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 30 Telephone and Data Systems, Inc. Annual Report 2001 Telephone and Data Systems, Inc. Annual Report 2001 31 TDS Telecom’s local telephone operations are subject to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 71, “Accounting for the Effects of Certain Types of Regulation.” TDS Telecom periodically reviews the criteria for applying these provisions to determine whether continuing application of SFAS No. 71 is appropriate. TDS Telecom believes that such criteria are still being met and therefore has no current plans to change its method of accounting. In analyzing the effects of discontinuing the application of SFAS No. 71, management has determined that the useful lives of plant assets used for regulatory and financial reporting purposes are consistent with generally accepted accounting principles, and therefore, any adjustments to telecommunications plant would be immaterial, as would be any write-off of regulatory assets and liabilities. TDS Telecom launched competitive local exchange operations in five new markets serving over 25 cities in Illinois and Michigan in 2001 and will continue to explore opportunities for future growth. Access lines increased by 76% in 2001 and 70% in 2000. TDS Telecom has incurred and expects to incur substantial operating losses from expansion of competitive operations. Operating revenues (revenue from the provision of local and long-distance telephone service and revenue from a long- distance provider) increased 40% ($34.1 million) to $118.8 million in 2001 and 54% ($29.5 million) to $84.7 million in 2000. The increases were primarily due to the increases in access lines in both years. Operating expenses increased 62% ($62.1 million) in 2001 and 54% ($35.0 million) in 2000 due primarily to the costs incurred to grow the customer base and expand the service territories, especially new market areas in Wisconsin, Illinois and Michigan.  Operating loss was $43.0 million in 2001, $15.0 million in 2000 and $9.5 million in 1999. The competitive local exchange operating losses reflect the expenses associated with the growth and expansion in the business. TDS Telecom expects The Company will adopt SFAS No. 142 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 or goodwill for equity method investments. Cellular license costs, telephone franchise and other costs, and equity method goodwill totaled $1,334.5 million, $348.7 million and $76.8 million respectively, at December 31, 2001, and amortization for the year ended December 31, 2001 totaled $37.6 million, $6.2 million and $1.3 million, respectively.  SFAS No. 142 also defines the accounting for goodwill. Goodwill will be tested for impairment annually. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.  to continue to grow the competitive local exchange business in certain mid-sized cities. Operating losses from competitive local exchange operations are expected to increase in 2002 due to costs associated with market expansion. Management believes that inflation affects TDS’s business to no greater extent than the general economy.  The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 141 “Business Combinations” and No. 142 “Goodwill and Other Intangible Assets” in July 2001. These statements require, among other things, that all future business combinations be accounted for using the purchase method of accounting and prohibit the use of the pooling-of-interest method. For acquisitions completed after July 1, 2001, goodwill will not be amortized. In addition, effective January 1, 2002, previously recorded goodwill and other intangible assets with indefinite lives will no longer be amortized but will be subject to impairment tests. SFAS No. 142 defines the accounting for intangible assets. The accounting for a recognized intangible asset is based on the useful life to the entity. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized. The useful life of the intangible asset is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the entity.  An intangible asset that is not subject to amortization shall be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test shall consist of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess.  In addition, pursuant to SFAS No. 142, the Company is assessing its recorded balances of Cellular license costs and telephone franchise and other costs for potential impairment. As allowed under the standard, 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. issue the final Statement in the first quarter of 2002. When adopted, the Company would no longer report gains and losses on the retirement of long-term debt as an extraordinary item. The following table shows certain information relating to TDS’s financial resources and requirements.  SFAS No. 143, “Accounting for Asset Retirement Obligations” was issued in June 2001, and will become effective for the Company beginning January 1, 2003. SFAS No. 143 requires entities to record the fair value of a liability for legal obligations associated with an asset retirement in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. The Company is currently reviewing the requirements of this new standard and has not yet determined the impact, if any, on the Company’s financial position or results of operations. SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” was issued in October 2001, and became effective for the Company beginning January 1, 2002. SFAS No. 144 requires entities to measure long-lived assets at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS No. 144 also revises standards for the reporting of discontinued operations. This statement broadens the presentation of discontinued operations to include a component of an entity (rather than a segment of a business). A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. The Company is currently reviewing the requirements of this new standard, but does not expect implementation to have a material impact on its financial position or results of operations. The Financial Accounting Standards Board issued an exposure draft on November 15, 2001, “Rescission of FASB Statements No. 4, 44 and 64 and Technical Corrections.” This proposed Statement would rescind Statement 4 and Statement 64, an amendment to Statement 4, thereby eliminating the requirements that gains and losses from extinguishment of debt be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. The provisions of this Statement related to the rescission of Statement 4 shall be applied as of the beginning of the fiscal year in which this Statement is issued. The Board expects to represents a significant source of funds to the Company. Income from continuing operations excluding all noncash items totaled $583.7 million in 2001, $592.5 million in 2000 and $554.9 million in 1999. Proceeds from the settlement of litigation added $42.5 million in 2000. Changes in assets and liabilities from operations required $37.9 million in 2001, provided $120.5 million in 2000 and required $75.0 million in 1999, reflecting timing differences in the collection of accounts receivable, payment of accounts payable and accrued taxes. Cash Flows From Continuing Operating Activities Financial Resources  Inflation  Accounting Pronouncements Competitive Local Exchange Operations Year Ended December 31,  2001 2000 1999 (Dollars in thousands) Cash flows from (used in) Operating activities $ 545,805 $ 755,422 $ 479,832 Investing activities (519,858) (605,659) (285,350) Financing activities 15,778 (155,191) (272,522) Discontinued operations  — (6,563) 143,911 Net increase (decrease) in  cash and cash equivalents  $ 41,725 $ (11,991) $ 65,871 Capitalization $6,134,589 $ 6,362,631 $ 4,561,767 Percent equity to total capital 65.0% 68.6% 64.8% Interest coverage ratio (excluding gains and losses) 3.9x 3.6x 3.1x Book value per share  $ 56.36 $ 63.07 $ 39.25 Senior unsecured debt rating S&P/Moody’s A-/A3 A-/A3 BBB/Baa3  Year-end stock price  $ 89.75 $ 90.00 $ 126.00  Year Ended December 31,  2001 2000 1999 (Dollars in thousands) Income (loss) from  continuing operations $(168,248) $ 145,527 $ 291,326 Noncash items included  in income from continuing  operations 751,973 446,949 263,532 Income from continuing  operations excluding  noncash items 583,725 592,476 554,858 Proceeds from  litigation settlement — 42,457 — Changes in assets and  liabilities from operations (37,920)  120,489 (75,026) $ 545,805 $ 755,422 $ 479,832 – 140 – 130 – 120 – 110 – 100 – 90 – 80 119 115 128 TDS Telecom Operating Income $ Millions