SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q/A

Amendment No. 1

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006				OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                             to

 

Commission File Number 001-14157

TELEPHONE AND DATA SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

30 North LaSalle Street, Chicago, Illinois  60602
(Address of principal executive offices)  (Zip Code)

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

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

Yes   x  No    o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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

Yes   o  No    x

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

Class		Outstanding at June 30, 2006
Common Shares, $.01 par value		51,431,735 Shares
Special Common Shares, $.01 par value		57,782,076 Shares
Series A Common Shares, $.01 par value		6,446,079 Shares

 

 

Telephone and Data Systems, Inc. and Subsidiaries

Explanatory Note

Telephone and Data Systems, Inc. (“TDS”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2006, which was originally filed with the Securities and Exchange Commission (“SEC”) on August 25, 2006 (“Original Form 10-Q”), to amend Part I Financial Information – Item 1 “Financial Statements,” Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (“MD&A”), Item 3 “Quantitative and Qualitative Disclosures About Market Risk,” and Item 4 “Controls and Procedures,” and Part II Other Information – Item 6 “Exhibits and Financial Statement Schedules.”

As discussed in Note 1 to the Consolidated Financial Statements, TDS and its audit committee concluded on November 6, 2006, that TDS would amend its Annual Report on Form 10-K for the year ended December 31, 2005 to restate its consolidated financial statements and financial information for each of the three years in the period ended December 31, 2005, including quarterly information for 2005 and 2004, and certain selected financial data for 2002.  TDS and its audit committee also concluded that TDS would amend its Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 to restate the consolidated financial statements and financial information included therewith.

The restatement adjustments are described below.

·                  Forward contracts and related derivative instruments - In reviewing the accounting and disclosure of its prepaid forward contracts, TDS concluded that its continued designation of the embedded collars within the forward contracts as cash flow hedges of marketable equity securities was not appropriate.  TDS did not contemporaneously de-designate, re-designate, and assess hedge effectiveness when the embedded collars were contractually modified for differences between the actual and expected dividend rates on the underlying securities in 2004, 2003 and 2002.  As a result, the embedded collars no longer qualified for cash flow hedge accounting treatment upon the modification of the terms of the collars for changes in dividend rates and, from that point forward, must be accounted for as derivative instruments  that do not qualify for cash flow hedge accounting treatment.  Accordingly, all changes in the fair value of the embedded collars from the time of the contractual modification of each collar must be recognized in the statement of operations.  The restatement adjustments represent reclassifications of unrealized gains or losses related to changes in the fair value of the embedded collars from other comprehensive income or loss, included in common stockholders’ equity, to the statement of operations.

·                  Expense reclassifications - Certain prior period amounts, primarily labor, maintenance, rent and utilities expenses at the competitive local exchange carriers (“CLEC”), previously reported in selling, general and administrative expense have been corrected to properly reflect the classification of the expenses in cost of service and products in the current period.  Certain expenses, primarily universal service costs, at both the incumbent local exchange carriers (“ILEC”) and the CLEC previously reported in cost of service and products have been adjusted to properly reflect the classification of the expenses in selling, general and administrative expense.  These adjustments did not have an effect on operating income or net income.

·                  Establishment of an Asset Retirement Obligation (“ARO”) - Upon initial implementation of Statement of Financial Accounting Standards No. 143 – “Accounting for Asset Retirement Obligations” (“SFAS No. 143”) in 2003, TDS Telecom’s ILEC operations concluded that it was not necessary to record an ARO asset and corresponding regulatory liability of equal amount.  TDS Telecom’s ILECs have their rates regulated by the respective state public utility commissions and the Federal Communications Commission (“FCC”), and therefore, reflect the effects of the rate-making actions of these regulatory bodies in their financial statements.  In 2002, the FCC notified carriers by Order that it would not be adopting SFAS No. 143 since the FCC concluded that SFAS No. 143 conflicted with the FCC’s current accounting rules that require ILECs to accrue for asset retirement obligations through prescribed depreciation rates.  Upon adoption of SFAS No. 143, and pursuant to the FCC’s order and the provisions of SFAS No. 71 “Accounting for the Effects of Certain Types of Regulation,” (“SFAS No.71”) the ILECs reclassified their existing remediation liabilities, previously recorded in accumulated depreciation, to an ARO liability and a separate regulatory liability.  Upon further review, TDS has concluded that upon adoption of SFAS No. 143, and in accordance with SFAS No. 71, it should have recognized an ARO asset and a corresponding ARO liability, rather than establish the ARO liability through a reclassification of its existing remediation liabilities.  The adjustment did not affect previously reported revenues, operating income or net income (loss).

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·                  Contracts with maintenance and support services – U.S. Cellular entered into certain equipment and software contracts that included maintenance and support services.  In one case, U.S. Cellular did not properly allocate expenditures between equipment purchases and maintenance and support services.  In other cases, U.S. Cellular did not properly record fees for maintenance and support services over the specified term of the agreement.  The restatement adjustments properly record property, plant and equipment, related depreciation expense and fees for maintenance and support services in the correct periods.

·                  Classification of Asset Retirement Obligation on the Statement of Cash Flows – The additions to property, plant and equipment and other deferred liabilities representing additional asset retirement obligations (“ARO”) should be treated as non-cash items in the statement of cash flows.  From 2004 through the second quarter of 2006, U.S. Cellular included additional ARO liabilities as a change in other assets and liabilities in cash flows from operating activities and the increase in the ARO asset balance as a capital expenditure in cash flows from investing activities resulting in an overstatement of cash flows from operating activities and an overstatement of cash flows required by investing activities.  In the restatement, adjustments were recorded in the statement of cash flows to offset the change in ARO liabilities against the ARO asset.

·                  Income taxes – In the restatement, TDS adjusted its income tax expense, income taxes payable, goodwill, deferred income tax assets and liabilities and related disclosures for the years ended December 31, 2005, 2004, 2003 and 2002 for items identified based on its annual analysis reconciling its 2005 income tax expense and income tax balance sheet accounts as determined in its comparison of the 2005 year-end income tax provision to the 2005 federal and state income tax returns. These adjustments included corrections for certain accounts that had not previously been included in the financial reporting basis used in determining the cumulative temporary differences in computing deferred income tax assets and liabilities, as well as adjustments to certain cumulative temporary differences that had historically been incorrectly associated with operating license assets which, in this restatement, have been correctly classified as investments in partnership assets.  Accordingly, the company has adjusted the deferred tax liabilities related to these assets.  Goodwill was adjusted to record the income tax effect of the difference between the financial reporting basis and the income tax basis of certain acquisitions made prior to 2004.

TDS determined that the state deferred tax liabilities attributable to marketable equity securities, as presented in prior periods, should have been lower to reflect carryover of a higher stock basis than the federal basis for certain states that have not adopted the federal consolidated return regulations.  TDS also identified a valuation allowance related to state net operating loss carry forwards for which deferred tax liabilities related to marketable equity securities provide positive evidence supporting reductions to previously established valuation allowances.

·      Cash and interest income – In reviewing cash accounts, it was determined that cash and interest income were overstated in the three months ended March 31, 2006 and six months ended June 30, 2006.  In the restatement, TDS corrected the overstatement by reducing cash and interest income.

·      Property, plant and equipment – U.S. Cellular did not properly record certain transfers and disposals of equipment removed from service.  Also, U.S. Cellular did not properly record depreciation expense for certain leasehold improvements and other equipment due to the use of incorrect asset lives.  The restatement adjustments properly record equipment disposals and depreciation expense in the correct amounts and periods.

·      Other items – In addition to the adjustments described above, TDS recorded a number of other adjustments to correct and record revenues, expenses and equity in earnings of unconsolidated entities in the periods in which such revenues, expenses and equity in earnings of unconsolidated entities were earned or incurred. Adjustments were also made to correct certain balance sheet amounts, including corrections to purchase price accounting for certain acquisitions prior to 2003.  These individual adjustments were not material.

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In connection with the restatement, TDS concluded that certain material weaknesses existed in its internal control over financial reporting.  See Part I – Item 4 “Controls and Procedures.”

For the convenience of the reader, this Form 10-Q/A sets forth the Original Form 10-Q, as amended hereby, in its entirety.  However, this Form 10-Q/A amends and restates only Items 1, 2, 3, and 4 of Part I and Item 6 of Part II of the Original Form 10-Q, in each case solely as a result of and to reflect the adjustments discussed above and more fully in Note 1 of the accompanying consolidated financial statements, and no other information in the Original Form 10-Q is amended hereby. The foregoing items have not been updated to reflect other events occurring after the filing of the Original Form 10-Q, or to modify or update those disclosures affected by other subsequent events.  In particular, forward-looking statements included in the Form 10-Q/A represented management’s views as of the date of filing of the Original Form 10-Q for the quarterly period ended March 31, 2006 on August 25, 2006. Such forward-looking statements should not be assumed to be accurate as of any future date. TDS undertakes no duty to update such information whether as a result of new information, future events or otherwise.

As required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by TDS’s principal executive officer and principal financial officer are being filed with this Form 10-Q/A as Exhibits 31.1, 31.2, 32.1 and 32.2.

 

Telephone and Data Systems, Inc. and Subsidiaries

Quarterly Report on Form 10-Q/A

For the Period Ended March 31, 2006

Index

				Page No.
Part I.		Financial Information
Item 1.		Financial Statements (Unaudited) – As Restated
		Consolidated Statements of Operations – As Restated Three Months Ended March 31, 2006 and 2005		3
		Consolidated Statements of Cash Flows – As Restated Three Months Ended March 31, 2006 and 2005		4
		Consolidated Balance Sheets – As Restated March 31, 2006 and December 31, 2005		5
		Notes to Consolidated Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		38
		Three Months Ended March 31, 2006 and 2005
		U.S. Cellular Operations		45
		TDS Telecom Operations		54
		Recent Accounting Pronouncements		57
		Financial Resources		57
		Liquidity and Capital Resources		58
		Application of Critical Accounting Policies and Estimates		64
		Certain Relationships and Related Transactions		70
		Safe Harbor Cautionary Statement		71
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		74
Item 4.		Controls and Procedures		76
Part II.		Other Information
Item 1.		Legal Proceedings		80
Item 1A.		Risk Factors		80
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		80
Item 5.		Other Information		81
Item 6.		Exhibits		81
Signatures

 

 

Part I.  Financial Information

Item 1.  Financial Statements

Telephone and Data Systems, Inc. and Subsidiaries

Consolidated Statements of Operations

Unaudited

		Three Months Ended March 31,
		2006			2005
		(As Restated)			(As Restated)
		(Dollars in thousands, except per share amounts)
Operating Revenues		$	1,059,077		$	933,962
Operating Expenses
Cost of services and products (exclusive of depreciation, amortization and accretion expense shown below)		376,306			343,817
Selling, general and administrative expense		392,621			345,072
Depreciation, amortization and accretion expense		182,966			170,141
Total Operating Expenses		951,893			859,030
Operating Income		107,184			74,932
Investment and Other Income (Expense)
Equity in earnings of unconsolidated entities		19,805			14,751
Interest and dividend income		11,483			8,118
Interest expense		(58,532		)	(51,856		)
Fair value adjustment of derivative instruments		30			335,400
Gain on investments		—			500
Other expense		(927		)	(4,274		)
Total Investment and Other Income (Expense)		(28,141		)	302,639
Income Before Income Taxes and Minority Interest		79,043			377,571
Income tax expense		32,342			148,400
Income Before Minority Interest		46,701			229,171
Minority share of income		(10,704		)	(5,610		)
Net Income		35,997			223,561
Preferred dividend requirement		(51		)	(50		)
Net Income Available To Common		$	35,946		$	223,511
Basic Weighted Average Shares Outstanding (000s)		115,741			114,999
Basic Earnings Per Share (Note 6)		$	0.31		$	1.94
Diluted Weighted Average Shares Outstanding (000s)		116,327			115,795
Diluted Earnings Per Share (Note 6)		$	0.31		$	1.93
Dividends Per Share		$	0.0925		$	0.0875

 

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

3

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Telephone and Data Systems, Inc. and Subsidiaries

 

Consolidated Statements of Cash Flows

Unaudited

		Three Months Ended March 31,
		2006			2005
		(As Restated)			(As Restated)
		(Dollars in thousands)
Cash Flows from Operating Activities
Net income		$	35,997		$	223,561
Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization and accretion		182,966			170,141
Bad debts expense		9,075			8,135
Stock-based compensation expense		8,638			1,171
Deferred income taxes		(15,228		)	131,965
Equity earnings of unconsolidated entities		(19,805		)	(14,751		)
Distributions from unconsolidated entities		5,676			1,520
Minority share of income		10,704			5,610
Fair value adjustment of derivative instruments		(30		)	(335,400		)
Gain on investments		—			(500		)
Noncash interest expense		5,480			5,029
Other noncash expense		1,504			2,467
Changes in assets and liabilities
Change in accounts receivable		9,164			10,707
Change in materials and supplies		7,546			7,482
Change in accounts payable		(53,405		)	(64,763		)
Change in customer deposits and deferred revenues		5,209			4,911
Change in accrued taxes		47,703			21,868
Change in accrued interest		4,567			3,971
Change in other assets and liabilities		(32,525		)	(33,755		)
		213,236			149,369
Cash Flows from Investing Activities
Additions to property, plant and equipment		(143,776		)	(133,997		)
Cash paid for acquisitions		—			(120,924		)
Other investing activities		(1,467		)	(564		)
		(145,243		)	(255,485		)
Cash Flows from Financing Activities
Issuance of notes payable		55,000			165,000
Issuance of long-term debt		560			112,588
Repayment of notes payable		(105,000		)	(60,000		)
Repayment of long-term debt		(748		)	(110,510		)
Repayment of medium-term notes		(35,000		)	(17,200		)
TDS Common Shares and Special Common Shares issued for benefit plans		3,080			6,684
U.S. Cellular Common Shares issued for benefit plans		3,858			6,836
Capital (distributions) to minority partners		(4,146		)	—
Dividends paid		(10,749		)	(10,122		)
Other financing activities		1,207			131
		(91,938		)	93,407
Net Increase (Decrease) in Cash and Cash Equivalents		(23,945		)	(12,709		)
Cash and Cash Equivalents -
Beginning of period		1,095,791			1,171,105
End of period		$	1,071,846		$	1,158,396

 

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

4

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Telephone and Data Systems, Inc. and Subsidiaries

 

Consolidated Balance Sheets

Assets

Unaudited

		March 31, 2006			December 31, 2005
		(As Restated)			(As Restated)
		(Dollars in thousands)
Current Assets
Cash and cash equivalents		$	1,071,846		$	1,095,791
Accounts receivable
Due from customers, less allowance of $11,805 and $15,200, respectively		329,084			332,278
Other, principally connecting companies, less allowance of $6,806 and $5,620, respectively		141,944			157,182
Materials and supplies, at average cost		96,359			103,211
Prepaid expenses		49,363			41,746
Deferred income tax asset		13,434			13,438
Other current assets		32,874			34,774
		1,734,904			1,778,420
Investments
Marketable equity securities		2,559,507			2,531,690
Licenses		1,364,836			1,365,063
Goodwill		882,486			882,168
Customer lists, net of accumulated amortization of $50,313 and $44,616, respectively		41,952			47,649
Investments in unconsolidated entities		232,953			217,180
Other investments, less valuation allowance of $55,144 in both periods		12,044			12,274
		5,093,778			5,056,024
Property, Plant and Equipment
In service and under construction		7,252,589			7,131,977
Less accumulated depreciation		3,754,353			3,602,217
		3,498,236			3,529,760
Other Assets and Deferred Charges		55,259			55,830
		$	10,382,177		$	10,420,034

 

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

5

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Telephone and Data Systems, Inc. and Subsidiaries

 

Consolidated Balance Sheets

Liabilities and Stockholders’ Equity

Unaudited

 

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

6

 

TELEPHONE AND DATA SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.               Basis of Presentation

The accounting policies of Telephone and Data Systems, Inc. (“TDS”) conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”).  The consolidated financial statements include the accounts of TDS and its majority-owned subsidiaries, including TDS’s 81.2%-owned wireless telephone subsidiary, United States Cellular Corporation (“U.S. Cellular”), TDS’s 100%-owned wireline telephone subsidiary, TDS Telecommunications Corporation (“TDS Telecom”) and TDS’s 80%-owned printing and distribution company, Suttle Straus, Inc.  In addition, the consolidated financial statements include all entities in which TDS has a variable interest that requires TDS to absorb a majority of the entity’s expected gains or losses, or both.  All material intercompany accounts and transactions have been eliminated.

The consolidated financial statements included herein have been prepared by TDS, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. However, TDS believes that the disclosures included herein are adequate to make the information presented not misleading.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in TDS’s Annual Report on Form 10-K/A for the year ended December 31, 2005 (“Form 10-K/A”).

The accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring items unless otherwise disclosed) necessary to present fairly the financial position as of March 31, 2006, and the results of operations for the three months ended March 31, 2006 and 2005 and the cash flows for the three months ended March 31, 2006 and 2005.  The results of operations for the three months ended March 31, 2006, are not necessarily indicative of the results to be expected for the full year.

Restatement

TDS and its audit committee concluded on November 6, 2006, that TDS would amend its Annual Report on Form 10-K for the year ended December 31, 2005 to restate its consolidated financial statements and financial information for each of the three years in the period ended December 31, 2005, including quarterly information for 2005 and 2004, and certain selected financial data for 2002.  TDS and its audit committee also concluded that TDS would amend its Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 to restate the consolidated financial statements and financial information included therewith.

The restatement adjustments are described below.

·                  Forward contracts and related derivative instruments - In reviewing the accounting and disclosure of its prepaid forward contracts, TDS concluded that its continued designation of the embedded collars within the forward contracts as cash flow hedges of marketable equity securities was not appropriate.  TDS did not contemporaneously de-designate, re-designate, and assess hedge effectiveness when the embedded collars were contractually modified for differences between the actual and expected dividend rates on the underlying securities in 2004, 2003 and 2002.  As a result, the embedded collars no longer qualified for cash flow hedge accounting treatment upon the modification of the terms of the collars for changes in dividend rates and, from that point forward, must be accounted for as derivative instruments  that do not qualify for cash flow hedge accounting treatment.  Accordingly, all changes in the fair value of the embedded collars from the time of the contractual modification of each collar must be recognized in the statement of operations.  The restatement adjustments represent reclassifications of unrealized gains or losses related to changes in the fair value of the embedded collars from other comprehensive income or loss, included in common stockholders’ equity, to the statement of operations.

7

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·                  Expense reclassifications - Certain prior period amounts, primarily labor, maintenance, rent and utilities expenses at the competitive local exchange carriers (“CLEC”), previously reported in selling, general and administrative expense have been corrected to properly reflect the classification of the expenses in cost of service and products in the current period.  Certain expenses, primarily universal service costs, at both the incumbent local exchange carriers (“ILEC”) and the CLEC previously reported in cost of service and products have been adjusted to properly reflect the classification of the expenses in selling, general and administrative expense.  For the ILEC, cost of services and products decreased by $2.7 million and $1.7 million with a corresponding increase in selling, general and administrative expenses in the three months ended March 31, 2006 and 2005, respectively.  For the CLEC, cost of services and products increased by $5.4 million and $5.8 million with a corresponding decrease in selling, general and administrative expenses in the three months ended March 31, 2006 and 2005, respectively.  On a TDS consolidated basis, cost of services and products increased by $2.7 million and $4.1 million with a corresponding decrease in selling, general and administrative expenses in the three months ended March 31, 2006 and 2005, respectively.  The adjustments did not affect previously reported revenues, operating income or net income.

·                  Establishment of an Asset Retirement Obligation (“ARO”) - Upon initial implementation of Statement of Financial Accounting Standards No. 143 – “Accounting for Asset Retirement Obligations” (“SFAS No. 143”) in 2003, TDS Telecom’s ILEC operations concluded that it was not necessary to record an ARO asset and corresponding regulatory liability of equal amount.  TDS Telecom's ILECs have their rates regulated by the respective state public utility commissions and the Federal Communications Commission (“FCC”), and therefore, reflect the effects of the rate-making actions of these regulatory bodies in their financial statements.  In 2002, the FCC notified carriers by Order that it would not be adopting SFAS No. 143 since the FCC concluded that SFAS No. 143 conflicted with the FCC's current accounting rules that require ILECs to accrue for asset retirement obligations through prescribed depreciation rates.  Upon adoption of SFAS No. 143, and pursuant to the FCC's order and the provisions of SFAS No. 71 “Accounting for the Effects of Certain Types of Regulation,” (“SFAS No.71”) the ILECs reclassified their existing remediation liabilities, previously recorded in accumulated depreciation, to an ARO liability and a separate regulatory liability.  Upon further review, TDS has concluded that upon adoption of SFAS No. 143, and in accordance with SFAS No. 71, it should have recognized an ARO asset and a corresponding ARO liability, rather than establish the ARO liability through a reclassification of its existing remediation liabilities. The impact of establishing the ARO asset increased Property, Plant and Equipment and the corresponding ARO liability by $27.0 million and $27.3 million as of March 31, 2006 and December 31, 2005, respectively.  The adjustment did not affect previously reported revenues, operating income or net income (loss).

·                  Contracts with maintenance and support services – U.S. Cellular entered into certain equipment and software contracts that included maintenance and support services.  In one case, U.S. Cellular did not properly allocate expenditures between equipment purchases and maintenance and support services.  In other cases, U.S. Cellular did not properly record fees for maintenance and support services over the specified term of the agreement.  The restatement adjustments properly record property, plant and equipment, related depreciation expense and fees for maintenance and support services in the correct periods.

·      Classification of Asset Retirement Obligation on the Statement of Cash Flows – The additions to property, plant and equipment and other deferred liabilities representing additional asset retirement obligations (“ARO”) should be treated as non-cash items in the statement of cash flows.  From 2004 through the second quarter of 2006, U.S. Cellular included additional ARO liabilities as a change in other assets and liabilities in cash flows from operating activities and the increase in the ARO asset balance as a capital expenditure in cash flows from investing activities resulting in an overstatement of cash flows from operating activities and an overstatement of cash flows required by investing activities.  In the restatement, adjustments were recorded in the statement of cash flows to offset the change in ARO liabilities against the ARO asset. The reduction in the change in other assets and liabilities in cash flows from operating activities and the reduction in additions to property, plant and equipment in cash flows from investing activities totaled $1.5 million and $0.7 million in the three months ended March 31, 2006 and 2005, respectively.

8

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·                  Income taxes – In the restatement, TDS adjusted its income tax expense, income taxes payable, goodwill, deferred income tax assets and liabilities and related disclosures for the years ended December 31, 2005, 2004, 2003 and 2002 for items identified based on its annual analysis reconciling its 2005 income tax expense and income tax balance sheet accounts as determined in its comparison of the 2005 year-end income tax provision to the 2005 federal and state income tax returns. These adjustments included corrections for certain accounts that had not previously been included in the financial reporting basis used in determining the cumulative temporary differences in computing deferred income tax assets and liabilities, as well as adjustments to certain cumulative temporary differences that had historically been incorrectly associated with operating license assets which, in this restatement, have been correctly classified as investments in partnership assets.  Accordingly, the company has adjusted the deferred tax liabilities related to these assets.  Goodwill was adjusted by $10.2 million to record the income tax effect of the difference between the financial reporting basis and the income tax basis of certain acquisitions made prior to 2004.

TDS determined that the state deferred tax liabilities attributable to marketable equity securities, as presented in prior periods, should have been lower to reflect carryover of a higher stock basis than the federal basis for certain states that have not adopted the federal consolidated return regulations.  TDS also identified a valuation allowance related to state net operating loss carry forwards for which deferred tax liabilities related to marketable equity securities provide positive evidence supporting reductions to previously established valuation allowances.

·      Cash and interest income – In reviewing cash accounts, it was determined that cash and interest income were overstated in the three months ended March 31, 2006 and six months ended June 30, 2006.  In the restatement, TDS corrected the overstatement by reducing cash and interest income.

·      Property, plant and equipment – U.S. Cellular did not properly record certain transfers and disposals of equipment removed from service.  Also, U.S. Cellular did not properly record depreciation expense for certain leasehold improvements and other equipment due to the use of incorrect asset lives.  The restatement adjustments properly record equipment disposals and depreciation expense in the correct amounts and periods.

·      Other items – In addition to the adjustments described above, TDS recorded a number of other adjustments to correct and record revenues, expenses and equity in earnings of unconsolidated entities in the periods in which such revenues, expenses and equity in earnings of unconsolidated entities were earned or incurred. Adjustments were also made to correct certain balance sheet amounts, including $2.1 million corrections to purchase price accounting for certain acquisitions prior to 2003.  These individual adjustments were not material.

9

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The table below summarizes the impacts of the restatement on income before income taxes and minority interest.

 

 

The table below summarizes the net income and diluted earnings per share impacts from the restatement.

		Three Months Ended March 31,
		2006						2005
		Net Income			Diluted Earnings Per Share			Net Income			Diluted Earnings Per Share
		(Increase (decrease) dollars in thousands, except per share amounts)
As previously reported		$	39,875		$	0.34		$	23,049		$	0.20
Forward contracts and related derivative instruments		(672		)	(0.01		)	201,920			1.75
Contracts with maintenance and support services		75			—			(84		)	—
Income taxes		679			0.01			549			—
Interest income		(2,876		)	(0.02		)	—			—
Property, plant and equipment		754			0.01			(109		)	—
Other items		(1,838		)	(0.02		)	(1,764		)	(0.02		)
Total adjustment		(3,878		)	(0.03		)	200,512			1.73
As restated		$	35,997		$	0.31		$	223,561		$	1.93

 

10

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The effect of the restatement on the previously reported Consolidated Statements of Operations is as follows:

		Three Months Ended March 31,
		2006						2005
		As Previously Reported			As Restated			As Previously Reported			As Restated
		(Dollars in thousands, except per share amounts)
Operating Revenues		$	1,060,312		$	1,059,077		$	935,787		$	933,962
Operating Expenses
Cost of service and products
(exclusive of depreciation, amortization and accretion shown separately below)		375,139			376,306			338,624			343,817
Selling, general and administrative expense		393,421			392,621			348,571			345,072
Depreciation, amortization and accretion expense		182,667			182,966			169,748			170,141
Total Operating Expenses		951,227			951,893			856,943			859,030
Operating Income		109,085			107,184			78,844			74,932
Investment and Other Income (Expense)
Equity in earnings of unconsolidated entities		19,805			19,805			14,754			14,751
Interest and dividend income		16,237			11,483			8,286			8,118
Interest expense		(58,532		)	(58,532		)	(51,856		)	(51,856		)
Fair value adjustment of derivative instruments		425			30			(47		)	335,400
Gain on investments		—			—			500			500
Other income (expense), net		(927		)	(927		)	(4,274		)	(4,274		)
Total Investment and Other Income (Expense)		(22,992		)	(28,141		)	(32,637		)	302,639
Income before Income Taxes and Minority Interest		86,093			79,043			46,207			377,571
Income tax expense		35,968			32,342			17,395			148,400
Income before Minority Interest		50,125			46,701			28,812			229,171
Minority share of income		(10,250		)	(10,704		)	(5,763		)	(5,610		)
Net Income		39,875			35,997			23,049			223,561
Preferred dividend requirement		(51		)	(51		)	(50		)	(50		)
Net Income Available to Common		$	39,824		$	35,946		$	22,999		$	223,511
Basic Earnings per Share		$	0.34		$	0.31		$	0.20		$	1.94
Diluted Earnings per Share		$	0.34		$	0.31		$	0.20		$	1.93

 

11

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The effect of the restatement on the previously reported Consolidated Statements of Cash Flows is as follows:

		Three Months Ended March 31,
		2006			2006			2005			2005
		As Previously Reported			As Restated			As Previously Reported			As Restated
		(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$  39,875			$  35,997			$  23,049			$  223,561
Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization and accretion		182,667			182,966			169,748			170,141
Bad debts expense		9,075			9,075			8,135			8,135
Stock-based compensation expense		7,023			8,638			1,171			1,171
Deferred income taxes		(11,602		)	(15,228		)	960			131,965
Equity in earnings of unconsolidated entities		(19,805		)	(19,805		)	(14,754		)	(14,751		)
Distributions from unconsolidated entities		5,676			5,676			1,520			1,520
Minority share of income		10,250			10,704			5,763			5,610
Fair value adjustment of derivative instruments		(425		)	(30		)	47			(335,400		)
Gain on investments		—			—			(500		)	(500		)
Noncash interest expense		5,480			5,480			5,029			5,029
Other noncash expense		1,504			1,504			2,467			2,467
Changes in assets and liabilities
Change in accounts receivable		9,065			9,164			9,620			10,707
Change in materials and supplies		7,546			7,546			7,482			7,482
Change in accounts payable		(53,405		)	(53,405		)	(64,793		)	(64,763		)
Change in customer deposits and deferred revenues		4,349			5,209			3,844			4,911
Change in accrued taxes		47,703			47,703			21,868			21,868
Change in accrued interest		4,567			4,567			3,971			3,971
Change in other assets and liabilities		(28,967		)	(32,525		)	(34,468		)	(33,755		)
		220,576			213,236			150,159			149,369
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment		(146,362		)	(143,776		)	(134,787		)	(133,997		)
Cash paid for acquisitions		—			—			(120,924		)	(120,924		)
Other investing activities		(1,467		)	(1,467		)	(564		)	(564		)
		(147,829		)	(145,243		)	(256,275		)	(255,485		)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of notes payable		55,000			55,000			165,000			165,000
Issuance of long-term debt		560			560			112,588			112,588
Repayment of notes payable		(105,000		)	(105,000		)	(60,000		)	(60,000		)
Repayment of long-term debt		(748		)	(748		)	(110,510		)	(110,510		)
Repayment of medium-term notes		(35,000		)	(35,000		)	(17,200		)	(17,200		)
TDS Common Shares and Special Common Shares issued for benefit plans		3,080			3,080			6,684			6,684
U.S. Cellular Common Shares issued for benefit plans		3,858			3,858			6,836			6,836
Capital (distributions) to minority partners		(4,146		)	(4,146		)	—			—
Dividends paid		(10,749		)	(10,749		)	(10,122		)	(10,122		)
Other financing activities		1,207			1,207			131			131
		(91,938		)	(91,938		)	93,407			93,407
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(19,191		)	(23,945		)	(12,709		)	(12,709		)
CASH AND CASH EQUIVALENTS
Beginning of period		1,095,791			1,095,791			1,171,105			1,171,105
End of period		$	1,076,600		$	1,071,846		$	1,158,396		$	1,158,396

 

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The effect of the restatement on the previously reported Consolidated Balance Sheets is as follows:

		March 31,						December 31,
		2006			2006			2005			2005
		As Previously Reported			As Restated			As Previously Reported			As Restated
		(Dollars in thousands)
CURRENT ASSETS
Cash and cash equivalents		$	1,076,600		$	1,071,846		$	1,095,791		$	1,095,791
Accounts receivable
Due from customers,		332,811			329,084			336,005			332,278
Other, principally connecting companies		145,437			141,944			160,577			157,182
Materials and supplies, at average cost		96,359			96,359			103,211			103,211
Prepaid expenses		47,889			49,363			40,704			41,746
Deferred income tax asset		13,434			13,434			13,438			13,438
Other current assets		31,723			32,874			29,243			34,774
		1,744,253			1,734,904			1,778,969			1,778,420
INVESTMENTS
Marketable equity securities		2,559,507			2,559,507			2,531,690			2,531,690
Licenses		1,364,836			1,364,836			1,365,063			1,365,063
Goodwill		870,110			882,486			869,792			882,168
Customer lists, net of accumulated amortization		46,286			41,952			49,318			47,649
Investments in unconsolidated entities		231,196			232,953			215,424			217,180
Other investments		12,044			12,044			12,274			12,274
		5,083,979			5,093,778			5,043,561			5,056,024
PROPERTY, PLANT AND EQUIPMENT
In service and under construction		7,262,283			7,252,589			7,140,447			7,131,977
Less accumulated depreciation		3,768,618			3,754,353			3,614,242			3,602,217
		3,493,665			3,498,236			3,526,205			3,529,760
OTHER DEFERRED CHARGES		55,259			55,259			55,830			55,830
TOTAL ASSETS		$	10,377,156		$	10,382,177		$	10,404,565		$	10,420,034

 

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		March 31,						December 31,
		2006			2006			2005			2005
		As Previously Reported			As Restated			As Previously Reported			As Restated
		(Dollars in thousands)
CURRENT LIABILITIES
Current portion of long-term debt		$	203,124		$	203,124		$	237,948		$	237,948
Notes payable		85,000			85,000			135,000			135,000
Accounts payable		303,869			306,530			357,273			359,934
Customer deposits and deferred revenues		125,577			131,663			121,228			126,454
Accrued interest		33,513			33,513			28,946			28,946
Accrued taxes		85,875			80,380			47,180			46,061
Accrued compensation		45,866			45,866			67,443			67,443
Other current liabilities		71,130			73,676			61,086			63,539
		953,954			959,752			1,056,104			1,065,325
DEFERRED LIABILITIES AND CREDITS
Net deferred income tax liability		1,378,914			1,330,258			1,383,031			1,337,716
Derivative liability		454,049			454,049			449,192			449,192
Asset retirement obligation		167,645			194,642			163,093			190,382
Other deferred liabilities and credits		112,328			113,669			104,984			107,924
		2,112,936			2,092,618			2,100,300			2,085,214
LONG-TERM DEBT
Long-term debt, excluding current portion		1,633,268			1,633,268			1,633,519			1,633,519
Forward contracts		1,711,813			1,711,813			1,707,282			1,707,282
		3,345,081			3,345,081			3,340,801			3,340,801
MINORITY INTEREST IN SUBSIDIARIES		561,711			555,559			552,884			546,833
PREFERRED SHARES		3,863			3,863			3,863			3,863
COMMON STOCKHOLDERS’ EQUITY
Common Shares, par value $.01 per share		565			565			565			565
Special Common Shares, par value $.01 per share		629			629			629			629
Series A Common Shares, par value $.01 per share		64			64			64			64
Additional paid-in capital		1,830,780			1,834,516			1,826,420			1,828,634
Treasury Shares, at cost:
Common Shares		(207,524		)	(207,524		)	(208,156		)	(208,156		)
Special Common Shares		(209,421		)	(209,421		)	(210,600		)	(210,600		)
Accumulated other comprehensive income		322,710			378,006			309,009			363,641
Retained earnings		1,661,808			1,628,469			1,632,682			1,603,221
		3,399,611			3,425,304			3,350,613			3,377,998
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	10,377,156		$	10,382,177		$	10,404,565		$	10,420,034

 

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2.               Summary of Significant Accounting Policies

Change in Accounting Principle – Stock-Based Compensation

TDS has established long-term incentive plans, employee stock purchase plans, and dividend reinvestment plans, which are described more fully in Note 3 – Stock-Based Compensation. Prior to January 1, 2006, TDS accounted for those plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, as permitted by Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”. Total stock-based employee compensation cost recognized in the Consolidated Statements of Operations under APB 25 was $1.2 million for the three months ended March 31, 2005, primarily for restricted stock unit and deferred compensation stock unit awards. No compensation cost was recognized in the Consolidated Statements of Operations under APB 25 for stock option awards for the three months ended March 31, 2005, because all outstanding options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.  The employee stock purchase plans and dividend reinvestment plans qualified as non-compensatory plans under APB 25; therefore, no compensation cost was recognized for these plans during the three months ended March 31, 2005.

Effective January 1, 2006, TDS adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”), using the modified prospective transition method. In addition, TDS applied the provisions of Staff Accounting Bulletin No. 107 (“SAB 107”), issued by the Securities and Exchange Commission in March 2005 in its adoption of SFAS 123(R).  Under the modified prospective transition method, compensation cost recognized during the three months ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated.

Under SFAS 123(R), the long-term incentive plans are considered compensatory plans; therefore, recognition of compensation costs for grants made under these plans is required.

Under SFAS 123(R), the employee stock purchase plans are considered compensatory plans; therefore, recognition of compensation costs for grants made under these plans is required. However, due to restrictions on activity under these plans that were in place during the three months ended March 31, 2006, no compensation expense was recognized during this period.

Under SFAS 123(R), the dividend reinvestment plans are not considered compensatory plans, therefore recognition of compensation costs for grants made under these plans is not required.

Upon adoption of SFAS 123(R), TDS elected to continue to value its share-based payment transactions using a Black-Scholes valuation model, which was previously used by TDS for purposes of preparing the pro forma disclosures under SFAS 123. Under the provisions of SFAS 123(R), stock-based compensation cost recognized during the period is based on the portion of the share-based payment awards that is ultimately expected to vest. Accordingly, stock-based compensation cost recognized in the first quarter of 2006 has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated based on historical experience related to similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. TDS believes that its historical experience is the best estimate of future expected life. In TDS’s pro forma information required under SFAS 123, TDS also reduced stock-based compensation cost for estimated forfeitures. The expected life assumption was determined based on TDS’s historical experience. For purposes of both SFAS 123 and SFAS 123(R), the expected volatility assumption was based on the historical volatility of TDS’s common stock. The dividend yield was included in the assumptions. The risk-free interest rate assumption was determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the stock options.

Compensation cost for stock option awards granted after January 1, 2006 will be recognized over the respective requisite service period of the awards, which is generally the vesting period, on a straight-line basis over the requisite service period for each separately vesting portion of the awards as if the awards were, in-substance, multiple awards (graded vesting attribution method), which is the same attribution method that was used by TDS for purposes of its pro forma disclosures under SFAS 123.

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Certain employees were eligible for retirement at the time that compensatory stock options were granted.  Under the terms of the TDS option agreements, options granted to these individuals do not vest upon retirement. Under the terms of the U.S. Cellular option agreements, options granted to these individuals will fully vest upon their retirement if they have reached the age of 65. Similarly, under the terms of TDS’s restricted stock unit agreements, restricted stock units vest upon retirement if the employee has reached the age of 66. Under the terms of U.S. Cellular’s restricted stock unit agreements, restricted stock units vest upon retirement if the employee has reached the age of 65. Prior to the adoption of SFAS 123(R), TDS used the “nominal vesting method” to recognize the pro forma stock-based compensation cost related to options and restricted stock units awarded to retirement-eligible employees. This method does not take into account the effect of early vesting due to the retirement of eligible employees.  Upon adoption of SFAS 123(R), TDS adopted the “non-substantive vesting method”, which requires the recognition of the entire expense related to options granted to retirement-eligible employees.  If the non-substantive vesting method had been applied in prior periods, the effect on previously disclosed pro forma stock-based compensation cost would not have been material.

On March 7, 2006, the TDS Compensation Committee approved amendments to stock option award agreements. The amendments modify current and future options to extend the exercise period until 30 days following (i) the lifting of a “suspension” if options otherwise would expire or be forfeited during the suspension period and (ii) the lifting of a blackout if options otherwise would expire or be forfeited during a blackout period.  TDS temporarily suspended issuances of shares under the 2004 Long Term Incentive Plan between March 17, 2006 and October 10, 2006 as a consequence of late SEC filings.  As required under the provisions of SFAS 123(R), TDS evaluated the impact of this plan modification and originally determined that the adjustment to stock based compensation was not material.  However, in connection with the restatement discussed above, TDS further reviewed the accounting for the plan modification.  Upon such further review, TDS determined that it should have recognized stock-based compensation expense of $1.6 million in the three months ended March 31, 2006 as a result of this modification.  This expense has been reflected in the restatement of such period.

Pension Plan

TDS sponsors a qualified noncontributory defined contribution pension plan. The plan provides benefits for the employees of TDS Corporate, TDS Telecom and U.S. Cellular.  Under this plan, pension benefits and costs are calculated separately for each participant and are funded currently.  Pension costs were $3.5 million and $3.4 million for the three months ended March 31, 2006 and March 31, 2005, respectively.

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

Other Postretirement Benefits

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

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

 

TDS will contribute $5.3 million to the postretirement plan assets during the second quarter of 2006.

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Recent Accounting Pronouncements

FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), was issued in July 2006.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in accordance with FASB Statement No. 109, “Accounting for Income Taxes.”  The interpretation prescribes a recognition threshold and measurement attribute for the recognition and measurement of a tax position taken or expected to be taken in an income tax return.  It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.  FIN 48 is effective for fiscal years beginning after December 15, 2006.  TDS is currently reviewing the requirements of FIN 48 and has not yet determined the impact, if any, on its financial position or results of operations.

3.               Stock-Based Compensation

As a result of adopting SFAS 123(R) on January 1, 2006, TDS’s income before income taxes and net income for the three months ended March 31, 2006, are $5.1 million and $2.5 million lower, respectively, than if it had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for the three months ended March 31, 2006 are $0.02 and $0.02 lower, respectively, than if TDS had continued to account for share-based compensation under APB 25.

Stock-Based Compensation Expense

For comparison, the following table illustrates the pro forma effect on net income and earnings per share had TDS applied the fair value recognition provisions of SFAS 123(R) to its stock-based employee compensation plans for the three months ended March 31, 2005:

(Dollars in thousands, except per share amounts)		(As Restated)
Net income, as reported		$	223,561
Add: Stock-based compensation expense included in reported net income, net of related tax effects and minority interest		619
Deduct: Stock-based compensation expense determined under fair value based method for all awards, net of related tax effects and minority interest		(2,881		)
Pro forma net income		$	221,299
Earnings per share:
Basic—as reported		$	1.94
Basic—pro forma		$	1.92
Diluted—as reported		$	1.93
Diluted—pro forma		$	1.91

 

Prior to the adoption of SFAS 123(R), TDS presented all tax benefits resulting from tax deductions associated with the exercise of stock options by employees as cash flows from operating activities in the Consolidated Statements of Cash Flows. SFAS 123(R) requires that “excess tax benefits” be classified as cash flows from financing activities in the Consolidated Statement of Cash Flows.  For this purpose, the excess tax benefits are tax benefits related to the difference between the total tax deduction associated with the exercise of stock options by employees and the amount of compensation cost recognized for those options. For the three months ended March 31, 2006, excess tax benefits of $0.4 million were included within Other Financing Activities of the Cash Flows from Financing Activities pursuant to this requirement of SFAS 123(R).

The following table summarizes stock-based compensation expense recognized during the three months ended March 31, 2006:

(Amounts in thousands)
Compensation expense recognized for stock option awards		$	5,127
Compensation expense recognized for restricted stock unit awards		2,751
Compensation expense recognized for deferred compensation matching stock unit awards		760
Compensation expense recognized for awards under employee stock purchase plans		0
Total stock-based compensation, before income taxes		8,638
Income tax benefit		(3,549		)
Total stock-based compensation expense, net of income taxes		$	5,089

 

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At March 31, 2006, unrecognized compensation cost for all stock-based compensation awards was $19.7 million. The unrecognized compensation cost for stock-based compensation awards at March 31, 2006 is expected to be recognized over a weighted average period of 0.8 years.

All stock-based compensation expense recognized during the three months ended March 31, 2006 was recorded in Selling, general and administrative expense.

TDS

The information in this section relates to stock-based compensation plans utilizing the equity instruments of TDS.  Participants in these plans are generally employees of TDS Corporate and TDS Telecom, although U.S. Cellular employees are eligible to participate in the TDS Employee Stock Purchase Plan.  Information related to plans utilizing the equity instruments of U.S. Cellular are shown in the U.S. Cellular section following the TDS section.

Under the TDS 2004 Long-Term Incentive Plan (and a predecessor plan), TDS may grant fixed and performance-based incentive and non-qualified stock options, restricted stock, restricted stock units, and deferred compensation stock unit awards to key employees.  TDS had reserved 4,006,000 Common Shares and 11,893,000 Special Common Shares at March 31, 2006, for equity awards granted and to be granted under this plan. At March 31, 2006, the only types of awards outstanding are fixed non-qualified stock option awards, restricted stock unit awards, and deferred compensation stock unit awards. At March 31, 2006, TDS also had reserved 174,000 Common Shares and 323,000 Special Common Shares for issuance under the Automatic Dividend Reinvestment and Stock Purchase Plan and 49,000 Series A common shares for issuance under the Series A common share Automatic Dividend Reinvestment Plan, and 185,000 Common Shares and 320,000 Special Common Shares under an employee stock purchase plan. The maximum number of TDS Common Shares, TDS Special Common Shares and TDS Series A Common Shares that may be issued to employees under all stock-based compensation plans in effect at March 31, 2006 was 4,365,000, 12,536,000 and 49,000 shares, respectively. TDS currently utilizes treasury stock to satisfy stock option exercises, issuances under its employee stock purchase plan, restricted stock unit awards and deferred compensation stock unit awards.

Stock Options—Stock options granted to key employees are exercisable over a specified period not in excess of ten years.  Stock options generally vest over periods up to four years from the date of grant.  Stock options outstanding at March 31, 2006 expire between 2006 and 2015.  However, vested stock options typically expire 30 days after the effective date of an employee’s termination of employment for reasons other than retirement.  Employees who leave at the age of retirement have 90 days (or one year if they satisfy certain requirements) within which to exercise their vested stock options. The exercise price of the option generally equals the market value of TDS common stock on the date of grant.

TDS estimates the fair value of stock options granted using the Black-Scholes valuation model. The fair value is then recognized as compensation cost on a straight-line basis over the requisite service period, which is generally the vesting period, for each separately vesting portion of the awards as if the awards were, in-substance, multiple awards, which is the same attribution method that was used by TDS for purposes of its pro forma disclosures under SFAS 123.  TDS did not grant stock options during the three months ended March 31, 2006 and March 31, 2005.

A summary of TDS stock options (total and portion exercisable) at March 31, 2006 and changes during the three months then ended is presented in the table and narrative below:

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All TDS options outstanding at March 31, 2006 were granted prior to the distribution of the TDS Special Common Share Dividend in 2005, more fully described in TDS’s 2005 Annual Report on Form 10-K. As a result of the Special Common Share Dividend, an employee will receive one Common Share and one Special Common Share per tandem option exercised. Each tandem option is exercisable at its original exercise price.

				Weighted			Weighted Average
		Number		Average			Remaining
		of Tandem		Exercise			Contractual		Aggregate
		Options(1)		Prices			Term		Intrinsic Value
Outstanding at December 31, 2005 (2,461,000 exercisable)		2,701,000		$	73.86		6.5 years		$	30,119,000
Granted		—		—					—
Exercised		23,000		$	52.28				466,000
Forfeited		12,000		$	56.70				273,000
Expired		—		—					—
Outstanding at March 31, 2006 (2,438,000 exercisable)		2,666,000		$	74.12		6.3 years		$	29,285,000

 

(1) Upon exercise, each tandem option is converted into one TDS Common Share and one TDS Special Common Share.

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between TDS’s closing stock price on the last trading day of the period and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2006. This amount will change in future periods based on the market price of TDS’s stock. TDS received $1.2 million in cash from the exercise of stock options during the three months ended March 31, 2006.

A summary of TDS’s nonvested stock options at March 31, 2006 and changes during the three months then ended is presented in the table below:

				Weighted Average
		Number of		Fair Values of
		Stock Options(1)		Stock Options
Nonvested at December 31, 2005		240,000		$	21.67
Granted		—		—
Vested		—		—
Forfeited		12,000		21.99
Nonvested at March 31, 2006		228,000		$	21.66

 

(1) Upon exercise, each restricted stock option outstanding at March 31, 2006 is converted into one TDS Common Share and one TDS Special Common Share.

Restricted Stock Units—Beginning in April 2005, TDS granted restricted stock unit awards to key employees. These awards generally vest after three years. All TDS restricted stock units outstanding at March 31, 2006 were granted prior to the distribution of the TDS Special Common Share Dividend in 2005. As a result of the Special Common Share Dividend, an employee will receive one Common Share and one Special Common Share upon the vesting of such restricted stock units. The restricted stock unit awards outstanding at March 31, 2006 will vest in December 2007. When vested, employees will receive an equal number of TDS Common Shares and TDS Special Common Shares with respect to such restricted stock units.

TDS estimates the fair value of restricted stock units based on the closing market price of TDS shares on the date of grant. The fair value is then recognized as compensation cost on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

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A summary of TDS nonvested restricted stock units at March 31, 2006 and changes during the three months then ended is presented in the table below:

 

				Weighted Average
		Number		Fair Values of
		of Restricted		Restricted
		Stock Units(1)		Stock Units
Nonvested at December 31, 2005		90,286		$	77.55
Granted		—		—
Vested		—		—
Forfeited		—		—
Nonvested at March 31, 2006		90,286		$	77.55

 

(1) Upon exercise, each restricted stock unit outstanding at March 31, 2006 is converted into one TDS Common Share and one TDS Special Common Share.

Deferred Compensation Stock Units—Certain TDS employees may elect to defer receipt of all or a portion of their annual bonuses and to receive stock unit matches on the amount deferred up to $400,000. Deferred compensation, which is immediately vested, is deemed to be invested in TDS Common Share units or, at the election of the committee that administers the plan after the TDS Special Common Share Dividend in 2005, TDS Special Common Share units. TDS match amounts depend on the amount of annual bonus that is deferred into stock units. Participants receive a 25% stock unit match for amounts deferred up to 50% of their total annual bonus and a 33% match for amounts that exceed 50% of their total annual bonus. The matched stock units vest ratably at a rate of one-third per year over three years. When fully vested and upon distribution, employees will receive the vested TDS Common Shares and/or TDS Special Common Shares, as applicable.

TDS estimates the fair value of deferred compensation matching stock units based on the closing market price of TDS shares on the date of grant. The fair value of the matched stock units is then recognized as compensation cost on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

A summary of TDS nonvested deferred compensation stock unit plans at March 31, 2006 and changes during the three months then ended is presented in the table that follows:

				Weighted Average
		Number of		Fair Values
		Stock Units(1)		of Stock Units
Nonvested at December 31, 2005		1,025		$	72.50
Granted		—		—
Vested		—		—
Forfeited		—		—
Nonvested at March 31, 2006		1,025		$	72.50

 

(1)          Upon exercise, each deferred compensation stock unit outstanding at March 31, 2006 is converted into one TDS Common Share and one TDS Special Common Share.

Employee Stock Purchase Plan—Under the 2003 Employee Stock Purchase Plan, eligible employees of TDS and its subsidiaries may purchase a limited number of shares of TDS common stock on a quarterly basis. Prior to 2006, such common stock consisted of TDS Common Shares. Beginning in 2006, such common stock consisted of TDS Special Common Shares. TDS had reserved 185,000 Common Shares and 320,000 Special Common Shares at March 31, 2006 for issuance under this plan.  The plan became effective on April 1, 2003 and will terminate on December 31, 2008. The per share cost to each participant is 85% of the market value of the Common Shares or Special Common Shares as of the issuance date. Under SFAS 123(R), the employee stock purchase plan is considered a compensatory plan; therefore recognition of compensation costs for stock issued under this plan is required. Compensation cost is measured as the difference between the cost of the shares to the plan participants and the fair market value of the shares on the date of issuance. However, due to restrictions on activity under these plans in place during the three months ended March 31, 2006, no compensation expense was recognized during this period.

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