periods.

 

The Board of Directors of U.S. Cellular has authorized the repurchase of up to 1% of the outstanding U.S. Cellular Common Shares held by non-affiliates in each three month period, primarily for use in employee benefit plans.  This authorization does not have an expiration date. During the three months ended March 31, 2008, U.S. Cellular repurchased 150,000 Common Shares for $10.8 million, or an average of $71.70 per share, pursuant to this authorization.  U.S. Cellular also received $4.6 million in cash during the first quarter of 2008 as a final settlement payment for 2007 Common Share repurchases executed through accelerated share repurchase agreements with an investment banking firm.  U.S. Cellular did not repurchase any Common Shares in the first quarter of 2007.

 

TDS’ ownership percentage of U.S. Cellular increases upon such U.S. Cellular share repurchases. Therefore, TDS accounts for U.S. Cellular’s purchases of U.S. Cellular Common Shares as step acquisitions using purchase accounting. See Note 8 - Licenses and Goodwill, and Note 9 - Customer Lists, for details on the amounts allocated to Licenses, Goodwill and Customer Lists related to the repurchase of U.S. Cellular Common Shares for the three months ended March 31, 2008.

 

20



 

14.   Accumulated Other Comprehensive Income

 

The cumulative balances of unrealized gains (losses) on marketable equity securities, derivative instruments and retirement plans and related income tax effects included in Accumulated other comprehensive income are as follows.

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Marketable Equity Securities

 

 

 

 

 

Balance, beginning of period (prior to adoption of SFAS 159)

 

$

665,377

 

$

749,978

 

Cumulative effect adjustment upon the adoption of SFAS 159(1)

 

(647,260

)

 

Balance, beginning of period (after adoption of SFAS 159)

 

18,117

 

749,978

 

Add (deduct):

 

 

 

 

 

Unrealized gains (losses)

 

101

 

(247,902

)

Deferred tax (expense) benefit

 

(39

)

90,774

 

 

 

62

 

(157,128

)

Minority share of unrealized gains

 

(5

)

962

 

Net increase (decrease) in unrealized gains

 

57

 

(156,166

)

Initial application of FIN 48(2)

 

 

30,306

 

Balance, end of period

 

$

18,174

 

$

624,118

 

 

 

 

 

 

 

Derivative Instruments

 

 

 

 

 

Balance, beginning of period (prior to adoption of SFAS 159)

 

$

(144,583

)

$

(215,122

)

Cumulative effect adjustment upon the adoption of SFAS 159(1)

 

144,583

 

 

Balance, beginning of period (after adoption of SFAS 159)

 

 

(215,122

)

Add (deduct):

 

 

 

 

 

Minority share of unrealized losses

 

 

(4

)

Net (increase) decrease in unrealized losses

 

 

(4

)

Initial application of FIN 48(2)

 

 

(9,583

)

Balance, end of period

 

$

 

$

(224,709

)

 

 

 

 

 

 

Retirement Plans

 

 

 

 

 

Balance, beginning of period

 

$

(9,018

)

$

(12,743

)

Add (deduct):

 

 

 

 

 

Amounts included in net periodic benefit cost for the period

 

 

 

 

 

Amortization of prior service cost

 

(207

)

(207

)

Amortization of unrecognized net loss

 

242

 

340

 

 

 

35

 

133

 

Deferred income tax (expense)

 

(11

)

(51

)

Net change in retirement plans

 

24

 

82

 

Balance, end of year

 

$

(8,994

)

$

(12,661

)

 

 

 

 

 

 

Accumulated Other Comprehensive Income

 

 

 

 

 

Balance, beginning of period (prior to adoption of SFAS 159)

 

$

511,776

 

$

522,113

 

Cumulative effect adjustment upon the adoption of SFAS 159(1)

 

(502,677

)

 

Balance, beginning of period (after adoption of SFAS 159)

 

9,099

 

522,113

 

Add (deduct):

 

 

 

 

 

Net change in marketable equity securities

 

57

 

(156,166

)

Net change in derivative instruments

 

 

(4

)

Net change in retirement plans

 

24

 

82

 

Net change included in comprehensive income

 

81

 

(156,088

)

Initial application of FIN 48(2)

 

 

20,723

 

Net change included in accumulated comprehensive income

 

81

 

(135,365

)

Balance, end of period

 

$

9,180

 

$

386,748

 

 


(1)         See Note 5 - Fair Value Measurements for additional detail related to the cumulative effect adjustment related to the adoption of SFAS 159.

(2)         FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”).

 

21



 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

(Dollars in thousands)

 

Comprehensive Income

 

$

73,487 

 

$

219,325 

 

Net income

 

81 

 

(156,088

)

Net change included in comprehensive income

 

$

73,568 

 

$

63,237 

 

 

15.       Business Segment Information

 

Financial data for TDS’ business segments for the three month period ended or as of March 31, 2008 and 2007 are as follows. TDS Telecom’s incumbent local exchange carriers are designated as “ILEC” in the table and its competitive local exchange carrier is designated as “CLEC”.

 

 

 

 

Three Months Ended or as of

 

 

 

 

 

 

 

Non-

 

Other

 

 

 

March 31, 2008

 

U.S.

 

TDS Telecom

 

Reportable

 

Reconciling

 

 

 

(Dollars in thousands)

 

Cellular

 

ILEC

 

CLEC

 

Segment(1)

 

Items(2)

 

Total

 

Operating revenues

 

$

1,037,856

 

$

151,815

 

$

56,129

 

$

11,623

 

$

(8,322

)

$

1,249,101

 

Cost of services and products

 

365,053

 

44,834

 

26,333

 

8,479

 

(2,316

)

442,383

 

Selling, general and administrative expense

 

407,634

 

42,481

 

17,026

 

1,902

 

(5,744

)

463,299

 

Operating income before depreciation, amortization and accretion, (gain) loss on asset disposals(3)

 

265,169

 

64,500

 

12,770

 

1,242

 

(262

)

343,419

 

Depreciation, amortization and accretion expense

 

142,530

 

33,624

 

5,884

 

722

 

3,398

 

186,158

 

(Gain) loss on asset disposals

 

3,673

 

(21

)

 

 

 

3,652

 

Operating income (loss)

 

118,966

 

30,897

 

6,886

 

520

 

(3,660

)

153,609

 

Significant non-operating items:

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

21,235

 

1

 

 

 

234

 

21,470

 

Gain (loss) on investments and financial instruments

 

 

 

 

 

(3,490

)

(3,490

)

Marketable equity securities

 

16,404

 

 

 

 

952,907

 

969,311

 

Investments in unconsolidated entities

 

172,586

 

6,528

 

 

 

45,168

 

224,282

 

Total assets

 

5,926,074

 

1,659,633

 

146,902

 

29,304

 

1,476,500

 

9,238,413

 

Capital expenditures

 

111,690

 

14,646

 

3,436

 

929

 

1,764

 

132,465

 

 

22



 

 

 

 

Three Months Ended or as of

 

 

 

 

 

 

 

Non-

 

Other

 

 

 

March 31, 2007

 

U.S.

 

TDS Telecom

 

Reportable

 

Reconciling

 

 

 

(Dollars in thousands)

 

Cellular

 

ILEC

 

CLEC

 

Segment (1)

 

Items(2)

 

Total

 

Operating revenues

 

$

934,674

 

$

157,592

 

$

61,350

 

$

9,323

 

$

(6,382

)

$

1,156,557

 

Cost of services and products

 

318,028

 

49,097

 

28,957

 

7,298

 

(1,347

)

402,033

 

Selling, general and administrative expense

 

358,866

 

41,859

 

21,603

 

1,466

 

(3,377

)

420,417

 

Operating income before depreciation, amortization and accretion, (gain) loss on asset disposals(3)

 

257,780

 

66,636

 

10,790

 

559

 

(1,658

)

334,107

 

Depreciation, amortization and accretion expense

 

145,952

 

34,046

 

5,859

 

632

 

1,516

 

188,005

 

(Gain) loss on asset disposals

 

3,305

 

 

 

 

 

3,305

 

Operating income (loss)

 

108,523

 

32,590

 

4,931

 

(73

)

(3,174

)

142,797

 

Significant non-operating items:

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

23,098

 

 

 

 

598

 

23,696

 

Gain (loss) on investments and financial instruments

 

12,461

 

 

 

 

243,409

 

255,870

 

Marketable equity securities

 

245,228

 

 

 

 

2,300,027

 

2,545,255

 

Investments in unconsolidated entities

 

171,040

 

3,623

 

 

 

44,211

 

218,874

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

5,798,194

 

1,663,824

 

155,870

 

25,001

 

2,777,050

 

10,419,939

 

Capital expenditures

 

109,729

 

16,055

 

2,583

 

1,057

 

1,293

 

130,717

 

 


(1)         Represents Suttle Straus.

 

(2)         Consists of the Corporate operations, intercompany eliminations, TDS Corporate and TDS Telecom marketable equity securities and other corporate investments.

 

(3)         The amount of operating income before depreciation, amortization and accretion and (gain) loss on asset disposals is a non-GAAP financial measure. The amount may also be commonly referred to by management as operating cash flow. TDS has presented operating cash flow because this financial measure, in combination with other financial measures, is an integral part of our internal reporting system utilized by management to assess and evaluate the performance of its business. Operating cash flow is also considered a significant performance measure. It is used by management as a measurement of its success in obtaining, retaining and servicing customers by reflecting its ability to generate subscriber revenue while providing a high level of customer service in a cost effective manner. The components of operating cash flow include the key revenue and expense items for which operating managers are responsible and upon which TDS evaluates its performance.

 

Other companies in the wireless industry may define operating cash flow in a different manner or present other varying financial measures, and, accordingly, TDS’ presentation may not be comparable to other similarly titled measures of other companies.

 

Operating cash flow should not be construed as an alternative to operating income (loss), as determined in accordance with U.S. GAAP, as an alternative to cash flows from operating activities, as determined in accordance with U.S. GAAP, or as a measure of liquidity. TDS believes operating cash flow is useful to investors as a means to evaluate TDS’ operating performance prior to noncash depreciation and amortization expense, and certain other noncash charges. Although operating cash flow may be defined differently by other companies in the wireless industry, TDS believes that operating cash flow provides some commonality of measurement in analyzing operating performance of companies in the wireless industry.

 

16.       Supplemental Cash Flow Disclosures

 

TDS withheld 1,368 Special Common Shares with an aggregate value of $0.1 million in the three months ended March 31, 2008 from employees who exercised stock options or who received distribution of vested restricted stock awards. Such shares were withheld to cover the exercise price of stock options, if applicable, and required tax withholdings. No Common Shares were withheld in the same period.  No Special Common Shares or Common Shares were withheld in the three months ended March 31, 2007.

 

U.S. Cellular withheld 145,827 and 6,950 Common Shares with an aggregate value of $8.6 million and $0.5 million in the three months ended March 31, 2008 and 2007, respectively, from employees who exercised stock options or who received a distribution of vested restricted stock awards. Such shares were withheld to cover the exercise price of stock options, if applicable, and required tax withholdings.

 

23



 

TDS declared a dividend of $0.1025 per share during the first quarter of 2008.  This resulted in aggregate dividends of $12.0 million, which were paid in April 2008.  This amount is recorded as a component of Other current liabilities in TDS’ March 31, 2008 Consolidated Balance Sheet.

 

17.       Subsequent Events

 

U.S. Cellular has a $700 million revolving credit facility available for general corporate purposes. U.S. Cellular may select borrowing periods of either seven days or one, two, three or six months. If U.S. Cellular provides less than two days’ notice of intent to borrow, the related borrowings bear interest at the prime rate less 50 basis points. This credit facility expires in December 2009.

 

On April 15, 2008, U.S. Cellular borrowed $100 million under its revolving credit facility.  These proceeds along with additional cash on hand of $103.5 million were contributed to King Street Wireless and its general partner.  King Street Wireless in turn paid $203.5 million to the FCC in order to fulfill its remaining obligation incurred upon the purchase of licenses in Auction 73.  See Note 3 - Acquisitions, Divestitures and Exchanges for more information on Auction 73.  U.S. Cellular is a limited partner of King Street Wireless and consolidates this entity pursuant to the provisions of FIN 46(R).  See Note 4 - Variable Interest Entities for more information on King Street Wireless.  U.S. Cellular anticipates repaying the amount borrowed from future cash flows from operations and/or long-term debt financing.

 

During the period April 1, 2008 through May 7, 2008, TDS settled or has agreed to settle variable prepaid forward contracts related to 46,969,689 Deutsche Telekom shares.  These forward contracts were or will be settled prior to their scheduled maturity dates in May 2008 through September 2008.  TDS settled or will settle these forward contracts through a combination of delivery of Deutsche Telekom shares and the payment of cash. The Deutsche Telekom shares retained by TDS related to variable prepaid forward contracts that have settled in April and May 2008 were subsequently sold.  These early settlements are not expected to have a significant impact on TDS’ results of operations.  After these transactions, TDS will hold 9 million Deutsche Telekom shares and forward contracts related to such shares which mature in June 2008.

 

24



 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Telephone and Data Systems, Inc. (“TDS”) is a diversified telecommunications company providing high-quality telecommunications services in 26 states to approximately 6.2 million wireless customers and 1.2 million wireline equivalent access lines at March 31, 2008. TDS conducts substantially all of its wireless operations through its 80.8%-owned subsidiary, United States Cellular Corporation (“U.S. Cellular”), and its incumbent local exchange carrier (“ILEC”) and competitive local exchange carrier (“CLEC”) wireline operations through its wholly owned subsidiary, TDS Telecommunications Corporation (“TDS Telecom”). TDS conducts printing and distribution services through its 80%-owned subsidiary, Suttle Straus, Inc. which represents a small portion of TDS’ operations.

 

The following discussion and analysis should be read in conjunction with TDS’ interim consolidated financial statements and footnotes included herein and the description of TDS’ business included in Item 1 of the TDS Annual Report on Form 10-K for the year ended December 31, 2007.

 

OVERVIEW

 

The following is a summary of certain selected information contained in the comprehensive Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows. The overview does not contain all of the information that may be important. You should carefully read the entire Management’s Discussion and Analysis of Financial Condition and Results of Operations and not rely solely on the overview.

 

U.S. Cellular - U.S. Cellular provides wireless telecommunications services to approximately 6.2 million customers in five geographic market areas in 26 states. As of March 31, 2008, U.S. Cellular owned or had rights to acquire interests in 260 wireless markets and operated approximately 6,452 cell sites. U.S. Cellular operates on a customer satisfaction strategy, meeting customer needs by providing a comprehensive range of wireless products and services, excellent customer support, and a high-quality network. U.S. Cellular’s business development strategy is to operate controlling interests in wireless licenses in areas adjacent to or in proximity to its other wireless licenses, thereby building contiguous operating market areas. U.S. Cellular anticipates that operating in contiguous market areas will continue to provide it with certain economies in its capital and operating costs.

 

Financial and operating highlights in the first quarter of 2008 included the following:

 

·                  Total customers increased 4% year-over-year to 6.2 million at March 31, 2008; net retail customer additions were 85,000;

 

·                  The retail postpay churn rate was 1.4% per month. Retail postpay customers comprised approximately 86% of U.S. Cellular’s customer base as of March 31, 2008;

 

·                  Average monthly service revenue per customer increased 7% year-over-year to $52.06;

 

·                  Additions to property, plant and equipment totaled $111.7 million, including expenditures to construct cell sites, increase capacity in existing cell sites and switches, outfit new and remodel existing retail stores and continue the development and enhancements of U.S. Cellular’s office systems. Total cell sites in service increased 7% year-over-year to 6,452; and

 

·                  To strengthen its operating footprint, U.S. Cellular participated in the Federal Communications Commission (“FCC”) auction of spectrum in the 700 megahertz band, known as Auction 73, indirectly through its interest in King Street Wireless, L.P. (“King Street Wireless”). U.S. Cellular is a limited partner in King Street Wireless. King Street Wireless was the provisional winning bidder for 152 licenses for an aggregate bid of $300.5 million, net of its designated entity discount of 25%. The licenses expected to be awarded to King Street Wireless cover areas that overlap or are proximate or contiguous to areas covered by licenses that U.S. Cellular currently owns, operates and/or consolidates.

 

25



 

Service revenues increased $101.5 million, or 12%, to $962.1 million in 2008 from $860.6 million in 2007.  Customer growth and improvements in average monthly revenue per unit have driven increased revenues. U.S. Cellular continues to experience growth in its customer base, primarily in the retail postpay segment. In addition, U.S. Cellular continues to experience increases in average monthly revenue per unit driven by continuing migration of customers to national, wide area and family service plans and growth in revenues from data products and services.

 

Operating Income increased $10.4 million, or 10%, to $119.0 million in 2008 from $108.5 million in 2007. Operating income margin (as a percent of service revenues) was 12.4% in 2008 compared to 12.6% in 2007.

 

U.S. Cellular anticipates that there will be continued pressure on its operating income and operating income margin in the next few years related to the following factors:

 

·                  increasing penetration in the wireless industry;

 

·                  costs of customer acquisition and retention, such as equipment subsidies and advertising;

 

·                  effects of competition;

 

·                  providing service in recently launched areas or potential new market areas;

 

·                  potential increases in prepaid and reseller customers as a percentage of U.S. Cellular’s customer base;

 

·                  costs of developing and introducing new products and services;

 

·                  continued enhancements to its wireless networks, including potential deployments of new technology;

 

·                  increasing costs of regulatory compliance; and

 

·                  uncertainty in future eligible telecommunication carrier (“ETC”) funding.

 

In addressing these challenges, U.S. Cellular will continue to focus on improving customer satisfaction and enhancing the quality of its networks, its product and service offerings and its sales distribution.

 

See “Results of Operations—Wireless.”

 

TDS Telecom - TDS Telecom provides high-quality telecommunication services, including full-service local exchange service, long distance telephone service, and Internet access, to rural and suburban area communities. TDS Telecom’s business plan is designed for a full-service telecommunications company, including competitive local exchange carrier operations (“CLEC”), by leveraging TDS Telecom’s strength as an incumbent local exchange carrier (“ILEC”). TDS Telecom’s strategy is to be the preferred provider of telecommunications services—including voice, broadband, and video services—in its chosen markets. This strategy encompasses many components, including developing service and product, market and customer strategies; investing in networks and deploying advanced technologies; monitoring the competitive environment; advocating with respect to state and federal regulation for positions that support its ability to provide advanced telecommunications services to its customers; and exploring transactions to acquire or divest properties that would result in strengthening its operations.

 

Both ILECs and CLECs are faced with significant challenges, including the industry decline in use of second lines by customers, growing competition from wireless and other wireline providers (other CLECs and cable providers), changes in regulation, new technologies such as Voice over Internet Protocol (“VoIP”), and the uncertainty in the economy. These challenges could have a material adverse effect on the financial condition, results of operations and cash flows of TDS Telecom in the future.

 

26



 

Overall equivalent access lines served by TDS Telecom as of March 31, 2008 decreased 2% compared to March 31, 2007, while physical access lines declined 5% as of March 31, 2008 compared to March 31, 2007.  Equivalent access lines are the sum of physical access lines and high-capacity data lines adjusted to estimate the equivalent number of physical access lines in terms of capacity.  A physical access line is an individual circuit connecting a customer to a telephone company’s central office facilities.

 

Operating revenues decreased $11.5 million, or 5.3% to $206.1 million in the three months ended March 31, 2008 from $217.6 million in 2007. The decrease in 2008 was primarily due to a decline in ILEC and CLEC physical access lines, lower rates from bundling promotions and a decrease in network usage by inter-exchange carriers.

 

Operating income remained substantially unchanged at $37.8 million in 2008 compared to $37.5 million in 2007, as decreased revenues were offset by lower costs.  Operating margins improved in 2008 to 18.3% from 17.2% in 2007. The increase in 2008 was primarily due to cost reduction initiatives.

 

See “Results of Operations—Wireline.”

 

Cash Flows and Investments - TDS and its subsidiaries had cash and cash equivalents totaling $1,209.8 million, availability under their revolving credit facilities of $1,296.4 million, and additional bank lines of credit of $25 million as of March 31, 2008. Also, during the quarter ended March 31, 2008, TDS and its subsidiaries generated $269.0 of cash flows from operating activities. Management believes that cash on hand, expected future cash flows from operating activities and sources of external financing provide substantial financial flexibility and are sufficient to permit TDS and its subsidiaries to finance their contractual obligations and anticipated capital expenditures for the foreseeable future.

 

See “Financial Resources” and “Liquidity and Capital Resources” for additional information related to cash flows and investments.

 

Recent Developments

 

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007, before the FCC for comment are proposals made by the Federal-State Joint Board and by the FCC itself to change the universal service high cost fund in various ways. On April 29, 2008, the FCC adopted an interim "cap" on the high cost program for funding that goes to competitive ETCs, limiting total high cost funding for the state to the levels being provided to all such carriers in that state in March 2008, with an exemption from the cap for carriers serving tribal lands and Alaskan Native Lands. The cap, which will be of indefinite duration, will result in wireless ETCs, such as U.S. Cellular, receiving less support than they would have been otherwise eligible to receive while the cap is in effect, as overall support will not increase as a carrier adds customers or as new competitive carriers are granted ETC status in the state. The decision to cap overall funding to competitive ETCs will not impact the wireline carriers owned by TDS Telecom. The FCC will also consider the other changes in the Federal Universal Service Fund (“USF”) discussed in our Form 10-K.

 

27



 

RESULTS OF OPERATIONS - CONSOLIDATED

 

 

 

 

 

Increase/

 

Percentage

 

 

 

Three Months Ended March 31,

 

2008

 

(Decrease)

 

Change

 

2007

 

 

 

(Dollars in thousands)

 

Operating revenues

 

 

 

 

 

 

 

 

 

U.S. Cellular

 

$

1,037,856

 

$

103,182

 

11.0

%

$

934,674

 

Telecom

 

206,076

 

(11,546

)

(5.3

)%

217,622

 

All other(1)

 

5,169

 

908

 

21.3

%

4,261

 

Total operating revenues

 

1,249,101

 

92,544

 

8.0

%

1,156,557

 

Operating expenses

 

 

 

 

 

 

 

 

 

U.S. Cellular

 

918,890

 

92,739

 

11.2

%

826,151

 

Telecom

 

168,293

 

(11,808

)

(6.6

)%

180,101

 

All other(1)

 

8,309

 

801

 

10.7

%

7,508

 

Total operating expenses

 

1,095,492

 

81,732

 

8.1

%

1,013,760

 

Operating income (loss)

 

 

 

 

 

 

 

 

 

U.S. Cellular

 

118,966

 

10,443

 

9.6

%

108,523

 

Telecom

 

37,783

 

262

 

0.7

%

37,521

 

All other(1)

 

(3,140

)

107

 

3.3

%

(3,247

)

Total operating income (loss)

 

153,609

 

10,812

 

7.6

%

142,797

 

Other income and (expenses)

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

21,470

 

(2,226

)

(9.4

)%

23,696

 

Interest and dividend income

 

9,746

 

(6,450

)

(39.8

)%

16,196

 

Gain (loss) on investments and financial instruments

 

(3,490

)

(259,360

)

(101.4

)%

255,870

 

Interest expense

 

(41,380

)

16,421

 

28.4

%

(57,801

)

Other income (expense)

 

(199

)

2,025

 

91.1

%

(2,224

)

Income tax expense

 

(49,251

)

91,987

 

65.1

%

(141,238