UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

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

 

For the fiscal year ended December 31, 2012

 

OR

 

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

 

Commission file number 001-14157

 

 

TELEPHONE AND DATA SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

 

30 North LaSalle Street, Chicago, Illinois 60602

(Address of principal executive offices) (Zip code)

 

Registrant’s Telephone Number:  (312) 630-1900

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of each exchange on which registered
Common Shares, $.01 par value		New York Stock Exchange
6.625% Senior Notes due 2045		New York Stock Exchange
6.875% Senior Notes due 2059		New York Stock Exchange
7.0% Senior Notes due 2060		New York Stock Exchange
5.875% Senior Notes due 2061		New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No  o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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.

 

 

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

 

As of June 30, 2012, the aggregate market values of the registrant’s Common Shares, Series A Common Shares and Preferred Shares held by non-affiliates were approximately $1.7 billion, $2.2 million and $0.8 million, respectively.  For purposes hereof, it was assumed that each director, executive officer and holder of 10% or more of any class of voting equity security of Telephone and Data Systems, Inc. (“TDS”) is an affiliate.  The June 30, 2012 closing price of the Common Shares was $21.29 as reported by the New York Stock Exchange. Because trading in the Series A Common Shares and Preferred Shares is infrequent, the registrant has assumed for purposes hereof that (i) each Series A Common Share has a market value equal to one Common Share because the Series A Common Shares are convertible on a share-for-share basis into Common Shares, (ii) each nonredeemable Preferred Share has a market value of $100 because each of such shares had a stated value of $100 when issued, and (iii) each Preferred Share that is redeemable by the delivery of TDS Common Shares has a value equal to the value of the number of Common Shares (at $21.29 per share) on June 30, 2012 that would be required to be delivered upon redemption.

 

The number of shares outstanding of each of the registrant’s classes of common stock, as of January 31, 2013, is 100,876,000 Common Shares, $.01 par value, and 7,160,000 Series A Common Shares, $.01 par value.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Those sections or portions of the registrant’s 2012 Annual Report to Shareholders, filed as Exhibit 13 hereto, and of the registrant’s Notice of Annual Meeting of Shareholders and Proxy Statement for its 2013 Annual Meeting of Shareholders scheduled to be held May 16, 2013, described in the cross reference sheet and table of contents included herein are incorporated by reference into Parts II and III of this report.

 

 

 

Telephone and Data Systems, Inc.

 

Annual Report on Form 10-K

For The Period Ended December 31, 2012

 

CROSS REFERENCE SHEET AND TABLE OF CONTENTS

 

		Page Number or Reference (1)
Part I		1
Item 1.	Business	1
Item 1A.	Risk Factors	26
Item 1B.	Unresolved Staff Comments	45
Item 2.	Properties	45
Item 3.	Legal Proceedings	45
Item 4.	Mine Safety Disclosures	45
Part II		46
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	46	(2)
Item 6.	Selected Financial Data	46	(3)
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46	(4)
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	46	(5)
Item 8.	Financial Statements and Supplementary Data	47	(6)
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	47
Item 9A.	Controls and Procedures	47
Item 9B.	Other Information	48
Part III		49
Item 10.	Directors, Executive Officers and Corporate Governance	49	(7)
Item 11.	Executive Compensation	49	(8)
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	49	(9)
Item 13.	Certain Relationships and Related Transactions, and Director Independence	49	(10)
Item 14.	Principal Accountant Fees and Services	49	(11)
Part IV		50
Item 15.	Exhibits and Financial Statement Schedules	50

 

(1)                Parenthetical references are to information incorporated by reference from Exhibit 13 hereto, which includes portions of the registrant’s Annual Report to Shareholders for the year ended December 31, 2012 (“Annual Report”) and from the registrant’s Notice of Annual Meeting of Shareholders and Proxy Statement for its 2013 Annual Meeting of Shareholders (“Proxy Statement”) to be filed on or prior to April 30, 2013.

(2)                Annual Report sections entitled “Shareholder Information” and “Consolidated Quarterly Information (Unaudited),” except that “Securities Authorized for Issuance under Equity Compensation Plans” is incorporated in Item 12 of this Form 10-K and “Issuer Purchases of Equity Securities,” is included under Item 5 of this Form 10-K.

(3)                Annual Report section entitled “Selected Consolidated Financial Data,” except that Ratio of Earnings to Fixed Charges is included in Exhibit 12 to this Form 10-K.

(4)                Annual Report section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(5)                Annual Report section entitled “Market Risk.”

(6)                Annual Report sections entitled “Consolidated Statement of Operations,” “Consolidated Statement of Comprehensive Income,” “Consolidated Statement of Cash Flows,” “Consolidated Balance Sheet,” “Consolidated Statement of Changes in Equity,” “Notes to Consolidated Financial Statements,” “Consolidated Quarterly Information (Unaudited),” “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm.”

(7)                Proxy Statement sections entitled “Election of Directors,” “Corporate Governance,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

(8)                Proxy Statement section entitled “Executive and Director Compensation.”

(9)                Proxy Statement sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance under Equity Compensation Plans.”

(10)         Proxy Statement sections entitled “Corporate Governance,” and “Certain Relationships and Related Transactions.”

(11)         Proxy Statement section entitled “Fees Paid to Principal Accountants.”

 

 

Telephone and Data Systems, Inc. 30 NORTH LASALLE STREET, CHICAGO, ILLINOIS 60602 TELEPHONE (312) 630-1900

 

PART I

 

Item 1.  Business

 

Telephone and Data Systems, Inc. (“TDS”) is a diversified telecommunications service company with wireless operations provided by TDS’ 84%-owned subsidiary, United States Cellular Corporation (“U.S. Cellular”) and both wireline operations and hosted and managed services provided by TDS’ wholly-owned subsidiary, TDS Telecommunications Corporation (“TDS Telecom”).  At December 31, 2012, TDS served 5.8 million U.S. Cellular customers and 1.0 million TDS Telecom customer connections.  U.S. Cellular and TDS Telecom provided approximately 83% and 16%, respectively, of TDS’ consolidated revenues during 2012.  TDS’ business strategy is to expand its existing operations through internal growth and acquisitions and to explore and develop other related businesses that management believes will utilize TDS expertise in customer-focused services.

 

TDS is also the majority owner of Airadigm Communications, Inc. (“Airadigm”), a Wisconsin-based wireless service provider. Airadigm operates independently from U.S. Cellular and at this time there are no plans to combine the operations of these subsidiaries. TDS also conducts printing and distribution services through its majority-owned subsidiary, Suttle-Straus, Inc. (“Suttle-Straus”).  Airadigm and Suttle-Straus provided approximately 1% of consolidated revenues combined.

 

Historically, TDS had reported the following business segments: U.S. Cellular, TDS Telecom’s Incumbent Local Exchange Carrier (“ILEC”) which included TDS Telecom’s Hosted and Managed Services (“HMS”), TDS Telecom’s Competitive Local Exchange Carrier (“CLEC”) and Non-Reportable Segment which includes Suttle-Straus and, as of September 23, 2011, Airadigm.  As a result of recent acquisitions and changes in TDS’ strategy, operations, personnel and internal reporting, TDS reevaluated and changed its reportable business segments in the quarter ended March 31, 2012.  TDS’ business segments reflected in this Annual Report on Form 10-K are: U.S. Cellular’s wireless operations, ILEC, CLEC, HMS, and the Non-Reportable Segment.  Information about each of the reportable segments is disclosed below.  Periods presented for comparative purposes have been re-presented to conform to this revised presentation.  All of TDS’ segments operate only in the United States, except for HMS, which includes an insignificant foreign operation.  Additional information about TDS’ segments is incorporated herein by reference from Note 17 — Business Segment Information, in TDS’ Annual Report to Shareholders, filed as Exhibit 13 hereto.

 

TDS was incorporated in 1968 and changed its state of incorporation from Iowa to Delaware in 1998.  TDS executive offices are located at 30 North LaSalle Street, Chicago, Illinois 60602.  TDS’ telephone number is 312-630-1900.

 

TDS Common Shares trade under the ticker symbol “TDS” on the New York Stock Exchange (“NYSE”).  U.S. Cellular Common Shares trade on the NYSE under the ticker symbol “USM.”  On January 13, 2012, TDS shareholders approved a Share Consolidation Amendment to the Restated Certificate of Incorporation of TDS whereby (a) each Special Common Share was reclassified as a Common Share on a one-for-one basis, (b) each Common Share was reclassified as 1.087 Common Shares, and (c) each Series A Common Share was reclassified as 1.087 Series A Common Shares.  The Share Consolidation became effective on January 24, 2012, as such, TDS Special Common Shares, which had formerly traded under the ticker symbol “TDS.S” on the NYSE, began trading as TDS Common Shares under the ticker symbol “TDS” on January 25, 2012.

 

TDS’ 6.625% Senior Notes due 2045 trade on the NYSE under the symbol “TDI,” TDS’ 6.875% Senior Notes due 2059 trade under the symbol “TDE,” TDS’ 7.0% Senior Notes due 2060 trade under the symbol “TDJ” and TDS’ 5.875% Senior Notes due 2061 trade under the symbol “TDA.”  U.S. Cellular’s 6.95% Senior Notes due 2060 trade under the symbol “UZA.” U.S. Cellular’s 6.7% Senior Notes due 2033 are not listed on any stock exchange and trade over the counter.

 

Under listing standards of the NYSE, TDS is a “controlled company” as such term is defined by the NYSE.  TDS is a controlled company because over 50% of the voting power for the election of directors of TDS is held by the trustees of the TDS Voting Trust.

 

U.S. Cellular is a majority-owned subsidiary of TDS.  As of December 31, 2012, TDS owned 84% of the combined total of the outstanding Common Shares and Series A Common Shares of U.S. Cellular and controlled 96% of the combined voting power of both classes of common stock.

 

1

---

 

Available Information

 

TDS’ website is http://www.teldta.com .  TDS files with, or furnishes to, the Securities and Exchange Commission (“SEC”) annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, as well as various other information.  Anyone may access, free of charge, through the Investor Relations portion of the website, the TDS annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practical after such material is electronically filed with the SEC.  The public may read and copy any materials TDS files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington D.C. 20549.  The public may obtain information on the operation of the Reference Room by calling the SEC at 1-800-732-0330.  The public may also view electronic filings of TDS by accessing SEC filings at http://www.sec.gov .

 

U.S. Cellular’s website address is http://www.uscellular.com .  U.S. Cellular files with, or furnishes to, the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, as well as various other information.  Investors may access, free of charge, through the Investor Relations portion of the website, U.S. Cellular’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practical after such material is filed electronically with the SEC.  The public may read and copy any materials U.S. Cellular files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington D.C. 20549.  The public may obtain information on the operation of the Reference Room by calling the SEC at 1-800-732-0330.  The public may also view electronic filings of U.S. Cellular by accessing SEC filings at http://www.sec.gov .

 

2

 

U.S. Cellular Operations

 

General

 

United States Cellular Corporation (“U.S. Cellular”) was incorporated under the laws of the state of Delaware in 1983. At December 31, 2012, U.S. Cellular’s consolidated operating markets cover approximately 5.8 million customers in five geographic market areas in 26 states. U.S. Cellular operates in one reportable segment, wireless operations, and all of its wireless operating markets are in the United States.

 

U.S. Cellular is a wireless telecommunications service provider.  U.S. Cellular groups its individual markets (geographic service areas as defined by the Federal Communications Commission (“FCC”) in which wireless carriers are licensed, for fixed terms, to provide service) into broader geographic market areas (as discussed below in “Total Consolidated Markets” and “Consolidated Operating Markets”) to offer customers large service areas that primarily utilize U.S. Cellular’s network.  Since 1985, when it began providing wireless telecommunications service in Knoxville, Tennessee and Tulsa, Oklahoma, U.S. Cellular has expanded its consolidated wireless networks and customer service operations to cover five geographic market areas in portions of 26 states, which collectively represent a total population of 47.0 million as of December 31, 2012.  U.S. Cellular uses roaming agreements with other wireless carriers to provide service to its customers in areas not covered by U.S. Cellular’s network.

 

U.S. Cellular is subject to regulation by the FCC as a provider of wireless telecommunication services. The FCC regulates the licensing, construction, and operation of providers of wireless telecommunications systems, as well as the provision of services over those systems.  See “Regulation” below for further discussion regarding licenses as well as the regulations promulgated by the FCC.

 

U.S. Cellular’s ownership interests in wireless licenses include both consolidated and investment interests in licenses covering portions of 36 states and a total population of 93.2 million at December 31, 2012.

 

For purposes of tracking population counts in order to calculate market penetration, when U.S. Cellular acquires a licensed area that overlaps a licensed area it already owns, it does not duplicate the population counts for any overlapping licensed area.  Only incremental population counts are added to the reported amount of “total market population” in the case of an acquisition of a licensed area that overlaps a previously owned licensed area.

 

Total market population measures are provided to allow comparison of the relative size of each of U.S. Cellular’s geographic market areas to its total consolidated markets and consolidated operating markets, as defined below.  The total population of U.S. Cellular’s consolidated markets may have no direct relationship to the number of wireless customers or the revenues that may be realized from the operation of the related wireless systems.  In addition, population equivalents for investment interests have been provided to allow comparison to the relative size of U.S. Cellular’s consolidated markets.

 

Total Consolidated Markets (Including non-operating markets)

 

The following table summarizes information regarding licensed areas which U.S. Cellular consolidates as of December 31, 2012.  The population shown is the total population within each geographic market area, regardless of U.S. Cellular’s percentage ownership in the licenses included in such geographic market areas:

 

Geographic Market Areas		Population (1)		Customers		Penetration		States
Central Region (2)		65,931,000		3,688,000		5.6	%	AL, AR, CO, FL, GA, IA, IL, IN, KS, KY, LA, MI, MN, MO, MS, NE, OH, OK, SD, TX, WI
Mid-Atlantic Region		20,291,000		1,104,000		5.4	%	MD, NC, PA, SC, TN, VA, WV
New England Region		2,857,000		422,000		14.8	%	ME, NH, VT
Northwest Region		3,685,000		369,000		10.0	%	CA, ID, OR, WA
New York Region (3)		480,000		215,000		44.8	%	NY
Total		93,244,000		5,798,000		6.2	%

 

3

 

Consolidated Operating Markets

 

The following table summarizes information regarding licensed areas which U.S. Cellular consolidates and are in operation as of December 31, 2012.  The population shown is the total population within each geographic market area, regardless of U.S. Cellular’s percentage ownership in the licenses included in such geographic market areas:

 

Geographic Market Areas		Population (1)		Customers		Penetration		States
Central Region (2)		33,235,000		3,688,000		11.1	%	IA, IL, IN, KS, MI, MN, MO, NE, OH, OK, TX, WI
Mid-Atlantic Region		8,006,000		1,104,000		13.8	%	MD, NC, PA, SC, TN, VA, WV
New England Region		2,857,000		422,000		14.8	%	ME, NH, VT
Northwest Region		2,388,000		369,000		15.5	%	CA, OR, WA
New York Region (3)		480,000		215,000		44.8	%	NY
Total		46,966,000		5,798,000		12.3	%

 

(1)          Represents 100% of the population of the licensed areas, based on 2011 Claritas® population estimates.  “Population” in this context includes only the areas covering such markets and is used only for the purposes of calculating market penetration and is not related to “population equivalents,” as defined below. It also includes 100% of the population of two licensed areas where U.S. Cellular owns a controlling interest and has contracted with another wireless operator to manage the operations.

 

(2)          At December 31, 2012, the Divestiture Markets are included in the Central Geographic Market Area.

 

(3)          Markets in the New York Region are operated by Verizon Wireless under the Verizon Wireless brand.  U.S. Cellular owns a greater than 50% interest in each of these markets and consolidates the financial results of these markets in accordance with Generally Accepted Accounting Principles (“GAAP”).

 

Investment Markets

 

The following table summarizes the markets in which U.S. Cellular owns an investment interest at December 31, 2012.  For licenses in which U.S. Cellular owns an investment interest, the related population equivalents are shown.

 

Market Area/Market		Population (1)		Current Percentage Interest (2)		Current Population Equivalents (3)
Los Angeles/Oxnard, CA		18,095,000		5.5	%	995,000
Oklahoma City, OK		1,209,000		14.6	%	177,000
Others (fewer than 100,000 population equivalents each)		4,667,000		Varies		290,000
Total population equivalents in investment markets						1,462,000

 

(1)          Represents 100% of the total population of the licensed area in which U.S. Cellular owns an interest based on 2011 Claritas® population estimates.

 

(2)          Represents U.S. Cellular’s percentage ownership interest in the licensed area as of December 31, 2012.

 

(3)          “Current Population Equivalents” are derived by multiplying the amount in the “Population” column by the percentage interest indicated in the “Current Percentage Interest” column.

 

Divestiture Transaction

 

As more fully described in the Divesture Transaction section of Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 7 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements, on November 6, 2012, U.S. Cellular entered into a Purchase and Sale Agreement (the “Divestiture Transaction”) with subsidiaries of Sprint Nextel Corporation (“Sprint”).

 

The Purchase and Sale Agreement provides that U.S. Cellular will transfer to Sprint certain rights and assets (collectively, the “Subject Assets”), and Sprint will assume certain liabilities (“Subject Liabilities”), related to U.S. Cellular’s Chicago, central Illinois, St. Louis and certain Indiana/Michigan/Ohio markets (the “Divestiture Markets”), in consideration for $480 million in cash at closing, subject to pro-rations of certain assets and liabilities.  U.S. Cellular will retain all other assets (“Retained Assets”) and liabilities (“Retained Liabilities”) related to the Divestiture Markets.  U.S. Cellular is not transferring and will continue to operate and provide service in Peoria, Rockford and certain other areas in Illinois, and in Columbia, Joplin, Jefferson City and certain other areas in Missouri.

 

4

 

The Subject Assets include customers and most of U.S. Cellular’s PCS licenses in the Divestiture Markets.  U.S. Cellular will retain its direct and indirect ownership interests in other spectrum in the Divestiture Markets. The transaction does not include spectrum licenses held by U.S. Cellular or variable interest entities consolidated by U.S. Cellular that are not currently used in the operations of the Divestiture Markets.  The Subject Liabilities that will be assumed by Sprint include only (i) liabilities as of the closing relating to the Subject Assets and (ii) liabilities arising after the closing relating to the Subject Assets.

 

The Retained Assets include all assets other than the Subject Assets, including cash, accounts receivable, inventory, naming rights, real estate, cell sites including towers, network equipment, stores, retail equipment, furniture and fixtures, and all other assets, including the corporate and other facilities located in the Divestiture Markets.  The Retained Liabilities include all liabilities other than the Subject Liabilities, including accounts payable, accrued expenses, liabilities to employees, taxes, obligations under benefit plans, contracts, leases and asset retirement obligations.

 

The transaction is subject to FCC approval, compliance with the Hart-Scott-Rodino Act and other conditions.  Subject to the satisfaction or (if permitted) waiver of all conditions, the transaction is expected to close in mid-2013.

 

The table below provides selected information related to the Divestiture Markets as of December 31, 2012:

 

Market population		15,037,000
Market penetration		3.7	%
Total customers		560,000
Postpaid customers		463,000
Prepaid customers		81,000
Reseller customers		16,000
Postpaid churn rate		2.95	%

 

Products and Services

 

Wireless Services.  U.S. Cellular’s postpaid customers are able to choose from a variety of national plans with voice, messaging and data pricing that are designed to fit different customer needs, usage patterns and budgets.  The ability to help a customer find the right pricing plan is central to U.S. Cellular’s brand positioning.  U.S. Cellular offers national consumer plans with both bundled and unbundled options that can be tailored to a customer’s needs. Many plans enable small work groups or families to share the plan minutes, enabling customers to get more value for their money.  U.S. Cellular offers data plans in a variety of tiers to fit customers’ needs and budgets.  Business rate plans are offered to companies to meet their unique needs.  U.S. Cellular’s popular national plans price all calls, regardless of where they are made or received in the United States, as local calls with no long distance or roaming charges. All incoming calls, texts, and picture messages are free on currently offered plans.  Additionally, U.S. Cellular offers prepaid service plans, which include voice minutes, messaging and data in a variety of ways for a monthly fee.  In May 2012, U.S. Cellular began offering U Prepaid, a no contract wireless service in select Walmart stores in an effort to expand points of distribution for U.S. Cellular products and services.  In October 2012, U.S. Cellular began offering a postpaid option through Walmart as well, and continues to explore new distribution options.

 

U.S. Cellular recognizes customer loyalty with national bundled rate plans and industry-leading benefits without requiring customers to sign continuous contracts . Customers who subscribe to national plans can earn loyalty reward points that can be used for accelerated phone upgrades just for being a customer. Points can also be used for other rewards such as additional lines, phones, accessories and ringtones . Available postpaid plans include Overage Cap, a free service that prevents voice overage charges from exceeding $50 for a National Single Line Plan or $150 for a Family Plan.

 

U.S. Cellular’s portfolio of Android TM -powered, BlackBerry® and Windows Mobile® smartphones and Android TM -powered tablets are key parts of its strategy to deliver wireless devices which allow customers to stay productive, entertained and connected on the go. Backed by U.S. Cellular’s high-speed networks, including a fourth generation Long Term Evolution (“4G LTE”) network, which, as of December 31, 2012, covers 61% of its postpaid customers and a third generation (“3G”) network that supports nationwide roaming, U.S. Cellular’s smartphone messaging, data and internet services allow customers to access the web and social network sites, e-mail, text, picture and video message, utilize turn-by-turn GPS navigation, and browse and download thousands of applications to customize their wireless devices to fit their lifestyles.

 

U.S. Cellular offers enhanced multimedia services, including Digital Radio, Mobile TV and 3D Gaming, over its 4G LTE and 3G networks.  U.S. Cellular’s easy edge SM  brand of enhanced data services uses a Binary Runtime Environment for Wireless (“BREW”) technology which adds limited computer-like functionality to non-smartphone wireless devices, enabling applications to be downloaded over-the-air directly to the customer’s wireless device.  These enhanced data services include news, weather, sports, information, games, ring tones and other services.

 

5

 

U.S. Cellular plans to further enhance its advanced data services in 2013 and beyond.

 

Wireless Devices. U.S. Cellular offers a comprehensive range of wireless devices such as handsets, modems, mobile hotspots and tablets for use by its customers.  U.S. Cellular offers wireless devices that are compatible with some or all of its 4G LTE, 3G and 2G networks and all are compliant with the FCC’s enhanced wireless 911 (“E-911”) requirements.  In addition, U.S. Cellular offers a wide range of accessories, such as carrying cases, hands-free devices, batteries, battery chargers, memory cards and other items to customers. U.S. Cellular also sells wireless devices to agents and other third-party distributors for resale. U.S. Cellular frequently discounts wireless devices sold to new and current customers and provides discounts on upgraded wireless devices to current customers, in order to attract new customers or to retain existing customers by reducing the cost of becoming or remaining a wireless customer.  With plans offering “no contract after the first,” customers who are eligible for a wireless device upgrade are able to obtain wireless devices at promotional prices without signing a new contract.

 

U.S. Cellular has established service facilities in many of its local markets to ensure quality service and repair of the wireless devices it sells.  These facilities allow U.S. Cellular to provide convenient and timely repair service to customers who experience device problems.  Additionally, U.S. Cellular offers several programs which allow the customer to receive a replacement device through a retail store or through direct mail.

 

Handset selection and availability are significant areas of competitive differentiation in the industry today. During 2012, U.S. Cellular continued to bolster its expanding smartphone and tablet portfolio with the launch of high-performance Android TM -powered wireless devices, such as the Samsung Galaxy S III TM . U.S. Cellular’s smartphone offerings play a significant role in driving data service usage and revenues.  The devices offered include a full array of smartphones from the top-tier Android TM -powered Samsung Galaxy S III TM  to lower-tier smartphones.

 

U.S. Cellular purchases wireless devices and accessory products from a number of manufacturers, including Samsung, Motorola, Personal Communications Devices, LG, BlackBerry®, Superior Communications and Xentris Wireless. U.S. Cellular negotiates volume discounts with its suppliers and works with them in promoting specific equipment in its local advertising.  U.S. Cellular does not own significant product warehousing and distribution infrastructure.  Instead, it contracts with third party providers for substantially all of its product warehousing, distribution and direct customer fulfillment activities. U.S. Cellular also contracts with third party providers for services related to its reward points and phone replacement programs.

 

U.S. Cellular monitors the financial condition of all of its wireless device and accessory suppliers.  Because U.S. Cellular purchases wireless devices and accessories from numerous suppliers, U.S. Cellular does not expect the financial condition of any single supplier to affect U.S. Cellular’s ability to offer a competitive variety of wireless devices and accessories for sale to customers.

 

Marketing

 

Customer Acquisition and Retention.   U.S. Cellular’s marketing plan is focused on acquiring, retaining and growing customer relationships by offering high-quality products and services built around customer needs at fair prices, supported by outstanding customer service.

 

U.S. Cellular believes that creating positive connections with its customers enhances their wireless experience and builds customer loyalty.  U.S. Cellular currently offers several innovative, customer-centric programs and services, at no cost to the customer.  The Overage Protection service provides customers peace-of-mind by sending them text message alerts when they come close to reaching their allowable monthly plan minutes or text messages in order to avoid overage charges. Although the FCC approved a proposal in 2011 that would require carriers to notify customers before they incur excessive charges, U.S. Cellular believes that it was the first to offer this service to all of its customers. My Contacts Backup offers extra security for customers by allowing them to retrieve their contact numbers if they lose or damage their wireless devices.

 

U.S. Cellular increases customer awareness using media such as television, radio, newspaper, direct mail advertising, the Internet, social media and sponsorships.  U.S. Cellular has achieved its current level of penetration of its markets through a combination of a strong brand position, promotional advertising, broad distribution, maintaining a high-quality wireless network and providing outstanding customer service.  U.S. Cellular’s advertising is directed at attracting and retaining customers, improving potential customers’ awareness of the U.S. Cellular brand, increasing existing customers’ usage of U.S. Cellular’s services and increasing the public awareness and understanding of the wireless services it offers.  U.S. Cellular attempts to select the advertising and promotional media that are most appealing to the targeted groups of potential customers in each local market.  U.S. Cellular supplements its advertising with a focused public relations program that drives store traffic, supports sales of products and services, and builds brand awareness and preference.  The approach combines national and local media relations in mainstream and social media channels with market-wide activities, events, and sponsorships. Since 2008, U.S. Cellular has focused its giving strategy on the pressing needs of schools and has invested millions of dollars in its education initiatives, such as Calling All Communities and Calling All Teachers, which support schools and teachers in the communities U.S. Cellular serves.

 

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U.S. Cellular manages customer retention by focusing on outstanding customer service through the development of processes that are customer-friendly, extensive training of frontline sales and support associates and the implementation of retention programs.  The marketing plan highlights the value of U.S. Cellular’s service offerings and incorporates combinations of rate plans, additional value-added features and services and wireless devices which are designed to meet the needs of customers.

 

Through 2012, U.S. Cellular operated five regional customer care centers.  Effective January 1, 2013, U.S. Cellular transferred its Bolingbrook Customer Care Center operations to an existing third-party vendor.  In connection with the Bolingbrook Customer Care Center transaction, the majority of U.S. Cellular’s associates at the Bolingbrook, Illinois location became employees of the third party vendor, which will continue to provide services to U.S. Cellular through a transition period.  Through the Bolingbrook and other customer care center operations, U.S. Cellular will continue to deliver award-winning customer service.  U.S. Cellular will continue to operate four other regional customer care centers with personnel who are responsible for customer service activities, and a national financial services center with personnel who perform credit and other customer payment activities.  U.S. Cellular also contracts with third parties that provide additional customer care support.

 

Distribution Channels.  U.S. Cellular supports a multi-faceted distribution program, including retail sales and service centers, direct sales, third-party national retailers, and independent agents, plus the website and telesales for customers who wish to contact U.S. Cellular through the Internet or by phone.

 

Company retail store locations are designed to market wireless products and services to the consumer and small business segments in a setting familiar to these types of customers.  As of December 31, 2012, retail sales associates work in over 400 U.S. Cellular-operated retail stores and kiosks. Direct sales consultants market wireless services to mid-size business customers. Additionally, the U.S. Cellular website enables customers to activate service and purchase wireless devices online.

 

U.S. Cellular maintains an ongoing training program to improve the effectiveness of retail sales associates and direct sales consultants by focusing their efforts on obtaining customers by facilitating the sale of appropriate packages for the customer’s expected usage and value-added services that meet customer needs.

 

In May 2012, U.S. Cellular began offering U Prepaid, a no contract wireless service, in select Walmart stores within its service areas.  In October 2012, U.S. Cellular began offering a postpaid option through Walmart, and continues to explore new distribution options.

 

U.S. Cellular has relationships with exclusive and non-exclusive agents, which are independent businesses that obtain customers for U.S. Cellular on a commission basis.  At December 31, 2012, U.S. Cellular had contracts with these businesses aggregating over 1,000 locations.  U.S. Cellular provides additional support and training to its exclusive agents to increase customer satisfaction for customers they serve.  U.S. Cellular’s agents are generally in the business of selling wireless devices, wireless service packages and other related products.  No single agent accounted for 10% or more of U.S. Cellular’s operating revenues during the past three years.

 

U.S. Cellular also markets wireless service through resellers.  The resale business involves the sale of wholesale access and minutes to independent companies that package and resell wireless services to end-users.  These resellers generally provide prepaid and postpaid services to subscribers under their own brand names and also provide their own billing and customer service.  U.S. Cellular incurs no direct subscriber acquisition costs related to reseller customers.  At December 31, 2012, U.S. Cellular had approximately 241,000 customers of resellers.  For the year ended December 31, 2012, revenues from resale business were less than 1% of total service revenues.

 

Seasonality.  There is seasonality in operating expenses, which tend to be higher in the fourth quarter than in the other quarters due to increased marketing activities, which may cause operating income to vary from quarter to quarter.

 

Customers and System Usage

 

U.S. Cellular provides service to customers from a variety of demographic segments.  U.S. Cellular uses a segmentation model to classify businesses and consumers into logical groupings for developing new products and services, direct marketing campaigns, and retention efforts.  U.S. Cellular focuses on both retail consumers and small-to-mid-size business customers in vertical industries such as construction, retail, professional services and real estate.  These industries are primarily served through U.S. Cellular’s retail and direct sales channels.

 

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U.S. Cellular’s main sources of revenues are from its own customers and from customers of competitors who roam on its network. The interoperability of wireless service enables a customer who is in a wireless service area other than the customer’s home service area to place or receive a call or use data in that service area.  U.S. Cellular has entered into reciprocal roaming agreements with operators of other wireless systems covering virtually all systems with Code Division Multiple Access (“CDMA”) technology in the United States, Canada and Mexico.  Roaming agreements offer customers the opportunity to roam on these systems.  These reciprocal agreements automatically pre-register the customers of U.S. Cellular’s systems in the other carriers’ systems.  In addition, a customer of a participating system roaming in a U.S. Cellular market where this arrangement is in effect is able to make and receive calls or data on U.S. Cellular’s system.  The charge for this service is negotiated as part of the roaming agreement between U.S. Cellular and the roaming customer’s carrier. U.S. Cellular bills this charge to the customer’s home carrier, which then may bill the customer.  In many instances, based on competitive factors, carriers, including U.S. Cellular, may not charge their customers, or charge lower amounts to their customers than the amounts actually charged by other wireless carriers for roaming. Since 2010, U.S. Cellular has offered nationwide 3G data roaming services, allowing its customers to access high-speed data across the country. U.S. Cellular is currently exploring 4G roaming agreements with operators of other wireless systems. The FCC’s adoption of mandatory 4G roaming rules, which were upheld by the United States Court of Appeals for the District of Columbia, may be of assistance in the negotiation of 4G roaming agreements with other wireless operators in the future. However, technological challenges currently exist which limit the interoperability of 4G wireless devices on other carriers’ networks. Specifically, wireless devices support certain configurations of 4G spectrum frequencies and as a result 4G wireless devices offered by carriers are not necessarily compatible with the networks of other carriers. U.S. Cellular is working with other carriers and original equipment manufacturers in order to resolve and mitigate interoperability issues; however, there is no assurance that these issues will be fully resolved or mitigated. Accordingly, both the timing of when U.S. Cellular will be able to offer 4G roaming, and in which geographies, are uncertain.

 

Technology and System Design and Construction

 

Technology .  Wireless telecommunication systems transmit voice, data, graphics and video through the transmission of signals over networks of radio towers using radio spectrum licensed by the FCC.  Access to local, regional, national and worldwide telecommunications networks is provided through system interconnections.

 

U.S. Cellular currently deploys CDMA digital technology throughout its networks.  Through roaming agreements with other CDMA-based wireless carriers, U.S. Cellular’s customers may access CDMA service in virtually all areas of the United States, as well as parts of Canada and Mexico.  U.S. Cellular believes that CDMA technology offers advantages compared to the other second generation digital technologies, including greater spectral efficiency as well as better call quality.  Another digital technology, Global System for Mobile Communication (“GSM”), has a larger installed base of customers worldwide. Since CDMA technology currently is not compatible with GSM technology, U.S. Cellular customers with CDMA-only based wireless devices are currently not able to use their wireless devices when traveling through areas serviced only by GSM-based networks. However, both CDMA and GSM technologies are expected to be succeeded by 4G LTE technology over the next several years.  As described above, there are challenges to implementing 4G LTE roaming and interoperability.  Carriers may deploy 4G LTE technology on different radio bands, or spectrum, and devices from one carrier may not have the required antennas to operate on another carrier’s network and, as such, would not be able to roam on that network.

 

A high-quality network, supported by continued investments in that network, will remain an important factor for wireless companies to remain competitive.  U.S. Cellular continually reviews its long-term technology plans.  Since 2006, U.S. Cellular has offered services based on 3G technology and, in 2012, U.S. Cellular launched services based on 4G LTE technology in conjunction with King Street Wireless L.P.  As of December 31, 2012, U.S. Cellular deployed 4G LTE technology that covered approximately 61% of its postpaid customers and anticipates further expansion of 4G LTE in 2013.

 

System Design and Construction.  U.S. Cellular designs and constructs its systems in a manner it believes will permit it to provide high-quality service to substantially all types of compatible wireless devices.  Designs are based on engineering studies which relate to specific markets, in support of the larger network.  Such engineering studies are performed by U.S. Cellular personnel or third-party engineering firms.  Network reliability is given careful consideration and extensive backup redundancy is employed in many aspects of U.S. Cellular’s network design.  Route diversity, ring topology and extensive use of emergency standby power are also utilized to enhance network reliability and minimize service disruption from any particular network element failure.

 

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In accordance with its strategy of building and strengthening its operating market areas, U.S. Cellular has selected high-capacity digital wireless switching systems that are capable of serving multiple markets through a single mobile telephone switching office.  U.S. Cellular’s wireless systems are designed to facilitate the installation of equipment that will permit microwave interconnection between the mobile telephone switching office and the cell sites.  U.S. Cellular has implemented such microwave interconnection in many of the wireless systems it operates.  In other areas, U.S. Cellular’s systems rely upon wireline telephone connections to link cell sites with the mobile telephone switching office.  Although the installation of microwave network interconnection equipment requires a greater initial capital investment, a microwave network enables a system operator to reduce the current and future charges associated with leasing backhaul capacity from a wireline telephone company. U.S. Cellular is currently transitioning its existing wireline backhaul capacity to a packet-based Ethernet technology from circuit-switched technology. In addition to allowing for increased data capacity, the packet-based backhaul reduces the costs of data transmission.

 

U.S. Cellular believes that currently available technologies and appropriate capital additions will allow sufficient capacity on its networks to meet anticipated demand for voice and data services over the next few years. U.S. Cellular’s continued investment in new licenses will support future demand for fourth generation broadband services using 4G LTE. Increasing demand for high-speed data and video services may require the acquisition of additional licenses or spectrum to provide sufficient capacity in markets where U.S. Cellular currently offers or may offer these services.

 

Construction of wireless systems is capital-intensive, requiring substantial investment for land and improvements, buildings, towers, mobile telephone switching offices, cell site equipment, microwave equipment, engineering and installation.  U.S. Cellular primarily uses its own personnel to engineer each wireless system it owns and operates, and engages contractors to construct the facilities.

 

The costs (inclusive of the costs to acquire licenses) to develop the systems which U.S. Cellular operates have historically been financed primarily through proceeds from debt and equity offerings, with cash generated by operations, and proceeds from the sales of wireless interests.  U.S. Cellular believes that existing cash and investments balances, expected cash flows from operating and investing activities and funds available under its revolving credit facility provide substantial liquidity and financial flexibility for U.S. Cellular to meet its normal financing needs (including working capital, construction and development expenditures) for the foreseeable future. In addition, U.S. Cellular may access public and private capital markets to help meet its financing needs.

 

Competition

 

The wireless telecommunication industry is highly competitive.  U.S. Cellular competes directly with several wireless service providers in each of its markets. In general, there are between three and five competitors in each wireless market in which U.S. Cellular provides service, excluding resellers and mobile virtual network operators. U.S. Cellular generally competes against each of the national wireless companies: Verizon Wireless, AT&T Mobility, Sprint Nextel, and T-Mobile USA.  These competitors have substantially greater financial, technical, marketing, sales, purchasing and distribution resources than U.S. Cellular.  In addition, in certain markets, U.S. Cellular competes against other regional wireless companies, including Leap Wireless International, and resellers of wireless services.  Since U.S. Cellular’s competitors do not disclose their subscriber counts in specific regional service areas, market share for the competitors in each regional market cannot be precisely determined.

 

Since each of these competitors operates on systems using spectrum licensed by the FCC and has comparable technology and facilities, competition among wireless service providers for customers is principally on the basis of types of products and services, price, size of area covered, call quality, network speed and responsiveness of customer service.  U.S. Cellular employs a customer satisfaction strategy throughout its markets that it believes has contributed to its overall success.

 

Wireless service providers continue to use wireless device availability and pricing to gain a competitive advantage since the markets for wireless service are nearly fully saturated.  The wireless device has become more than just a means for communication.  Consumers’ attitudes have shifted, and continue to shift, and a wireless device becomes more important year after year as it expands to become the primary communication link to the world as well as a personal entertainment center and source of information.  U.S. Cellular believes that customer growth will be achieved primarily by capturing customers switching from other wireless carriers, selling additional products and services to its existing customers, and increasing the number of multi-device users among its existing customers.

 

The use of national advertising and promotional programs by the national wireless service providers may be a source of additional competitive and pricing pressures in all U.S. Cellular markets, even if those operators may not provide direct service in a particular market.  In addition, in the current wireless environment, U.S. Cellular’s ability to compete depends on its ability to offer family and national calling plans. U.S. Cellular provides wireless services comparable to the national competitors, but the national wireless companies operate in a wider geographic area and are able to offer no- or low-cost roaming and long-distance calling packages over a wider area on their own networks than U.S. Cellular can offer on its network.  When U.S. Cellular offers the same calling area as one of these competitors, U.S. Cellular incurs roaming charges for calls made in portions of the calling area which are not part of its network, thereby increasing its cost of operations. U.S. Cellular depends on roaming agreements with other wireless carriers to provide voice and data roaming capabilities in areas not covered by U.S. Cellular’s network.

 

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Bundled offerings, in the form of “triple plays” and “quadruple plays” (combination of cable or satellite video service, high-speed internet, wireline service, and wireless service), are common among some of U.S. Cellular’s competitors.  In addition, wireless carriers and others are beginning to roll out new or enhanced technologies to better meet the needs of the “anytime, anywhere” consumer.  Convergence is taking place on many levels, including dual-mode wireless devices that act as wireline or wireless devices depending on location and the incorporation of wireless “hot spot” technology in wireless devices for improved in-building coverage and for making internet access seamless regardless of location.  Although less directly a substitute for other wireless services, wireless data services such as Wi-Fi may be adequate for those who do not need full mobility wide area roaming or full two-way voice services.  Technological advances or regulatory changes in the future may make available other alternatives to wireless service, thereby creating additional sources of competition.

 

U.S. Cellular’s approach in 2013 and in future years will be to focus on the unique needs and attitudes towards wireless service of its selected target segments.  U.S. Cellular will deliver selected, targeted high quality products and services at fair prices and will continue to differentiate itself through the customer experience and service quality. U.S. Cellular’s customer-centric approach, highly reliable network, as evidenced by numerous consumer satisfaction awards based on survey results, and cutting-edge wireless devices all represent examples of how U.S. Cellular believes it is differentiating itself from competitors as it relates to the customer experience. U.S. Cellular’s ability to compete successfully in the future, and to meet necessary growth and return on capital, will depend upon its ability to anticipate and respond to changes related to new service offerings, customer preferences, competitors’ pricing strategies, technology, demographic trends, economic conditions and access to adequate spectrum resources.

 

Business Development Strategy

 

U.S. Cellular’s business development strategy is to obtain interests in and access to 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 grouping its operations into market areas will continue to provide it with certain economies in its capital and operating costs.  U.S. Cellular may continue to make opportunistic acquisitions or exchanges of markets that further strengthen its operating market areas and in other attractive markets. U.S. Cellular also believes that the acquisition of additional licenses within its operating territories will enhance its network capacity to meet its customers’ increased demand for data services. U.S. Cellular seeks to acquire noncontrolling interests in licenses in which it already owns the majority interest and/or operates the license.  From time to time, U.S. Cellular has divested outright or included in exchanges for other wireless interests certain consolidated and investment interests that were considered less essential to its operating strategy.  As part of this strategy, U.S. Cellular from time to time may be engaged in negotiations relating to the acquisition, exchange or disposition of companies, strategic properties or wireless spectrum.  In general, U.S. Cellular may not disclose such transactions until there is a definitive agreement.  In addition, U.S. Cellular may participate as a bidder, or member of a bidding group, in auctions for wireless spectrum administered by the FCC. In general, U.S. Cellular may not disclose any such participation unless it or such bidding group is announced as a winning bidder by the FCC.

 

In addition to the Divestiture Transaction discussed above, U.S. Cellular engaged in the following significant transactions in the last five years.

 

Spectrum Transactions. The following significant license transactions provided U.S. Cellular with additional spectrum to meet anticipated future capacity and coverage requirements in several of its markets.  No cash, customers, network assets, other assets or liabilities were included in these transactions.  In addition to the licenses listed below, U.S. Cellular has acquired a number of other licenses as part of less significant transactions in recent years.

 

2012 700 MHz A-Block . On August 15, 2012, U.S. Cellular completed a license purchase whereby U.S. Cellular received four 700 MHz A-Block spectrum licenses covering portions of Iowa, Kansas, Missouri, Nebraska, and Oklahoma.  On November 20, 2012, U.S. Cellular completed a license purchase whereby U.S. Cellular received seven 700 MHz A-Block spectrum licenses covering portions of Illinois, Michigan, Minnesota, Missouri, Nebraska, Oregon, Washington and Wisconsin.

 

2011 Spectrum Swap. On September 30, 2011, U.S. Cellular completed an exchange whereby U.S. Cellular received eighteen 700 MHz spectrum licenses covering portions of Idaho, Illinois, Indiana, Kansas, Nebraska, Oregon and Washington in exchange for two PCS spectrum licenses covering portions of Illinois and Indiana.

 

FCC Auctions.   As more fully described in the Regulation section below, in 2012, the FCC conducted a single round, sealed bid, reverse auction to award Mobility Fund Phase I support to bidders that commit to provide wireless service in areas designated as unserved by the FCC.  U.S. Cellular and several of its subsidiaries were winning bidders in eligible areas within 10 states.

 

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From time to time, the FCC conducts auctions through which additional spectrum is made available for the provision of wireless services.  U.S. Cellular has participated in certain prior FCC auctions indirectly through its limited partnership interests.  Each entity qualified as a “designated entity” and thereby was eligible for bidding credits with respect to most licenses purchased in accordance with the rules defined by the FCC for each auction.  In most cases, the bidding credits resulted in a 25% discount from the gross winning bid.

 

The FCC’s Auction 73 for spectrum in the 700 MHz band closed on March 20, 2008.  U.S. Cellular participated in Auction 73 indirectly through its limited partnership interest in King Street Wireless L.P. (“King Street Wireless”).  King Street Wireless was the successful winning bidder of 152 licenses in Auction 73. These licenses were granted by the FCC in December 2009.

 

Regulation

 

Regulatory Environment.   U.S. Cellular’s operations are subject to FCC and state regulation.  The wireless licenses that are held by U.S. Cellular and by the designated entities in which U.S. Cellular owns a non-controlling interest are granted by the FCC for the use of radio frequencies and are an important component of the overall value of U.S. Cellular’s consolidated assets.  The construction, operation and transfer of wireless systems in the United States are regulated to varying degrees by the FCC pursuant to the Communications Act of 1934 (“Communications Act”).  In 1996, Congress enacted the Telecommunications Act of 1996 (“Telecommunications Act”), which amended the Communications Act.  The Telecommunications Act mandated significant changes in telecommunications rules and policies to promote competition, ensure the availability of telecommunications services to all parts of the United States and streamline regulation of the telecommunications industry to remove regulatory burdens, as competition developed.  The FCC has promulgated regulations governing construction and operation of wireless systems, licensing (including renewal of licenses) and technical standards for the provision of wireless services under the Communications Act, and has implemented the legislative objectives of the Telecommunications Act, as discussed below.

 

Licensing—Wireless Service. Wireless licenses are granted by the FCC based on various geographic areas. The completion of acquisitions, involving the transfer of control of all or a portion of a wireless system, requires prior FCC approval.  The FCC determines on a case-by-case basis whether an acquisition of wireless licenses is in the public interest.

 

The Communications Act also requires the FCC to award new licenses for most commercial wireless services through a competitive bidding process in which spectrum is awarded to bidders in an auction.  From time to time, the FCC conducts auctions through which additional spectrum is made available for the provision of wireless services.  U.S. Cellular has participated in such auctions in the past and is likely to participate in any other auctions conducted by the FCC in the future as an applicant or as a non-controlling partner in another auction applicant. FCC anti-collusion rules place certain restrictions on business communications and disclosures by participants in an FCC auction.

 

Licensing—Facilities.   The FCC must be notified each time an additional cell site for a cellular system is constructed which enlarges the service area of a given cellular system.  U.S. Cellular believes that its facilities are in compliance with these requirements.

 

Licensing—Commercial Mobile Radio Service.   Pursuant to the 1993 amendments to the Communications Act, cellular, personal communications, advanced wireless, and 700 MHz services are classified as commercial mobile radio service in that they are services offered to the public for a fee and are interconnected to the public switched telephone network.  The FCC has determined that it will not require carriers providing such services to comply with a number of statutory provisions otherwise applicable to common carriers, such as the filing of tariffs.  All commercial mobile radio service wireless licensees must satisfy specified coverage requirements.  Licensees which fail to meet the coverage requirements may be subject to forfeiture of their licenses.

 

Wireless licenses are generally granted for a ten year term or, in some cases, for fifteen years.  The FCC has established standards for conducting comparative renewal proceedings between a wireless licensee seeking renewal of its license and challengers filing competing applications.  All of U.S. Cellular’s licenses for which it applied for renewal between 1995 and 2012 have been renewed. In 2010, the FCC released a Notice of Proposed Rulemaking (“NPRM”) regarding wireless services renewal proceedings.  Pursuant to the NPRM, the FCC would abolish comparative renewal proceedings, but establish criteria by which it would determine whether a wireless licensee was entitled to license renewal.  The proposed changes have been opposed by most wireless carriers, including U.S. Cellular.  It is, however, likely that the FCC will take some action to modify the license renewal process.  U.S. Cellular expects to meet the current criteria of any license renewal process.

 

U.S. Cellular conducts and plans to conduct its operations in accordance with all relevant FCC rules and regulations and anticipates being able to qualify for renewal expectancy in its upcoming renewal filings whatever renewal criteria are applied.  Accordingly, U.S. Cellular expects to be able to renew its licenses under current regulations.  However, changes in the regulation of wireless operators or their activities and of other mobile service providers or changes in the FCC’s renewal requirements could have a material adverse effect on U.S. Cellular’s operations.

 

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E-911 .  The FCC has imposed E-911 regulations on wireless carriers.  The rules require wireless carriers to provide different levels of detailed location information about E-911 callers depending on the capabilities of the local emergency call center.  U.S. Cellular is in compliance with the FCC’s requirements regarding E-911.

 

Hearing Aid Compatibility.  The FCC has imposed Hearing Aid Compatibility requirements on wireless carriers.  These rules mandate that carriers offer to customers a certain number or percentage of handsets which are compatible with different types of hearing aids.  The rules also require certain types of marketing and labeling practices in relation to such handsets, as well as certain disclosures on wireless carrier websites.  There are also annual carrier reporting requirements regarding Hearing Aid Compatibility.  U.S. Cellular is in compliance with the FCC’s Hearing Aid Compatibility requirements.

 

Telecommunications Act—General.   The primary purpose of the Telecommunications Act is to open all telecommunications markets to competition.  The Telecommunications Act makes most direct or indirect state and local barriers to competition unlawful.  It directs the FCC to preempt all inconsistent state and local laws and regulations, after notice and comment proceedings.  It also enables electric and other utilities to engage in telecommunications service through qualifying subsidiaries.

 

Only narrow powers over wireless carriers are left to state and local authorities.  Each state retains the power to impose competitively neutral requirements that are consistent with the Telecommunications Act’s universal service provisions and necessary for universal services, public safety and welfare, continued service quality and consumer rights.  While a state may not impose requirements that effectively function as barriers to entry, it retains limited authority to regulate certain competitive practices in rural telephone company service areas.

 

The Telecommunications Act authorizes and directs the FCC to establish an explicit universal service fund, to preserve and advance universal access to telecommunications services in rural and high-cost areas of the country, to ensure that low-income consumers have access, and to promote access for schools, libraries and health care providers. The Telecommunications Act requires all interstate telecommunications providers, including wireless service providers, to “make an equitable and non-discriminatory contribution” to support the cost of providing universal service, unless their contribution would be de minimis. At present, the provision of wireline and wireless telephone service in high cost areas is subsidized by support from the Universal Service Fund (“USF”) to which all carriers with interstate and international revenues must contribute.  Carriers are free to pass on the cost of such contributions to their customers.  In 2012, U.S. Cellular contributed $112 million into the federal USF and passed on the cost of such contributions to its customers.

 

Wireless carriers may be designated by states, or in some cases by the FCC, as eligible to receive universal service support payments if they provide specified services in “high cost” areas.  In 2012, U.S. Cellular received approximately $140.8 million in high cost support for service to high cost areas in the states of Illinois, Iowa, Kansas, Maine, Missouri, Nebraska, New Hampshire, New York, North Carolina, Oklahoma, Oregon, Tennessee, Virginia, Washington, Wisconsin and West Virginia.  This high cost support is undergoing change, as set forth below.

 

National Broadband Plan.  In 2009, Congress directed the FCC to develop a National Broadband Plan (the “Plan”) to ensure every American has “access to broadband capability.”  In March 2010, the FCC released the Plan which describes the FCC’s goals in enhancing broadband availability and the methods for achieving those goals over the next decade. Among the recommendations in the Plan which are significant to wireless providers are a series of proposals to make up to 500 MHz of spectrum newly available for broadband wireless uses by 2020, with a benchmark of making 300 MHz available by 2015, to reserve additional spectrum for unlicensed wireless use and to make more spectrum available for opportunistic and secondary uses. The Plan also made recommendations for transitioning the USF from supporting voice networks to broadband networks over time.

 

FCC’s USF and ICC Reform Order .  Pursuant to the Plan and subsequent notices of proposed rulemaking, on November 18, 2011, the FCC released a Report and Order and Further Notice of Proposed Rulemaking (“Reform Order”) adopting reforms of its universal service and intercarrier compensation mechanisms, and proposing further rules to advance reform.  The Reform Order substantially revises the current USF high cost program and intercarrier compensation regime.  The current USF program, which supports voice services, began to be phased out in 2012. As a replacement, the FCC is adopting the Connect America Fund (“CAF”), a new Mobility Fund, and a Remote Area Fund, which will collectively support broadband-capable networks.  Mobile wireless carriers such as U.S. Cellular may be eligible to receive funding under each of these funds under certain circumstances.

 

The FCC has determined that both wireline and wireless facilities should be supported with one wireline carrier and one mobile carrier receiving support in each area.  The Mobility Fund will be implemented in two phases.  The Phase I Mobility Fund which was implemented in 2012 is designed to provide one-time funding through a reverse auction to fill in coverage in “dead zones” that currently lack 3G wireless service.  In Phase I, $300 million was allocated throughout the country and an additional $50 million was set aside for tribal lands through the reverse auction described below.  The Phase II Mobility Fund will have a budget of up to $500 million per year (up to $100 million of which is reserved for tribal lands), with the method of disbursement to be determined in a further NPRM.  Phase II funding will be provided to areas that lack 4G wireless service.  The CAF will support service to homes, businesses, and anchor institutions, using any technology that can meet the technical requirements.

 

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On September 27, 2012, the FCC conducted a single round, sealed bid, reverse auction to award up to $300 million in one-time Mobility Fund Phase I support to successful bidders that commit to provide 3G, or better, wireless service in areas designated as unserved by the FCC.  This auction was designated by the FCC as Auction 901. U.S. Cellular and several of its wholly-owned subsidiaries participated in Auction 901 and were winning bidders in eligible areas within 10 states and will receive up to $40.1 million in one-time support from the Mobility Fund.  As part of the auction rules, winning bidders must complete network build-out projects to provide 3G or 4G service to these areas within two or three years, respectively, and must also make their networks available to other providers for roaming.  Winning bidders will receive support funding primarily upon achievement of coverage milestones defined in the auction rules. As a result of the funding awards in the Phase I Mobility Fund, U.S. Cellular will be required to meet certain regulatory conditions in the areas where it will receive funding to provide service.  Examples of these regulatory conditions include: allowing other carriers to collocate on U.S. Cellular’s towers, allowing voice and data roaming on U.S. Cellular’s network, and submitting various reports and certifications to retain eligibility each year.  It is possible that additional regulatory requirements will be imposed pursuant to the FCC’s Reform Order.

 

The terms and rules for participating in the CAF as a wireless eligible telecommunications carrier (“ETC”) have not been developed yet by the FCC.  It is uncertain whether U.S. Cellular will obtain support through the CAF or Phase II of the Mobility Fund.  If U.S. Cellular is successful in obtaining support, it will be required to meet certain regulatory conditions to obtain and retain the right to receive support including, for example, allowing other carriers to collocate on U.S. Cellular’s towers, allowing voice and data roaming on U.S. Cellular’s network, and submitting various reports and certifications to retain eligibility each year.  It is possible that additional regulatory requirements will be imposed pursuant to the FCC’s Reform Order.

 

U.S. Cellular’s current ETC support is scheduled to be phased down.  Support for 2012 (excluding certain adjustments) was frozen on January 1, 2012 using support for 2011 as a baseline and was reduced by 20% starting in July 2012.  The reduction in USF support that U.S. Cellular otherwise would have received in 2012 was approximately $16 million.  Support will be further reduced by 20% in July of each subsequent year; however, if the Phase II Mobility Fund is not operational by July 2014, the phase down will halt at that time and U.S. Cellular will receive 60% of its baseline support until the Phase II Mobility Fund is operational.

 

With respect to intercarrier compensation, the Reform Order provides for a reduction in the charges that U.S. Cellular pays to wireline phone companies to transport and terminate calls that originate on U.S. Cellular’s network, which will reduce U.S. Cellular’s operating expenses.  The reductions in intercarrier charges are to increase over the next five to ten years, further reducing U.S. Cellular’s operating expenses.

 

The FCC’s Reform Order, and any subsequent orders it adopts to reform universal service and intercarrier compensation, are subject to judicial review.  Multiple appeals and petitions for reconsideration have been filed with respect to the FCC Reform Order, but it has not been stayed.  At this time, U.S. Cellular cannot predict the timing or outcome of any such appeals or petitions, or whether such appeals or petitions would result in a material adverse effect on U.S. Cellular’s business, financial condition or results of operations.

 

U.S. Cellular also cannot predict the net effect of the FCC’s changes to the USF high cost support program in the Reform Order or whether reductions in support will be fully offset with additional support from the CAF or the Mobility Fund.  Accordingly, U.S. Cellular cannot predict whether such changes will have a material adverse effect on U.S. Cellular’s business, financial condition or results of operations.

 

Incremental Charges. In October 2010, the FCC released an NPRM proposing that wireless carriers be required, among other things, to alert customers when they approach and reach usage limits for voice and data services which, if exceeded, would result in extra charges beyond the customer’s rate plan.  In October 2011, a number of carriers, including U.S. Cellular, entered into voluntary commitments to minimize unexpected incremental charges on customers’ bills, precluding the need for the FCC to adopt rules proposed in its NPRM.  Although U.S. Cellular already offers certain consumer protections, such as its Overage Cap and Overage Protection services, U.S. Cellular will incur additional regulatory obligations as a result of the voluntary commitments; however, such burdens are not expected to have a material effect on U.S. Cellular’s operations.

 

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Net Neutrality. In 2009, the FCC initiated a rulemaking proceeding designed to codify its existing “Net Neutrality” principles and impose new requirements that could have the effect of restricting the ability of wireless internet service providers to manage applications and content that traverse their networks.  In December 2010, after a lengthy proceeding which considered different approaches including the “reclassification” of internet access as “common carrier” service under Title II of the Communications Act, the FCC adopted a net neutrality rule based on its Title I “ancillary” authority to enforce different parts of the Communications Act. The rule requires all providers of broadband internet access, including both fixed (that is, telephone and cable) and wireless providers, to publicly disclose accurate information regarding their network management practices, performance and commercial terms sufficient for consumers to make informed choices regarding the use of such services. The rule also prohibits all internet providers from blocking consumers’ access to lawful websites, subject to reasonable network management, and from blocking applications that compete with the provider’s voice or video telephony services, also subject to reasonable network management. The rule subjects the providers of fixed but not wireless broadband internet access to a prohibition on “unreasonable discrimination” in transmitting internet traffic over their networks, also subject to reasonable network management. The exemption of wireless providers from this part of the rule reflects recognition of the capacity constraints and other “special conditions” under which mobile broadband service is offered and the competitive nature of evolving wireless networks. Thus, the FCC at this time considered it appropriate to take only the “measured steps” with respect to mobile broadband service reflected in the rule. The Reform Order is generally controversial and has been challenged in the courts.  U.S. Cellular cannot predict the outcome of such cases.

 

Data Roaming.   In 2007, the FCC adopted a rule requiring that wireless carriers offer “voice” roaming agreements to each other on a just, reasonable and non-discriminatory basis.  The FCC stated that this was a common carrier obligation under Title II of the Communications Act.  In 2011, the FCC broadened this obligation to require carriers to offer wireless “data” roaming agreements to each other.  However, because this obligation involved the use of the Internet, it could not be a “common carrier” obligation.  Thus, the FCC grounded the obligation in Title III of the Communications Act, under which the FCC regulates use of the radio spectrum.  This order was challenged in the U.S. Court of Appeals for the District of Columbia Circuit on the grounds that it constituted an unlawful common carrier regulation.  However, in December 2012, the court upheld the FCC’s ruling.  U.S. Cellular was an intervenor in the case in support of the FCC and believes that the FCC and court rulings will be beneficial to it and similarly situated wireless carriers.

 

CVAA.   In 2010, Congress enacted the Twenty-First Century Communications and Video Accessibility Act (“CVAA”), to ensure that people with disabilities have access to “advanced communications services” (“ACS”).  The CVAA is currently the subject of two FCC rulemakings.  The first deals with access to ACS generally and specifically with access to mobile “browsers” by persons who are blind or who have visual impairments. The second deals with the closed captioning obligations of wireless manufacturers and wireless providers.  There are also recordkeeping and reporting requirements, which come into effect in March and April of 2013, respectively.

 

As of October 1, 2013, a mobile phone manufacturer that includes a browser in its device or a mobile phone provider such as U.S. Cellular that sells a mobile phone which includes such a browser must ensure that the browser functions are accessible to and usable by individuals who are blind or who have a visual impairment, unless doing so is not achievable.

 

As of January 1, 2014, wireless carriers will be required to deliver all programming received from a video programming owner or other origination source containing closed captioning with the original closed captioning data intact, unless such programming is recaptioned or the captions are reformatted by the programming distributor.

 

U.S. Cellular is working with its trade association, with standards setting organizations and with its vendors to comply with these requirements.

 

Spectrum Holdings. In September 2012, the FCC adopted an NPRM which proposed a review of its policies regarding mobile spectrum holdings in the context of both auctions and secondary market transactions.  Comments and reply comments were filed in November 2012 and January 2013.  In the proceeding, the FCC sought and received comment on whether it should retain or modify the current case by case analysis used to evaluate mobile spectrum holdings, or adopt “bright line” limits on the amount of wireless spectrum which may be held by any carrier.

 

The FCC also is considering updating the spectrum bands included in the evaluation of mobile spectrum holdings and whether to make distinctions between different bands in evaluating spectrum holdings.  The FCC also is re-examining its determinations of geographic and product markets in the context of evaluating wireless transactions.  It also is reviewing its spectrum “attribution” rules and remedies if a proposed transaction does not comply with its rules or policies.

 

U.S. Cellular cannot predict what, if any, changes the FCC will make to the foregoing rules, but intends to comply with all applicable requirements.

 

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State and Local Regulation.   U.S. Cellular is subject to state and local regulation in some instances. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure.  In 1993, Congress preempted states from regulating the entry of wireless systems into service and the rates charged by wireless systems to customers.  The siting and construction of wireless facilities, including transmitter towers, antennas and equipment shelters are still subject to state or local zoning and land use regulations.  However, in 1996, Congress amended the Communications Act to provide that states could not discriminate against wireless carriers in tower zoning proceedings and had to decide on zoning requests with reasonable speed.  In addition, states may still regulate other terms and conditions of wireless service.

 

In 2000, the FCC ruled that the preemption provisions of the Communications Act do not preclude the states from acting under state tort, contract, and consumer protection laws to regulate the practices of commercial mobile radio service carriers, even if such activities might have an incidental effect on wireless rates.  This ruling has led to more state regulation of commercial mobile radio service carriers, particularly from the standpoint of consumer protection.  U.S. Cellular intends to comply with state regulation and to seek reasonable regulation of its activities in this regard.

 

The FCC is required to forbear from applying any statutory or regulatory provision that is not necessary to keep telecommunications rates and terms reasonable or to protect consumers.  A state may not apply a statutory or regulatory provision that the FCC decides to forbear from applying.  In addition, the FCC must review its telecommunications regulations every two years and change any that are no longer necessary.  Further, the FCC is empowered under certain circumstances to preempt state regulatory authorities if a state is obstructing the Communications Act’s basic purposes.

 

U.S. Cellular and its subsidiaries have been and intend to remain active participants in proceedings before the FCC and state regulatory authorities.  Proceedings with respect to the foregoing policy issues before the FCC and state regulatory authorities could have a significant impact on the competitive market structure among wireless providers and the relationships between wireless providers and other carriers.  U.S. Cellular is unable to predict the scope, pace or financial impact of policy changes which could be adopted in these proceedings.

 

Radio Frequency Emissions.   The FCC has adopted rules specifying standards and the methods to be used in evaluating radio frequency emissions from radio equipment, including network equipment and wireless devices used in connection with commercial mobile radio service.  These rules were upheld on appeal by the U.S. Court of Appeals for the Second Circuit in 2000. The U.S. Supreme Court declined to review the Second Circuit’s ruling. U.S. Cellular’s network facilities and the wireless devices it sells to customers comply with these standards.  In August 2012, the Government Accountability Office issued a report which recommended that the FCC reassess its current radio frequency emission limits.  In October 2012, in guidance released by the FCC Office of Engineering and Technology, it was stated that that the FCC intends to initiate a rulemaking proceeding dealing, in part, with radio frequency emissions from mobile devices. The FCC could adopt amended radio frequency emission limits and/or testing procedures for mobile devices in such a rulemaking proceeding, following review of comments filed by affected parties and members of the public.

 

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TDS Telecom Operations

 

General

 

TDS Telecom is a holding company that provides diversified telecommunications services (voice, broadband, network access and video services) and hosted and managed services. TDS Telecom’s wireline subsidiaries provide high-quality telecommunications services to commercial and residential customers primarily in rural and suburban communities.  As of December 31, 2012, TDS Telecom operates 115 incumbent local exchange carriers (“ILEC”) in 28 states and provides telecommunications services as a competitive local exchange carrier (“CLEC”) in Illinois, Michigan, Minnesota, and Wisconsin. TDS Telecom also operates TDS Hosted & Managed Services, LLC (“TDS HMS”) which specializes in planning, engineering, procurement, installation, sales and management of Information Technology (“IT”) infrastructure, including: hosted application management, managed hosting, and ReliaCloud™ enterprise cloud services. TDS HMS operates data centers in Arizona, Iowa, Minnesota and Wisconsin.

 

Wireline Operations

 

TDS Telecom operates in a mix of rural, small town and suburban ILEC markets and urban CLEC markets, with the largest concentrations of its customers in the Upper Midwest and the Southeast.  TDS Telecom provides retail telecommunications services to both residential and commercial customers that reside within its respective service territories.  TDS Telecom also provides services to wholesale customers, who are primarily interexchange carriers (companies that provide long-distance telephone and data services between local exchange areas) that compensate TDS Telecom for the use of its facilities to originate and terminate their voice and data transmissions. The table below provides information about the wireline customer connections served by TDS Telecom as of December 31, 2012.

 

		TDS Telecom
		Customer Connections as of December 31, 2012 (1)
State		Residential		Commercial		Total		Percent of Total
Wisconsin		148,200		138,400		286,600		29	%
Tennessee		84,600		21,100		105,700		11	%
Michigan		30,800		67,400		98,200		10	%
Minnesota		29,200		53,100		82,300		8	%
Georgia		47,900		9,800		57,700		6	%
New Hampshire		33,100		7,800		40,900		4	%
Indiana		30,800		5,900		36,700		4	%
Alabama		22,300		4,800		27,100		3	%
Maine		22,100		4,400		26,500		3	%
Oklahoma		19,500		3,800		23,300		2	%
Total for 10 Largest States		468,500		316,500		785,000		80	%
Other States		144,000		50,900		194,900		20	%
Total		612,500		367,400		979,900		100	%

 

(1)  “Customer connections” are the sum of physical access lines and high-capacity data circuits via various technologies including DSL and dedicated internet, plus the number of telephone handsets, data lines and Internet Protocol (“IP”) trunks providing communications using IP networking technology.  A physical access line is the individual circuit connecting a customer to a telephone company’s central office facilities.

 

Wireline Products, Services and Revenue Sources

 

TDS Telecom’s ILECs and CLECs generate revenues by providing the following products and services to commercial and residential customers and carriers:

 

·                   Voice services, including basic local and long-distance telephone service, Voice over Internet Protocol (“VoIP”) and enhanced local services like voice mail, caller ID and call forwarding;

 

·                   Broadband services, including Digital Subscriber Line (“DSL”), other forms of high-speed internet and other enhanced data services;

 

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·                   Network access services to interexchange carriers for the origination and termination of interstate and intrastate long distance phone calls on TDS Telecom’s network and special access services to carriers and others; and

 

·                   Internet Protocol television (“IPTV”) and satellite video.

 

The following table summarizes TDS Telecom’s ILEC and CLEC Operating revenue by category:

 

For Year Ended December 31, 2012
(Dollars in thousands)		ILEC			%		CLEC			%		Total			%
Residential		$	279,400		37	%	$	17,192		2	%	$	296,592		39	%
Commercial		97,382			13	%	138,637			19	%	236,019			32	%
Wholesale		201,630			27	%	17,568			2	%	219,198			29	%
Total Operating Revenue		$	578,412		77	%	$	173,397		23	%	$	751,809		100	%

 

Residential .  TDS Telecom’s residential customer operations provide diversified telecommunications services, including wireline local and long-distance telephone service, high-speed data products and video services.  Video services are offered through either TDS Telecom’s own IPTV offering or through a resale agreement with a satellite provider.  TDS Telecom provides long-distance service by reselling long-distance service in its markets and through connections with long-distance carriers which purchase network access from the TDS Telecom ILECs.  Residential customer operations account for 63% of TDS Telecom’s combined ILEC and CLEC connections and 39% of total combined ILEC and CLEC revenue.  As of December 31, 2012, approximately 85% of TDS Telecom’s ILEC residential customers are located in rural and small town areas, while the other 15% are located in more suburban markets.

 

TDS Telecom’s CLEC residential customer strategy is to provide continuing service to its current residential customer base with high quality customer service and competitive pricing, but not to seek any new residential customers due to their high acquisition costs and due to regulatory changes which have increased network cost and limited network availability.  Therefore, it is expected that the number of residential customers within TDS Telecom’s CLEC markets will continue to decline.  There are 32,800 residential connections remaining at December 31, 2012.

 

Commercial.   TDS Telecom’s commercial customer operations provide high-quality voice and data solutions including local and long-distance telephone service, broadband, IP based services, and other services to businesses ranging in size from primarily small businesses up to large corporations.  TDS Telecom provides these commercial customers with secure and reliable internet access, data connections and advanced voice service with innovative VoIP features.  TDS Telecom addresses customer needs for increased communications capabilities at reduced costs by matching these needs to new and existing technologies to create greater efficiencies and by providing support for these technologies after the sale.  The TDS Telecom flagship product is managedIP, a fully-hosted, software and hardware solution that provides customers with a secure internet connection and the latest VoIP features and capabilities.  TDS managedIP is available in all CLEC markets and to selected ILEC markets covering 83% of ILEC commercial customers at December 31, 2012.

 

TDS Telecom’s telecommunications services for commercial customers are focused on small to medium-sized customers.  Medium-sized commercial prospects are characterized by above average access line to employee ratios, heavier utilization of broadband services and a focus on using telecommunications for business improvement.  An emphasis on product development has led to the introduction of several integrated voice and data solutions, as well as the creation of small business bundled products.  These bundled products make buying voice and broadband services easier and increase the value of these products to targeted business customers.  Offering bundled voice and broadband solutions provisioned on a single access line provides for direct cost savings to the customer, removes distance limitations commonly associated with high speed data technology, and gives the customer greater flexibility to grow business telecommunications use.

 

Additional products, services and applications are also available to new and existing commercial accounts.  Expanded offerings for the commercial sector include IP-enabled telephone systems and traditional telephone systems.  Combining service offerings with Customer Premise Equipment (“CPE”) is intended to drive greater revenue per customer while promoting a “One Vendor” telecommunications provider experience for CPE, voice and broadband services. IP and managed services product sets offered include firewall services, Internet intrusion protection services, and universal resource locater (“URL”) filtering. All of these provide commercial customers with additional services, controls and network protection.

 

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Wholesale.   TDS Telecom continues to provide a high level of service to traditional interexchange carriers. TDS Telecom’s wholesale market focus is on access revenues, which is the compensation received for carrying long distance and data traffic on its networks .  Universal Service Fund (“USF”) revenues, which support the cost of providing telecommunication services in high cost areas, are also included in wholesale service revenues.  Recent and proposed regulatory changes may affect the amounts of TDS Telecom’s future wholesale revenues.  On November 18, 2011, the FCC released the Reform Order adopting reforms of its universal service and intercarrier compensation mechanisms, establishing a new, broadband-focused support mechanism, and proposing further rules to advance reform.  See “Regulation” below.

 

Wireline Strategy

 

TDS Telecom seeks to be the preferred telecommunications solutions provider for both residential and commercial customers by developing and delivering high-quality products that meet or exceed customers’ needs and to outperform the competition by maintaining superior customer service. TDS Telecom’s residential customer strategy is to provide voice, high-speed data, and video services through value-added bundling of products.  The commercial focus is to provide advanced IP-based voice and data services, as well as information technology solutions.  TDS Telecom is actively investing in the continuing transformation of its networks as it works to deploy advanced technologies and new services. TDS Telecom seeks to capitalize on its strong local presence and strives to champion economic development in its communities by actively advocating for state and federal regulatory frameworks that would enable its operations to grow profitably and continue to meet customer expectations for new and improved services.

 

TDS Telecom’s professional field service representatives both live and work in many of the communities they serve.  To better meet the changing needs of its customers, TDS Telecom utilizes specialized customer service teams to more effectively and efficiently serve the individual needs of its retail customer segment.

 

TDS Telecom believes that its residential and business customers have a strong preference to purchase complementary telecommunications services from a single provider.  TDS Telecom has found that by offering and bundling services in customer-friendly packages, it can build customer loyalty and reduce customer churn.  TDS Telecom offers bundles which include local telephone services, high-speed data services, long-distance services and video services.

 

TDS Telecom’s objective is to be the preferred broadband provider in its ILEC residential markets by offering a wide range of premium internet services.  It continues to invest in high-speed data service and as of December 31, 2012, was able to provide this service to 95% of its ILEC physical access lines.  At that date, 58% of the households passed in its ILEC markets had 10 megabits per second or faster service available.  In selected markets, TDS Telecom’s marketing and promotional strategies will lead with superior quality IPTV video.  This interactive video offering is intended to counter intensifying competition for video service and retain the video component of the double and triple play customer bundles.

 

TDS Telecom has continued to expand its presence in the business broadband market with hosted-managedIP telephony, high-speed symmetrical dedicated broadband and point-to-point Ethernet services.  TDS managedIP delivers business customers a converged voice and data communications solution to the desktop.  Point-to-point Ethernet provides customers secure and reliable high-speed data links for two or more locations over TDS Telecom’s internal network, not the public Internet.  The long-term strategy includes leveraging products such as managedIP and hosted and managed services to all of TDS Telecom’s commercial customers, differentiating both on service excellence and a superior product portfolio.

 

TDS Telecom focuses its marketing on information-intensive industries such as financial services, health services, real estate, hotels and motels, retail, education and government.  TDS Telecom uses its direct sales force, targeted mailings, and telemarketing to sell products and services to commercial markets, which are segmented into tiers based on size (in terms of connections and revenues) and strategic importance.  Different sales and distribution channels are used to target each segment.

 

TDS Telecom has continued to grow its long-distance product line and is the number one long-distance provider for its local service customers in its ILEC territories.  Seventy-seven percent of TDS’ ILEC physical access lines have a TDS long-distance product at December 31, 2012.

 

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The following table summarizes additional information regarding TDS Telecom’s ILEC and CLEC customers for December 31, 2012.

 

Year Ended December 31, 2012		ILEC		CLEC		Total
Residential connections
Physical access lines (1)		350,100		24,600		374,700
Broadband connections (2)		221,700		8,200		229,900
IPTV customers		7,900		—		7,900
Residential connections		579,700		32,800		612,500
Commercial Connections
Physical access lines (1)		107,600		135,500		243,100
Broadband connections (2)		18,500		11,200		29,700
managedIP connections (3)		17,200		77,400		94,600
Commercial connections		143,300		224,100		367,400
Total Customer Connections		723,000		256,900		979,900

 

(1)          Individual circuits connecting customers to TDS Telecom’s central office facilities.

 

(2)          The number of customers provided high-capacity data circuits via various technologies, including DSL and dedicated internet circuit technologies.

 

(3)          The number of telephone handsets, data lines and IP trunks providing communications using IP networking technology.

 

Wireline Network Architecture and Technology

 

TDS Telecom operates an integrated, highly-reliable network that consists of central office hosts and remote sites, primarily equipped with digital and IP switches.  Fiber optic and copper cable connect the host central offices with remote switches and ultimately with end customers.  TDS Telecom continues to upgrade and expand its telecommunications network to respond to the needs of its customers for greater bandwidth and advanced technologies. The network is transitioning from its legacy circuit-switched network to a highly reliable IP-based broadband network to facilitate the integration of voice services, the Internet, and media.

 

TDS Telecom has developed and deployed an inter-regional data routing infrastructure using leased fiber capacity which allows TDS Telecom to reach over 85% of its physical access lines with its 10 GHz core network.  This configuration along with the continued development of a ubiquitous IP network that interconnects substantially all the existing service territories will allow for next generation IP service offerings; namely, IPTV, managedIP, residential VoIP and least-cost routing as well as comprehensive IP policy management.

 

TDS Telecom has pursued a plan to deploy passive optical network technology, which enables significantly greater broadband speeds to selected residential subdivisions and to commercial customers, when the investment is economically justified.

 

TDS Telecom is also standardizing equipment and processes to increase efficiency in maintaining its network.  For example, TDS Telecom utilizes centralized monitoring and management of its network to reduce costs and improve service reliability.  Network standardization has supported TDS Telecom in operating its 24-hours-a-day / 7-days-per-week Network Management Center, which continuously monitors the network in an effort to proactively identify and correct network faults prior to any customer impact.

 

Rapid and significant changes in technology are expected to continue to occur in the communications industry.  TDS Telecom’s success will depend, in part, on its ability to anticipate and adapt to technological changes.  TDS Telecom believes that its existing network architecture will enable it to respond to these technological changes efficiently.  In addition, TDS Telecom anticipates reducing costs through the sharing of best practices across operations, centralization or standardization of functions and processes, and deployment of technologies and systems that provide for greater efficiencies and profitability.

 

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Wireline Competition

 

The competitive environment in the telecommunications industry has changed significantly as a result of technological advances, changing customer requirements and changes to regulation.  TDS Telecom continues to seek to develop and maintain an efficient cost structure to ensure that it can match price-based initiatives from competitors.  TDS Telecom is faced with significant challenges, including competition from cable VoIP, wireless and other wireline providers, decreases in intercarrier compensation received for the use of TDS Telecom’s networks and increases in the cost for TDS Telecom’s use of other providers’ networks.  These challenges could have a material adverse effect on the financial condition, results of operations and cash flows of TDS Telecom.

 

TDS Telecom has experienced physical access line losses and access minute declines due to competition from cable providers offering voice (“VoIP”) and data services via cable modems, from wireless carriers offering local and nationwide voice and data plans, and from other VoIP providers.

 

Cable companies have developed technological improvements that have allowed them to extend their competitive operations beyond major markets and have enabled them to provide a broader range of voice and data services over their cable networks.  Several national cable companies have aggressively pursued the bundling of voice communications, data and video at discounted prices to attract customers from traditional telephone companies.  In addition, cable companies have added value to their internet offerings by increasing speeds at no cost to the customer.  TDS Telecom estimates that 69% of its ILEC access lines face active competition from cable providers at December 31, 2012.  Due to the rural nature of TDS Telecom’s ILEC access lines, 31% of access lines are not subject to cable competition.  Cable companies are increasingly targeting not only residential customers, but commercial customers as well.

 

Wireless telephone service providers offering feature-rich wireless devices and improved network quality constitute a significant source of competition.  Some customers have chosen to completely forego use of traditional wireline telephone service and instead rely solely on wireless service for voice communications services.  This trend is more pronounced among residential customers, which comprise approximately 63% of TDS Telecom’s customer connections as of December 31, 2012. Some small businesses may follow the residential path by choosing wireless service and disconnecting wireline service.  Increasing penetration of wireless broadband services has led to substitution for long-distance calling, which impacts both TDS Telecom’s retail and access revenue.

 

VoIP technology also has improved and has led cable, internet and other communications companies to substantially increase their offerings of VoIP service to commercial and residential customers.  VoIP providers route calls partially or wholly over the Internet, without the use of ILEC circuit switches and, in the case of cable operators and CLECs, without the use of ILEC networks to carry their communications traffic.  VoIP providers frequently use existing internet networks to deliver flat-rate, all-distance calling plans that may also offer features that cannot readily be provided by traditional ILECs.  These plans may also be priced below the prices currently charged for traditional ILEC local and long-distance telephone services.

 

While TDS Telecom positions itself as a high-quality telecommunications provider, it is experiencing competition from Regional Bell Operating Companies (“RBOCs”) (in areas where TDS Telecom competes as a CLEC), other CLECs, cable providers, wireless carriers, and VoIP providers as it seeks to gain and retain customers.  In addition, the RBOCs are continuing to implement technological changes that could impede TDS Telecom’s access to facilities used to provide CLEC telecommunications services.

 

TDS Telecom’s CLEC operations compete with RBOCs on the basis of price, reliability, state-of-the-art technology, product and service offerings, route diversity, ease of ordering, and customer service, including responsiveness to customer needs.  RBOCs have long-standing relationships with their customers and are well-established in their respective markets.  RBOCs are offering increased pricing flexibility for their services and have implemented long-term customer contracts with high cancellation penalties for retention purposes.  RBOCs continue to pursue aggressive “Win back” programs that have been effective in regaining lines lost to CLECs.  TDS Telecom believes that, in general, its CLEC operations provide more attention and responsiveness to customers than RBOCs provide to similar-sized customers in TDS Telecom’s CLEC markets.

 

Wireline Business Development Strategy

 

In the last five years, TDS Telecom has acquired four ILECs for an aggregate consideration of $71 million.  As of the dates they were purchased these companies served a total of 26,600 customer connections.

 

On February 25, 2013, TDS entered into an Asset Purchase Agreement with Baja Broadband, LLC (“Baja”) to acquire substantially all of the assets of Baja for $267.5 million in cash, subject to a working capital adjustment.  Baja is a cable company that passes approximately 212,000 households in markets in Colorado, New Mexico, Texas, and Utah and offers video, broadband and voice services.  The transaction is subject to governmental regulatory approvals, compliance with the Hart-Scott-Rodino Act and other conditions.  Subject to approvals, the transaction is expected to close in the third quarter of 2013.

 

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TDS Telecom may make additional opportunistic acquisitions of telecommunications companies or related service businesses, including cable companies, in the future.  TDS Telecom’s acquisition strategy is to identify and target companies that support cost economies and complement TDS Telecom’s product and services growth strategy.  While management believes that it will be successful in making additional acquisitions, there can be no assurance that TDS or TDS Telecom will be able to negotiate additional acquisitions on terms acceptable to them or that regulatory approvals, where required, will be received.

 

TDS Telecom continually evaluates existing wireline operations and may pursue alternative strategies in selected markets in future periods in order to maximize the return on capital of its overall wireline business.

 

Wireline Regulation

 

Regulatory Environment .  As communications common carriers, TDS Telecom’s ILECs are subject to federal, state and local regulation and TDS Telecom strives to maintain positive relationships with these regulators.  The Communications Act of 1934, as amended by the Telecommunications Act, provides the statutory framework for United States communications policy.  The Federal Communications Commission (“FCC”) generally exercises jurisdiction over all facilities of, and services offered by, communications common carriers to the extent those facilities are used to provide, originate or terminate interstate or international telecommunications.  State public utility commissions (“PUCs”) generally exercise jurisdiction over intrastate communications facilities and services.  Regulators establish and oversee the implementation of the provisions of federal and state telecommunications laws, including interconnection requirements, universal service obligations, promotion of competition, and the deployment of advanced services.  Maximum rates for regulated interstate services are prescribed by the FCC, and local rates paid by end user customers and intrastate access charges paid by carriers that furnish traffic to the TDS Telecom ILECs continue to be subject to state commission approval in many states.  TDS Telecom routinely pursues desired changes in regulation and rate structures in an attempt to maintain affordable rates and reasonable earnings. Revenues generated from access charges to other carriers, support mechanisms and surcharges to end user customers are included in the financial results as components of Residential, Commercial and Wholesale Revenues.

 

Most of the TDS Telecom ILEC subsidiaries participate in both the National Exchange Carrier Association (“NECA”) interstate common line and traffic sensitive access charge tariffs and participate in the access revenue pools administered by the FCC-supervised NECA, which collects and distributes the revenues from interstate access charges.  The FCC retains regulatory oversight over interstate toll (long-distance) rates and other issues relating to interstate telephone service and continues to regulate the interstate access system.  Where applicable, and subject to state regulatory approval, TDS Telecom’s ILEC subsidiaries also utilize intrastate access tariffs and participate in intrastate revenue pools.

 

TDS Telecom’s ILEC subsidiaries also draw from the federal and state universal service funds. Universal service support helps keep services in rural and underserved markets comparable in quality and price to services in more urban markets, as Congress mandated in the Telecommunications Act.  Specifically, the High Cost Program of the federal USF ensures that consumers have access to and pay rates for telecommunications services in rural and underserved areas that are reasonably comparable to those provided in urban areas.  TDS Telecom’s subsidiaries draw from the USF because the cost of providing service in many of its rural markets is high, and all of those costs cannot be recovered solely from customers while still providing service that is reasonably comparable to services in urban markets.

 

TDS Telecom’s CLEC operations, like its ILEC operations, are regulated by federal, state and local agencies.  However, CLECs are subject to significantly less regulation than ILECs. The FCC has established different levels of regulation for “dominant” carriers and “non-dominant” carriers.  For domestic interstate telecommunications services, only incumbent local exchange carriers are classified as dominant carriers.  All other carriers typically are classified as non-dominant.  The FCC regulates many of the rates, charges and services of dominant carriers to a greater degree than those of non-dominant carriers.  As non-dominant carriers, CLECs also are subject to fewer regulatory requirements in connection with their installation and operation of facilities for domestic interstate telecommunications.  CLECs are not required to maintain tariffs for domestic interstate long-distance services.  However, they are required to submit certain periodic reports to the FCC, pay regulatory fees, and meet certain other obligations.

 

The Telecommunications Act requires ILECs to provide requesting carriers such as TDS Telecom’s CLEC with nondiscriminatory access to unbundled network elements (“UNEs”) at cost-based rates.  UNEs are components of ILEC networks that CLECs lease, and in some cases, combine with their own network facilities to provide services to end user customers.  Subsequent rulings have modified the circumstances under which ILECs must make UNEs available to CLECs at cost-based rates, e.g., the extent to which ILECs must unbundle and make available fiber optic lines and broadband hybrid loops.  This has had the practical effect of increasing CLEC costs to deliver certain high-capacity services to customers because CLECs no longer can rely on ILECs to lease them fiber lines and broadband hybrid loops at cost-based rates.  CLEC options can be further limited by the fact that in many jurisdictions ILECs are retiring their copper lines, thus removing those lines as an option for CLEC use as UNEs in connection with the provision of DSL services.  As a result of these factors, TDS Telecom’s CLEC today either must construct its own fiber optic lines and hybrid loops, pay a higher rate to lease these facilities from ILECs, or seek other alternative providers where available.

 

21

 

Federal Regulation

 

TDS Telecom is required to comply with the Telecommunications Act, which requires, among other things, that communications common carriers offer interstate services when requested at just and reasonable rates at terms and conditions that are non-discriminatory.  The Telecommunications Act’s stated objective is to promote competition for the provision of local service by removing regulatory barriers to competing providers.

 

National Broadband Plan.   In 2009, Congress directed the FCC to develop a National Broadband Plan (the “Plan”) to ensure every American has “access to broadband capability.”  In March 2010, the FCC released the Plan which describes the FCC’s goals in enhancing broadband availability and the methods for achieving those goals over the next decade.  Since that time, the FCC has taken steps to implement several aspects of the Plan, including comprehensively reforming its USF and intercarrier compensation regime.

 

USF and ICC Reform Order.   Pursuant to the Plan and subsequent notices of proposed rulemaking, on November 18, 2011, the FCC released a Reform Order adopting reforms of its universal service and intercarrier compensation mechanisms, establishing a new broadband-focused support mechanism, and proposing further rules to advance reform.  Prior to the Reform Order, the intercarrier compensation system had carriers recovering their costs, in part, from one another.  The Reform Order established certain rules for transitioning, over time, from the existing system to one where carriers will recover their costs directly from their end user subscribers.  The Reform Order also was accompanied by a Further Notice of Proposed Rulemaking seeking comment on a range of follow up proposals.  The future proposed rulemaking is especially important to TDS Telecom, as numerous issues relevant to rate of return carriers, such as TDS Telecom, will be addressed in it.  The Reform Order also has been the subject of numerous Petitions for Reconsideration, which have asked the FCC to reconsider portions of its decision, and it is also the subject of a judicial appeal pending before the U.S. Court of Appeals for the Tenth Circuit.  In 2012, TDS Telecom received $219 million in wholesale revenues which included approximately $87 million received under all the USF programs.  TDS Telecom cannot predict the outcome of future rulemaking, reconsideration and legal challenges and as a consequence, the impacts they may have on TDS Telecom’s wholesale revenues.

 

The FCC has determined that the deployment of both wireline and wireless broadband facilities should be supported, with one wireline carrier and one mobile carrier receiving support in each area.  This aspect of the FCC’s decision could subject TDS Telecom to additional competitive forces and improve the financial position of those competitors.

 

For wireline rate of return carriers such as TDS Telecom, the Reform Order establishes a $2 billion annual fund that is intended to maintain existing levels of support in the aggregate while at the same time transitioning support mechanisms so that, over time, rate of return carriers receive support for the deployment of wireline broadband facilities principally through the Connect America Fund (“CAF”) rather than through the intercarrier compensation regime.  To effectuate the first phase of this effort, the Reform Order: establishes benchmarks that limit certain reimbursable capital and operating expenses for determining High Cost Loop Support; reduces High Cost Loop Support on a dollar-for-dollar basis where a carrier’s local rates are set below a specified urban local rate floor; phases out safety net additive support; eliminates local switching support; eliminates support for service areas that overlap with the service areas of others; and imposes a $250 absolute cap on per line support.  Although the Reform Order is intended to permit rate of return carriers to recover any lost support through the explicit support mechanism in the CAF, it remains unclear whether the CAF will provide TDS Telecom with the same level of support over time that TDS Telecom currently receives.

 

With respect to intercarrier compensation, the Reform Order provides for a reduction in the charges that TDS Telecom pays to wireline phone companies to transport and terminate calls that originate on TDS Telecom’s network, which will reduce TDS Telecom’s operating expenses.  However, TDS Telecom also receives revenue from other carriers to transport and terminate calls that originate on those carriers’ networks.  As a general matter, the amount and timeframe for these reductions will depend on the nature of the traffic at issue.  In some cases, such as with the exchange of traffic between wireline and wireless carriers, the reduction is scheduled to occur quickly, whereas in other cases, such as with the exchange of traffic between wireline rate of return carriers, the reduction is scheduled to occur over a period of time.  The fundamental goal of the Reform Order is to, over time, transition all intercarrier compensation to a default “bill and keep” arrangement so that, in the absence of some commercial arrangement, support for the deployment of broadband services is based solely on funds received from the CAF and end-user customers.  As reductions in intercarrier charges increase over the next five to ten years, TDS Telecom’s related revenues and operating expenses are expected to decline.

 

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Net Neutrality.   In 2009, the FCC initiated a rulemaking proceeding designed to codify its existing “Net Neutrality” principles and impose new requirements that could have the effect of restricting the ability of wireless internet service providers to manage applications and content that traverse their networks.  In December 2010, after a lengthy proceeding that considered different approaches, including the “reclassification” of internet access as “common carrier” service under Title II of the Communications Act, the FCC adopted net neutrality rules based on its Title I “ancillary” authority to enforce different parts of the Communications Act. The rules require all providers of broadband internet access, including both fixed (that is, telephone and cable) and wireless providers, to publicly disclose accurate information regarding their network management practices, performance and commercial terms, sufficient for consumers to make informed choices regarding the use of such services. The rules also prohibits all internet service providers from blocking consumers’ access to lawful websites, subject to reasonable network management, and from blocking applications that compete with the provider’s voice or video telephony services, also subject to reasonable network management.  The rules subject providers of fixed but not wireless broadband internet access to a prohibition on “unreasonable discrimination” in transmitting internet traffic over their networks, also subject to reasonable network management. The exemption of wireless providers from this part of the rule reflects a recognition of the capacity constraints and other “special conditions” under which mobile broadband service is offered and the competitive nature of evolving wireless networks. The Reform Order is generally controversial and has been challenged in the courts.  TDS Telecom cannot predict the outcome of such cases.  TDS Telecom also cannot predict the extent to which parties may ask the FCC to apply the rules in circumstances not previously envisioned, which could have the practical effect of expanding their scope and application.

 

American Recovery and Reinvestment Act.   Congress enacted the American Recovery and Reinvestment Act of 2009, (“the Recovery Act”), which provides, among other things, for an aggregate appropriation of $7.2 billion to fund grants and loans to provide broadband infrastructure, access and equipment to consumers residing in rural, unserved or underserved areas of the United States. Under the Recovery Act, TDS Telecom will receive $105.1 million in federal grants and will provide $30.9 million of its own funds to complete 44 projects.  TDS Telecom began these projects in 2011 and expects to complete them before June 2015 as required under the terms of the grants. As of December 31, 2012, TDS Telecom has made $65.0 million of total capital expenditures under this program, has received reimbursement for $21.6 million in grants, and has requested or will request reimbursement for an additional $27.6 million.

 

Other federal regulations.   The FCC and various provisions of federal law require carriers to comply with numerous regulatory requirements.  Compliance with these requirements may be costly and noncompliance can lead to lawsuits and financial penalties.  These requirements include letting subscribers change to competitors’ services without changing their telephone numbers, taking actions to preserve the available pool of telephone numbers, making telecommunications accessible for those with disabilities, monitoring and reporting network outages, and properly handling and protecting customer proprietary network information.  Under the Communications Assistance to Law Enforcement Act, all telecommunications carriers, including TDS Telecom, must implement certain equipment changes necessary to assist law enforcement authorities in achieving an enhanced ability to conduct electronic surveillance of those suspected of criminal activity.  TDS Telecom believes it is in material compliance with these requirements.

 

State Regulation

 

State regulators generally must approve rate adjustments, service areas and service standards and these regulators are authorized to limit the return earned on capital, subject to applicable state law.  In some states, construction plans, borrowing, affiliated charge transactions and certain other financial transactions of ILECs are also subject to regulatory oversight and approval.  Historically, states have designated a single ILEC as the provider of last resort in a local market and then regulated the entry of additional competing providers into the same local market.  However, the Telecommunications Act largely preempted state authority over market entry.  While states retain authority to regulate competitive entry in rural telephone company service areas, states may not impose requirements that effectively function as barriers to entry, and the FCC is required to preempt state requirements if they impose such barriers to entry.

 

As a general matter, TDS Telecom has elected alternative forms of regulation for its ILEC subsidiaries in most states and will continue to pursue alternative regulation, as appropriate, for its remaining ILEC subsidiaries.  Alternative regulation typically limits the ability to increase rates for local service, but relieves TDS Telecom from the requirement to meet certain earnings tests and allows more flexibility in the pricing of enhanced and bundled service offerings.

 

CLECs are also subject to state regulation.  Certain states require CLECs to obtain operating authority prior to initiating intrastate services.  Certain states also require the filing of tariffs or price lists and/or customer-specific contracts.  TDS Telecom’s CLEC operations are not currently subject to rate-of-return or price regulation.  However, CLECs are subject to state-specific quality of service, universal service, periodic reporting and other regulatory requirements, although the extent of these requirements generally is less than those applicable to ILECs.  In addition, local governments may require CLECs to obtain licenses or franchises which regulate the use of public rights-of-way necessary to install and operate their networks.

 

23

 

Hosted and Managed Services

 

TDS HMS provides colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, sales and management of IT infrastructure hardware solutions. TDS HMS was formed in 2010 to participate in the growing IT outsourcing marketplace and to leverage TDS Telecom’s core competencies in network management, IT, customer service and reliability.  During the last three years, TDS has made multiple strategic acquisitions to position TDS HMS in the fast-growing hosted and managed services industry.

 

TDS HMS operations include:

 

·                   Vital Support Systems, LLC (“Vital”) based in Des Moines, Iowa which was acquired in June 2012.

Vital provides technology solutions to businesses which includes the planning, design, procurement, installation, sales and management of business-critical IT components such as servers, security, local and wide area networks, wireless, storage, voice and IP telephony.

 

·                   OneNeck IT Services Corporation (“OneNeck”) located in Scottsdale, Arizona which was acquired in July 2011.

OneNeck provides hosted application management and managed services.  These offerings include a comprehensive, flexible suite of enterprise resource planning (“ERP”) outsourcing solutions designed specifically to help mid-market companies manage their IT infrastructure and applications and improve system performance.

 

·                   TEAM Technologies, LLC (“TEAM”) based in Cedar Falls, Iowa which was acquired in December 2010.

TEAM, now doing business as Vital, provides a wide-range of data center solutions including colocation, managed services, hosted services, and cloud computing to companies that range in size from mid-sized businesses to large business enterprises (“enterprise”).

 

·                   VISI Incorporated (“VISI”) based in Eden Prairie, Minnesota which was acquired in March 2010.

VISI provides a wide-range of data center solutions including colocation, managed services, hosted services, and cloud computing to companies that range in size from mid-sized businesses to enterprise.

 

HMS Business Development Strategy

 

TDS HMS’ business development strategy is to increase its presence in the IT infrastructure, application outsourcing and solution provider markets through organic growth, expansion or acquisition.  TDS HMS’ service platform with coverage across all of its product categories provides the potential for expansion of current products and services to additional markets in or near TDS HMS’ current footprint. TDS HMS may continue to make opportunistic acquisitions of companies that further strengthen its operating market areas and enter additional attractive markets.  In these circumstances customer relationships, management talent, product sets, and operational capabilities are foremost considerations.  As part of this strategy, TDS HMS from time to time may be engaged in negotiations relating to the acquisition, exchange or disposition of companies, products or lines of service.  In general, TDS HMS may not disclose such transactions until there are definitive agreements.

 

HMS Products and Services

 

TDS HMS provides IT equipment and solutions to meet its business customers’ needs across several broad product categories: data center, managed services, hosted services, cloud services and solutions provider services. TDS HMS operates fault tolerant, continuously maintainable data center facilities.  Value is provided to its customers through experienced teams that manage mission critical data centers, cloud, and customer infrastructure 24 hours per day 365 days per year. Statement on Standards for Attestation Engagements 16 (“SSAE 16”) reports, which describe the controls in place at TDS HMS’ facilities, provide assurances to customers that their data is secure, available, and meets processing integrity, confidentiality and privacy requirements. Data centers are the foundation for outsourced IT services, which include managed services, hosted services and cloud services.

 

TDS HMS acquired a line of hosted products including servers, firewalls, and Microsoft® Exchange through its VISI acquisition.  The OneNeck acquisition brought significant expertise in Hosted Application Management, particularly ERP systems, as well as other hosted infrastructure products similar to those of VISI.  Internal development efforts have added capabilities in both the hosted and managed services areas.  TDS HMS is able to support a portfolio of hosted and managed services covering servers, networks, Microsoft Exchange environments, ERP applications, storage and service desk capabilities on equipment located both within TDS HMS data centers and at customer locations.

 

24

 

TDS HMS’ cloud services offering, branded ReliaCloud™, is an Infrastructure as a Service solution designed to run traditional business applications in a secure and compliant operational framework within a cloud environment.  ReliaCloud™ is a complete, enterprise-class cloud solution that handles scalability and high performance data management for use in public, private, and hybrid cloud configurations. The compliant-capable cloud solution is designed for resource intense applications and databases that require a secure operational framework, while enabling customers to meet regulatory compliance requirements.

 

The Vital acquisition added solutions provider services, which include planning, engineering, procurement, installation, sales and management of IT infrastructure solutions from world-class Original Equipment Manufacturers (“OEMs”). The breadth and depth of technical certifications held by team members have allowed Vital to achieve the highest levels of partner status with Cisco Systems®, Hewlett-Packard Company, EMC®, VMware® and Microsoft®.

 

HMS Strategy

 

The goal of TDS HMS is to create, deliver and support a platform of IT products and services tailored for mid-sized businesses customers.  By combining a solution provider’s status as trusted IT advisor with data center assets and an expansive product set, TDS HMS intends to create synergy between the provider and customer. Furthermore, cloud computing presents an opportunity for growth as it is a transformational tool that is changing the way businesses buy computing power and IT services. TDS HMS is positioning itself to grow by building sophisticated sales teams, strong customer service delivery, extensive engineering talent, and deep ties to vendors to partner with customers to reduce their risk profiles and create cost savings.

 

A highly sophisticated sales force is critical to success in the hosted and managed services marketplace.  With the complexity of the sales process and the high level interactions necessary to win customer orders, highly sophisticated account executives, sales engineers and support staff are needed to gain the trust of customers looking to outsource IT functions. TDS HMS continues to enhance its sales capabilities to be able to deliver products and services in all TDS HMS product categories in all of its markets. TDS HMS also has been transforming its support organization into one capable of meeting mid-market customer demands for enhanced product offerings.  TDS HMS is putting in place an integrated, scalable, service delivery platform intended to exceed the quality commitments made to customers.

 

HMS Customers

 

TDS HMS’ customers span multiple industries including healthcare, financial, manufacturing, retail, and government and are located across the United States.

 

HMS Competition

 

The IT services market is large and complex, with a diverse array of segments in which performance and market dynamics vary considerably.  As a result of these dynamics the IT services market is a highly competitive environment.  Market competitors include large diversified telecommunications and technology companies as well as smaller independent companies that focus on mid-sized business customers. In addition, new entrants may emerge and grow rapidly creating additional sources of competition.

 

HMS Regulation

 

TDS HMS is subject to varying degrees of regulation in each of the jurisdictions in which it operates. Federal, state and local laws and regulations, and their interpretation and enforcement may be applicable and may differ significantly among those jurisdictions. These regulations and laws may cover taxation, privacy, data protection, copyrights and other intellectual property, electronic communications and regulations applicable to electronic products and services.  TDS Telecom believes it is in material compliance with these requirements.

 

TDS—Other Items

 

Employees

 

TDS had approximately 12,100 full-time and part-time employees as of December 31, 2012, less than 1% of whom were represented by labor organizations.  TDS considers its relationship with its employees to be good.

 

25

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

U.S. Cellular

The physical properties for mobile telephone switching offices, cell sites, call centers and retail locations are located primarily in U.S. Cellular’s operating markets and are either owned or leased under long-term leases by U.S. Cellular, one of its subsidiaries, or the partnership or corporation which holds the license issued by the FCC.

 

U.S. Cellular leases space for its corporate offices in Chicago, Bensenville and Wood Dale, Illinois; it also leases space for its network operations center in Schaumburg, Illinois and its four regional offices.  As of January 1, 2013, U.S. Cellular operates four customer care centers; one of the facilities used in these operations is owned and three are leased.

 

TDS Telecom

The physical properties of TDS Telecom’s wireline operations are located primarily in its operating markets and consist principally of telephone lines and network electronic equipment for both the ILEC and CLEC operations, and land and buildings associated with ILEC operations.  The physical properties of TDS Telecom’s HMS operations are located in several states.  TDS Telecom owns most of its central office buildings, local administrative buildings, data centers and storage facilities used in its ILEC and HMS operations. TDS Telecom leases most of its office space, retail sites, equipment, switching facility buildings, storage facilities and sales offices used in its CLEC operations.

 

TDS Telecom leases space for its corporate headquarters office in Madison, Wisconsin.

 

Corporate

TDS leases space for its corporate offices in Chicago, Illinois and Middleton, Wisconsin.

 

General

U.S. Cellular’s cell and transmitter sites and TDS Telecom’s telephone lines are located on private and public property.  Locations on private land are by virtue of easements or other arrangements.  U.S. Cellular and TDS Telecom have not experienced major problems with obtaining zoning approval for cell and transmitter sites, telephone lines or other operating facilities and do not anticipate significant problems in this area in future periods.

 

U.S. Cellular’s and TDS Telecom’s properties, plant and equipment are maintained in good operating condition and are suitable and adequate for TDS’ business operations.

 

As of December 31, 2012, Property, plant and equipment, net of accumulated depreciation, totaled $3,022.6 million at U.S. Cellular, $767.4 million at TDS Telecom’s ILEC, $85.1 million at TDS Telecom’s CLEC, $81.7 million at TDS Telecom’s HMS; and $40.5 million at Corporate, Airadigm and Suttle-Straus.

 

Item 3.  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.

 

See Note 14 — Commitments and Contingencies in the Notes to Consolidated Financial Statements for further information.

 

Item 4.  Mine Safety Disclosures.

 

Not applicable

 

45

---

 

PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market, holder, dividend and performance graph information is incorporated by reference from Exhibit 13 to this Form 10-K, Annual Report sections entitled “Shareholder Information” and “Consolidated Quarterly Information (Unaudited).”

 

Information relating to Issuer Purchases of Equity Securities is set forth below.

 

On November 19, 2009, the Board of Directors of TDS authorized a $250 million stock repurchase program for both TDS Common and Special Common shares. The following table provides certain information with respect to all purchases made by or on behalf of TDS, and any open market purchases made by any “affiliated purchaser” (as defined by the SEC) of TDS, of TDS Common Shares during the fourth quarter of 2012.

 

This authorization expired on November 19, 2012 and has not been renewed.  TDS determines whether to repurchase shares from time to time based on many considerations, including cash needed for other known or possible requirements, the stock price, market conditions, debt rating considerations, business forecasts, business plans, macroeconomic conditions, share issuances under compensation plans, provisions in governing and legal documents and other legal requirements, and other facts and circumstances.  Subject to these considerations, TDS may approve the repurchase of its shares from time to time when circumstances warrant.

 

		(a)		(b)			(c)		(d)
Period		Total Number of Shares Purchased		Average Price Paid per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Dollar Value of Shares that may yet be Purchased Under the Plans or Programs
October 1 - 31, 2012		—		$	—		—		$	157,570,912
November 1 - 30, 2012		867,841		23.08			867,841		—
December 1 - 31, 2012		—		—			—		—
Total for or as of the end of the quarter ended December 31, 2012		867,841		$	23.08		867,841		$	—

 

The following is additional information with respect to the Common and Special Common Shares authorization:

 

i.                   The date the program was announced was November 20, 2009 by Form 8-K.

 

ii.                The amount originally approved was up to $250 million in aggregate purchase price of TDS Common and Special Common Shares.

 

iii.             The program expired on November 19, 2012.

 

Item 6.  Selected Financial Data

 

Incorporated by reference from Exhibit 13 to this Form 10-K, Annual Report section entitled “Selected Consolidated Financial and Operating Data,” except for Ratio of earnings to fixed charges, which is incorporated herein by reference from Exhibit 12 to this Form 10-K.

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Incorporated by reference from Exhibit 13 to this Form 10-K, Annual Report section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

 

Incorporated by reference from Exhibit 13 to this Form 10-K, Annual Report section entitled “Market Risk.”

 

46

 

 

Item 8.  Financial Statements and Supplementary Data

 

Incorporated by reference from Exhibit 13 to this Form 10-K, Annual Report sections entitled “Consolidated Statement of Operations,” “Consolidated Statement of Comprehensive Income,” “Consolidated Statement of Cash Flows,” “Consolidated Balance Sheet,” “Consolidated Statement of Changes in Equity,” “Notes to Consolidated Financial Statements,” “Management’s Report on Internal Control Over Financial Reporting,” “Report of Independent Registered Public Accounting Firm,” and “Consolidated Quarterly Information (Unaudited).”

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

TDS maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in its reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to TDS’ management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

 

As required by SEC Rule 13a-15(b), TDS carried out an evaluation, under the supervision and with the participation of management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of TDS’ disclosure controls and procedures as of the end of the period covered by this Annual Report.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that TDS’ disclosure controls and procedures were effective as of December 31, 2012, at the reasonable assurance level.

 

Management’s Report on Internal Control Over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  TDS’ internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  TDS’ internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and, where required, the board of directors of the issuer; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the issuer’s assets that could have a material effect on the interim or annual consolidated financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision and with the participation of TDS’ management, including its Chief Executive Officer and Chief Financial Officer, TDS conducted an evaluation of the effectiveness of its internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  Management has concluded that TDS maintained effective internal control over financial reporting as of December 31, 2012 based on criteria established in Internal Control — Integrated Framework issued by the COSO.

 

The effectiveness of TDS’ internal control over financial reporting as of December 31, 2012 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in the firm’s report which is incorporated by reference into Item 8 of this Annual Report on Form 10-K from Exhibit 13 filed herewith.

 

47

 

Changes in Internal Control Over Financial Reporting

 

There were no changes in TDS’ internal control over financial reporting during the fourth quarter of 2012 that have materially affected, or are reasonably likely to materially affect, TDS’ internal control over financial reporting.

 

Item 9B.  Other Information

 

None.

 

48

 

PART III

 

Item 10.  Directors, Executive Officers and Corporate Governance

 

Incorporated by reference from Proxy Statement sections entitled “Election of Directors,” “Corporate Governance,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

Item 11.  Executive Compensation

 

Incorporated by reference from Proxy Statement section entitled “Executive and Director Compensation.”

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Incorporated by reference from Proxy Statement sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance under Equity Compensation Plans.”

 

Item 13.  Certain Relationships and Related Transactions, and Director Independence

 

Incorporated by reference from Proxy Statement sections entitled “Corporate Governance” and “Certain Relationships and Related Transactions.”

 

Item 14.  Principal Accountant Fees and Services

 

Incorporated by reference from Proxy Statement section entitled “Fees Paid to Principal Accountants.”

 

49

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PART IV

 

Item 15.  Exhibits and Financial Statement Schedules

 

(a)	The following documents are filed as a part of this report:
	(1)	Financial Statements
		Consolidated Statement of Operations	Annual Report*
		Consolidated Statement of Comprehensive Income	Annual Report*
		Consolidated Statement of Cash Flows	Annual Report*
		Consolidated Balance Sheet	Annual Report*
		Consolidated Statement of Changes in Equity	Annual Report*
		Notes to Consolidated Financial Statements	Annual Report*
		Management’s Report on Internal Control Over Financial Reporting	Annual Report*
		Report of Independent Registered Public Accounting Firm—PricewaterhouseCoopers LLP	Annual Report*
		Consolidated Quarterly Information (Unaudited)	Annual Report*

 

* Incorporated by reference from Exhibit 13.

 

	(2)	Financial Statement Schedules	Location
		Los Angeles SMSA Limited Partnership Financial Statements	S-1
		Report of Independent Registered Public Accounting Firm — Deloitte & Touche LLP	S-2
		Balance Sheets	S-3
		Statements of Operations	S-4
		Statements of Changes in Partners’ Capital	S-5
		Statements of Cash Flows	S-6
		Notes to Financial Statements	S-7

 

All other schedules have been omitted because they are not applicable or not required or because the required information is shown in the financial statements or notes thereto.

 

(3)

Exhibits

 

The exhibits set forth in the accompanying Index to Exhibits are filed as a part of this Report.  Compensatory plans or arrangements are identified in the Index to Exhibits with an asterisk.

 

50

 

LOS ANGELES SMSA LIMITED PARTNERSHIP

  FINANCIAL STATEMENTS

 

TDS’ subsidiary, U.S. Cellular, owns a 5.5% limited partnership interest in the Los Angeles SMSA Limited Partnership and accounts for such interest by the equity method.  The partnership’s financial statements were obtained by U.S. Cellular as a limited partner.

 

S-1

 

 

Los Angeles SMSA Limited Partnership

Balance Sheets - As of December 31, 2012 and 2011

(Dollars in Thousands)

 

		2012			2011
ASSETS
CURRENT ASSETS:
Accounts receivable, net of allowance of $14,205 and $14,076		$	338,599		$	306,384
Unbilled revenue		19,491			22,252
Due from affiliate		243,748			143,649
Prepaid expenses and other current assets		4,537			3,777
Total current assets		606,375			476,062
PROPERTY, PLANT AND EQUIPMENT—Net		1,569,418			1,632,776
WIRELESS LICENSES		79,543			79,543
OTHER ASSETS		655			674
TOTAL ASSETS		$	2,255,991		$	2,189,055
LIABILITIES AND PARTNERS’ CAPITAL
CURRENT LIABILITIES:
Accounts payable and accrued liabilities		$	132,558		$	105,979
Advance billings and customer deposits		144,849			135,023
Deferred gain on lease transaction		4,923			4,923
Total current liabilities		282,330			245,925
LONG TERM LIABILITIES:
Deferred gain on lease transaction		33,833			38,790
Other long term liabilities		23,964			19,756
Total long term liabilities		57,797			58,546
Total liabilities		340,127			304,471
PARTNERS’ CAPITAL		1,915,864			1,884,584
TOTAL LIABILITIES AND PARTNERS’ CAPITAL		$	2,255,991		$	2,189,055

 

See notes to financial statements.

 

S-3

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Los Angeles SMSA Limited Partnership

Statements of Operations - Years Ended December 31, 2012, 2011 and 2010

(Dollars in Thousands)

 

		2012			2011			2010
OPERATING REVENUE:
Service revenue		$	3,920,064		$	3,782,027		$	3,533,581
Equipment and other		677,836			593,330			381,790
Total operating revenue		4,597,900			4,375,357			3,915,371
OPERATING COSTS AND EXPENSES:
Cost of service (exclusive of depreciation and amortization)		705,065			797,797			674,007
Depreciation and amortization		343,565			366,119			338,700
Cost of equipment		948,130			955,002			625,225
Selling, general and administrative		1,375,852			1,263,604			1,140,518
Total operating costs and expenses		3,372,612			3,382,522			2,778,450
OPERATING INCOME		1,225,288			992,835			1,136,921
OTHER INCOME:
Interest income, net		1,051			561			35,211
Other		4,941			6,964			6,567
Total other income		5,992			7,525			41,778
NET INCOME		$	1,231,280		$	1,000,360		$	1,178,699
Allocation of Net Income:
Limited Partners		$	738,768		$	600,216		$	707,219
General Partner		$	492,512		$	400,144		$	471,480

 

See notes to financial statements.

 

S-4

 

Los Angeles SMSA Limited Partnership

Statements of Changes in Partners’ Capital - Years Ended December 31, 2012, 2011 and 2010

(Dollars in Thousands)

 

		General Partner			Limited Partners
		AirTouch Cellular			AirTouch Cellular			Cellco Partnership			United States Cellular Corporation			Total Partners’ Capital
BALANCE—January 1, 2010		$	842,210		$	890,637		$	256,875		$	115,803		$	2,105,525
Distributions		(480,000		)	(507,600		)	(146,400		)	(66,000		)	(1,200,000		)
Net Income		471,480			498,590			143,801			64,828			1,178,699
BALANCE—December 31, 2010		833,690			881,627			254,276			114,631			2,084,224
Distributions		(480,000		)	(507,600		)	(146,400		)	(66,000		)	(1,200,000		)
Net Income		400,144			423,152			122,044			55,020			1,000,360
BALANCE—December 31, 2011		753,834			797,179			229,920			103,651			1,884,584
Distributions		(480,000		)	(507,600		)	(146,400		)	(66,000		)	(1,200,000		)
Net Income		492,512			520,832			150,216			67,720			1,231,280
BALANCE—December 31, 2012		$	766,346		$	810,411		$	233,736		$	105,371		$	1,915,864

 

See notes to financial statements.

 

S-5