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 |
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36-2669023 |
(State or other jurisdiction of |
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(I.R.S. Employer Identification No.) |
incorporation or organization) |
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30 North LaSalle Street, Chicago, Illinois 60602
(Address of principal executive offices) (Zip Code)
Registrants telephone number, including area code: (312) 630-1900
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check 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 |
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Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) |
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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 issuers classes of common stock, as of the latest practicable date.
Class |
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Outstanding at March 31, 2008 |
Common Shares, $.01 par value |
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53,164,628 Shares |
Special Common Shares, $.01 par value |
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57,234,617 Shares |
Series A Common Shares, $.01 par value |
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6,442,058 Shares |
Telephone and Data Systems, Inc.
Quarterly Report on Form 10-Q
For the Period Ended March 31, 2008
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Page No. |
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3 |
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Consolidated Statements of Operations Three Months Ended March 31, 2008 and 2007 |
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3 |
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Consolidated Statements of Cash Flows Three Months Ended March 31, 2008 and 2007 |
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4 |
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Consolidated Balance Sheets March 31, 2008 and December 31, 2007 |
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5 |
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7 |
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Managements Discussion and Analysis of Financial Condition and Overview |
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25 |
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28 |
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31 |
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37 |
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60 |
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Telephone and Data Systems, Inc.
Consolidated Statements of Operations
Unaudited
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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(Dollars and shares in thousands, |
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except per share amounts) |
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Operating Revenues |
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$ |
1,249,101 |
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$ |
1,156,557 |
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Operating Expenses |
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Cost of services and products (excluding Depreciation, amortization and accretion expense reported below) |
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442,383 |
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402,033 |
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Selling, general and administrative expense |
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463,299 |
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420,417 |
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Depreciation, amortization and accretion expense |
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186,158 |
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188,005 |
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Loss on asset disposals, net |
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3,652 |
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3,305 |
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Total Operating Expenses |
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1,095,492 |
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1,013,760 |
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Operating Income |
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153,609 |
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142,797 |
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Investment and Other Income (Expense) |
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Equity in earnings of unconsolidated entities |
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21,470 |
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23,696 |
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Interest and dividend income |
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9,746 |
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16,196 |
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Interest expense |
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(41,380 |
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(57,801 |
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Gain (loss) on investments and financial instruments |
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(3,490 |
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255,870 |
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Other, net |
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(199 |
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(2,224 |
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Total Investment and Other Income (Expense) |
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(13,853 |
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235,737 |
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Income Before Income Taxes and Minority Interest |
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139,756 |
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378,534 |
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Income tax expense |
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49,251 |
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141,238 |
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Income Before Minority Interest |
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90,505 |
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237,296 |
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Minority share of income, net of tax |
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(17,018 |
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(17,971 |
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Net Income |
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73,487 |
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219,325 |
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Preferred dividend requirement |
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(13 |
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(13 |
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Net Income Available To Common |
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$ |
73,474 |
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$ |
219,312 |
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Basic Weighted Average Shares Outstanding |
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117,570 |
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116,837 |
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Basic Earnings Per Share (Note 7) |
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$ |
0.62 |
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$ |
1.88 |
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Diluted Weighted Average Shares Outstanding |
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118,191 |
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118,383 |
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Diluted Earnings Per Share (Note 7) |
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$ |
0.62 |
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$ |
1.85 |
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Dividends Per Share |
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$ |
0.1025 |
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$ |
0.0975 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
Telephone and Data Systems, Inc.
Consolidated Statements of Cash Flows
Unaudited
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Three Months Ended |
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March 31, |
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2008 |
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2007 |
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(Dollars in thousands) |
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Cash Flows from Operating Activities |
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Net income |
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$ |
73,487 |
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$ |
219,325 |
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Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities |
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Depreciation, amortization and accretion |
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186,158 |
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188,005 |
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Bad debts expense |
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20,405 |
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12,255 |
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Stock-based compensation expense |
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3,116 |
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4,651 |
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Deferred income taxes |
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(102,540 |
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81,841 |
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(Gain) loss on investments and financial instruments |
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3,490 |
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(255,870 |
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Equity in earnings of unconsolidated entities |
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(21,470 |
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(23,696 |
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Distributions from unconsolidated entities |
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7,047 |
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2,321 |
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Minority share of income |
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17,018 |
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17,971 |
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Loss on asset disposals, net |
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3,652 |
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3,305 |
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Noncash interest expense |
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5,319 |
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5,378 |
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Other noncash expense |
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189 |
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Excess tax benefit from stock awards |
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(1,138 |
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(1,522 |
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Changes in assets and liabilities |
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Change in accounts receivable |
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(10,156 |
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20,262 |
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Change in inventory |
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(15,485 |
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15,785 |
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Change in accounts payable |
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(14,529 |
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(27,048 |
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Change in customer deposits and deferred revenues |
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6,162 |
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12,648 |
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Change in accrued taxes |
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149,349 |
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55,355 |
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Change in accrued interest |
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5,807 |
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5,403 |
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Change in other assets and liabilities |
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(46,882 |
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(49,901 |
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268,999 |
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286,468 |
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Cash Flows from Investing Activities |
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Additions to property, plant and equipment |
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(132,465 |
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(130,717 |
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Cash paid for acquisitions |
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(107,685 |
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(18,237 |
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Cash received from divestitures |
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6,838 |
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279 |
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Proceeds from sale of investments |
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48,619 |
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Other investing activities |
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371 |
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2,246 |
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(184,322 |
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(146,429 |
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Cash Flows from Financing Activities |
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Issuance of notes payable |
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25,000 |
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Issuance of long-term debt |
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454 |
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Repayment of long-term debt |
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(928 |
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(848 |
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TDS Common Shares and Special Common Shares reissued for benefit plans, net of tax payments |
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1,103 |
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7,040 |
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U.S. Cellular Common Shares reissued for benefit plans, net of tax payments |
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(2,526 |
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5,558 |
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Excess tax benefit from stock awards |
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1,138 |
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1,522 |
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Repurchase of TDS Special Common Shares |
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(40,584 |
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Repurchase of U.S. Cellular Common Shares |
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(6,201 |
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Dividends paid |
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(13 |
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(11,399 |
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Distributions to minority partners |
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(2,588 |
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(2,519 |
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Other financing activities |
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1,262 |
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(1,769 |
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(49,337 |
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23,039 |
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Net Increase in Cash and Cash Equivalents |
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35,340 |
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163,078 |
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Cash and Cash Equivalents - |
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Beginning of period |
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1,174,446 |
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1,013,325 |
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End of period |
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$ |
1,209,786 |
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$ |
1,176,403 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
Telephone and Data Systems, Inc.
Assets
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March 31, |
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December 31, |
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2008 |
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2007 |
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(Unaudited) |
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(Dollars in thousands) |
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Current Assets |
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Cash and cash equivalents |
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$ |
1,209,786 |
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$ |
1,174,446 |
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Accounts receivable |
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Due from customers, less allowances of $15,104 and $16,326, respectively |
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368,337 |
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379,558 |
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Other, principally connecting companies, less allowances of $5,670 and $5,297, respectively |
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141,044 |
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150,863 |
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Marketable equity securities |
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969,311 |
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1,917,893 |
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Inventory |
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128,771 |
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115,818 |
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Prepaid expenses |
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92,890 |
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77,155 |
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Other current assets |
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23,872 |
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59,855 |
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2,934,011 |
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3,875,588 |
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Investments |
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Licenses |
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1,824,144 |
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1,516,629 |
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Goodwill |
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684,164 |
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679,129 |
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Customer lists, net of accumulated amortization of $85,947 and $82,243, respectively |
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25,794 |
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25,851 |
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Investments in unconsolidated entities |
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224,282 |
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206,418 |
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Other investments |
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11,279 |
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11,509 |
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2,769,663 |
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2,439,536 |
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Property, Plant and Equipment |
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In service and under construction |
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8,174,705 |
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8,064,229 |
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Less accumulated depreciation |
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4,692,065 |
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4,539,127 |
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3,482,640 |
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3,525,102 |
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Other Assets and Deferred Charges |
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52,099 |
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53,917 |
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Total Assets |
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$ |
9,238,413 |
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$ |
9,894,143 |
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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
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March 31, |
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December 31, |
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2008 |
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2007 |
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(Unaudited) |
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(Dollars in thousands) |
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Current Liabilities |
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Current portion of long-term debt |
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$ |
4,444 |
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$ |
3,860 |
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Forward contracts |
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669,226 |
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1,005,512 |
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Accounts payable |
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298,840 |
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308,882 |
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Customer deposits and deferred revenues |
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172,377 |
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166,191 |
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Accrued interest |
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24,264 |
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18,456 |
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Accrued taxes |
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153,245 |
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40,439 |
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Accrued compensation |
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61,806 |
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91,703 |
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Derivative liability |
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156,081 |
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711,692 |
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Deferred income tax liability |
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209,074 |
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327,162 |
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Other current liabilities |
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335,535 |
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125,622 |
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2,084,892 |
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2,799,519 |
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Deferred Liabilities and Credits |
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Net deferred income tax liability |
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570,747 |
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555,593 |
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Asset retirement obligation |
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177,527 |
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173,468 |
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Other deferred liabilities and credits |
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157,195 |
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154,602 |
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905,469 |
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883,663 |
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Long-Term Debt |
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Long-term debt, excluding current portion |
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1,635,373 |
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1,632,226 |
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Commitments and Contingencies |
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Minority Interest |
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665,701 |
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651,537 |
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Preferred Shares |
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860 |
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860 |
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Common Stockholders Equity |
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Common Shares, par value $.01 per share; authorized 100,000,000 shares; issued 56,581,000 and 56,581,000 shares, respectively |
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566 |
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566 |
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Special Common Shares, par value $.01 per share; authorized 165,000,000 shares; issued 62,946,000 and 62,946,000 shares, respectively |
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629 |
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629 |
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Series A Common Shares, par value $.01 per share; authorized 25,000,000 shares; issued and outstanding 6,442,000 and 6,442,000 shares, respectively |
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64 |
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64 |
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Capital in excess of par value |
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2,049,738 |
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2,048,110 |
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Treasury Shares at cost: |
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Common Shares, 3,416,000 and 3,433,000 shares, respectively |
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(119,598 |
) |
(120,544 |
) |
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Special Common Shares, 5,711,000 and 4,712,000 shares, respectively |
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(245,177 |
) |
(204,914 |
) |
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Accumulated other comprehensive income |
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9,180 |
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511,776 |
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Retained earnings |
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2,250,716 |
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1,690,651 |
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3,946,118 |
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3,926,338 |
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Total Liabilities and Stockholders Equity |
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$ |
9,238,413 |
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$ |
9,894,143 |
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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 entitys 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
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Three Months Ended |
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March 31, |
|
||||
|
|
2008 |
|
2007 |
|
||
|
|
(Dollars in thousands) |
|
||||
Service Cost |
|
$ |
499 |
|
$ |
609 |
|
Interest on accumulated benefit obligation |
|
863 |
|
858 |
|
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Expected return on plan assets |
|
(948 |
) |
(821 |
) |
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Amortization of: |
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|
|
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|
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Prior service cost |
|
(207 |
) |
(207 |
) |
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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 Telecoms 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 Telecoms ILEC operations. In the third quarter of 2007, TDS Telecom discontinued the application of SFAS 71 for its ILEC operations. Therefore, TDS Telecoms 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 entitys 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 Combinationsa 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 Subsidiariesa 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 entitys 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. Cellulars 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 |
|
Goodwill(1) |
|
Licenses |
|
Customer |
|
Net tangible |
|
|||||
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. Cellulars income computed as if all of
15
U.S. Cellulars 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. Cellulars balances include licenses allocated from TDS.
(2) This adjustment is the allocation of value related to U.S. Cellulars share buyback programs. See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellulars 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. Cellulars 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. Cellulars share buyback programs. See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellulars 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. Cellulars 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. Cellulars balance include customer lists allocated from TDS.
(2) This adjustment is the allocation of value related to U.S. Cellulars share buyback programs. See Note 13 - TDS Special Common and U.S. Cellular Common Share Repurchases for a discussion of U.S. Cellulars 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 collars upside potential typically is reduced. If the dividend decreases, the collars 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. Cellulars 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 Telecoms incumbent local exchange carriers are designated as ILEC in the table and its competitive local exchange carrier is designated as CLEC.
Three Months Ended or 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. Managements 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.
The following is a summary of certain selected information contained in the comprehensive Managements 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 Managements 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. Cellulars 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. Cellulars 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. Cellulars 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. Cellulars 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 OperationsWireless.
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 Telecoms business plan is designed for a full-service telecommunications company, including competitive local exchange carrier operations (CLEC), by leveraging TDS Telecoms strength as an incumbent local exchange carrier (ILEC). TDS Telecoms strategy is to be the preferred provider of telecommunications servicesincluding voice, broadband, and video servicesin 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 companys 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 OperationsWireline.
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 |
) |
|||
Minority share of income |
|
(17,018 |
) |
953 |
|
5.3 |
% |
(17,971 |
) |
|||
Preferred dividend requirement |