Telephone and Data Systems, Inc. Management’s Discussion and Analysis of Results of Operation and Financial Condition Management’s Discussion and Analysis of Results of Operation and Financial Condition TDS and U.S. Cellular may continue the repurchase of their common shares, as market conditions warrant, on the open market or at negotiated prices in private transactions. The repurchase programs are intended to create value for the shareholders. The repurchases of common shares will be funded by internal cash flow, supplemented by short-term borrowings. The U.S. Cellular Board of Directors has authorized management to opportunistically repurchase LYONs in private transactions. U.S. Cellular may also purchase a limited amount of LYONs in open-market transactions from time to time. U.S. Cellular LYONs are convertible, at the option of their holders, at any time prior to maturity, redemption or purchase, into U.S. Cellular common shares at a conversion rate of 9.475 U.S. Cellular common shares per LYON. Upon conversion, U.S. Cellular has the option to deliver to holders either U.S. Cellular common shares or cash equal to the market value of the U.S. Cellular common shares into which the LYONs are convertible. U.S. Cellular may redeem the notes for cash at the issue price plus accrued original issue discount through the date of redemption. TDS holds various investments in publicly traded companies valued at $2,700.2 million as of December 31, 2001. These assets are classified for financial reporting purposes as available-for-sale securities. TDS may purchase additional shares, sell or transfer shares in public or private transactions and/or may enter into privately negotiated derivative transactions to hedge the market risk of some or all of its positions in the securities. Market Risk Critical Accounting Policies and Estimates TDS is subject to market rate risks due to fluctuations in interest rates and equity markets. The majority of TDS’s debt is in the form of long-term, fixed-rate notes, convertible debt, debentures and trust securities with original maturities ranging up to 40 years. Accordingly, fluctuations in interest rates can lead to significant fluctuations in the fair value of such instruments. TDS has not entered into any significant financial derivatives to reduce its exposure to interest rate risks. The annual requirements for principal payments on long-term debt and the average interest rates are shown above in the Liquidity section. The aggregate principal amounts of long-term debt were $1,746.0 million at December 31, 2001 and $1,438.5 million at December 31, 2000, the estimated fair value was $1,559.7 million and $1,367.9 million, respectively, and the average interest rate on the debt was 7.28% and 7.14%, respectively. The fair value was estimated using market prices for TDS’s 7.6% Series A Notes and U.S. Cellular LYONs and discounted cash flow analysis for the remaining debt. The trust securities instruments totaling $300 million, with an average interest rate of 8.27%, are due in 2037 and 2038. The fair value of the trust securities was $299.2 million and $279.0 million based upon the market price at December 31, 2001 and 2000, respectively. TDS maintains a portfolio of available-for-sale marketable equity securities. The market value of these investments aggregated $2,700.2 million at December 31, 2001 and $4,121.9 million at December 31, 2000. A hypothetical 10% decrease in the share prices of these investments at December 31, 2001 would result in a $270.0 million decline in the market value of the investments. As of December 31, 2001, the net unrealized holding loss, net of tax, included in accumulated other comprehensive loss totaled $352.1 million. Management does not consider the unrealized loss to be “other than temporary.” Management continues to review the valuation of the investments on a periodic basis. If management determines in the future that the unrealized loss is other than temporary, the loss will be recognized and recorded in the income statement. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions and information that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements about the carrying values of assets and liabilities. Actual results may differ from estimates under different assumptions or conditions. Management believes the following critical accounting policies reflect its more significant judgements and estimates used in the preparation of its consolidated financial statements. The Company holds a substantial amount of marketable securities that are publicly traded and can have volatile share prices. The marketable securities are marked to market each period with the change in value of the securities reported as Other Comprehensive Income, net of income taxes, which is included in the stockholders’ equity section of the balance sheet. If management determined that the decline in value of the marketable securities was “other than temporary,” the unrealized loss included in other comprehensive income would be recognized and recorded as a loss in the income statement. Factors that management reviews in determining an other than temporary decline include whether there has been a significant change in the financial condition, operational structure or near-term prospects of the issuer; how long the security has been below historical cost; and whether TDS has the ability to retain its investment in the issuer’s securities to allow the market value to return to historical cost levels. TDS has substantial investments in long-lived assets, including substantial amounts of intangible assets, primarily cellular license costs and telephone franchise costs (goodwill), as a result of acquisitions of wireless markets and licenses, and telephone companies. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company evaluates the asset for possible impairment based on Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement an estimate of related undiscounted cash flows over the remaining asset life. If an impairment is identified, a loss is recognized for the difference between the fair value of the asset (less cost to sell) and the carrying value of the asset. TDS will adopt SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002, and will no longer amortize cellular license costs, telephone franchise and other costs in excess of the underlying book value of subsidiaries, and goodwill for equity method investments. In connection with SFAS No. 142, TDS is assessing its recorded balances of cellular license costs and telephone franchise and other costs for potential impairment. The Company expects to complete its impairment assessment in the first quarter of 2002. Any required impairment charge would be recorded as a cumulative effect of accounting change as of January 1, 2002. The Company does not currently expect to record an impairment charge upon the completion of the initial impairment review. However, there can be no assurance that at the time the review is completed a material impairment charge will not be recorded. Deferred tax assets are reduced by a valuation allowance when, in management’s opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. TDS considers future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. If it were determined that TDS would be able to realize the deferred tax asset in excess of its net recorded amount, an adjustment to deferred tax assets would increase income. Likewise, if it were determined that TDS would not be able to realize the net deferred tax asset amount, an adjustment to deferred tax assets would reduce income. This Management’s Discussion and Analysis of Results of Operations and Financial Condition and other sections of this Annual Report contain statements that are not based on historical fact, including the words “believes,” “anticipates,” “intends,” “expects” and similar words. These statements constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, events or develop- ments to be significantly different from any future results, events or developments expressed or implied by such forward- looking statements. Such factors include the following.  • Increases in the level of competition in the markets in which TDS operates could adversely affect TDS’s revenues or increase its costs to compete. • Advances or changes in telecommunications technology could render certain technologies used by TDS obsolete. • Changes in telecommunications regulatory environment could adversely affect TDS’s financial condition or results of operations. • Changes in the supply or demand of the market for wireless licenses or telephone companies, increased competition, adverse developments in the TDS’s businesses or the industries in which TDS is involved and/or other factors could result in an impairment of the value of TDS’s license costs and/or goodwill, which may require TDS to record a write down in the value of such assets.  • Competition, construction delays and other challenges in executing TDS’s expansion and development of its CLEC business could result in higher than planned losses, additional financing requirements and/or the write down of the CLEC assets if TDS is unable to successfully implement its plans in this business undertaking. • Continued depressed market values, continued declines thereof or other events evidencing an impairment in the value of TDS’s investments in available-for-sale marketable equity securities that are other than temporary may require TDS to write down the value of such securities. • Settlement, judgments, restraints on its current manner of doing business and/or legal costs resulting from pending and future litigation could have an adverse effect on TDS’s financial condition, results of operations or ability to do business.  • Costs, integration problems or other factors associated with acquisitions/divestitures of properties and/or licenses could have an adverse effect on TDS’s financial condition or results of operations. • Changes in growth in the number of wireless customers, average revenue per unit, penetration rates, churn rates, roaming rates and the mix of products and services offered in wireless markets could have an adverse effect on TDS’s wireless business operations. • Changes in growth in the number of ILEC and CLEC customers, churn rates and mix of products and services offered in ILEC and CLEC markets could have an adverse effect on such TDS business segments. • Changes in market conditions 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 and acquisition programs. • Changes in general economic and business conditions, both nationally and in the regions in which TDS operates, could have an adverse effect on TDS’s businesses. 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. 37 Telephone and Data Systems, Inc. Annual Report 2001 Telephone and Data Systems, Inc. Annual Report 2001 36