2013 Annual Report www.teldta.com 2013 Annual Report www.teldta.com

 

 

Ensuring a strong financial foundation TDS U.S. Cellular Shares Repurchased (in millions of shares) 8 7 6 5 4 3 2 1 0 07 08 09 10 11 12 13 Capital Allocation Strategy $0.60 $0.50 $0.40 $0.30 $0.20 $0.10 $0.00 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 TDS Annual Dividend Per Share At TDS, we take a balanced approach to capital allocation, investing to build our businesses for the long term, and returning value to our shareholders. Investing for our future Over the next several years, we expect to allocate approximately 75 percent of our available resources to build and strengthen our cable and hosted and managed services businesses through attractive acquisition opportunities. Returning value to our shareholders At the same time, we plan to return approximately 25 percent of our available resources to our shareholders, through cash dividends and share repurchases. We are proud to have increased our annual dividend for 40 consecutive years—an achievement accomplished by only a handful of companies. Over the past seven years, TDS has repurchased $930 million of TDS and U.S. Cellular shares. 40 years of consecutive dividend increases New $250 million TDS share repurchase program authorized in 2013 Investing for our future Returning value to shareholders

 

 

TELEPHONE AND DATA SYSTEMS 1 To Our Shareholders Total Company Performance For TDS, 2013 was a year of signifi cant strategic action. We divested underperforming wireless markets to focus on stronger markets. We identified cable as an attractive growth area and made our first acquisition, Baja Broadband, to build the business. We united our hosted and managed services businesses under one brand to focus more effectively on attracting midmarket commercial customers. We also took action to return value to TDS and U.S. Cellular shareholders, and to strengthen our financial foundation by monetizing non-strategic assets. TDS’ mission is to provide outstanding communication services to our customers and meet the needs of our shareholders, our people and our communities. In pursuing this mission, we seek to continuously grow our businesses, create opportunities for our associates and employees, and steadily build value over the long term for our shareholders. While our financial and operating results continue to refl ect the competitive environment and the impact of necessary investments, we believe the actions we’ve taken to better position our businesses will enable us to improve our performance over time. In addition to the initiatives above, we made progress in a number of important areas: U.S. Cellular continued to increase smartphone penetration and data use through its expanded 4G LTE network, shared data plans, and a competitive portfolio of Android, Apple, and Windows devices. U.S. Cellular further expanded retail distribution through agreements with Sam’s Club and Amazon, and launched a new billing and operational system that provides an important platform for future growth. Although implementation challenges impacted customer service more than anticipated, we believe the long-term benefits will be substantial. TDS Telecom increased wireline residential average revenue per connection and maintained strong growth in commercial managedIP customers. TDS has invested in substantial initiatives over the past few years to position our businesses to operate more efficiently and compete more effectively. We are confident that the short-term impact to performance is worth the long-term benefits for our businesses and our customers. Thank you to the leadership teams at TDS and each of our businesses for leading us through challenges and opportunities with the highest ethical and professional standards. We appreciate your vision and dedication. TDS Telecom began integrating the Baja Broadband acquisition and implementing strategies to increase residential and commercial penetration in Baja markets. We strengthened our hosted and managed services business with the acquisition of solutions provider MSN Communications, and then united all five HMS businesses under a single brand—OneNeck IT Solutions.

 


2 TELEPHONE AND DATA SYSTEMS J.D. Power Customer Champion, 2014 Attracting Customers and Building Loyalty Attracting new customers and reducing churn are our highest priorities. We enhanced our value proposition in 2013 by expanding 4G LTE access to nearly 90 percent of our customers, launching Apple devices to strengthen our portfolio, offering shared data plans, and working to provide a seamless and consistently high-quality experience across our sales and service channels. We introduced customizable plans for small and medium businesses, and expanded our distribution to Sam’s Club and Amazon. We also converted to a new billing and operational support system—an essential platform for delivering services and products more efficiently. During and following the conversion, many of our customers experienced extended reductions in service levels as we worked through implementation issues, and this led to an increase in postpaid churn. These experiences were below our standards, and we provided additional rewards points to postpaid customers in appreciation for their patience and commitment. We launched Apple devices for the fi rst time in November of 2013, and reinstituted contracts for postpaid customers, to help reduce postpaid churn over time. Our strategy is to provide the best customer experiences in the wireless industry, centered around a best-in-class network. A fast and reliable 4G LTE network is the backbone for our competitive data products and services and strong portfolio of Android, Apple, and Windows devices. Our Rewards Program—unique in the wireless industry—creates a membership experience for our customers. More than ever, we believe network quality is the most important element of customer satisfaction. U.S. Cellular Value Proposition Data Products & Services Membership Experience Local Market Foc us Competitive devices, plans, and pricing Understanding customer needs in each of our markets Outstanding customer service and Rewards Program Best-in-Class Network

 


TELEPHONE AND DATA SYSTEMS 3 Growth in data use is a critical driver of U.S. Cellular’s future success. Total data traffic increased 97 percent from 2012 to 2013. Increasing Smartphone Penetration and Monetizing Data Use A best-in-class 4G LTE network is the foundation for competitive data offerings and devices that enable us to maximize and monetize the dramatic growth in data use. By the end of 2013, we offered our strongest-ever portfolio of Android, Apple, and Windows devices, along with attractive shared data plans. Fifty-one percent of postpaid customers were smartphone customers in the fourth quarter, and 80 percent of total devices sold in the quarter were smartphones. We expanded 4G LTE coverage to nearly 90 percent of customers by year end, and 4G LTE devices were 69 percent of devices sold in the fourth quarter. Comprehensive 4G LTE coverage provides signifi cant capacity to promote and monetize smartphone adoption and data use in all of our markets. The recent Federal Communications Commission decision to mandate device interoperability supports our strategy by ensuring that we can continue to offer a greater choice of devices to our customers, and offer nationwide 4G LTE roaming coverage in the future. “Highest Network Quality Performance Among Wireless Cell Phone Users in North Central Region” - J.D. Power Smartphones as a Percentage of Total Devices Sold 90% 80% 70% 60% 50% 40% 30% 20% 10% 0 63% 62% 66% 80% 65% 69% Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 4G 3G 46% 46% 58% 55% Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Smartphone Customers as a Percentage of Postpaid Customers 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0 42% 43% 46% 51% 47% 42% 15% 21% 29% 4G 3G 33%

 


Wireline Residential TDS Telecom is increasing average revenue per residential connection as customers chose faster broadband speeds and higher-tier packages of our IPTV service, TDS TV®. We continued to increase broadband speeds and expand TDS TV availability in our markets, and we marketed high-speed fiber and TDS TV services in new neighborhoods to build momentum prior to buildouts. By the fourth quarter, TDS TV was available in 11 markets, and 13 percent of residential households were passed by facilities that enable TDS TV. Broadband and video service bundles are key to our retention strategy, and by the end of 2013, 73 percent of residential customers had double- or triple-play bundles. We also neared completion of stimulus projects nationwide that will bring broadband access to approximately 27,000 previously underserved households when complete. Commercial Our commercial strategy is to be a trusted partner to our business customers, and our reputation for service quality and reliability enabled us to achieve a 35 percent increase in connections for managedIP, a hosted VoIP voice and data solution. This offset a decline in traditional voice services, which resulted in a slight increase in commercial revenues in 2013. TDS TELECOM Our strategy is to attract customers by providing high-quality, reliable communications services and products. We expanded our business strategically in 2013 by entering the cable sector through the acquisition of Baja Broadband, opening substantial opportunities to leverage our existing products, services, and infrastructure in new markets. We also positioned our hosted and managed services business to offer comprehensive IT solutions through a unified brand and sales force. 4 TELEPHONE AND DATA SYSTEMS Twenty-five percent of customers had access to 25Mbps or faster broadband service at the end of 2013. The average monthly churn rate for customers with three services is very low, at approximately one-half of one percent. 130 120 110 100 90 80 70 60 50 40 30 20 10 0 15 30 54 128 95 managedIP Connections (in thousands) 09 10 11 12 13

 


Suttle-Straus Suttle-Straus, a marketing and graphic communications solutions provider, continued to improve its performance in 2013, expanding its commercial client base and enhancing its bundled packages of marketing services, from creative development through print and distribution. Suttle-Straus also improved margins and increased productivity through continuous improvement initiatives. Airadigm Communications Airadigm Communications, Inc. offers mobile services to customers in Wisconsin. Airadigm operates independently of U.S. Cellular. OTHER TDS SUBSIDIARIES TELEPHONE AND DATA SYSTEMS 5 The high-capacity cable pipeline offers significant growth potential for our residential and commercial data products and services. Recurring hosted and managed services revenues increased 10 percent in 2013. Cable We identified cable broadband as an attractive growth area and entered the sector in 2013 with the acquisition of Baja Broadband, which provides a high-capacity data pipeline to homes and businesses in the southwest U.S. After the acquisition closed in August, we began leveraging our marketing experience and network capabilities to increase residential and commercial penetration in Baja’s markets. As we execute on our integration and growth strategies, we’re identifying operational and infrastructure synergies to increase effi ciency. We plan to continue to build our cable portfolio with acquisitions that offer signifi cant growth potential in complementary markets. Hosted and Managed Services Our strategy is to sell comprehensive IT solutions to mid-market commercial customers. We strengthened our value proposition in 2013 with the acquisition of solutions provider MSN Communications, and then unified our fi ve hosted and managed services businesses under one brand—OneNeck IT Solutions. With a comprehensive, unifi ed service portfolio that includes colocation, cloud and hosting solutions, managed services, professional services, ERP application management, and IT hardware, OneNeck is well positioned to be a single, trusted source of end-to-end IT solutions for commercial customers.

 


6 TELEPHONE AND DATA SYSTEMS TDS Telecom We’re working to attract residential and commercial customers through superior experiences and highquality, reliable services. We plan to bring faster broadband, high-quality video service, and competitive bundles to more residential customers, and increase fiber network coverage for both residential and commercial customers. We’ll continue to optimize our investment in Baja Broadband and seek additional opportunities to build our cable business through acquisitions. We’re focused on developing comprehensive hosted and managed solutions through OneNeck IT Solutions, and increasing recurring revenues from mid-market customers. Our strategic imperative is to increase customer and revenue growth in our businesses by leveraging our improved competitive positioning and allocating our resources effectively to support growth initiatives. U.S. Cellular We plan to attract new customers and build customer loyalty with customer experiences grounded in network quality, competitive data products and services and devices, an innovative Rewards Program that makes customers feel like members, and localized attention to customer needs. We’re focused on driving revenues through smartphone penetration and monetized data use, as we continue to expand and enhance 4G LTE access. We will continue to increase operational efficiency. LOOKING FORWARD Thank you to the employees and associates of the TDS companies for their dedication and innovation in providing outstanding services, products, and experiences to our customers. Thank you also to our shareholders and debt holders for your continuing support of our long-term strategies. Sincerely, LeRoy T. Carlson, Jr. Walter C.D. Carlson President and Chief Chairman of the Board Executive Officer

 

 

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TELEPHONE AND DATA SYSTEMS, INC.

ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2013
Pursuant to SEC Rule 14a-3

The following audited financial statements and certain other financial information for the year ended December 31, 2013, represent Telephone and Data Systems' annual report to shareholders as required by the rules and regulations of the Security and Exchange Commission ("SEC").

The following information was filed with the SEC on February 28, 2014 as Exhibit 13 to Telephone and Data Systems' Annual Report on Form 10-K for the year ended December 31, 2013. Such information has not been updated or revised since the date it was originally filed with the SEC. Accordingly, you are encouraged to review such information together with any subsequent information that we have filed with the SEC and other publicly available information.


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Exhibit 13

Telephone and Data Systems, Inc.

Financial Reports Contents

Management's Discussion and Analysis of Results of Operations and Financial Condition

  1

Overview

  1

Results of Operations—Consolidated

  7

Results of Operations—U.S. Cellular

  10

Results of Operations—TDS Telecom

  16

Inflation

  22

Recently Issued Accounting Pronouncements

  22

Financial Resources

  22

Liquidity and Capital Resources

  26

Application of Critical Accounting Policies and Estimates

  30

Certain Relationships and Related Transactions

  38

Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement

  39

Market Risk

  42

Consolidated Statement of Operations

  43

Consolidated Statement of Comprehensive Income

  44

Consolidated Statement of Cash Flows

  45

Consolidated Balance Sheet—Assets

  46

Consolidated Balance Sheet—Liabilities and Equity

  47

Consolidated Statement of Changes in Equity

  48

Notes to Consolidated Financial Statements

  51

Reports of Management

  106

Report of Independent Registered Public Accounting Firm

  108

Selected Consolidated Financial Data

  109

Consolidated Quarterly Information (Unaudited)

  110

Shareholder Information

  111

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Telephone and Data Systems, Inc. ("TDS") is a diversified telecommunications company providing high-quality telecommunications services to approximately 4.8 million wireless customers and 1.1 million wireline and cable connections at December 31, 2013. TDS conducts substantially all of its wireless operations through its 84%-owned subsidiary, United States Cellular Corporation ("U.S. Cellular"). TDS provides wireline services, cable services and hosted and managed services ("HMS"), through its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom").

TDS conducts printing and distribution services through its majority-owned subsidiary, Suttle-Straus, Inc. ("Suttle-Straus") and provides wireless services through its wholly-owned subsidiary, Airadigm Communications, Inc. ("Airadigm"), a Wisconsin-based service provider. At this time, Airadigm operates independently from U.S. Cellular. Suttle-Straus and Airadigm's financial results were not significant to TDS' operations for the year ended December 31, 2013 and collectively represent the "Non-Reportable Segment."

The following discussion and analysis should be read in conjunction with TDS' audited consolidated financial statements and the description of TDS' business included in Item 1 of the TDS Annual Report on Form 10-K ("Form 10-K") for the year ended December 31, 2013. The discussion and analysis contained herein refers to consolidated data and results of operations, unless otherwise noted.


OVERVIEW

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

Previously, TDS had reported the following reportable segments: U.S. Cellular, TDS Telecom's incumbent local exchange carrier ("ILEC"), its competitive local exchange carrier ("CLEC"), its HMS operations and the Non-Reportable Segment. As a result of recent acquisitions and changes in TDS' strategy, operations and internal reporting, TDS has reevaluated and changed its operating segments during the year ended December 31, 2013, which resulted in the following reportable segments: U.S. Cellular, TDS Telecom's Wireline, Cable and HMS operations, and the Non-Reportable Segment. The Wireline segment consists of the former ILEC and CLEC segments. The Cable segment consists of Baja Broadband, LLC ("Baja"), which was acquired in August 2013. The HMS segment remains unchanged. Periods presented for comparative purposes have been re-presented to conform to this revised presentation.

U.S. Cellular

In its consolidated operating markets, U.S. Cellular serves approximately 4.8 million customers in 23 states. As of December 31, 2013, U.S. Cellular's average penetration rate in its consolidated operating markets was 15.0%. U.S. Cellular operates on a customer satisfaction strategy, striving to meet or exceed customer needs by providing a comprehensive range of wireless products and services, excellent customer support, and a high-quality network. U.S. Cellular's business development strategy is to obtain interests in and access to wireless licenses in its current operating markets and in areas that are adjacent to or in close proximity to its other wireless licenses, thereby building contiguous operating market areas with strong spectrum positions. U.S. Cellular believes that the acquisition of additional licenses within its current operating markets will enhance its network capacity to meet its customers' increased demand for data services. 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.

Financial and operating highlights in 2013 included the following:

On April 3, 2013, U.S. Cellular entered into an agreement relating to St. Lawrence Seaway RSA Cellular Partnership ("NY1") and New York RSA 2 Cellular Partnership ("NY2" and, together with NY1,

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

On May 16, 2013, U.S. Cellular completed the sale of customers and certain PCS license spectrum in U.S. Cellular's Chicago, central Illinois, St. Louis and certain Indiana/Michigan/Ohio markets ("Divestiture Markets"), to Sprint Corp., fka Sprint Nextel Corporation, for $480 million in cash (the "Divestiture Transaction"). In connection with the sale, U.S. Cellular recognized a pre-tax gain of $266.4 million which was recorded in (Gain) loss on sale of business and other exit costs, net in the Consolidated Statement of Operations. See Note 5—Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information regarding this transaction.

On June 25, 2013, U.S. Cellular paid a special cash dividend of $5.75 per share, for an aggregate amount of $482.3 million, to all holders of U.S. Cellular Common Shares and Series A Common Shares as of June 11, 2013. Of the $482.3 million paid, TDS received $407.1 million while noncontrolling public shareholders received $75.2 million.

On October 4, 2013, U.S. Cellular sold the majority of its Mississippi Valley non-operating market license ("unbuilt license") for $308.0 million. A pre-tax gain of $250.6 million was recorded in (Gain) loss on license sales and exchanges in the Consolidated Statement of Operations.

In the fourth quarter of 2013, U.S. Cellular issued loyalty reward points with a value of $43.5 million as a loyalty bonus in recognition of the inconvenience experienced by customers during U.S. Cellular's recent billing system conversion. The loyalty bonus reduced Operating revenues in the Consolidated Statement of Operations and increased Customer deposits and deferred revenues in the Consolidated Balance Sheet.

Total consolidated customers were 4,774,000 at December 31, 2013, including 4,610,000 retail customers (97% of total).

The following operating information is presented for Core Markets. As used here, Core Markets is defined as all consolidated markets in which U.S. Cellular currently conducts business and, therefore, excludes the Divestiture Markets and the NY1 & NY2 Deconsolidated Markets. Core Markets as defined also includes any other income or expenses due to U.S. Cellular's direct or indirect ownership interests in other spectrum in the Divestiture Markets which was not included in the Divestiture Transaction and other retained assets from the Divestiture Markets.

Retail customer net losses were 215,000 in 2013 compared to net additions of 32,000 in 2012. In the postpaid category, there were net losses of 217,000 in 2013, compared to net losses of 92,000 in 2012. Prepaid net additions were 2,000 in 2013 compared to net additions of 124,000 in 2012.

Postpaid customers comprised approximately 93% of U.S. Cellular's retail customers as of December 31, 2013 and December 31, 2012. The postpaid churn rate was 1.7% in 2013 and 1.5% in 2012. The prepaid churn rate was 6.7% in 2013 and 5.2% in 2012.

Billed average revenue per user ("ARPU") increased to $50.82 in 2013 from $50.54 in 2012 reflecting an increase in postpaid ARPU due to increases in smartphone adoption and corresponding revenues from data products and services, offset by a decrease in prepaid ARPU. Service revenue ARPU decreased to $57.66 in 2013 from $58.49 in 2012 due primarily to decreases in inbound roaming and eligible telecommunications carriers ("ETC") revenues. The special issuance of loyalty rewards points in the fourth quarter of 2013 negatively impacted both billed ARPU and service revenue ARPU by $0.73 in 2013.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Postpaid customers on smartphone service plans increased to 51% as of December 31, 2013 compared to 41% as of December 31, 2012. In addition, smartphones represented 69% of all devices sold in 2013 compared to 56% in 2012.

The following financial information is presented for U.S. Cellular consolidated results:

Retail service revenues of $3,165.5 million decreased $382.5 million year-over-year, due to a decrease of 619,000 in the average number of customers (including approximately 550,000 due to the reductions caused by the Divestiture Transaction and NY1 & NY2 Deconsolidation).

Total additions to Property, plant and equipment were $737.5 million, including expenditures to deploy fourth generation Long-Term Evolution ("4G LTE") equipment, construct cell sites, increase capacity in existing cell sites and switches, outfit new and remodel existing retail stores, develop new billing and other customer management related systems and platforms, and enhance existing office systems. Total cell sites in service decreased 13% year-over-year to 6,975 primarily as a result of the NY1 & NY2 Deconsolidation and the deactivation of certain cell sites in the Divestiture Markets.

Operating income decreased $9.8 million, or 6%, to $146.9 million in 2013 from $156.7 million in 2012, reflecting lower service revenues as discussed above as well as lower inbound roaming revenues, higher equipment subsidies and accelerated depreciation related to the Divestiture Transaction. The impacts of these items were offset by lower operating expenses in other categories and gains related to sales of the Divestiture Markets and spectrum licenses. See additional discussion below in "Results of Operations—U.S. Cellular".

U.S. Cellular anticipates that future results will be affected by the following factors:

Impacts of selling Apple iPhone products;

Relative ability to attract and retain customers in a competitive marketplace in a cost effective manner;

Effects of industry competition on service and equipment pricing as well as the impacts associated with the expanding presence of carriers and other retailers offering low-priced, unlimited prepaid service;

Expanded distribution of products and services in third-party national retailers;

Potential increases in prepaid customers, who generally generate lower ARPU and higher churn, as a percentage of U.S. Cellular's customer base in response to changes in customer preferences and industry dynamics;

The nature and rate of growth in the wireless industry, requiring U.S. Cellular to grow revenues primarily from selling additional products and services to its existing customers, increasing the number of multi-device users among its existing customers, increasing the use of data products and services and attracting wireless customers switching from other wireless carriers;

Continued growth in revenues and costs related to data products and services and declines in revenues from voice services;

Rapid growth in the demand for new data devices and services which may result in increased cost of equipment sold and other operating expenses and the need for additional investment in network capacity and enhancements;

Further consolidation among carriers in the wireless industry, which could result in increased competition for customers and/or cause roaming revenues to decline;

Uncertainty related to various rulemaking proceedings under way at the Federal Communications Commission ("FCC");

The ability to negotiate satisfactory 4G LTE data roaming agreements with other wireless operators;

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

U.S. Cellular completed the migration of its customers to a new Billing and Operational Support System ("B/OSS") in the third quarter of 2013. This conversion caused billing delays, which were largely resolved in the fourth quarter of 2013. In addition, intermittent system outages and delayed system response times negatively impacted customer service and sales operations at certain times. Continuing operational problems associated with the conversion to the new billing system could have adverse effects on U.S. Cellular's business (in areas such as overall customer satisfaction, customer attrition, uncollectible accounts receivable, gross customer additions, or operating expenses). All of these factors could have a material adverse effect on U.S. Cellular's results of operations or cash flows; and

On August 14, 2013 U.S. Cellular entered into a definitive agreement to sell the majority of its St. Louis area unbuilt license for $92.3 million. The sale will result in an estimated pre-tax gain of $76.2 million. This transaction is subject to regulatory approval and is expected to close in the first quarter of 2014 at which time, the gain on sale will be recorded. In accordance with GAAP, the book value of the license has been accounted for and disclosed as "held for sale" in the Consolidated Balance Sheet at December 31, 2013.

See "Results of Operations—U.S. Cellular."

TDS Telecom

The Wireline and Cable segments seek to be the preferred telecommunications solutions providers in their chosen markets serving 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 provides broadband, voice, and video services to residential customers through value-added bundling of products. The commercial focus is to provide advanced IP-based voice and data services to small to medium sized businesses. The HMS segment provides colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, sales and management of Information Technology ("IT") infrastructure hardware solutions.

On October 4, 2013, TDS acquired 100% of the outstanding shares of MSN Communications, Inc. ("MSN") for $43.6 million in cash. The operations of MSN are included in the HMS segment since the date of acquisition.

On August 1, 2013, TDS Telecom acquired substantially all of the assets of Baja Broadband, LLC ("Baja") for $264.1 million in cash. Baja operates in markets primarily in Colorado, New Mexico, Texas, and Utah. The operations of Baja are included in the Cable segment since the date of acquisition.

TDS Telecom acquired Vital Support Systems, LLC ("Vital") in June 2012 and OneNeck IT Services Corporation ("OneNeck IT Services") in July 2011. The operations of Vital and OneNeck IT Services are included in the HMS segment since their respective dates of acquisition.

All of these acquisitions impact the comparability of TDS Telecom operating results.

Financial and operating highlights in 2013 included the following:

Operating revenues increased $92.5 million or 11% to $947.0 million in 2013. The increase was due primarily to $100.1 million from acquisitions of Vital in June 2012, Baja in August 2013 and MSN in October 2013, partially offset by a decrease in revenues due to declines in Wireline connections and a decline in Wireline wholesale revenues.

Operating expenses increased $88.4 million or 11% to $902.2 million in 2013 due primarily to $101.2 million from the acquisitions noted above, partially offset by a decrease in Wireline expenses.

Additions to Property, plant and equipment totaled $164.9 million in 2013 including strategic investment in increased network capabilities for broadband services, HMS expansion, IPTV expansion,

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

TDS anticipates that TDS Telecom's future results will be affected by the following factors:

Continued increases in competition from wireless and other wireline providers, cable providers, and technologies such as VoIP, DOCSIS 3.0 and fourth generation ("4G") mobile technology;

Continued increases in consumer data usage and demand for high-speed data services;

Continued declines in Wireline voice connections;

Continued focus on customer retention programs, including discounting for "triple-play" bundles including voice, broadband and video or satellite video;

The expansion of IPTV into additional market areas;

Continued growth in hosted and managed services which may result in the need for additional investment in data centers;

Continued focus on cost-reduction initiatives through product and service cost improvements and process efficiencies;

The Federal government's disbursement of Broadband Stimulus Funds to bring broadband to rural customers;

The National Broadband Plan and other rulemaking by the FCC, including uncertainty related to future funding from the Universal Service Fund ("USF"), broadband requirements, intercarrier compensation and changes in access reform;

Impacts of the Baja and MSN transactions, including, but not limited to, the ability to successfully integrate and operate these businesses and the financial impacts of such transactions; and

Potential acquisitions or divestitures by TDS and/or TDS Telecom of wireline, cable, HMS, or other businesses.

See "Results of Operations—TDS Telecom."

Pro Forma Financial Information

Refer to TDS' Form 8-K filed on February 26, 2014 for pro forma financial information related to the Divestiture Transaction and the NY1 & NY2 Deconsolidation for the three and twelve months ended December 31, 2013, as if the transactions had occurred at the beginning of the respective periods. Also refer to TDS' Form 8-K filed on May 3, 2013 for pro forma financial information related to the Divestiture Transaction and the NY1 & NY2 Deconsolidation for the twelve months ended December 31, 2012.

REGULATORY DEVELOPMENTS

FCC Reform Order

In 2011, the FCC released an order ("Reform Order") to: reform its universal service and intercarrier compensation mechanisms; establish a new, broadband-focused support mechanism; and propose further rules to advance reform. Appeals of the Reform Order were consolidated and argued in the U.S. Court of Appeals for the 10th Circuit on November 19, 2013, with a decision anticipated in 2014.

There have been no significant changes to the Reform Order since December 31, 2012 that are expected to adversely affect U.S. Cellular or TDS Telecom. U.S. Cellular and TDS Telecom cannot predict the outcome of the consolidated appeals referred to above or any future rulemaking, reconsideration or legal challenges and, as a consequence, the impacts that such potential developments may have on U.S. Cellular's or TDS Telecom's business, financial condition or results of operations.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

FCC Interoperability Order

On October 25, 2013, the FCC adopted a Report and Order and Order of Proposed Modification confirming a voluntary industry agreement on interoperability in the Lower 700 MHz spectrum band. The FCC's Report and Order lays out a roadmap for the voluntary commitments of AT&T and DISH Network Corporation ("DISH") to become fully binding under a regulatory framework which will require the FCC to take additional actions proposed to be completed by the first quarter of 2014. Pursuant to this voluntary agreement, AT&T will begin incorporating changes in its network and devices that will foster interoperability across all paired spectrum blocks in the Lower 700 MHz Band, collectively comprising "Band 12" under the standards of the 3rd Generation Partnership Project ("3GPP"). AT&T also agreed to support LTE roaming on its networks for carriers with compatible Band 12 devices, consistent with the FCC's rules on roaming. As outlined in its voluntary commitment, AT&T will be implementing the foregoing changes in phases starting with network software enhancement taking place possibly through the third quarter of 2015 with its Band 12 device roll-out to follow. In addition the FCC has adopted changes in its technical rules for certain unpaired spectrum licensed to AT&T and DISH in the Lower 700 MHz band to enhance prospects for Lower 700 MHz interoperability. AT&T's network and devices currently only interoperate across two of the three paired blocks in the Lower 700 MHz band. U.S. Cellular's LTE deployment, carried out in conjunction with its partner, King Street Wireless, utilizes spectrum in all three of these blocks and consequently was not interoperable with the AT&T configuration. U.S. Cellular believes that the FCC action will broaden the ecosystem of devices available to U.S. Cellular's customers over time.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS—CONSOLIDATED

Year Ended December 31,
  2013   Increase/
(Decrease)
  Percentage
Change
  2012   Increase/
(Decrease)
  Percentage
Change
  2011  
(Dollars in thousands, except per share amounts)
 

Operating revenues

                                           

U.S. Cellular

  $ 3,918,836   $ (533,248 )   (12 )% $ 4,452,084   $ 108,738     3 % $ 4,343,346  

TDS Telecom

    947,003     92,497     11 %   854,506     39,118     5 %   815,388  

All other(1)

    35,397     (3,290 )   (9 )%   38,687     16,950     78 %   21,737  
                                   

Total operating revenues

    4,901,236     (444,041 )   (8 )%   5,345,277     164,806     3 %   5,180,471  

Operating expenses

   
 
   
 
   
 
   
 
   
 
   
 
   
 
 

U.S. Cellular

    3,771,971     (523,457 )   (12 )%   4,295,428     232,862     6 %   4,062,566  

TDS Telecom

    902,171     88,407     11 %   813,764     97,027     14 %   716,737  

All other(1)

    (8,265 )   (60,487 )   >(100 )%   52,222     13,556     35 %   38,666  
                                   

Total operating expenses

    4,665,877     (495,537 )   (10 )%   5,161,414     343,445     7 %   4,817,969  

Operating income (loss)

   
 
   
 
   
 
   
 
   
 
   
 
   
 
 

U.S. Cellular

    146,865     (9,791 )   (6 )%   156,656     (124,124 )   (44 )%   280,780  

TDS Telecom

    44,832     4,090     10 %   40,742     (57,909 )   (59 )%   98,651  

All other(1)

    43,662     57,197     >100 %   (13,535 )   3,394     20 %   (16,929 )
                                   

Total operating income

    235,359     51,496     28 %   183,863     (178,639 )   (49 )%   362,502  

Other income (expenses)

   
 
   
 
   
 
   
 
   
 
   
 
   
 
 

Equity in earnings of unconsolidated entities

    132,714     39,847     43 %   92,867     10,329     13 %   82,538  

Interest and dividend income

    9,092     (156 )   (2 )%   9,248     103     1 %   9,145  

Gain (loss) on investments

    14,547     18,265     >100 %   (3,718 )   (27,821 )   >(100 )%   24,103  

Interest expense

    (98,811 )   12,066     14 %   (86,745 )   (31,456 )   (27 )%   (118,201 )

Other, net

    (37 )   (757 )   >(100 )%   720     (2,938 )   (80 )%   3,658  
                                   

Total other income (expenses)

    57,505     45,133     >100 %   12,372     11,129     >100 %   1,243  
                                   

Income before income taxes

    292,864     96,629     49 %   196,235     (167,510 )   (46 )%   363,745  

Income tax expense

    126,043     52,461     71 %   73,582     (39,921 )   (35 )%   113,503  
                                   

Net income

    166,821     44,168     36 %   122,653     (127,589 )   (51 )%   250,242  

Less: Net income attributable to noncontrolling interests, net of tax

    24,894     (15,898 )   (39 )%   40,792     (8,884 )   (18 )%   49,676  
                                   

Net income attributable to TDS shareholders

    141,927     60,066     73 %   81,861     (118,705 )   (59 )%   200,566  

Preferred dividend requirement

    (49 )   (1 )   (2 )%   (50 )           (50 )
                                   

Net income available to common shareholders

  $ 141,878   $ 60,067     73 % $ 81,811   $ (118,705 )   (59 )% $ 200,516  
                                   
                                   

Basic earnings per share attributable to TDS shareholders

  $ 1.31   $ 0.56     75 % $ 0.75   $ (1.10 )   (59 )% $ 1.85  

Diluted earnings per share attributable to TDS shareholders

  $ 1.29   $ 0.54     72 % $ 0.75   $ (1.08 )   (59 )% $ 1.83  

N/M—Percentage change not meaningful

(1)
Consists of Non-Reportable Segment, corporate operations and intercompany eliminations between U.S. Cellular, TDS Telecom, the Non-Reportable Segment and corporate operations. TDS recognized an incremental gain of $53.5 million compared to U.S. Cellular upon closing of the Divestiture Transaction as a result of lower asset basis in the assets disposed.

Operating Revenues and Expenses

See "Results of Operations—U.S. Cellular" and "Results of Operations—TDS Telecom" below for factors that affected Operating revenues and expenses.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Equity in earnings of unconsolidated entities

Equity in earnings of unconsolidated entities represents TDS' share of net income from entities in which it has a noncontrolling interest and that are accounted for by the equity method. TDS generally follows the equity method of accounting for unconsolidated entities in which its ownership interest is less than or equal to 50% but equals or exceeds 20% for corporations and 3% for partnerships and limited liability companies, or for unconsolidated entities in which its ownership is greater than 50% but TDS does not have a controlling financial interest.

TDS' investment in the Los Angeles SMSA Limited Partnership ("LA Partnership") contributed $78.4 million, $67.2 million and $55.3 million to Equity in earnings of unconsolidated entities in 2013, 2012 and 2011, respectively. TDS received cash distributions from the LA Partnership of $71.5 million in 2013 and $66.0 million in 2012 and 2011.

On April 3, 2013, TDS deconsolidated the NY1 & NY2 Partnerships and began reporting them as equity method investments in its consolidated financial statements as of that date. In 2013, TDS' investment in the NY1 & NY2 Partnerships contributed $24.7 million to Equity in earnings of unconsolidated entities subsequent to their deconsolidation. No amounts were included in 2012 or 2011 because the NY1 & NY2 Partnerships were consolidated in those years. Distributions from the NY1 & NY2 Partnerships of $29.4 million in 2013, after the deconsolidation on April 1, 2013, are included in Distributions from unconsolidated entities on the Consolidated Statement of Cash Flows.

Gain (loss) on investments

In connection with the deconsolidation of the NY1 & NY2 Partnerships, TDS recognized a non-cash pre-tax gain of $14.5 million which was recorded in Gain (loss) on investments in 2013. See Note 7—Investments in Unconsolidated Entities for additional information.

Loss on investment in 2012 includes a provision for loss of $3.7 million related to a note receivable and preferred stock acquired by U.S. Cellular in connection with an acquisition in 1998. Gain on investment in 2011 includes a gain of $12.7 million from TDS' acquisition of 63% of Airadigm in September 2011 and a $13.4 million gain recorded as a result of adjusting the carrying value of a pre-existing noncontrolling interest for which U.S. Cellular purchased the remaining interest in May 2011, as more fully described in Note 5—Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements.

Interest expense

Interest expense increased $12.1 million due primarily to the issuance of TDS' 5.875% Senior Notes in November 2012 for $195.0 million. This amount was partially offset by an increase in capitalized interest during 2013. TDS recorded $15.4 million in interest expense to write-off unamortized debt issuance costs related to TDS' $282.5 million, 7.6% Senior Notes, and U.S. Cellular's $330 million, 7.5% Senior Notes, redeemed on May 2, 2011 and June 20, 2011, respectively. The impact of these write-offs in 2011, along with lower effective interest rates on long-term debt and an increase in capitalized interest for multi-year projects during 2012, resulted in the year-over-year decrease of $31.5 million expense from 2011 to 2012.

Income tax expense

The effective tax rates on Income before income taxes and extraordinary items ("pre-tax income") for 2013, 2012 and 2011 were 43.0%, 37.5% and 31.2%, respectively. The following significant discrete and other items impacted income tax expense for these years:

2013—Includes tax expense of $14.9 million related to the NY1 & NY2 Deconsolidation and the Divestiture Transaction, and a tax benefit of $5.5 million resulting from statute of limitation expirations.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

2012—Includes tax benefits of $11.3 million resulting from statute of limitation expirations and $6.1 million resulting from corrections relating to prior periods, offset by tax expense of $1.3 million related to state income tax audits and tax expense associated with increases to state deferred tax asset valuation allowances of $5.2 million.

2011—Includes a tax benefit of $26.9 million resulting from state tax law changes, a tax benefit of $9.0 million resulting from statute of limitation expirations and tax expense of $6.0 million resulting from correction of partnership tax basis relating to a prior period.

See Note 3—Income Taxes in the Notes to Consolidated Financial Statements for further information on the effective tax rate.

Net income attributable to noncontrolling interests, net of tax

Net income attributable to noncontrolling interests, net of tax includes the noncontrolling public shareholders' share of U.S. Cellular's net income, the noncontrolling shareholders' or partners' share of certain U.S. Cellular subsidiaries' net income or loss and other TDS noncontrolling interests.

Year Ended December 31,
  2013   2012   2011  
(Dollars in thousands)
   
 

Net income attributable to noncontrolling interest, net of tax U.S. Cellular

                   

Noncontrolling public shareholders'

  $ 21,775   $ 18,431   $ 28,934  

Noncontrolling shareholders' or partners'(1)

    3,119     22,361     20,742  
               

  $ 24,894   $ 40,792   $ 49,676  
               
               

(1)
The large decrease in 2013 is primarily due to the elimination of the noncontrolling interest as a result of the NY1 & NY2 Deconsolidation on April 3, 2013.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONSU.S. CELLULAR

TDS provides wireless telephone service through U.S. Cellular, an 84%-owned subsidiary. U.S. Cellular owns, manages and invests in wireless markets throughout the United States.

Summary Operating Data for U.S. Cellular Consolidated Markets

Following is a table of summarized operating data for U.S. Cellular's Consolidated Markets. Consolidated Markets herein refers to markets which U.S. Cellular currently consolidates, or previously consolidated in the periods presented, and is not adjusted in prior periods presented for subsequent divestitures or deconsolidations. Unless otherwise noted, figures reported in Results of Operations are representative of consolidated results.

As of or for the Year Ended December 31,
  2013   2012   2011  

Retail Customers

                   

Postpaid

                   

Total at end of period

    4,267,000     5,134,000     5,302,000  

Gross additions

    697,000     880,000     836,000  

Net additions (losses)

    (325,000 )   (165,000 )   (117,000 )

ARPU(1)

  $ 54.31   $ 54.32   $ 52.20  

Churn rate(2)

    1.8 %   1.7 %   1.5 %

Smartphone penetration(3)(4)

    50.8 %   41.8 %   30.5 %

Prepaid

                   

Total at end of period

    343,000     423,000     306,000  

Gross additions

    309,000     368,000     228,000  

Net additions (losses)

    (21,000 )   118,000     (8,000 )

ARPU(1)

  $ 31.44   $ 33.26   $ 33.42  

Churn rate(2)

    7.0 %   6.0 %   6.6 %

Total customers at end of period

    4,774,000     5,798,000     5,891,000  

Billed ARPU(1)

  $ 50.73   $ 50.81   $ 48.63  

Service revenue ARPU(1)

  $ 57.61   $ 58.70   $ 56.54  

Smartphones sold as a percent of total devices sold

    68.4 %   55.8 %   44.0 %

Total Population

                   

Consolidated markets(5)

    58,013,000     93,244,000     91,965,000  

Consolidated operating markets(5)

    31,759,000     46,966,000     46,888,000  

Market penetration at end of period

                   

Consolidated markets(6)

    8.2 %   6.2 %   6.4 %

Consolidated operating markets(6)

    15.0 %   12.3 %   12.6 %

Capital expenditures (000s)

  $ 737,501   $ 836,748   $ 782,526  

Total cell sites in service

    6,975     8,028     7,882  

Owned towers in service

    4,448     4,408     4,311  

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Summary Operating Data for U.S. Cellular Core Markets

Following is a table of summarized operating data for U.S. Cellular's Core Markets (which excludes the Divestiture Markets and NY1 and NY2 markets) as of or for the year ended December 31, 2013 or 2012.

As of or for the Year Ended December 31,
  2013   2012  

Retail Customers

             

Postpaid

             

Total at end of period

    4,267,000     4,496,000  

Gross additions

    682,000     746,000  

Net additions (losses)

    (217,000 )   (92,000 )

ARPU(1)

  $ 54.23   $ 53.65  

Churn rate(2)

    1.7 %   1.5 %

Smartphone penetration(3)(4)

    50.8 %   41.1 %

Prepaid

             

Total at end of period

    343,000     342,000  

Gross additions

    295,000     288,000  

Net additions (losses)

    2,000     124,000  

ARPU(1)

  $ 31.45   $ 32.98  

Churn rate(2)

    6.7 %   5.2 %

Total customers at end of period

    4,774,000     5,022,000  

Billed ARPU(1)

  $ 50.82   $ 50.54  

Service revenue ARPU(1)

  $ 57.66   $ 58.49  

Smartphones sold as a percent of total devices sold

    68.6 %   56.1 %

Total Population

             

Consolidated markets(5)

    58,013,000     83,384,000  

Consolidated operating markets(5)

    31,759,000     31,445,000  

Market penetration at end of period

             

Consolidated markets(6)

    8.2 %   6.0 %

Consolidated operating markets(6)

    15.0 %   16.0 %

Capital expenditures (000s)

  $ 735,082   $ 768,884  

Total cell sites in service

    6,161     6,130  

Owned towers in service

    3,913     3,847  

(1)
ARPU metrics are calculated by dividing a revenue base by an average number of customers by the number of months in the period. These revenue bases and customer populations are shown below:

a.
Postpaid ARPU consists of total postpaid service revenues and postpaid customers.

b.
Prepaid ARPU consists of total prepaid service revenues and prepaid customers.

c.
Billed ARPU consists of total postpaid, prepaid and reseller service revenues and postpaid, prepaid and reseller customers.

d.
Service revenue ARPU consists of total retail service revenues, inbound roaming and other service revenues and postpaid, prepaid and reseller customers.

(2)
Churn metrics represent the percentage of the postpaid or prepaid customers that disconnects service each month. These metrics represent the average monthly postpaid or prepaid churn rate for each respective period.

(3)
Smartphones represent wireless devices which run on an Android, Apple, BlackBerry or Windows Mobile operating system, excluding tablets.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

(4)
Smartphone penetration is calculated by dividing postpaid smartphone customers by total postpaid customers.

(5)
Used only to calculate market penetration of consolidated and core markets and consolidated and core operating markets, respectively. See footnote (6) below.

(6)
Market penetration is calculated by dividing the number of wireless customers at the end of the period by the total population of consolidated and core markets and consolidated and core operating markets, respectively, estimated by Claritas.

Components of Operating Income

Year Ended December 31,
  2013   Increase/
(Decrease)
  Percentage
Change
  2012   Increase/
(Decrease)
  Percentage
Change
  2011  
(Dollars in thousands)
   
 

Retail service

  $ 3,165,496   $ (382,483 )   (11)%   $ 3,547,979   $ 61,457     2%   $ 3,486,522  

Inbound roaming

    263,186     (85,531 )   (25)%     348,717     408     N/M     348,309  

Other

    166,091     (36,069 )   (18)%     202,160     (16,806 )   (8)%     218,966  
                                   

Service revenues

    3,594,773     (504,083 )   (12)%     4,098,856     45,059     1%     4,053,797  

Equipment sales

    324,063     (29,165 )   (8)%     353,228     63,679     22%     289,549  
                                   

Total operating revenues

    3,918,836     (533,248 )   (12)%     4,452,084     108,738     3%     4,343,346  

System operations (excluding Depreciation, amortization and accretion reported below)

   
763,435
   
(183,370

)
 
(19)%
   
946,805
   
17,426
   
2%
   
929,379
 

Cost of equipment sold

    999,000     63,053     7%     935,947     144,145     18%     791,802  

Selling, general and administrative

    1,677,395     (87,538 )   (5)%     1,764,933     (4,768 )   N/M     1,769,701  

Depreciation, amortization and accretion

    803,781     195,148     32%     608,633     35,076     6%     573,557  

(Gain) loss on asset disposals, net

    30,606     (12,518 )   (69)%     18,088     (8,199 )   (83)%     9,889  

(Gain) loss on sale of business and other exit costs, net

    (246,767 )   267,789     >100%     21,022     (21,022 )   N/M      

(Gain) loss on license sales and exchanges

    (255,479 )   255,479     N/M         (11,762 )   N/M     (11,762 )
                                   

Total operating expenses

    3,771,971     (523,457 )   (12)%     4,295,428     232,862     6%     4,062,566  
                                   

Operating income

  $ 146,865   $ (9,791 )   (6)%   $ 156,656   $ (124,124 )   (44)%   $ 280,780  
                                   
                                   

N/M—Percentage change not meaningful

Operating Revenues

Service revenues

Service revenues consist primarily of: (i) charges for access, airtime, roaming, recovery of regulatory costs and value-added services, including data products and services, provided to U.S. Cellular's retail customers and to end users through third-party resellers ("retail service"); (ii) charges to other wireless carriers whose customers use U.S. Cellular's wireless systems when roaming, including long-distance roaming ("inbound roaming"); and (iii) amounts received from the Federal USF.

Retail service revenues

Retail service revenues decreased by $382.5 million, or 11%, to $3,165.5 million due primarily to a decrease in U.S. Cellular's average customer base (including the reductions caused by the Divestiture Transaction and NY1 & NY2 Deconsolidation) and a slight decrease in billed ARPU. In 2012, retail service revenues increased by $61.5 million, or 2%, to $3,548.0 million due primarily to the impact of an increase in billed ARPU, partially offset by a decrease in U.S. Cellular's average customer base.

In the fourth quarter of 2013, U.S. Cellular issued loyalty reward points with a value of $43.5 million as a loyalty bonus in recognition of the inconvenience experienced by customers during U.S. Cellular's recent billing system conversion. The value of the loyalty bonus reduced Operating revenues in the Consolidated Statement of Operations and increased Customer deposits and deferred revenues in the Consolidated Balance Sheet.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Billed ARPU of $50.73 in 2013 was relatively flat compared to $50.81 in 2012. The special issuance of loyalty rewards points in the fourth quarter of 2013 negatively impacted billed ARPU by $0.70 in 2013, which was partially offset by an increase in smartphone adoption and corresponding revenues from data products and services. The increase in billed ARPU in 2012 from $48.63 in 2011 also reflects the impact of a larger portion of the customer base using smartphones which drives incremental data access revenue.

U.S. Cellular expects continued pressure on revenues in the foreseeable future due to industry competition for customers and related effects on pricing of service plan offerings offset to some degree by continued adoption of smartphones and data usage.

Inbound roaming revenues

Inbound roaming revenues decreased by $85.5 million, or 25% in 2013 to $263.2 million. The decrease was due primarily to lower rates ($47.9 million) and the impacts of the Divestiture Transaction and NY1 & NY2 Deconsolidation ($37.6 million). Data volume increased year-over year but the impact of this increase was offset by the combined impacts of lower volume for voice and lower rates for both data and voice. The decline in roaming revenues was offset by a decline in roaming expense also due to lower rates. U.S. Cellular expects continued growth in data volume but also expects that the revenue impact of this growth will be offset by the impacts of decreases in data rates and voice volume.

Inbound roaming revenues of $348.7 million were flat in 2012 compared to 2011 as higher data revenues, reflecting significantly higher volumes but lower negotiated rates, were offset by lower voice revenues, reflecting both lower volumes and rates.

Other revenues

Other revenues decreased by $36.1 million, or 18%, in 2013 compared to 2012. In 2012, Other revenues decreased by $16.8 million, or 8%. The decreases in both years are due primarily to decreases in ETC support.

Pursuant to the FCC's Reform Order (See "Overview—FCC Reform Order"), U.S. Cellular's current ETC support is being phased down at the rate of 20% per year beginning July 1, 2012. 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 continue to receive 60% of its baseline support until the Phase II Mobility Fund is operational.

At this time, U.S. Cellular cannot predict the net effect of the FCC's changes to the USF high cost support program in the Reform Order. 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.

Equipment sales revenues

Equipment sales revenues include revenues from sales of wireless devices and related accessories to both new and existing customers, as well as revenues from sales of wireless devices and accessories to agents. All Equipment sales revenues are recorded net of rebates.

U.S. Cellular offers a competitive portfolio of quality wireless devices to both new and existing customers. U.S. Cellular's customer acquisition and retention efforts include offering new wireless devices to customers at discounted prices; in addition, customers on currently offered rate plans receive loyalty reward points that may be used to purchase a new wireless device or accelerate the timing of a customer's eligibility for a wireless device upgrade at promotional pricing. U.S. Cellular also continues to sell wireless devices to agents including national retailers; this practice enables U.S. Cellular to provide better control over the quality of wireless devices sold to its customers, establish roaming preferences and earn quantity discounts from wireless device manufacturers which are passed along to agents and other retailers.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

The decrease in 2013 equipment sales revenues of $29.2 million, or 8%, to $324.1 million was driven primarily by selling fewer devices, partially due to the Divestiture Transaction. Declines in volume were offset by an increase of 12.0% in average revenue per device. The increase in 2012 equipment sales revenues of $63.7 million, or 22%, to $353.2 million was driven primarily by a 17% increase in average revenue per wireless device sold; an increase in equipment activation fees also was a factor. Average revenue per wireless device sold increased in both years due to a continued shift in customer preference to higher priced smartphones.

Operating Expenses

System operations expenses (excluding Depreciation, amortization and accretion)

System operations expenses (excluding Depreciation, amortization and accretion) include charges from telecommunications service providers for U.S. Cellular's customers' use of their facilities, costs related to local interconnection to the wireline network, charges for cell site rent and maintenance of U.S. Cellular's network, long-distance charges, outbound roaming expenses and payments to third-party data product and platform developers.

System operations expenses decreased $183.4 million, or 19%, to $763.4 million in 2013 and increased $17.4 million, or 2%, to $946.8 million in 2012. Key components of the net changes in System operations expenses were as follows:

Expenses incurred when U.S. Cellular's customers used other carriers' networks while roaming decreased $64.1 million, or 27%, in 2013 and $11.1 million, or 4%, in 2012, due primarily to lower rates and the impacts of the Divestiture Transaction and NY1 & NY2 Deconsolidation. For both years, data roaming usage increased; however, the impact of the increase was more than offset by lower rates for both data and voice and lower voice volume.

Maintenance, utility and cell site expenses decreased $61.6 million, or 15%, in 2013 and increased $24.4 million, or 6%, in 2012. The decrease in 2013 is driven primarily by impacts of the Divestiture Transaction and reductions in expenses related to 3G equipment support and network costs, offset by increases in charges related to 4G LTE equipment and network costs. The increase in 2012 is driven primarily by an increase in the number of cell sites within U.S. Cellular's network and costs related to the deployment and operation of LTE networks.

Customer usage expenses decreased by $57.7 million, or 19%, in 2013, and increased by $4.1 million, or 1%, in 2012. The decrease in 2013 is driven by impacts of the Divestiture Transaction and decreases in intercarrier charges as a result of the FCC's Reform Order and certain data costs, partially offset by increases due to network costs for 4G LTE. The increase in 2012 is due primarily to an increase in data capacity and usage, offset by a decline in voice usage as well as reduced intercarrier compensation expenses as a result of the FCC's Reform Order.

U.S. Cellular expects system operations expenses to increase in the future to support the continued growth in cell sites and other network facilities as it continues to add capacity, enhance quality and deploy new technologies as well as to support increases in total customer usage, particularly data usage. However, these increases are expected to be offset to some extent by cost savings generated by shifting data traffic to the 4G LTE network from the 3G network.

Cost of equipment sold

Cost of equipment sold increased $63.1 million, or 7%, in 2013 and $144.1 million, or 18% in 2012. In both years, the increase was driven primarily by an increase in the average cost per wireless device sold (33% in 2013 and 18% in 2012). Average cost per device sold increased due to general customer preference for higher priced 4G LTE smartphones, including the introduction of Apple products in the fourth quarter of 2013. In 2013, total devices sold decreased by 18% partially due to the Divestiture Transaction; in 2012, total devices sold increased by 1%.

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Telephone and Data Systems, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

U.S. Cellular's loss on equipment, defined as equipment sales revenues less cost of equipment sold, was $674.9 million, $582.7 million and $502.3 million for 2013, 2012 and 2011, respectively. U.S. Cellular expects loss on equipment to continue to be a significant cost in the foreseeable future as wireless carriers continue to use device pricing as a means of competitive differentiation. In addition, U.S. Cellular expects increasing sales of data centric wireless devices to result in higher equipment subsidies over time; these devices generally have higher purchase costs which cannot be recovered through proportionately higher selling prices to customers under the standard contract/subsidy model the industry has operated with for many years. However, U.S. Cellular is beginning to offer new equipment pricing constructs such as device financing to offset a higher proportion of increasing equipment costs.

Selling, general and administrative expenses

Selling, general and administrative expenses include salaries, commissions and expenses of field sales and retail personnel and facilities; telesales department salaries and expenses; agent commissions and related expenses; corporate marketing and merchandise management; and advertising expenses. Selling, general and administrative expenses also include bad debts expense, costs of operating customer care centers and corporate expenses.

Selling, general and administrative expenses decreased by $87.5 million to $1,677.4 million in 2013 and by $4.8 million to $1,764.9 in 2012. Key components of the net changes in Selling, general and administrative expenses were as follows:

2013—

Selling and marketing expenses decreased by $75.7 million, or 9%, primarily from lower commission expenses, more cost-effective advertising spending and reduced employee and facilities costs as a result of the Divestiture Transaction.

General and administrative expenses decreased by $11.8 million, or 1%, driven by corporate cost containment and reduction initiatives and reduced spending as a result of the Divestiture Transaction, offset by costs associated with launching the new billing system of $55.8 million and higher bad debts expense of $31.5 million due to higher customer accounts receivable balances resulting from billing issues experienced after the system conversion.

2012—

Selling and marketing expenses decreased by $24.8 million, or 3%, primarily from more cost-effective advertising spending.

General and administrative expenses increased by $20.1 million, or 2%, driven by increases in bad debts expense, Federal Universal Service Charge ("FUSC") expense and non-income tax expense. FUSC charges are assessed to customers and also included in Service revenues.

Depreciation, amortization and accretion

Depreciation, amortization and accretion expense increased $195.1 million, or 32%, in 2013, and $35.1 million, or 6%, in 2012 due primarily to the acceleration of depreciation, amortization and accretion in the Divestiture Markets. The impact of the acceleration year over year was $158.5 million in 2013. The accelerated depreciation, amortization and accretion in the Divestiture Markets is expected to conclude in the first quarter of 2014.

(Gain) loss on asset disposals, net

(Gain) loss on asset disposals, net was a loss of $30.6 million in 2013 and $18.1 million in 2012 due primarily to losses resulting from the write-off and disposals of certain network assets.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

(Gain) loss on sale of business and other exit costs, net

(Gain) loss on sale of business and other exit costs, net was a gain of $246.8 million in 2013, primarily related to the closing of the Divestiture Transaction. The loss of $21.0 million in 2012 was due primarily to employee severance costs and asset write-offs in the Divestiture Markets, partially offset by a $4.2 million gain resulting from the sale of a wireless market in March 2012.

(Gain) loss on license sales and exchanges

(Gain) loss on license sales and exchanges resulted from the sale of the Mississippi Valley non-operating market license for $308.0 million, which resulted in a pre-tax gain of $250.6 million.


RESULTS OF OPERATIONS—TDS TELECOM

TDS conducts its Wireline, Cable and HMS operations through TDS Telecom, a wholly-owned subsidiary. The following table summarizes operating data for Wireline and Cable operations:

As of December 31,
  2013   2012   2011  

Wireline

                   

Residential connections

                   

Voice(1)

    352,100     374,700     399,300  

Broadband(2)

    227,000     229,900     230,600  

IPTV

    13,800     7,900     4,600  
               

Wireline residential connections

    592,900     612,500     634,500  
               
               

Commercial connections

                   

Voice(1)

    218,400     243,100     271,700  

Broadband(2)

    27,100     29,700     32,800  

managedIP(3)

    127,600     94,600     53,500  
               

Wireline commercial connections

    373,100     367,400     358,000  
               
               

Total Wireline connections

    966,000     979,900     992,500  
               
               

Total residential revenue per connection(4)

  $ 40.53   $ 39.65   $ 38.86  

Residential broadband penetration(5)

    66 %   63 %   60 %

Cable

   
 
   
 
   
 
 

Cable connections

                   

Video(6)

    69,200              

Broadband(7)

    61,000              

Voice(7)

    17,200              
                   

Cable connections

    147,400              
                   
                   

Total residential revenue per connection(4)

  $ 55.43              

(1)
The individual circuit connecting a customer 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.

(4)
Total residential revenue divided by the average number of total residential connections.

(5)
Total number of broadband connections divided by total primary residential connections.

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(6)
Generally, a home or business receiving video programming counts as one video connection. In counting bulk residential or commercial connections, such as an apartment building or a hotel, connections are counted based on the number of units/rooms within the building receiving service.

(7)
Broadband and voice connections reflect billable number of lines into a building for high speed data and voice services, respectively.

TDS Telecom Total (Wireline, Cable and HMS Operations)

Components of Operating Income

Year Ended December 31,
  2013   Increase/
(Decrease)
  Percentage
Change
  2012   Increase/
(Decrease)
  Percentage
Change
  2011  
(Dollars in thousands)
   
   
   
   
   
   
   
 

Operating revenues

                                       

Wireline

  $ 726,567   $ (15,181 ) (2)%   $ 741,748   $ (26,460 ) (3)%   $ 768,208  

Cable

    35,883     35,883   N/M           N/M      

HMS

    185,616     72,606   64%     113,010     65,830   >100%     47,180  

Intra-company elimination

    (1,063 )   (811 ) >(100)%     (252 )   (252 ) N/M      
                               

TDS Telecom operating revenues

    947,003     92,497   11%     854,506     39,118   5%     815,388  

Operating expenses

   
 
   
 
 
 
   
 
   
 
 
 
   
 
 

Wireline

    661,561     (21,805 ) (3)%     683,366     18,760   3%     664,606  

Cable

    35,927     35,927   N/M           N/M      

HMS

    205,746     75,096   57%     130,650     78,519   >100%     52,131  

Intra-company elimination

    (1,063 )   (811 ) >(100)%     (252 )   (252 ) N/M      
                               

TDS Telecom operating expenses

    902,171     88,407   11%     813,764     97,027   14%     716,737  
                               

TDS Telecom operating income

  $ 44,832   $ 4,090   10%   $ 40,742   $ (57,909 ) (59)%   $ 98,651  
                               
                               

N/M—Not meaningful

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Management's Discussion and Analysis of Financial Condition and Results of Operations

Wireline Operations

Components of Operating Income

Year Ended December 31,
  2013   Increase/
(Decrease)
  Percentage
Change
  2012   Increase/
(Decrease)
  Percentage
Change
  2011  
(Dollars in thousands)
   
   
   
   
   
   
   
 

Operating revenues

                                       

Residential

  $ 293,217   $ (3,375 ) (1)%   $ 296,592   $ (5,272 ) (2)%   $ 301,864  

Commercial

    232,910     2,436   1%     230,474     (951 ) N/M     231,425  

Wholesale

    200,440     (14,242 ) (7)%     214,682     (20,237 ) (9)%     234,919  
                               

Total operating revenues

    726,567     (15,181 ) (2)%     741,748     (26,460 ) (3)%     768,208  

Operating expenses

   
 
   
 
 
 
   
 
   
 
 
 
   
 
 

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

    270,466     (3,599 ) (1)%     274,065     (636 ) N/M     274,701  

Selling, general and administrative expenses

    220,097     (15,619 ) (7)%     235,716     14,602   7%     221,114  

Depreciation, amortization and accretion

    170,868     (1,658 ) (1)%     172,526     4,863   3%     167,663  

Loss on asset disposals, net

    130     (890 ) (87)%     1,020     (108 ) (10)%     1,128  

Loss on sale of business and other exit costs, net

        (39 ) N/M     39     39   N/M      
                               

Total operating expenses

    661,561     (21,805 ) (3)%     683,366     18,760   3%     664,606  
                               

Total operating income

  $ 65,006   $ 6,624   11%   $ 58,382   $ (45,220 ) (44)%   $ 103,602  
                               
                               

N/M—Not meaningful

Operating Revenues

Residential revenues consist of voice, data and video services to Wireline's residential customer base.

Residential revenues decreased $3.4 million or 1% to $293.2 million in 2013. A 3% reduction in the number of average residential connections reduced revenues by $7.9 million partially offset by a $5.2 million increase due to growth in average revenue per residential connection of 2%. The growth in average revenue was mainly driven by broadband price increases, growth in customers opting for faster broadband speeds and the growth of customers selecting higher tier IPTV packages.

Residential revenues decreased $5.3 million or 2% to $296.6 million in 2012. Reductions in the number of residential connections of 4% negatively impacted residential revenues by $9.8 million. Customers choosing higher speed data plans primarily drove a 2% increase in average revenue per residential connection in 2012, which increased residential revenues $6.6 million.

Commercial revenues consist of data and voice services and sales and installation of IP-based telecommunications systems to Wireline's commercial customer base.

Commercial revenues increased $2.4 million or 1% to $232.9 million in 2013. A 2% increase in average commercial connections, which was driven by the 49% growth in managedIP as customers converted from traditional voice and data connections, increased revenues by $4.4 million. This increase was partially offset by a 1% decline in average revenue per commercial connection, primarily driven by lower managedIP rates, which decreased revenues $2.7 million.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

Commercial revenues decreased $1.0 million to $230.5 million in 2012 due primarily to a $2.5 million decline in business systems sales and charges for directory assistance. A $4.8 million increase in revenue resulting from an increase in commercial connections was partially offset by a $3.2 million decrease in the average revenue per commercial connection primarily driven by lower managedIP rates.

Wholesale revenues consist of compensation from other carriers for utilizing TDS Telecom's network infrastructure and regulatory recoveries.

Wholesale revenues decreased $14.2 million or 7% to $200.4 million in 2013. Network access revenues decreased $6.8 million in 2013 as a result of changes in support mechanisms and in intercarrier compensation resulting from the Reform Order released by the FCC in November 2011. Wholesale revenues also declined $5.3 million due to a 15% reduction in intra-state minutes-of-use.

Wholesale revenues decreased $20.2 million or 9% to $214.7 million in 2012. Wholesale revenues decreased $10.0 million in 2012 as a result of changes in support mechanisms and in intercarrier compensation resulting from the Reform Order. Revenues received through interstate and intrastate regulatory recovery mechanisms also decreased $5.7 million due to changes in eligible expense recovery thresholds and reductions in the pool earnings. Additionally, Wholesale revenues declined $5.1 million due to a 11% decline in intrastate minutes of use.

Operating Expenses

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

Cost of services and products decreased $3.6 million or 1% to $270.5 million in 2013 due primarily to a $5.4 million decrease in cost of goods sold related to long distance services and promotional giveaways. In addition, carrier interconnection charges decreased $2.3 million as a result of lower access charges that became effective related to the Reform Order. Employee expense decreased $1.1 million due to a reduction in employees. Offsetting the decreases were increases in charges related to IPTV expansion.

Cost of services and products of $274.1 million in 2012 were flat compared to 2011. Increases in employee related costs, charges related to IPTV expansion and network maintenance costs were mostly offset by decreased long-distance costs, lower circuit charges, lower purchased network services, and a decrease in reciprocal compensation expense related to the FCC Reform Order which mandated rate reductions that became effective in July of 2012.

Selling, general and administrative expenses

Selling, general and administrative expenses decreased $15.6 million or 7% to $220.1 million in 2013 due primarily to decreases in employee expenses, Federal USF contributions due to lower revenues, bad debts, and property taxes.

Selling, general and administrative expenses increased $14.6 million or 7% to $235.7 million in 2012. Discrete benefits recorded in 2011 including receipt of insurance proceeds, the refund of certain prior year regulatory contributions and the settlement of a legal dispute, which decreased 2011 Selling, general and administrative expenses by $7.7 million. These discrete benefits in 2011 were the primary cause of the overall expense increase from 2011 to 2012. Additionally, higher employee related and contractor costs and Federal USF contributions added to the increase in 2012.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

Cable Operations

Components of Operating Income

Year Ended December 31,
  2013(1)  
(Dollars in thousands)
   
 

Operating revenues

       

Residential

  $ 29,016  

Commercial

    6,867  
       

Total operating revenues

    35,883  

Operating expenses

   
 
 

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

    17,274  

Selling, general and administrative expenses

    11,054  

Depreciation, amortization and accretion

    7,571  

Loss on asset disposals, net

    28  
       

Total operating expenses

    35,927  
       

Total operating income (loss)

  $ (44 )
       
       

(1)
Represents the operations of Baja from August 1, 2013 (date of acquisition) to December 31, 2013.

Operating Revenues

Residential revenues consist of video, broadband and voices services to Cable's residential customer base.

Baja had 104,900 residential connections which generated revenues of $29.0 million since the acquisition of Baja on August 1, 2013.

Commercial revenues consist of video, broadband and voice services to Cable's commercial customer base.

Baja had 42,500 commercial connections which generated revenues of $6.9 million since the acquisition of Baja.

Operating Expenses

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

Cost of services and products (excluding Depreciation, amortization and accretion) of $17.3 million were incurred for programming costs and expenses related to the delivery and support of services since the acquisition of Baja.

Selling, general and administrative expenses

Selling, general and administrative expenses of $11.1 million include legal and consulting costs of $2.0 million related to the acquisition.

Depreciation, amortization and accretion expense

Depreciation, amortization and accretion expense of $7.6 million was incurred since the acquisition of Baja. Amortization of the acquired customer list and trade name contributed $3.0 million of expense.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

HMS Operations

Components of Operating Income

Year Ended December 31,
  2013   Increase/
(Decrease)
  Percentage
Change
  2012   Increase/
(Decrease)
  Percentage
Change
  2011  
(Dollars in thousands)
   
   
   
   
   
   
   
 

Operating revenues

  $ 185,616   $ 72,606     64 % $ 113,010   $ 65,830     >100 % $ 47,180  

Operating expenses

   
 
   
 
   
 
   
 
   
 
   
 
   
 
 

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

    136,414     60,633     80 %   75,781     52,279     >100 %   23,502  

Selling, general and administrative expenses

    44,945     10,752     31 %   34,193     18,546     >100 %   15,647  

Depreciation, amortization and accretion

    24,262     3,694     18 %   20,568     7,701     60 %   12,867  

Loss on asset disposals, net

    125     17     16 %   108     (7 )   (6 )%   115  
                                   

Total operating expenses

    205,746     75,096     57 %   130,650     78,519     >100 %   52,131  
                                   

Total operating income (loss)

  $ (20,130 ) $ (2,490 )   (14 )% $ (17,640 ) $ (12,689 )   >(100 )% $ (4,951 )
                                   
                                   

Operating Revenues

HMS operating revenues consist primarily of colocation, cloud computing and hosted managed services, application management, and sales, installation and management of IT infrastructure hardware solutions.

Operating revenues increased $72.6 million to $185.6 million in 2013. The acquisitions of Vital in June of 2012 and MSN in October of 2013 contributed $64.3 million of incremental revenues. The remaining increase was due to 10% growth in recurring services primarily consisting of colocation, cloud and hosted managed services, and application management.

Operating revenues increased $65.8 million to $113.0 million in 2012. The acquisitions of OneNeck IT Services in June of 2011 and Vital in June of 2012 contributed $64.1 million of incremental revenues.

Operating Expenses

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

Cost of services and products increased $60.6 million to $136.4 million in 2013 and increased $52.3 million to $75.8 million in 2012. Acquisitions increased Cost of services and products $52.8 million and $47.7 million in 2013 and 2012, respectively. Employee related expense also increased in 2013 by $5.7 million in addition to increased data center costs to support revenue growth.

Selling, general and administrative expense

Selling, general and administrative expense increased $10.8 million to $44.9 million in 2013 and increased $18.5 million to $34.2 million in 2012. Acquisitions increased Selling, general and administrative expense $10.6 million and $15.1 million in 2013 and 2012, respectively. Additional expenses were incurred in both 2013 and 2012 as TDS Telecom developed the infrastructure and products and services to support growth of the HMS operations.

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Depreciation, amortization and accretion expense

Depreciation, amortization and accretion expense increased $3.7 million to $24.3 million in 2013 and increased $7.7 million to $20.6 million in 2012 due primarily to acquisitions. Customer list and trade name amortization contributed $2.2 million and $4.4 million of the increase in 2013 and 2012, respectively.


INFLATION

Management believes that inflation affects TDS' business to no greater or lesser extent than the general economy.


RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In general, recently issued accounting pronouncements did not have and are not expected to have a significant effect on TDS' financial condition and results of operations.

See Note 1—Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for information on recently issued accounting pronouncements.


FINANCIAL RESOURCES

TDS operates a capital- and marketing-intensive business. TDS utilizes cash on hand, cash from operating activities, cash proceeds from divestitures and disposition of investments, short-term credit facilities and long-term debt financing to fund its acquisitions (including licenses), construction costs, operating expenses and share repurchases. Cash flows may fluctuate from quarter to quarter and year to year due to seasonality, the timing of acquisitions, capital expenditures and other factors. The table below and the following discussion in this Financial Resources section summarize TDS' cash flow activities in 2013, 2012 and 2011.

 
  2013   2012   2011  
(Dollars in thousands)
   
   
   
 

Cash flows from (used in)

                   

Operating activities

  $ 494,610   $ 1,105,172   $ 1,255,711  

Investing activities

    (260,653 )   (998,069 )   (866,089 )

Financing activities

    (144,424 )   70,103     (168,030 )
               

Net increase in cash and cash equivalents

  $ 89,533   $ 177,206   $ 221,592  
               
               

Cash Flows from Operating Activities

Cash flows from operating activities were $494.6 million in 2013 and $1,105.2 million in 2012. Significant items to note are as follows:

Net income increased by $44.2 million. This increase resulted primarily from the gains recognized as a result of the closing of the Divestiture Transaction, the NY1& NY2 Deconsolidation and the Mississippi Valley license sale. These gains were partially offset by a decrease in Operating revenues, higher cost of equipment sold, and an increase in non-cash expenses, including depreciation expense.

Net income tax payments of $175.6 million were recorded in 2013 compared to net income tax refunds of $62.0 million in 2012. The 2013 tax payments were due primarily to the gain recognized as a result of the closing of the Divestiture Transaction and the Mississippi Valley license sale. Federal tax refunds of $71.5 million were received in 2012 primarily related to a federal net operating loss in 2011 largely attributable to 100% bonus depreciation applicable to qualified capital expenditures.

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Changes in Accounts receivable combined with the impact of Bad debts expense required $188.7 million and $6.4 million in 2013 and 2012, respectively. Changes in Accounts receivable were driven primarily by billing delays encountered as a result of the conversion to a new U.S. Cellular billing system in the third quarter of 2013, which caused Accounts receivable to increase at December 31, 2013. Given these billing delays and the corresponding increase in Accounts receivable, U.S. Cellular believes it has made an adequate provision for allowance for doubtful accounts at December 31, 2013. However, such provision is an estimate, and U.S. Cellular's actual experience with uncollectible accounts in future periods could materially differ from the amounts provided in the allowance for doubtful accounts at December 31, 2013. Any such difference could have a material adverse impact on future results of operations and cash flow.

Changes in Inventory required $83.5 million in 2013 and required $29.9 million in 2012. This change was due primarily to higher costs per unit related to 4G LTE smartphones.

Changes in Accounts payable provided $86.0 million in 2013 and required $12.3 million in 2012. Changes in Accounts payable were driven primarily by payment timing differences related to operating expenses, capital expenditures and device purchases.

Cash flows from operating activities were $1,105.2 million in 2012 and $1,255.7 million in 2011. Significant items to note are as follows:

Net income decreased by $127.6 million. This decrease resulted primarily from increases in Cost of services and products and non-cash expenses, including depreciation expense.

Net income tax refunds of $62.0 million were recorded in 2012 compared to net income tax refunds of $67.0 million in 2011. Tax refunds received in 2012 were primarily for federal net operating loss carrybacks from the 2011 tax year to the 2009 and 2010 tax years. Tax refunds received in 2011 primarily represented federal refunds related to overpayment of 2010 taxes.

Changes in Accounts receivable combined with the impact of Bad debts expense required $6.4 million and $26.8 million in 2012 and 2011, respectively. Accounts receivable balances fluctuate based on the timing of customer payments, promotions and other factors.

Changes in Inventory required $29.9 million in 2012 and $13.4 million in 2011. This change was due primarily to higher inventory levels and a change in inventory mix, resulting in a higher cost per unit.

Changes in Accounts payable required $12.3 million in 2012 and provided $29.3 million in 2011. Changes in Accounts payable were primarily driven by payment timing differences related to network equipment and device purchases.

Changes in Other assets and liabilities required $30.5 million and $4.4 million in 2012 and 2011, respectively. This change was due primarily to an increase in LTE-related deferred charges.

Cash Flows from Investing Activities

TDS makes substantial investments to acquire wireless licenses and properties and to construct and upgrade telecommunications networks and facilities as a basis for creating long-term value for shareholders. In recent years, rapid changes in technology and new opportunities have required substantial investments in potentially revenue-enhancing and cost-reducing upgrades to TDS' networks.

Capital expenditures (i.e., additions to property, plant and equipment and system development expenditures) totaled $909.7 million in 2013, $1,004.6 million in 2012 and $987.2 million in 2011. Cash used for additions to property, plant and equipment is reported in the Consolidated Statement of Cash Flows, and excludes amounts accrued in Accounts receivable and Accounts payable for capital expenditures at December 31 of the current year and includes amounts received and/or paid in the

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current period that were accrued at December 31 of the prior year. Cash used for additions to property, plant and equipment totaled $883.8 million, $995.5 million and $971.8 million in 2013, 2012 and 2011, respectively. These expenditures were made to provide for customer and usage growth (in recent periods, particularly with respect to data usage growth), to upgrade service and to take advantage of service-enhancing and cost-reducing technological developments in order to maintain competitive services.

U.S. Cellular's capital expenditures totaled $737.5 million in 2013, $836.7 million in 2012 and $782.5 million in 2011 representing expenditures made to construct new cell sites, build out 4G LTE networks in certain markets, increase capacity in existing cell sites and switches, develop new and enhance existing office systems such as the new Billing and Operational Support System ("B/OSS") and customer relationship management platforms, and construct new and remodel existing retail stores.

TDS Telecom's capital expenditures totaled $164.9 million, $173.9 million, and $191.2 million in 2013, 2012, and 2011, respectively. Capital expenditures for Wireline operations totaled $140.0 million in 2013, $158.6 million in 2012 and $164.2 million in 2011 primarily representing expenditures to upgrade plant and equipment to provide enhanced services. Capital expenditures for Cable operations totaled $8.4 million in 2013. Capital expenditures for HMS operations totaled $16.5 million in 2013, $15.3 million in 2012 and $27.0 million in 2011 representing expenditures to expand data center facilities and the purchase of IT-related equipment to deliver products and services.

Cash payments for acquisitions in 2013, 2012 and 2011 were as follows:

Cash Payments for Acquisitions
  2013   2012   2011  
(Dollars in thousands)
   
   
   
 

U.S. Cellular licenses

  $ 16,540   $ 122,690   $ 4,406  

U.S. Cellular business

            19,367  

TDS Telecom HMS businesses

    33,961     40,692     95,865  

TDS Telecom cable business

    264,069          

Non-Reportable Segment(1)

            (14,130 )
               

Total

  $ 314,570   $ 163,382   $ 105,508  
               
               

(1)
Cash held by Airadigm at acquisition. TDS acquired 63% of Airadigm on September 23, 2011.

Cash amounts paid for the acquisitions may differ from the purchase price due to cash acquired in the transactions and the timing of cash payments related to the respective transactions.

Cash Received from Divestitures
  2013   2012   2011  
(Dollars in thousands)
   
   
   
 

U.S. Cellular licenses

  $ 311,989   $   $  

U.S. Cellular businesses

    499,131     49,932      

TDS Telecom wireline business

        250      
               

Total

  $ 811,120   $ 50,182   $  
               
               

U.S. Cellular received $480.0 million in cash at the close of the Divestiture Transaction in May 2013. In addition, U.S. Cellular received $10.6 million in reimbursements for certain network decommissioning costs, network site lease rent and termination costs, network access termination costs, and employee termination benefits for specified engineering employees (the "Sprint Cost Reimbursement") in 2013.

On October 4, 2013, U.S. Cellular sold the majority of its Mississippi Valley unbuilt license for $308.0 million. This sale resulted in a $250.6 million gain which was recorded in the fourth quarter of 2013.

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On August 14, 2013 U.S. Cellular entered into a definitive agreement to sell the majority of its St. Louis area unbuilt license for $92.3 million. The sale will result in an estimated pre-tax gain of $76.2 million. This transaction is subject to regulatory approval and is expected to close in the first quarter of 2014.

TDS invested $120.0 million and $180.9 million in 2012 and 2011, respectively, in U.S. Treasury Notes and corporate notes with maturities greater than three months from the acquisition date. TDS realized cash proceeds of $115.0 million, $243.4 million and $393.2 million in 2013, 2012 and 2011, respectively, related to the maturities of its investments in U.S. Treasury Notes, corporate notes and certificates of deposit.

Cash Flows from Financing Activities

Cash flows from financing activities include repayments of and proceeds from short-term and long-term debt, dividends to shareholders, distributions to noncontrolling interests, cash used to repurchase Common Shares and cash proceeds from reissuance of Common Shares pursuant to stock-based compensation plans.

In November 2012, TDS issued $195.0 million of 5.875% Senior Notes due 2061, and paid related debt issuance costs of $7.1 million.

In September 2011, Airadigm paid $32.7 million to the FCC in satisfaction of amounts due pursuant to Airadigm's plan of reorganization. See Note 5—Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to this acquisition.

In May 2011, U.S. Cellular issued $342.0 million of 6.95% Senior Notes due 2060, and paid related debt issuance costs of $11.0 million. The net proceeds from the 6.95% Senior Notes were used primarily to redeem $330.0 million of U.S. Cellular's 7.5% Senior Notes in June 2011. The redemption price of the 7.5% Senior Notes was equal to 100% of the principal amount plus accrued and unpaid interest thereon to the redemption date.

In March 2011, TDS issued $300.0 million of 7% Senior Notes due 2060, and paid related debt issuance costs of $9.7 million. The net proceeds from the 7% Senior Notes were primarily used to redeem $282.5 million of TDS' 7.6% Series A Notes in May 2011. The redemption price of the 7.6% Series A Notes was equal to 100% of the outstanding aggregate principal amount, plus accrued and unpaid interest thereon to the redemption date.

On June 25, 2013, U.S. Cellular paid a special cash dividend of $5.75 per share, for an aggregate amount of $482.3 million, to all holders of U.S. Cellular Common Shares and Series A Common Shares as of June 11, 2013. Of the $482.3 million paid, TDS received $407.1 million while noncontrolling public shareholders received $75.2 million. The cash paid to noncontrolling public shareholders is presented as U.S. Cellular dividends paid to noncontrolling public shareholders on the Consolidated Statement of Cash Flows.

TDS repurchased Common Shares for $9.7 million and $20.0 million in 2013 and 2012, respectively, and Special Common Shares for $21.5 million in 2011. U.S. Cellular repurchased Common Shares for $18.5 million, $20.0 million and $62.3 million in 2013, 2012 and 2011, respectively. See Note 15—Common Shareholders' Equity in the Notes to Consolidated Financial Statements for additional information related to these transactions.

Free Cash Flow

The following table presents Free cash flow. Free cash flow is defined as Cash flows from operating activities less Cash used for additions to property, plant and equipment. Free cash flow is a non-GAAP financial measure which TDS believes may be useful to investors and other users of its financial

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information in evaluating the amount of cash generated by business operations, after Cash used for additions to property, plant and equipment.

(Dollars in thousands)
  2013   2012   2011  

Cash flows from operating activities

  $ 494,610   $ 1,105,172   $ 1,255,711  

Cash used for additions to property, plant and equipment

    (883,797 )   (995,517 )   (971,759 )
               

Free cash flow

  $ (389,187 ) $ 109,655   $ 283,952  
               
               

See Cash flows from Operating Activities and Cash flows from Investing Activities for details on the changes to the components of Free cash flow.


LIQUIDITY AND CAPITAL RESOURCES

TDS believes that existing cash and investment balances, funds available under its revolving credit facilities and expected cash flows from operating and investing activities provide substantial liquidity and financial flexibility for TDS to meet its normal financing needs for the foreseeable future. In addition, TDS and its subsidiaries may access public and private capital markets to help meet their financing needs.

U.S. Cellular's profitability historically has been lower in the fourth quarter as a result of significant marketing and promotional activity during the holiday season. Changes in these or other economic factors could have a material adverse effect on demand for TDS' products and services and on TDS' financial condition and results of operations.

TDS cannot provide assurances that circumstances that could have a material adverse effect on its liquidity or capital resources will not occur. Economic conditions, changes in financial markets or other factors could restrict TDS' liquidity and availability of financing on terms and prices acceptable to TDS, which could require TDS to reduce its capital expenditure, acquisition or share repurchase programs. Such reductions could have a material adverse effect on TDS' business, financial condition or results of operations.

The following table summarizes TDS' and U.S. Cellular's cash and investments as of December 31, 2013.

(Dollars in thousands)
  TDS   U.S. Cellular(1)  

Cash and cash equivalents

  $ 830,014   $ 342,065  

Short-term investments

  $ 50,104   $ 50,104  

(1)
Also included as a component of the TDS column.

Cash and Cash Equivalents

Cash and cash equivalents include cash and short-term, highly liquid investments with original maturities of three months or less. The primary objective of TDS' Cash and cash equivalents investment activities is to preserve principal. At December 31, 2013, the majority of TDS' Cash and cash equivalents was held in bank deposit accounts and in money market funds that invest exclusively in U.S. Treasury Notes or in repurchase agreements fully collateralized by such obligations. TDS monitors the financial viability of the money market funds and direct investments in which it invests and believes that the credit risk associated with these investments is low.

Short-term and Long-term Investments

Short-term investments consist of U.S. Treasury Notes which are designated as held-to-maturity investments and are recorded at amortized cost in the Consolidated Balance Sheet. For these investments, TDS' objective is to earn a higher rate of return on funds that are not anticipated to be required to meet liquidity needs in the near term, while maintaining a low level of investment risk. See

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Note 2—Fair Value Measurements in the Notes to Consolidated Financial Statements for additional information on Short-term investments. As of December 31, 2013, TDS does not hold Long-term investments.

Revolving Credit Facilities

TDS and U.S. Cellular have revolving credit facilities available for general corporate purposes.

In connection with U.S. Cellular's revolving credit facility, TDS and U.S. Cellular entered into a subordination agreement dated December 17, 2010 together with the administrative agent for the lenders under U.S. Cellular's revolving credit facility. At December 31, 2013, no U.S. Cellular debt was subordinated pursuant to this subordination agreement.

TDS' and U.S. Cellular's interest cost on their revolving credit facilities is subject to increase if their current credit ratings from nationally recognized credit rating agencies are lowered, and is subject to decrease if the ratings are raised. The credit facilities would not cease to be available nor would the maturity date accelerate solely as a result of a downgrade in TDS' or U.S. Cellular's credit rating. However, a downgrade in TDS' or U.S. Cellular's credit rating could adversely affect their ability to renew the credit facilities or obtain access to other credit facilities in the future.

As of December 31, 2013, TDS' and U.S. Cellular's senior debt credit ratings from nationally recognized credit rating agencies remained at investment grade.

In June 2013, U.S. Cellular provided $17.4 million in letters of credit to the FCC in connection with U.S. Cellular's winning bids in Auction 901. See Note 19—Supplemental Cash Flow Disclosures in the Notes to Consolidated Financial Statements for additional information on Auction 901.

The continued availability of the revolving credit facilities requires TDS and U.S. Cellular to comply with certain negative and affirmative covenants, maintain certain financial ratios and make representations regarding certain matters at the time of each borrowing. TDS and U.S. Cellular believe that they were in compliance as of December 31, 2013 with all of the financial covenants and requirements set forth in their revolving credit facilities. TDS also has certain other non-material credit facilities from time to time.

See Note 10—Debt in the Notes to Consolidated Financial Statements for additional information regarding the revolving credit facilities.

Long-Term Financing

TDS and its subsidiaries' long-term debt indentures do not contain any provisions resulting in acceleration of the maturities of outstanding debt in the event of a change in TDS' credit rating. However, a downgrade in TDS' credit rating could adversely affect its ability to obtain long-term debt financing in the future. TDS believes that it and its subsidiaries were in compliance as of December 31, 2013 with all financial covenants and other requirements set forth in its long-term debt indentures. TDS and U.S. Cellular have not failed to make nor do they expect to fail to make any scheduled payment of principal or interest under such indentures.

The long-term debt principal payments due for the next four years represent less than 1% of the total long-term debt obligation at December 31, 2013. Refer to Market Risk—Long-Term Debt for additional information regarding required principal payments and the weighted average interest rates related to TDS' Long-term debt.

TDS and U.S. Cellular, at their discretion, may from time to time seek to retire or purchase their outstanding debt through cash purchases and/or exchanges for other securities, in open market purchases, privately negotiated transactions, tender offers, exchange offers or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

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TDS and U.S. Cellular each have an effective shelf registration statement on Form S-3 to issue senior or subordinated debt securities. The proceeds from any such issuances may be used for general corporate purposes, including the possible reduction of other long-term debt; in connection with acquisition, construction and development programs; the reduction of short-term debt; for working capital; to provide additional investments in subsidiaries; or the repurchase of shares. The TDS shelf registration permits TDS to issue at any time and from time to time senior or subordinated debt securities in one or more offerings in an indeterminate amount. The U.S. Cellular shelf registration statement permits U.S. Cellular to issue at any time and from time to time senior or subordinated debt securities in one or more offerings up to an aggregate principal amount of $500 million. The ability of TDS or U.S. Cellular to complete an offering pursuant to such shelf registration statements is subject to market conditions and other factors at the time.

See Note 10—Debt in the Notes to Consolidated Financial Statements for additional information on Long-term financing.

Capital Expenditures

U.S. Cellular's capital expenditures for 2014 are expected to be approximately $640 million. These expenditures are expected to be for the following general purposes:

Expand and enhance network coverage in its service areas, including providing additional capacity to accommodate increased network usage, principally data usage, by current customers;

Continue to deploy 4G LTE technology in certain markets;

Expand and enhance the retail store network; and

Develop and enhance office systems.

TDS Telecom's capital expenditures for 2014 are expected to be approximately $200 million. These expenditures are expected to be for the following general purposes:

Fiber expansion in Wireline markets to support IPTV and super high speed data;

Success-based spending to sustain managedIP, IPTV and HMS growth;

Expansion of HMS data center facilities;

Plant upgrades and success-based spending at Baja; and

Process and productivity initiatives.

TDS plans to finance its capital expenditures program for 2014 using primarily Cash flows from operating activities, and as necessary, existing cash balances and short-term investments.

Acquisitions, Divestitures and Exchanges

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

TDS also may be engaged from time to time in negotiations relating to the acquisition, divestiture or exchange of companies, properties, wireless spectrum and other possible businesses. In general, TDS may not disclose such transactions until there is a definitive agreement. See Note 5—Acquisitions, Divestitures and Exchanges and Note 7—Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information related to significant transactions.

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Variable Interest Entities

TDS consolidates certain entities because they are "variable interest entities" under accounting principles generally accepted in the United States of America ("GAAP"). See Note 13—Variable Interest Entities in the Notes to Consolidated Financial Statements for additional information related to these variable interest entities. TDS may elect to make additional capital contributions and/or advances to these variable interest entities in future periods in order to fund their operations.

Common Share Repurchase Programs

In the past year, TDS and U.S. Cellular have repurchased and expect to continue to repurchase their Common Shares, in each case subject to any available repurchase program. For additional information related to the current TDS and U.S. Cellular repurchase authorizations and repurchases made during 2013, 2012 and 2011, see Note 15—Common Shareholders' Equity in the Notes to Consolidated Financial Statements and Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Contractual and Other Obligations

At December 31, 2013, the resources required for contractual obligations were as follows:

 
  Payments Due by Period  
(Dollars in millions)
  Total   Less Than 1 Year   1 - 3 Years   3 - 5 Years   More Than 5 Years  

Long-term debt obligations(1)

  $ 1,728.7   $ 1.5   $ 3.9   $   $ 1,723.3  

Interest payments on long-term debt obligations

    4,336.2     116.1     232.1     231.8     3,756.2  

Operating leases(2)

    1,510.2     175.2     285.0     201.0     849.0  

Capital leases

    8.4     0.6     1.2     1.2     5.4  

Purchase obligations(3)(4)

    1,959.6     675.3     1,058.7     141.3     84.3  
                       

  $ 9,543.1   $ 968.7   $ 1,580.9   $ 575.3   $ 6,418.2  
                       
                       

(1)
Includes current and long-term portions of debt obligations. The total long-term debt obligation differs from Long-term debt in the Consolidated Balance Sheet due to capital leases and the $11.6 million unamortized discount related to U.S. Cellular's 6.7% Senior Notes. See Note 10—Debt in the Notes to Consolidated Financial Statements for additional information.

(2)
Includes future lease costs related to telecommunications plant facilities, office space, retail sites, cell sites, data centers and equipment. See Note 12—Commitments and Contingencies in the Notes to Consolidated Financial Statements for additional information.

(3)
Includes obligations payable under non-cancellable contracts, commitments for network facilities and services, agreements for software licensing, long-term marketing programs, and an agreement with Apple to purchase Apple iPhone products. As described more fully in Note 5—Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements, U.S. Cellular expects to incur network-related exit costs in the Divestiture Markets as a result of the transaction, including: (i) costs to decommission cell sites and mobile telephone switching office ("MTSO") sites, (ii) costs to terminate real property leases and (iii) costs to terminate certain network access arrangements in the subject markets. The impacts of these exit activities on TDS' purchase obligation are reflected in the table above only to the extent that agreements were consummated at December 31, 2013.

(4)
Does not include reimbursable amounts TDS Telecom will provide to complete projects under the American Recovery and Reinvestment Act of 2009. TDS Telecom will receive $105.1 million in federal grants and will provide $30.9 million of its own funds to complete 44 projects. As of December 31, 2013, TDS Telecom has expended $24.8 million of the $30.9 million on these projects. Under the terms of the grants, the projects must be completed by June of 2015.

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The table above excludes liabilities related to "unrecognized tax benefits" as defined by GAAP because TDS is unable to predict the period of settlement of such liabilities. Such unrecognized tax benefits were $30.4 million at December 31, 2013. See Note 3—Income Taxes in the Notes to Consolidated Financial Statements for additional information on unrecognized tax benefits.

Agreements

As previously disclosed, on August 17, 2010, TDS and Amdocs Software Systems Limited ("Amdocs") entered into a Software License and Maintenance Agreement ("SLMA") and a Master Service Agreement ("MSA") (collectively, the "Amdocs Agreements") to develop a Billing and Operational Support System ("B/OSS"). In July 2013, TDS implemented B/OSS, pursuant to an updated Statement of Work dated June 29, 2012. Total payments to Amdocs related to this implementation are estimated to be approximately $183.9 million (subject to certain potential adjustments) over the period from commencement of the SLMA through the first half of 2014. As of December 31, 2013, $136.8 million had been paid to Amdocs.

Apple iPhone Products Purchase Commitment

In March 2013, U.S. Cellular entered into an agreement with Apple to purchase certain minimum quantities of iPhone products over a three-year period beginning in November 2013. The minimum quantity of iPhone products to be purchased during the first contract year is fixed and is subject to adjustment for the second and third contract years based on the percentage growth in smartphone sales in the United States for the immediately preceding calendar year. Based on current forecasts, TDS estimates that the remaining contractual purchase commitment as of December 31, 2013 is approximately $950 million. At this time, TDS expects to meet its contractual commitment with Apple.

Off-Balance Sheet Arrangements

TDS had no transactions, agreements or other contractual arrangements with unconsolidated entities involving "off-balance sheet arrangements," as defined by SEC rules, that had or are reasonably likely to have a material current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Dividends

TDS paid quarterly dividends per outstanding share of $0.1275 in 2013, $0.1225 in 2012 and $0.1175 in 2011. TDS increased the dividend per share to $0.1340 in the first quarter of 2014. The dividends per share amount for 2011 have not been retroactively adjusted to reflect the impact of the Share Consolidation Amendment. See Note 15—Common Shareholders' Equity in the Notes to Consolidated Financial Statements for additional information. TDS has no current plans to change its policy of paying dividends.

On June 25, 2013, U.S. Cellular paid a special cash dividend of $5.75 per share, for an aggregate amount of $482.3 million, to all holders of U.S. Cellular Common Shares and Series A Common Shares as of June 11, 2013. Of the $482.3 million paid, TDS received $407.1 million while noncontrolling public shareholders received $75.2 million.


APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

TDS prepares its consolidated financial statements in accordance with GAAP. TDS' significant accounting policies are discussed in detail in Note 1—Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements.

Management believes the application of the following critical accounting policies and the estimates required by such application reflect its most significant judgments and estimates used in the preparation of TDS' consolidated financial statements. Management has discussed the development and selection of each of the following accounting policies and related estimates and disclosures with the Audit Committee of TDS' Board of Directors.

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Goodwill, Licenses and Franchise rights

See the Goodwill, Licenses and Franchise rights Impairment Assessment section of Note 1—Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for information on Goodwill, Licenses and Franchise rights impairment testing policies and methods. TDS performs annual impairment testing of Goodwill, Licenses and Franchise rights, as required by GAAP, in the fourth quarter of its fiscal year, based on fair values and net carrying values determined as of November 1.

See Note 6—Intangible Assets in the Notes to Consolidated Financial Statements for additional information related to Goodwill, Licenses and Franchise rights activity in 2013 and 2012.

Goodwill—U.S. Cellular

U.S. Cellular tests Goodwill for impairment at the level of reporting referred to as a reporting unit. For purposes of impairment testing of Goodwill in 2013, U.S. Cellular identified four reporting units based on geographic service areas (all of which are included in TDS' wireless reportable operating segment). For purposes of the impairment testing of Goodwill in 2012, U.S. Cellular identified five reporting units based on geographic service areas. The change in reporting units resulted from the NY1 & NY2 Deconsolidation more fully described in Note 7—Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements. There were no changes to U.S. Cellular's overall Goodwill impairment testing methodology between November 1, 2013 and November 1, 2012.

A discounted cash flow approach was used to value each reporting unit, using value drivers and risks specific to the industry and current economic factors. The cash flow estimates incorporated assumptions that market participants would use in their estimates of fair value and may not be indicative of U.S. Cellular specific assumptions. The most significant assumptions made in this process were the revenue growth rate (shown as a ten year compound annual growth rate in the table below), the terminal revenue growth rate, the discount rate and capital expenditures as a percentage of revenue (shown as a simple average in the table below). The averages below are based on ten year projection periods. These assumptions were as follows for November 1, 2013 and 2012:

Key Assumptions
  November 1,
2013
  November 1,
2012
 

Revenue growth rate

    2.2 %   2.2 %

Terminal revenue growth rate

    2.0 %   2.0 %

Discount rate

    10.0 %   11.0 %

Capital expenditures as a percentage of revenue

    16.0 %   15.2 %

The carrying value of each U.S. Cellular reporting unit at TDS as of November 1, 2013 was as follows:

Reporting Unit
  Carrying Value
at TDS(1)
 
(Dollars in millions)
   
 

Central Region

  $ 2,753  

Mid-Atlantic Region

    836  

New England Region

    269  

Northwest Region

    328  
       

Total

  $ 4,186  
       
       

(1)
Under previous business combination guidance in effect prior to January 1, 2009, TDS had recorded Goodwill as a result of accounting for U.S. Cellular's purchases of U.S. Cellular Common Shares as step acquisitions using purchase accounting. As a result, the carrying values of the reporting units differ between U.S. Cellular and TDS. The carrying value of the reporting units at U.S. Cellular was $4,287 million at November 1, 2013.

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As of November 1, 2013, the fair values of the reporting units exceeded their respective carrying values by amounts ranging from 18.4% to 33.4%. Therefore, no impairment of Goodwill existed. Given that the fair values of the respective reporting units exceed their respective carrying values, provided all other assumptions remained the same, the discount rate would have to increase to a range of 11.4% to 12.7% to yield estimated fair values of reporting units that equal their respective carrying values at November 1, 2013. Further, assuming all other assumptions remained the same, the terminal growth rate assumptions would need to decrease to amounts ranging from negative 5.3% to negative 1.3% to yield estimates of fair value equal to the carrying values of the respective reporting units at November 1, 2013.

Goodwill—TDS Telecom

TDS Telecom has recorded Goodwill as a result of the acquisition of ILEC, HMS and cable companies. For purposes of Goodwill impairment testing, TDS Telecom has three reporting units: ILEC, HMS and Cable.

During the third quarter of 2013, due to continued competitive pressures and negative secular and regulatory trends in the ILEC industry, TDS determined that an interim impairment test of TDS Telecom's ILEC Goodwill was required. TDS performed the Step 1 Goodwill impairment test, as defined by GAAP, as of August 1, 2013, and determined that the fair value of the ILEC reporting unit exceeded its carrying value, and accordingly no Goodwill impairment resulted.

Prior to the third quarter of 2013, HMS was comprised of three reporting units: OneNeck IT Services, TEAM Technologies, LLC/VISI Incorporated ("TEAM/VISI") and Vital. Due to changes in the management of the HMS operations and related changes in internal financial reporting that culminated in the third quarter of 2013, the three separate HMS reporting units were combined into one HMS reporting unit. This change in reporting units required TDS to perform an interim impairment test of the Goodwill in the HMS reporting unit(s) in the third quarter of 2013. TDS performed the Step 1 Goodwill impairment test as of August 1, 2013 for the three historical HMS reporting units of OneNeck IT Services, TEAM/VISI, and Vital and the newly combined HMS reporting unit. In all four of these HMS-related Step 1 Goodwill impairment tests, TDS determined that the fair value of each of the reporting units exceeded its respective carrying value, and accordingly, no Goodwill impairment resulted.

In October 2013, TDS acquired MSN. MSN is included in the HMS reporting unit for purposes of Goodwill impairment testing. However, as MSN was acquired in the fourth quarter, the assumptions discussed below relate solely to the legacy HMS reporting unit. Consistent with fair value principles, as MSN was recently purchased from a third party in an arms-length transaction, management believes that MSN's purchase price of $44 million reflects fair value and carrying value at November 1, 2013. This amount was included in the overall HMS reporting unit fair value and carrying value.

The Cable reporting unit consists of Baja, which was acquired in August 2013. A qualitative assessment, as defined by GAAP, of the reporting unit was completed as of November 1, 2013. The qualitative assessment, which analyzed company, industry and economic trends, concluded that it was more likely than not that the fair value of this reporting unit was at least equal to its carrying value, and accordingly no Goodwill impairment resulted.

The discounted cash flow approach and publicly-traded guideline company method were used to value the ILEC and HMS reporting units. The discounted cash flow approach uses value drivers and risks specific to the industry and current economic factors. The cash flow estimates incorporated assumptions that market participants would use in their estimates of fair value and may not be indicative of TDS Telecom specific assumptions. The most significant assumptions made in this process were the revenue growth rate (shown as a compound annual growth rate in the table below), the terminal revenue growth rate, the discount rate and capital expenditures as a percentage of revenue (shown as a simple average in the table below).

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The publicly-traded guideline company method develops an indication of fair value by calculating average market pricing multiples for selected publicly-traded companies using multiples of: Revenue; Earnings before Interest, Taxes, and Depreciation and Amortization; and Earnings before Interest and Taxes. The developed multiples were applied to applicable financial measures of the respective reporting unit to determine fair value. The discounted cash flow approach and publicly-traded guideline company method were weighted to arrive at the total fair value used for impairment testing.

The following tables represent key assumptions used in estimating the fair value of the ILEC and HMS (excluding MSN, as previously discussed) reporting units as of November 1, 2013 and 2012, the annual impairment testing dates. The ILEC and HMS averages below are based on five and ten year projection periods, respectively. There are uncertainties associated with these key assumptions, and potential events and/or circumstances that could have a negative effect on the key assumptions, which are described below.

The assumptions were as follows for November 1, 2013:

Key Assumptions
  ILEC   HMS  

Revenue growth rate

    (0.5 )%   10.8 %

Terminal revenue growth rate

    0.0 %   2.5 %

Discount rate

    7.5 %   12.5 %

Capital expenditures as a percentage of revenue

    15.0 %   11.2 %

The assumptions were as follows for November 1, 2012:

Key Assumptions
  ILEC   HMS  

Revenue growth rate

    (0.3 )%   6.3-16.3 %

Terminal revenue growth rate

    0.0 %   1.5-3.0 %

Discount rate

    7.0 %   11.0-13.0 %

Capital expenditures as a percentage of revenue

    15.3 %   0.4-21.9 %

Revenue growth rates

The negative average expected growth rate for the ILEC reporting unit is due primarily to declines in voice and data market share and declines in regulatory and wholesale revenues.

The mix of products and services in the HMS reporting unit is diverse and offers the following services: colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, and sales and management of IT infrastructure hardware solutions. The following sources were used to generate projected revenues:

Market participant growth rates

Internally generated forecasts, which in addition to market participant growth rates, also considered:

Current and projected staffing of the sales teams and their reasonable potential for sales quota attainment

Observed customer demand

Market and competitive knowledge

There are risks that could negatively impact the projected revenue growth rates, including, but not limited to:

Sales process execution—including the ability to attract and retain qualified sales professionals.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

Competition—competitors may gain advantages over the HMS business, and may have the ability to offer product and service offerings which TDS Telecom is not able to offer, or offer competitively.

Operations—TDS Telecom could experience operational difficulties including service disruptions, security breaches, or other negative events that could harm the reputation of its HMS business and its future revenue prospects.

Discount rates

The discount rate of each reporting unit was computed by calculating the weighted average cost of capital ("WACC") of market participants with businesses reasonably comparable to each respective reporting unit. The following is a summary of the key components of the calculation:

Each reporting unit used a separate set of market participants based upon the primary products offered by each respective reporting unit.

The percentage of debt and equity in each market participant's capital structure was then computed. TDS then selected a capital allocation between debt and equity reflective of the corresponding market participant set. These relative debt and equity capital allocation percentages were then applied to the estimated after-tax cost of debt and estimated cost of equity of the market participants in each reporting unit to arrive at an estimated WACC of market participants, which was then used as the discount rate for each respective reporting unit.

The discount rate is dependent upon the cost of capital of other industry market participants. To the extent that the weighted average cost of capital of industry participants increases, this would decrease the estimated fair value of the reporting units. The weighted average cost of capital may increase if borrowing costs rise, market participants weight more of their capital structure towards equity (vs. debt), or other elements affecting the estimated cost of equity increase.

The WACC calculated for the ILEC reporting unit was lower than the WACC calculated for the HMS reporting unit as a result of the ILEC market participants having capital structures that are more heavily weighted toward debt (vs. higher cost equity) relative to the HMS market participants. ILEC market participants are more mature, capital intensive businesses than the HMS market participants. As a result, ILEC market participants generally have a higher ratio of debt relative to equity in their capital structures as compared to HMS market participants.

Capital expenditures as a percentage of revenue

Capital expenditures for the ILEC reporting unit primarily consist of upgrades to plant and equipment in the IPTV markets, general network support, IT infrastructure and the completion of broadband stimulus projects. To the extent costs associated with these capital expenditures increase at a rate higher than expected and disproportionate to forecasted future revenues, this could negatively impact future cash flows.

Capital expenditures for the HMS reporting unit primarily consist of buildings and improvements related to data center construction and information technology hardware. To the extent building capacity needs increase at a rate higher than expected and disproportionate to forecasted future revenues, this could negatively impact future cash flows. Further, should the cost of IT hardware increase at levels higher than expected, this could also cause future capital expenditures to exceed the amounts forecasted.

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Results

The following represents the carrying values of the reporting units tested for impairment as of November 1, 2013, and the results of the Step 1 Goodwill impairment tests.

Reporting unit
  Carrying value
(in millions)
  Percentage by which the estimated fair value of the reporting
unit exceeded its carrying value
 

ILEC

  $ 1,297     25.5 %

HMS

  $ 223     16.7 %

As of November 1, 2013, the fair value of the ILEC reporting unit exceeded its carrying value; therefore, no impairment of Goodwill existed. Given that the fair value of the reporting unit exceeded its respective carrying value, provided all other assumptions remained the same, the discount rate would have to increase to 9.7% for the discounted cash flow approach to yield an estimated fair value of the ILEC reporting unit that equals its carrying value at November 1, 2013. Further, provided all other assumptions remained the same, the terminal revenue growth rate assumption would need to decrease to negative 3.0%, for the discounted cash flow approach to yield an estimate of fair value equal to the carrying value of the ILEC reporting unit at November 1, 2013.

As of November 1, 2013 the fair value of the HMS reporting unit exceeded its carrying value; therefore, no impairment of Goodwill existed. Given that the fair value of the reporting unit exceeded its respective carrying value, provided all other assumptions remained the same, the discount rate would have to increase to 13.6% for the discounted cash flow approach to yield estimated fair value of the HMS reporting unit (excluding MSN, as previously discussed) that equals its carrying value at November 1, 2013. Further, provided all other assumptions remained the same, the terminal revenue growth rate assumption would need to decrease to negative 0.2%, for the discounted cash flow approach to yield an estimate of fair value equal to the carrying value of the HMS reporting unit (excluding MSN, as previously discussed) at November 1, 2013.

Licenses

U.S. Cellular tests licenses for impairment at the level of reporting referred to as a unit of accounting. For purposes of its impairment testing of licenses as of November 1, 2013, U.S. Cellular separated its FCC licenses into eleven units of accounting based on geographic service areas. As of November 1, 2012, U.S. Cellular separated its FCC licenses into thirteen units of accounting based on geographic service areas. The change in units of accounting resulted from (i) the Divestiture Transaction and the Mississippi Valley non-operating market license sale, both of which are more fully described in Note 5—Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements and (ii) the NY1 & NY2 Deconsolidation more fully described in Note 7—Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements. In both 2013 and 2012, seven of the units of accounting represented geographic groupings of licenses which, because they were not being utilized and, therefore, were not expected to generate cash flows from operating activities in the foreseeable future, were considered separate units of accounting for purposes of impairment testing.

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Developed operating market licenses ("built licenses")

U.S. Cellular applies the build-out method to estimate the fair values of built licenses. The most significant assumptions applied for purposes of the November 1, 2013 and 2012 licenses impairment assessments were as follows:

Key Assumptions
  November 1,
2013
  November 1,
2012
 

Build-out period

    5 years     7 years  

Discount rate

    8.5 %   8.5 %

Terminal revenue growth rate

    2.0 %   2.0 %

Terminal capital expenditures as a percentage of revenue

    13.6 %   13.2 %

Customer penetration rates

    12.5-16.7 %   13.3-17.3 %

The shorter build-out period in 2013 reflects a change in management's expectations of the time required to build out the U.S. Cellular network and is based on recent company-specific experience and industry observation.

The discount rate used in the valuation of licenses is less than the discount rate used in the valuation of reporting units for purposes of goodwill impairment testing. The discount rate used for licenses does not include a company-specific risk premium as a wireless license would not be subject to such risk.

The discount rate is the most significant assumption used in the build-out method. The discount rate is estimated based on the overall risk-free interest rate adjusted for industry participant information, such as a typical capital structure (i.e., debt-equity ratio), the after-tax cost of debt and the cost of equity. The cost of equity takes into consideration the average risk specific to individual market participants.

As of November 1, 2013, the fair values of the built licenses units of accounting exceeded their respective carrying values by amounts ranging from 28.0% to 75.9%. Therefore, no impairment of Licenses existed. Given that the fair values of the licenses exceed their respective carrying values, the discount rate would have to increase to a range of 8.9% to 9.5% to yield estimated fair values of licenses in the respective units of accounting that equal their respective carrying values at November 1, 2013. An increase of 50 basis points to the assumed discount rate would cause an impairment of approximately $11 million.

Non-operating market licenses ("unbuilt licenses")

For purposes of performing impairment testing of unbuilt licenses, U.S. Cellular prepares estimates of fair value by reference to prices paid in recent auctions and market transactions where available. If such information is not available, the fair value of the unbuilt licenses is assumed to have changed by the same percentage, and in the same direction, that the fair value of built licenses measured using the build-out method changed during the period. There was no impairment loss recognized related to unbuilt licenses as a result of the November 1, 2013 licenses impairment test.

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Carrying Value of Licenses

The carrying value of licenses at November 1, 2013 was as follows:

Unit of Accounting(1)
  Carrying Value  
(Dollars in millions)
   
 

U.S. Cellular—Developed Operating markets

       

Central Region

  $ 749  

Mid-Atlantic Region

    235  

New England Region

    107  

Northwest Region

    68  

U.S. Cellular—Non-operating markets

   
 
 

New England

    1  

North Northwest

    3  

South Northwest

    2  

North Central

    59  

South Central

    22  

East Central

    107  

Mid-Atlantic

    50  
       

Total(2)

  $ 1,403  
       

TDS Telecom

    3  

Airadigm

    15  
       

Total(3)

  $ 1,421  
       
       

(1)
U.S. Cellular participated in spectrum auctions indirectly through its interests in Aquinas Wireless L.P. ("Aquinas Wireless") and King Street Wireless L.P. ("King Street Wireless"), collectively, the "limited partnerships." Interests in other limited partnerships that participated in spectrum auctions have since been acquired. Each limited partnership participated in and was awarded spectrum licenses in one of two separate spectrum auctions (FCC Auctions 78 and 73). All of the units of accounting above, except New England, include licenses awarded to the limited partnerships.

(2)
Under previous business combination guidance in effect prior to January 1, 2009, TDS had recorded licenses as a result of accounting for U.S. Cellular's purchases of U.S. Cellular Common Shares as step acquisitions using purchase accounting. As a result, the carrying values of the units of accounting for the developed operating markets differ between U.S. Cellular and TDS. The total carrying value of all units of accounting at U.S. Cellular was $1,398 million at November 1, 2013.

(3)
Between November 1, 2013 and December 31, 2013, TDS capitalized interest on certain licenses pursuant to current network build-outs in the amount of $3 million.

Franchise rights

TDS Telecom has recorded Franchise rights as a result of the acquisition of a cable business in August 2013. The carrying value of Franchise rights as of December 31, 2013 was $123.7 million. TDS Telecom tests Franchise rights for impairment at a level of reporting referred to as a unit of accounting. For purposes of its impairment testing of Franchise rights in 2013, TDS Telecom identified one unit of accounting: Cable. A qualitative assessment, as defined by GAAP, of the Cable unit of accounting was completed as of November 1, 2013. The qualitative assessment, which analyzed company, industry and economic trends, concluded that it was more likely than not that the fair value of the Franchise rights was at least equal to their carrying value, and accordingly, no Franchise rights impairment resulted.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

Income Taxes

The amounts of income tax assets and liabilities, the related income tax provision and the amount of unrecognized tax benefits are critical accounting estimates because such amounts are significant to TDS' financial condition and results of operations.

The preparation of the consolidated financial statements requires TDS to calculate a provision for income taxes. This process involves estimating the actual current income tax liability together with assessing temporary differences resulting from the different treatment of items for tax purposes. These temporary differences result in deferred income tax assets and liabilities, which are included in TDS' Consolidated Balance Sheet. TDS must then assess the likelihood that deferred income tax assets will be realized based on future taxable income and, to the extent management believes that realization is not likely, establish a valuation allowance. Management's judgment is required in determining the provision for income taxes, deferred income tax assets and liabilities and any valuation allowance that is established for deferred income tax assets.

TDS recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.

See Note 3—Income Taxes in the Notes to Consolidated Financial Statements for details regarding TDS' income tax provision, deferred income taxes and liabilities, valuation allowances and unrecognized tax benefits, including information regarding estimates that impact income taxes.

Loyalty Reward Program

See the Revenue Recognition—U.S. Cellular section of Note 1—Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for a description of this program and the related accounting.

TDS follows the deferred revenue method of accounting for its loyalty reward program. Under this method, revenue allocated to loyalty reward points is deferred. Revenue is recognized at the time of customer redemption or when such points have been depleted via an account maintenance charge. TDS periodically reviews and revises the redemption and depletion rates as appropriate based on history and related future expectations. As of December 31, 2013, TDS estimated loyalty reward points breakage based on actuarial estimates and recorded a $7.4 million change in estimate, which reduced Customer deposits and deferred revenues in the Consolidated Balance Sheet and increased Operating revenues in the Consolidated Statement of Operations.


CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See Note 20—Certain Relationships and Related Transactions in the Notes to Consolidated Financial Statements.

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PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR CAUTIONARY STATEMENT

This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report contain statements that are not based on historical facts, including the words "believes," "anticipates," "intends," "expects" and similar words. These statements constitute and represent "forward-looking statements" as this term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, events or developments to be significantly different from any future results, events or developments expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors include, but are not limited to, the following risks:

Intense competition in the markets in which TDS operates could adversely affect TDS' revenues or increase its costs to compete.

A failure by TDS to successfully execute its business strategy (including planned acquisitions, divestitures and exchanges) or allocate resources or capital could have an adverse effect on TDS' business, financial condition or results of operations.

A failure by TDS' service offerings to meet customer expectations could limit TDS' ability to attract and retain customers and could have an adverse effect on TDS' business, financial condition or results of operations.

TDS' system infrastructure may not be capable of supporting changes in technologies and services expected by customers, which could result in lost customers and revenues.

Changes in roaming practices or other factors could cause TDS' roaming revenues to decline from current levels and/or impact TDS' ability to service its customers in geographic areas where TDS does not have its own network, which would have an adverse effect on TDS' business, financial condition or results of operations.

A failure by TDS to obtain access to adequate radio spectrum to meet current or anticipated future needs and/or to accurately predict future needs for radio spectrum could have an adverse effect on TDS' business, financial condition or results of operations.

To the extent conducted by the Federal Communications Commission ("FCC"), TDS is likely to participate in FCC auctions of additional spectrum in the future as an applicant or as a noncontrolling partner in another auction applicant and, during certain periods, will be subject to the FCC's anti-collusion rules, which could have an adverse effect on TDS.

Changes in the regulatory environment or a failure by TDS to timely or fully comply with any applicable regulatory requirements could adversely affect TDS' business, financial condition or results of operations.

Changes in Universal Service Fund ("USF") funding and/or intercarrier compensation could have an adverse impact on TDS' business, financial condition or results of operations.

An inability to attract and/or retain highly competent management, technical, sales and other personnel could have an adverse effect on TDS' business, financial condition or results of operations.

TDS' assets are concentrated primarily in the U.S. telecommunications industry. As a result, its results of operations may fluctuate based on factors related primarily to conditions in this industry.

TDS' lower scale relative to larger competitors could adversely affect its business, financial condition or results of operations.

Changes in various business factors could have an adverse effect on TDS' business, financial condition or results of operations.

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Advances or changes in technology could render certain technologies used by TDS obsolete, could put TDS at a competitive disadvantage, could reduce TDS' revenues or could increase its costs of doing business.

Complexities associated with deploying new technologies present substantial risk.

TDS is subject to numerous surcharges and fees from federal, state and local governments, and the applicability and the amount of these fees are subject to great uncertainty.

Performance under device purchase agreements could have a material adverse impact on TDS' business, financial condition or results of operations.

Changes in TDS' enterprise value, changes in the market supply or demand for wireless licenses, wireline or cable markets or IT service providers, adverse developments in the businesses or the industries in which TDS is involved and/or other factors could require TDS to recognize impairments in the carrying value of its licenses, goodwill, franchise rights and/or physical assets.

Costs, integration problems or other factors associated with acquisitions, divestitures or exchanges of properties or licenses and/or expansion of TDS' businesses could have an adverse effect on TDS' business, financial condition or results of operations.

A significant portion of TDS' wireless revenues is derived from customers who buy services through independent agents who market TDS' services on a commission basis and third-party national retailers. If TDS' relationships with these agents or third-party national retailers are seriously harmed, its business, financial condition or results of operations could be adversely affected.

TDS' investments in unproven technologies may not produce the benefits that TDS expects.

A failure by TDS to complete significant network construction and systems implementation activities as part of its plans to improve the quality, coverage, capabilities and capacity of its networks and support systems could have an adverse effect on its operations.

Financial difficulties (including bankruptcy proceedings) or other operational difficulties of TDS' key suppliers, termination or impairment of TDS' relationships with such suppliers, or a failure by TDS to manage its supply chain effectively could result in delays or termination of TDS' receipt of required equipment or services, or could result in excess quantities of required equipment or services, any of which could adversely affect TDS' business, financial condition or results of operations.

TDS has significant investments in entities that it does not control. Losses in the value of such investments could have an adverse effect on TDS' financial condition or results of operations.

A failure by TDS to maintain flexible and capable telecommunication networks or information technology, or a material disruption thereof, including breaches of network or information technology security, could have an adverse effect on TDS' business, financial condition or results of operations.

Wars, conflicts, hostilities and/or terrorist attacks or equipment failures, power outages, natural disasters or other events could have an adverse effect on TDS' business, financial condition or results of operations.

The market price of TDS' Common Shares is subject to fluctuations due to a variety of factors.

Identification of errors in financial information or disclosures could require amendments to or restatements of financial information or disclosures included in this or prior filings with the Securities and Exchange Commission ("SEC"). Such amendments or restatements and related matters, including resulting delays in filing periodic reports with the SEC, could have an adverse effect on TDS' business, financial condition or results of operations.

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The existence of material weaknesses in the effectiveness of internal control over financial reporting could result in inaccurate financial statements or other disclosures or failure to prevent fraud, which could have an adverse effect on TDS' business, financial condition or results of operations.

Changes in facts or circumstances, including new or additional information that affects the calculation of potential liabilities for contingent obligations under guarantees, indemnities, claims, litigation or otherwise, could require TDS to record charges in excess of amounts accrued in the financial statements, if any, which could have an adverse effect on TDS' business, financial condition or results of operations.

Disruption in credit or other financial markets, a deterioration of U.S. or global economic conditions or other events could, among other things, impede TDS' access to or increase the cost of financing its operating and investment activities and/or result in reduced revenues and lower operating income and cash flows, which would have an adverse effect on TDS' business, financial condition or results of operations.

Uncertainty of TDS' ability to access capital, deterioration in the capital markets, other changes in market conditions, changes in TDS' credit ratings or other factors could limit or restrict the availability of financing on terms and prices acceptable to TDS, which could require TDS to reduce its construction, development or acquisition programs.

Settlements, judgments, restraints on its current or future manner of doing business and/or legal costs resulting from pending and future litigation could have an adverse effect on TDS' business, financial condition or results of operations.

The possible development of adverse precedent in litigation or conclusions in professional studies to the effect that radio frequency emissions from wireless devices and/or cell sites cause harmful health consequences, including cancer or tumors, or may interfere with various electronic medical devices such as pacemakers, could have an adverse effect on TDS' wireless business, financial condition or results of operations.

Claims of infringement of intellectual property and proprietary rights of others, primarily involving patent infringement claims, could prevent TDS from using necessary technology to provide products or services or subject TDS to expensive intellectual property litigation or monetary penalties, which could have an adverse effect on TDS' business, financial condition or results of operations.

Certain matters, such as control by the TDS Voting Trust and provisions in the TDS Restated Certificate of Incorporation, may serve to discourage or make more difficult a change in control of TDS.

Any of the foregoing events or other events could cause revenues, earnings, capital expenditures and/or any other financial or statistical information to vary from TDS' forward-looking estimates by a material amount.

See "Risk Factors" in TDS' Annual Report on Form 10-K for the year ended December 31, 2013 for a further discussion of these risks. TDS undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Readers should evaluate any statements in light of these important factors.

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MARKET RISK

Long-Term Debt

As of December 31, 2013, the majority of TDS' long-term debt was in the form of fixed-rate notes with maturities ranging up to 48 years. Fluctuations in market interest rates can lead to significant fluctuations in the fair value of these fixed-rate notes.

The following table presents the scheduled principal payments on long-term debt and capital lease obligations, and the related weighted average interest rates by maturity dates at December 31, 2013:

 
  Principal Payments Due by Period  
(Dollars in millions)
  Long-Term
Debt Obligations(1)
  Weighted-Avg.
Interest Rates
on Long-Term
Debt Obligations(2)
 

2014

  $ 1.6     4.8 %

2015

    1.3     2.7 %

2016

    3.1     4.8 %

2017

    0.2     9.1 %

2018

    0.2     9.2 %

After 5 years

    1,726.9     6.7 %
           

Total

  $ 1,733.3     6.7 %
           
           

(1)
The total long-term debt obligation differs from Long-term debt in Consolidated Balance Sheet due to the $11.6 million unamortized discount related to U.S. Cellular's 6.7% Senior Notes. See Note 10—Debt in the Notes to Consolidated Financial Statements for additional information.

(2)
Represents the weighted average interest rates at December 31, 2013 for debt maturing in the respective periods.

Fair Value of Long-Term Debt

At December 31, 2013 and 2012, the estimated fair value of long-term debt obligations, excluding capital lease obligations and the current portion of such long-term debt, was $1,560.6 million and $1,827.6 million, respectively. The fair value of long-term debt, excluding capital lease obligations and the current portion of such long-term debt, was estimated using market prices for TDS' 7.0% Senior Notes, 6.875% Senior Notes, 6.625% Senior Notes, and 5.875% Senior Notes, and U.S. Cellular's 6.95% Senior Notes at December 31, 2013 and 2012 and discounted cash flow analysis for U.S. Cellular's 6.7% Senior Notes and the remaining debt at December 31, 2013 and 2012.

Other Market Risk Sensitive Instruments

The substantial majority of TDS' other market risk sensitive instruments (as defined in item 305 of SEC Regulation S-K) are short-term, including Cash and cash equivalents and Short-term investments. The fair value of such instruments is less sensitive to market fluctuations than longer term instruments. Accordingly, TDS believes that a significant change in interest rates would not have a material effect on such other market risk sensitive instruments.

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Consolidated Statement of Operations

Year Ended December 31,
  2013   2012   2011  
(Dollars and shares in thousands, except per share amounts)
   
   
   
 

Operating revenues

  $ 4,901,236   $ 5,345,277   $ 5,180,471  

Operating expenses

   
 
   
 
   
 
 

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

    2,225,316     2,272,570     2,050,644  

Selling, general and administrative

    1,947,778     2,033,901     2,002,359  

Depreciation, amortization and accretion

    1,018,077     813,626     765,776  

Loss on impairment of assets

        515      

(Gain) loss on asset disposals, net

    30,841     19,741     10,952  

(Gain) loss on sale of business and other exit costs, net

    (300,656 )   21,061      

(Gain) loss on license sales and exchanges

    (255,479 )       (11,762 )
               

Total operating expenses

    4,665,877     5,161,414     4,817,969  
               

Operating income

    235,359     183,863     362,502  

Investment and other income (expense)

   
 
   
 
   
 
 

Equity in earnings of unconsolidated entities

    132,714     92,867     82,538  

Interest and dividend income

    9,092     9,248     9,145  

Gain (loss) on investments

    14,547     (3,718 )   24,103  

Interest expense

    (98,811 )   (86,745 )   (118,201 )

Other, net

    (37 )   720     3,658  
               

Total investment and other income (expense)

    57,505     12,372     1,243  
               

Income before income taxes

    292,864     196,235     363,745  

Income tax expense

    126,043     73,582     113,503  
               

Net income

    166,821     122,653     250,242  

Less: Net income attributable to noncontrolling interests, net of tax

    24,894     40,792     49,676  
               

Net income attributable to TDS shareholders

    141,927     81,861     200,566  

TDS Preferred dividend requirement

    (49 )   (50 )   (50 )
               

Net income available to common shareholders

  $ 141,878   $ 81,811   $ 200,516  
               
               

Basic weighted average shares outstanding

    108,490     108,671     108,562  

Basic earnings per share attributable to TDS shareholders

  $ 1.31   $ 0.75   $ 1.85  
               
               

Diluted weighted average shares outstanding

    109,132     108,937     109,098  

Diluted earnings per share attributable to TDS shareholders

  $ 1.29   $ 0.75   $ 1.83  
               
               

Dividends per share to TDS shareholders

  $ 0.51   $ 0.49   $ 0.47  
               
               

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

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Consolidated Statement of Comprehensive Income

Year Ended December 31,
  2013   2012   2011  
(Dollars in thousands)
   
   
   
 

Net income

  $ 166,821   $ 122,653   $ 250,242  

Net change in accumulated other comprehensive income

                   

Change in net unrealized gain on equity investments

    51     49     138  

Change in foreign currency translation adjustment

    (34 )   4      

Change related to retirement plan

                   

Amounts included in net periodic benefit cost for the period

                   

Net actuarial gains (losses)

    13,345     90     (9,625 )

Amortization of prior service cost

    (3,605 )   (3,735 )   (3,815 )

Amortization of unrecognized net loss

    2,452     2,517     1,934  
               

    12,192     (1,128 )   (11,506 )

Change in deferred income taxes

    (4,646 )   1,797     5,722  
               

Change related to retirement plan, net of tax

    7,546     669     (5,784 )
               

Net change in accumulated other comprehensive income

    7,563     722     (5,646 )
               

Comprehensive income

    174,384     123,375     244,596  

Less: Comprehensive income attributable to noncontrolling interest

    24,894     40,792     49,676  
               

Comprehensive income attributable to TDS shareholders

  $ 149,490   $ 82,583   $ 194,920  
               
               

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

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Consolidated Statement of Cash Flows

Year Ended December 31,
  2013   2012   2011  
(Dollars in thousands)
   
   
   
 

Cash flows from operating activities

                   

Net income

  $ 166,821   $ 122,653   $ 250,242  

Add (deduct) adjustments to reconcile net income to net cash flows from
operating activities

                   

Depreciation, amortization and accretion

    1,018,077     813,626     765,776  

Bad debts expense

    105,629     74,695     68,611  

Stock-based compensation expense

    30,338     41,871     36,837  

Deferred income taxes, net

    (67,150 )   58,785     202,547  

Equity in earnings of unconsolidated entities

    (132,714 )   (92,867 )   (82,538 )

Distributions from unconsolidated entities

    127,929     84,884     92,231  

Loss on impairment of assets

        515      

(Gain) loss on asset disposals, net

    30,841     19,741     10,952  

(Gain) loss on sale of business and other exit costs, net

    (300,656 )   21,061      

(Gain) loss on license sales and exchanges

    (255,479 )       (11,762 )

(Gain) loss on investments

    (14,547 )   3,718     (24,103 )

Noncash interest expense

    2,463     (572 )   18,849  

Other operating activities

    612     1,393     1,067  

Changes in assets and liabilities from operations

                   

Accounts receivable

    (294,320 )   (81,107 )   (95,426 )

Inventory

    (83,536 )   (29,917 )   (13,382 )

Accounts payable

    86,028     (12,332 )   29,291  

Customer deposits and deferred revenues

    66,460     32,981     35,457  

Accrued taxes

    17,388     77,458     (27,871 )

Accrued interest

    380     (891 )   3,351  

Other assets and liabilities

    (9,954 )   (30,523 )   (4,418 )
               

    494,610     1,105,172     1,255,711  
               

Cash flows from investing activities

                   

Cash used for additions to property, plant and equipment

    (883,797 )   (995,517 )   (971,759 )

Cash paid for acquisitions and licenses

    (314,570 )   (163,382 )   (105,508 )

Cash received from divestitures

    811,120     50,182      

Cash paid for investments

        (120,000 )   (180,920 )

Cash received for investments

    115,000     243,444     393,246  

Other investing activities

    11,594     (12,796 )   (1,148 )
               

    (260,653 )   (998,069 )   (866,089 )
               

Cash flows from financing activities

                   

Repayment of short-term debt

            (32,671 )

Repayment of long-term debt

    (1,581 )   (2,566 )   (614,639 )

Issuance of long-term debt

    37     195,358     643,700  

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

    9,654     (1,119 )   32  

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

    5,784     (2,205 )   1,935  

Repurchase of TDS Common and Special Common Shares

    (9,692 )   (20,026 )   (21,500 )

Repurchase of U.S. Cellular Common Shares

    (18,544 )   (20,045 )   (62,294 )

Dividends paid to TDS shareholders

    (55,293 )   (53,165 )   (48,670 )

U.S. Cellular dividends paid to noncontrolling public shareholders

    (75,235 )        

Payment of debt issuance costs

    (23 )   (8,242 )   (21,657 )

Distributions to noncontrolling interests

    (3,766 )   (20,856 )   (16,236 )

Payments to acquire additional interest in subsidiaries

    (4,505 )   (3,167 )    

Other financing activities

    8,740     6,136     3,970  
               

    (144,424 )   70,103     (168,030 )
               

Net increase in cash and cash equivalents

    89,533     177,206     221,592  

Cash and cash equivalents

   
 
   
 
   
 
 

Beginning of period

    740,481     563,275     341,683  
               

End of period

  $ 830,014   $ 740,481   $ 563,275  
               
               

   

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

45


Table of Contents


Telephone and Data Systems, Inc.
Consolidated Balance Sheet—Assets

December 31,
  2013   2012  
(Dollars in thousands)
   
   
 

Current assets

             

Cash and cash equivalents

  $ 830,014   $ 740,481  

Short-term investments

    50,104     115,700  

Accounts receivable