UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-4996
ALLTEL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
34-0868285
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One Allied Drive, Little Rock, Arkansas
72202
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code (501) 905-8000
(Former name, former address and former fiscal year, if changed since last report)
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
Indicate by check mark whether the registrant is an accelerated filer (as defined by
Rule 12b-2 of the Act).
YES X NO
Number of common shares outstanding as of July 29, 2005: 327,489,268
The Exhibit Index is located on page 44.
ALLTEL CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
Item 1.
Financial Statements
2
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
15
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
41
Item 4.
Controls and Procedures
42
PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
*
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
42
Item 3.
Defaults Upon Senior Securities
*
Item 4.
Submission of Matters to a Vote of Security Holders
42
Item 5.
Other Information
*
Item 6.
Exhibits
42
*
No reportable information under this item.
Forward-Looking Statements
This Report on Form 10-Q includes, and future filings by the Company on Form 10-K, Form 10-Q and
Form 8-K and future oral and written statements by ALLTEL Corporation (“Alltel”) and its management
may include, certain “forward-looking statements” within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements are subject to uncertainties that could
cause actual future events and results to differ materially from those expressed in the
forward-looking statements. These forward-looking statements are based on estimates, projections,
beliefs, and assumptions and are not guarantees of future events and results. Words such as
“expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, and “should”, and
variations of these words and similar expressions, are intended to identify these forward-looking
statements. Alltel disclaims any obligation to update or revise any forward-looking statement
based on the occurrence of future events, the receipt of new information, or otherwise.
Actual future events and results may differ materially from those expressed in these
forward-looking statements as a result of a number of important factors. Representative examples of
these factors include (without limitation) adverse changes in economic conditions in the markets
served by Alltel; the extent, timing, and overall effects of competition in the communications
business; material changes in the communications industry generally that could adversely affect
vendor relationships with equipment and network suppliers and customer relationships with wholesale
customers; changes in communications technology; the risks associated with pending acquisitions and
dispositions and the integration of acquired businesses, including the integration of Western
Wireless and the disposition of the Irish assets; the uncertainties related to
any discussions or negotiations regarding the sale of any of the international assets,
including the Austrian business; adverse
changes in the terms and conditions of wireless roaming agreements of Alltel; the uncertainties
related to Alltel’s strategic investments; the effects of litigation; and the effects of federal
and state legislation, rules, and regulations governing the communications industry.
In addition to these factors, actual future performance, outcomes and results may differ materially
because of more general factors including (without limitation) general industry and market
conditions and growth rates, economic conditions, and governmental and public policy changes.
1
ALLTEL CORPORATION
FORM 10-Q
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in millions, except per share amounts)
June 30,
December 31,
Assets
2005
2004
Current Assets:
Cash and short-term investments
$
2,027.7
$
484.9
Accounts receivable (less allowance for doubtful accounts of $55.0 and $53.6, respectively)
929.0
912.7
Inventories
159.9
156.8
Prepaid expenses and other
89.1
62.4
Total current assets
3,205.7
1,616.8
Investments
207.1
804.9
Goodwill
5,151.9
4,875.7
Other intangibles
1,380.8
1,306.1
Property, Plant and Equipment:
Land
280.4
278.1
Buildings and improvements
1,147.1
1,134.8
Wireline
6,824.9
6,735.8
Wireless
6,057.5
5,764.0
Information processing
1,099.1
1,048.4
Other
495.4
489.9
Under construction
492.5
385.3
Total property, plant and equipment
16,396.9
15,836.3
Less accumulated depreciation
8,853.5
8,288.2
Net property, plant and equipment
7,543.4
7,548.1
Other assets
426.0
452.1
Total Assets
$
17,914.9
$
16,603.7
Liabilities and Shareholders’ Equity
Current Liabilities:
Current maturities of long-term debt
$
222.8
$
225.0
Accounts payable
422.4
448.2
Advance payments and customer deposits
219.4
219.3
Accrued taxes
286.3
158.2
Accrued dividends
124.6
105.9
Accrued interest
106.2
120.2
Other current liabilities
169.3
183.5
Total current liabilities
1,551.0
1,460.3
Long-term debt
4,954.0
5,352.4
Deferred income taxes
1,632.9
1,715.1
Other liabilities
922.0
947.2
Shareholders’ Equity:
Preferred stock, Series C, $2.06, no par value, 12,210 and 12,288 shares issued and outstanding,
respectively
0.3
0.3
Common stock, par value $1 per share, 1.0 billion shares authorized, 327,323,194 and
302,267,959 shares issued and outstanding, respectively
327.3
302.3
Additional paid-in capital
1,577.5
197.9
Unrealized holding gain on investments
–
153.9
Foreign currency translation adjustment
0.5
0.5
Retained earnings
6,949.4
6,473.8
Total shareholders’ equity
8,855.0
7,128.7
Total Liabilities and Shareholders’ Equity
$
17,914.9
$
16,603.7
See the accompanying notes to the unaudited interim consolidated financial statements.
2
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months
Six Months
Ended June 30,
Ended June 30,
(Millions, except per share amounts)
2005
2004
2005
2004
Revenues and sales:
Service revenues
$
1,989.2
$
1,825.9
$
3,887.5
$
3,591.5
Product sales
270.9
216.2
498.6
411.8
Total revenues and sales
2,260.1
2,042.1
4,386.1
4,003.3
Costs and expenses:
Cost of services (excluding depreciation of $244.2, $231.7, $486.1
and $463.6, respectively, included below)
660.9
584.2
1,287.2
1,145.0
Cost of products sold
308.1
256.0
589.9
513.3
Selling, general, administrative and other
420.6
372.9
828.0
748.1
Depreciation and amortization
348.3
321.2
689.5
642.5
Restructuring and other charges
–
–
–
51.8
Total costs and expenses
1,737.9
1,534.3
3,394.6
3,100.7
Operating income
522.2
507.8
991.5
902.6
Equity earnings in unconsolidated partnerships
15.2
15.9
25.9
29.2
Minority interest in consolidated partnerships
(18.9
)
(21.6
)
(37.2
)
(37.2
)
Other income, net
8.0
2.9
128.7
7.5
Interest expense
(76.3
)
(86.6
)
(163.0
)
(178.3
)
Gain on exchange or disposal of assets and other
188.3
–
188.3
–
Income before income taxes
638.5
418.4
1,134.2
723.8
Income taxes
236.4
155.8
419.1
271.4
Net income
402.1
262.6
715.1
452.4
Preferred dividends
0.1
0.1
0.1
0.1
Net income applicable to common shares
$
402.0
$
262.5
$
715.0
$
452.3
Earnings per share:
Basic
$1.28
$.85
$2.32
$1.46
Diluted
$1.27
$.85
$2.31
$1.46
See the accompanying notes to the unaudited interim consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months
Ended June 30,
(Millions)
2005
2004
Cash Provided from Operations:
Net income
$
715.1
$
452.4
Adjustments to reconcile net income to net cash provided from operations:
Depreciation and amortization
689.5
642.5
Provision for doubtful accounts
90.7
88.7
Non-cash portion of gain on exchange or disposal of assets and other
(202.2
)
–
Non-cash portion of restructuring and other charges
–
25.6
Increase in deferred income taxes
6.3
145.9
Other, net
11.1
(0.2
)
Changes in operating assets and liabilities, net of effects of acquisitions and dispositions:
Accounts receivable
(105.8
)
(65.6
)
Inventories
(2.3
)
25.8
Accounts payable
(31.3
)
(75.3
)
Other current liabilities
100.6
39.9
Other, net
(28.1
)
(31.6
)
Net cash provided from operations
1,243.6
1,248.1
Cash Flows from Investing Activities:
Additions to property, plant and equipment
(611.1
)
(480.5
)
Additions to capitalized software development costs
(26.9
)
(14.8
)
Additions to investments
(0.9
)
(2.5
)
Purchases of property, net of cash acquired
(223.7
)
–
Proceeds from the sale of assets
36.2
–
Proceeds from the sale of investments
353.4
–
Proceeds from the return on investments
20.4
36.9
Other, net
3.1
(4.2
)
Net cash used in investing activities
(449.5
)
(465.1
)
Cash Flows from Financing Activities:
Dividends on preferred and common stock
(220.7
)
(231.3
)
Reductions in long-term debt
(452.9
)
(252.9
)
Repurchases of common stock
–
(243.0
)
Distributions to minority investors
(27.0
)
(32.7
)
Long-term debt issued
50.0
–
Preferred stock redemptions
–
(0.1
)
Common stock issued
1,399.3
6.7
Net cash provided from (used in) financing activities
748.7
(753.3
)
Effect of exchange rate changes on cash and short-term investments
–
(0.1
)
Increase in cash and short-term investments
1,542.8
29.6
Cash and Short-term Investments:
Beginning of the period
484.9
657.8
End of period
$
2,027.7
$
687.4
Non-Cash Investing and Financing Activity:
Change in fair value of investments in equity securities
$
(236.8
)
$
23.7
Change in fair value of interest rate swap agreements
$
(1.2
)
$
(33.4
)
See the accompanying notes to the unaudited interim consolidated financial statements.
4
CONSOLIDATED STATEMENT
OF SHAREHOLDERS’ EQUITY (UNAUDITED)
Unrealized
Foreign
Additional
Holding
Currency
Preferred
Common
Paid-In
Gain On
Translation
Retained
(Millions)
Stock
Stock
Capital
Investments
Adjustment
Earnings
Total
Balance at December 31, 2004
$
0.3
$
302.3
$
197.9
$
153.9
$
0.5
$
6,473.8
$
7,128.7
Net income
–
–
–
–
–
715.1
715.1
Other comprehensive loss, net of
tax: (See Note 10)
Unrealized holding losses on
investments,
net of reclassification
adjustments
–
–
–
(153.9
)
–
–
(153.9
)
Foreign currency translation
adjustment
–
–
–
–
–
–
–
Comprehensive income
–
–
–
(153.9
)
–
715.1
561.2
Settle purchase obligation related to equity
units (See Note 4)
–
24.5
1,360.5
–
–
–
1,385.0
Employee plans, net
–
0.3
14.7
–
–
–
15.0
Restricted stock, net of unearned compensation
–
0.2
2.3
–
–
–
2.5
Tax benefit for non-qualified stock options
–
–
2.0
–
–
–
2.0
Conversion of preferred stock
–
–
0.1
–
–
–
0.1
Dividends:
Common — $.76 per share
–
–
–
–
–
(239.4
)
(239.4
)
Preferred
–
–
–
–
–
(0.1
)
(0.1
)
Balance at June 30, 2005
$
0.3
$
327.3
$
1,577.5
$
–
$
0.5
$
6,949.4
$
8,855.0
See the accompanying notes to the unaudited interim consolidated financial statements.
5
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1.
General:
Basis of Presentation — The consolidated financial statements at June 30, 2005 and
December 31, 2004 and for the three and six month periods ended June 30, 2005 and 2004 of
ALLTEL Corporation (“Alltel” or the “Company”) are unaudited. The consolidated financial
statements have been prepared in accordance with generally accepted accounting principles for
interim financial reporting and Securities and Exchange Commission rules and regulations.
Certain information and footnote disclosures have been condensed or omitted in accordance
with those rules and regulations. The consolidated financial statements reflect all
adjustments (consisting only of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair presentation of the financial position and operating results
for the interim periods presented.
2.
Acquisitions:
On April 15, 2005, Alltel and Cingular Wireless LLC (“Cingular”), a joint venture between
SBC Communications, Inc. and BellSouth Corporation, exchanged certain wireless assets.
Under the terms of the agreement, Alltel acquired former AT&T Wireless properties, including
licenses, network assets, and subscribers, in select markets in Kentucky, Oklahoma, Texas,
Connecticut and Mississippi covering approximately 2.7 million potential customers (“POPs”).
Alltel also acquired 20MHz of spectrum and network assets owned by AT&T Wireless in Kansas
and wireless spectrum in several counties in Georgia and Texas. In addition, Alltel and
Cingular exchanged partnership interests, with Cingular receiving interests in markets in
Kansas, Missouri and Texas, and Alltel receiving more ownership in majority-owned markets it
manages in Michigan, Louisiana and Ohio. Alltel also paid Cingular approximately $165.0
million in cash. The accompanying consolidated financial statements include the accounts
and results of operations of the acquired wireless properties from the date of acquisition.
During the second quarter of 2005, Alltel completed the purchase price allocation for this
exchange based upon a fair value analysis of the tangible and identifiable intangible assets
acquired and the partnership interests relinquished. The excess of the aggregate purchase
price over the fair market value of the tangible net assets acquired of $335.8 million was
assigned to customer list ($10.9 million), cellular licenses ($91.0 million) and goodwill
($233.9 million). The customer list recorded in connection with this transaction is being
amortized on a straight-line basis over its estimated useful life of three years. The
cellular licenses are classified as indefinite-lived intangible assets and are not subject
to amortization. In connection with this transaction, Alltel recorded a pretax gain of
approximately $127.5 million in the second quarter of 2005 (see Note 9) and expects to
record an additional gain of $29.0 million in the third quarter of 2005 (see Note 14).
On February 28, 2005, Alltel completed the purchase of certain wireless assets from Public
Service Cellular, Inc. (“PS Cellular”) for $48.3 million in cash, acquiring wireless properties with a potential
service area covering approximately 900,000 POPs in Alabama and Georgia. The accompanying
consolidated financial statements include the accounts and results of operations of the
acquired wireless properties from the date of acquisition. During the first quarter of
2005, Alltel completed the purchase price allocation for this acquisition based upon a fair
value analysis of the tangible and identifiable intangible assets acquired. The excess of
the aggregate purchase price over the fair market value of the tangible net assets acquired
of $37.9 million was assigned to customer list ($1.9 million), cellular licenses ($3.4
million) and goodwill ($32.6 million). The customer list recorded in connection with this
transaction is being amortized on a straight-line basis over its estimated useful life of
four years. The cellular licenses are classified as indefinite-lived intangible assets and
are not subject to amortization.
During the first six months of 2005, Alltel also acquired additional ownership interests in
wireless properties in Michigan, Ohio and Wisconsin in which the Company owned a majority
interest. In connection with these acquisitions, the Company paid $10.4 million in cash and
assigned the excess of the aggregate purchase price over the fair market value of the
tangible net assets acquired of $4.9 million to goodwill.
The purchase prices paid for the wireless property acquisitions discussed above were based on
estimates of future cash flows of the properties acquired. Alltel paid a premium (i.e.
goodwill) over the fair value of the net tangible and identifiable intangible assets acquired
because the purchase of wireless properties expanded the Company’s wireless footprint into
new markets in Alabama, Georgia, Kentucky, Oklahoma, Texas, Connecticut and Mississippi and
added 266,000 new customers to Alltel’s communications customer base. Additionally, in the
wireless properties acquired, Alltel should realize, over time, accelerated customer growth
and higher average revenue per customer as a result of the Company’s higher revenue national
rate plans.
3.
Goodwill and Other Intangible Assets:
Goodwill represents the excess of cost over the fair value of net identifiable tangible and
intangible assets acquired through various business combinations. The Company has acquired
identifiable intangible assets through its acquisitions of interests in various wireless and
wireline properties. The cost of acquired entities at the date of the acquisition is
allocated to identifiable assets, and the excess of the total purchase price over the amounts
assigned to identifiable assets is recorded as goodwill.
6
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3.
Goodwill and Other Intangible Assets, Continued:
As of January 1, 2005, Alltel completed the annual impairment reviews of its goodwill and
other indefinite-lived intangible assets and determined that no write-down in the carrying
value of these assets was required. The changes in the carrying amount of goodwill by
business segment for the six months ended June 30, 2005 were as follows:
Communications
Support
(Millions)
Wireless
Wireline
Services
Total
Balance at December 31, 2004
$
3,625.8
$
1,247.6
$
2.3
$
4,875.7
Acquired during the period
271.4
-
-
271.4
Other adjustments
4.8
-
-
4.8
Balance at June 30, 2005
$
3,902.0
$
1,247.6
$
2.3
$
5,151.9
The carrying values of indefinite-lived intangible assets other than goodwill were as
follows:
June 30,
December 31,
(Millions)
2005
2004
Cellular licenses
$
870.0
$
775.6
Personal Communications Services licenses
79.1
79.1
Franchise rights — wireline
265.0
265.0
$
1,214.1
$
1,119.7
Intangible assets subject to amortization were as follows:
June 30, 2005
Gross
Accumulated
Net Carrying
(Millions)
Cost
Amortization
Value
Customer lists
$
410.4
$
(250.6
)
$
159.8
Franchise rights
22.5
(15.6
)
6.9
$
432.9
$
(266.2
)
$
166.7
December 31, 2004
Gross
Accumulated
Net Carrying
(Millions)
Cost
Amortization
Value
Customer lists
$
397.6
$
(218.8
)
$
178.8
Franchise rights
22.5
(14.9
)
7.6
$
420.1
$
(233.7
)
$
186.4
Amortization expense for intangible assets subject to amortization was $16.7 million and
$32.5 million for the three and six month periods ended June 30, 2005, compared to $15.1
million and $30.2 million for the same periods of 2004. Amortization expense for
intangible assets subject to amortization is estimated to be $66.5 million in 2005, $48.9
million in 2006, $32.2 million in 2007, $23.1 million in 2008 and $8.6 million in 2009.
4.
Equity Units
During 2002, Alltel issued and sold 27.7 million equity units in an underwritten public
offering and received net proceeds of $1.34 billion. Each equity unit consisted of a
corporate unit, with a $50 stated amount, comprised of a purchase contract and a $50
principal amount senior note. The purchase contract obligated the holder to purchase, and
obligated Alltel to sell, on May 17, 2005, a variable number of newly-issued common shares
of Alltel common stock for $50. The number of Alltel shares issued to the holders of each
equity unit to settle the purchase contract was calculated by
dividing $50 by the average closing price per share of Alltel’s common stock for the 20
consecutive trading days that ended May 12, 2005. Upon settlement of the purchase contract
obligation, Alltel received cash proceeds of approximately $1,385.0 million and delivered
approximately 24.5 million shares of Alltel common stock in the aggregate to the holders of
the equity units. The proceeds from the stock issuance were utilized to finance certain
obligations associated with Alltel’s merger with Western Wireless Corporation (“Western
Wireless”), as further discussed in Note 14.
7
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4.
Equity Units, Continued:
The $50 principal amount senior notes become payable on May 17, 2007 and accrued interest
through May 17, 2005 at an initial annual rate of 6.25 percent. On February 17, 2005,
Alltel completed a remarketing of the senior notes that reset the annual interest rate on
the notes to 4.656 percent for periods subsequent to May 17, 2005. The proceeds of the
remarketed senior notes were used to purchase a portfolio of U.S. Treasury securities that
were pledged to secure the corporate unit holders’ obligations under the purchase contract
component of the corporate unit until settlement.
5.
Stock-Based Compensation:
Under the Company’s stock-based compensation plans, Alltel may grant fixed and
performance-based incentive and non-qualified stock options, restricted stock, and other
equity securities to officers and other management employees. The Company accounts for
these plans under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations.
For fixed stock options granted under these plans, the exercise price of the option equals
the market value of Alltel’s common stock on the date of grant. Accordingly, Alltel does
not record compensation expense for any of the fixed stock options granted, and no
compensation expense related to stock options was recognized in the three and six month
periods ended June 30, 2005 or 2004. In January 2005 and 2004, the Company granted to
certain senior management employees restricted stock of approximately 205,000 and 173,000
shares, respectively. The restricted shares granted in 2005 vest three years from the date
of grant, except that one-third of the restricted shares may vest after each of the first
two-year anniversaries from the grant date if the Company achieves a certain targeted total
stockholder return for its peer group during the three-year period preceding each of those
two years. The restricted shares granted in 2004 will vest in equal increments over a
three-year period following the date of grant. Compensation expense related to the
foregoing shares amounted to $1.6 million and $3.2 million and $0.7 million and $1.4
million for the three and six month periods ended June 30, 2005 and 2004, respectively. At
June 30, 2005 and 2004, unrecognized compensation expense for the restricted shares
amounted to $7.4 million and $7.1 million, respectively, and was included in additional
paid-in capital in the accompanying consolidated balance sheet and statement of
shareholders’ equity. The following table illustrates the effects on net income and
earnings per share had the Company applied the fair value recognition provisions of SFAS
No. 123, “Accounting for Stock-Based Compensation”, to its stock-based employee
compensation plans for the three and six months ended June 30:
Three Months Ended
Six Months Ended
(Millions, except per share amounts)
2005
2004
2005
2004
Net income as reported
$
402.1
$
262.6
$
715.1
$
452.4
Add stock-based compensation expense included in
net income, net of related tax effects
1.0
0.5
2.0
0.9
Deduct stock-based employee compensation expense
determined under fair value method for all awards,
net of related tax effects
(6.4
)
(6.3
)
(13.0
)
(12.9
)
Pro forma net income
$
396.7
$
256.8
$
704.1
$
440.4
Basic earnings per share:
As reported
$1.28
$.85
$2.32
$1.46
Pro forma
$1.26
$.83
$2.28
$1.42
Diluted earnings per share:
As reported
$1.27
$.85
$2.31
$1.46
Pro forma
$1.26
$.83
$2.27
$1.42
The pro forma amounts presented above may not be representative of the future effects on
reported net income and earnings per share, since the pro forma compensation expense is
allocated over the periods in which options become exercisable, and new option awards may be
granted each year.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123(R), “Share-Based Payment”, which is a revision of SFAS No. 123 and supercedes APB
Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be valued at fair value on the date of grant, and to be
expensed over the applicable vesting period. Pro forma disclosure of the income statement
effects of share-based payments is no longer an alternative. SFAS No. 123(R) is effective
for all stock-based awards granted on or after July 1, 2005. In addition, companies must
also recognize compensation expense related to any awards that are not fully vested as of
the effective date. Compensation expense for the unvested awards will be measured based on
the fair value of the awards previously calculated in developing the pro forma disclosures
in accordance with the provisions of SFAS No. 123. On
March 25, 2005, the SEC staff issued Staff Accounting Bulletin (“SAB”) 107, which summarizes
the staff’s views regarding the interaction between SFAS No. 123(R) and certain SEC rules
and regulations and provides additional guidance regarding the valuation of share-based
payment arrangements for public companies. In addition, on April 15, 2005, the SEC amended
8
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5.
Stock-Based Compensation, Continued:
Rule 4-01(a) of Regulation S-X regarding the date public companies are required to comply
with the provisions of SFAS No. 123(R), such that calendar year companies will now be
required to comply with the standard beginning January 1, 2006. Alltel is currently
assessing the impact of adopting SFAS No. 123(R), as interpreted by SAB 107, to its
consolidated results of operations.
6.
Employee Benefit Plans and Postretirement Benefits Other Than Pensions:
Alltel maintains a qualified defined benefit pension plan, which covers substantially all
employees. Prior to January 1, 2005, employees of the Company’s directory publishing
subsidiary did not participate in the plan. Alltel also maintains a supplemental executive
retirement plan that provides unfunded, non-qualified supplemental retirement benefits to a
select group of management employees. In addition, the Company has entered into individual
retirement agreements with certain retired executives providing for unfunded supplemental
pension benefits. The Company funds the accrued costs of the unfunded plans as benefits are
paid. The components of pension expense, including provision for executive retirement
agreements, were as follows for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Benefits earned during the year
$
8.3
$
7.7
$
16.7
$
15.4
Interest cost on benefit obligation
14.6
12.9
29.2
25.9
Amortization of prior service cost
0.2
0.1
0.3
0.2
Recognized net actuarial loss
7.7
4.9
15.3
9.8
Expected return on plan assets
(20.7
)
(17.6
)
(41.4
)
(35.2
)
Net periodic benefit expense
$
10.1
$
8.0
$
20.1
$
16.1
Alltel disclosed in its financial statements for the year ended December 31, 2004 that it
expected to contribute $5.2 million for retirement benefits in 2005 consisting solely of
amounts necessary to fund the expected benefit payments related to the unfunded
supplemental retirement plans. Primarily due to the timing of the required contributions
to fund the supplemental retirement plans, actual contributions were $3.2 million for the
six months ended June 30, 2005. Alltel does not expect that any contribution to the
qualified defined pension plan calculated in accordance with the minimum funding
requirements of the Employee Retirement Income Security Act of 1974 will be required in
2005. Future discretionary contributions to the plan will depend on various factors,
including future investment performance, changes in future discount rates and changes in
the demographics of the population participating in Alltel’s qualified pension plan.
The Company provides postretirement healthcare and life insurance benefits for eligible
employees. Employees share in the cost of these benefits. The Company funds the accrued
costs of these plans as benefits are paid. The components of postretirement expense were
as follows for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Benefits earned during the year
$
0.1
$
0.2
$
0.2
$
0.4
Interest cost on benefit obligation
3.5
4.0
7.0
7.9
Amortization of transition obligation
0.2
0.2
0.4
0.4
Amortization of prior service cost
0.5
0.4
1.0
0.8
Recognized net actuarial loss
1.7
2.2
3.4
4.4
Expected return on plan assets
-
-
-
-
Net periodic benefit expense
$
6.0
$
7.0
$
12.0
$
13.9
Under the Medicare Prescription Drug, Improvement and Modernization Act of 2003, (the
“Act”) beginning in 2006, the Act will provide a prescription drug benefit under Medicare
Part D, as well as a federal subsidy to plan sponsors of retiree healthcare plans that
provide a prescription drug benefit to their participants that is at least actuarially
equivalent to the benefit that will be available under Medicare. The amount of the federal
subsidy will be based on 28 percent of an individual beneficiary’s annual eligible
prescription drug costs ranging between $250 and $5,000. On May 19, 2004, the FASB issued
Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003” (“FSP No. 106-2”). FSP No.
106-2 clarified that the federal subsidy provided under the Act should be accounted for as
an actuarial gain in calculating the accumulated postretirement benefit obligation and
annual postretirement expense. Based on its understanding of the Act, Alltel determined
that a substantial
9
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
6.
Employee Benefit Plans and Postretirement Benefits Other Than Pension, Continued:
portion of the prescription drug benefits provided under its postretirement benefit plan
would be deemed actuarially equivalent to the benefits provided under Medicare Part D.
Effective July 1, 2004, Alltel prospectively adopted FSP No. 106-2 and remeasured its
accumulated postretirement benefit obligation as of that date to account for the federal
subsidy, the effects of which resulted in an $18.3 million reduction in the Company’s
accumulated postretirement obligation and a $2.9 million reduction in the Company’s 2004
postretirement expense. On January 21, 2005, the Department of Health and Human Services
issued final federal regulations related to the federal subsidy. Alltel is currently
evaluating the effects, if any, that these final rules may have on its future benefit costs
and accumulated postretirement benefit obligation.
7.
Restructuring and Other Charges:
A summary of the restructuring and other charges recorded during the six months ended June 30,
2004 was as follows:
Communications
Support
Corporate
(Millions)
Wireless
Wireline
Services
Operations
Total
Severance and employee benefit costs
$
8.8
$
11.2
$ 0.5
$ 2.1
$
22.6
Relocation costs
3.2
1.4
0.1
0.1
4.8
Lease and contract termination costs
0.5
(1.9
)
-
(0.1
)
(1.5
)
Write-down in carrying value of certain
facilities
0.7
-
-
24.1
24.8
Other exit costs
0.4
0.7
-
-
1.1
Total restructuring and other charges
$
13.6
$
11.4
$ 0.6
$ 26.2
$
51.8
In January 2004, the Company announced its plans to reorganize its operations and support
teams. Also, during February 2004, the Company announced its plans to exit its competitive
local exchange carrier (“CLEC”) operations in the Jacksonville, Florida market due to the
continued unprofitability of these operations. In connection with these activities, the
Company recorded a restructuring charge of $29.3 million consisting of $22.9 million in
severance and employee benefit costs related to a planned workforce reduction, $4.8 million
of employee relocation expenses, $0.5 million in lease termination costs and $1.1 million
of other exit costs. The severance and employee benefit costs included a $1.2 million
payment to a former employee of the Company’s sold financial services division that became
payable in the first quarter of 2004 pursuant to the terms of a change in control agreement
between the employee and Alltel. During the fourth quarter of 2004, the Company recorded a
$0.9 million reduction in the liabilities associated with the restructuring efforts
initiated in the first quarter of 2004, consisting of $0.7 million in employee relocation
expenses and $0.2 million in severance and employee benefit costs. The reductions
primarily reflected differences between estimated and actual costs paid in completing the
employee relocations and terminations. As of June 30, 2005, the Company had paid $22.6
million in severance and employee-related expenses, and all of the employee reductions and
relocations had been completed.
During the first quarter of 2004, Alltel also recorded a $2.3 million reduction in the
liabilities associated with various restructuring activities initiated prior to 2003,
consisting of $2.0 million in lease and contract termination costs and $0.3 million in
severance and employee benefit costs. The reductions primarily reflected differences
between estimated and actual costs paid in completing the previous planned workforce
reductions and lease and contract terminations. During the first quarter of 2004, the
Company also recorded a write-down in the carrying value of certain corporate and regional
facilities to fair value in conjunction with the 2004 organizational changes and the 2003
sale of the Company’s financial services division to Fidelity National Financial, Inc.
(“Fidelity National”).
At June 30, 2005, the remaining unpaid liability related to Alltel’s first quarter 2004
restructuring activities was $0.3 million, primarily consisting of lease and contract
termination costs, and is included in other current liabilities in the accompanying
consolidated balance sheets.
8.
Investments — Special Cash Dividend:
On March 28, 2005, Alltel received a special $10 per share cash dividend from Fidelity
National totaling $111.0 million, related to the shares of Fidelity National common stock
received as partial consideration for the sale of Alltel’s financial services business to
Fidelity National on April 1, 2003. As further discussed in Note 9, on April 6, 2005,
Alltel completed the sale of all of its shares of Fidelity National common stock. The
special cash dividend is included in other income, net in the accompanying consolidated
statement of income for the six months ended June 30, 2005.
10
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
9.
Gain on Exchange or Disposal of Assets and Other
As previously discussed in Note 2, on April 15, 2005, Alltel and Cingular exchanged certain
wireless assets. In connection with this transaction, Alltel recorded a pretax gain of
approximately $127.5 million. On April 6, 2005, Alltel completed the sale of all of its
shares of Fidelity National common stock to Goldman Sachs for approximately $350.8 million
and recognized a pretax gain of approximately $75.8 million. On April 8, 2005, Alltel
redeemed all of the issued and outstanding 7.50 percent senior notes due March 1, 2006,
representing an aggregate principal amount of $450.0 million. Concurrent with the debt
redemption, Alltel also terminated the related pay variable/receive fixed, interest rate swap
agreement that had been designated as a fair value hedge against the $450.0 million senior
notes. In connection with the early termination of the debt and interest rate swap
agreement, Alltel incurred net pretax termination fees of approximately $15.0 million. These
transactions increased net income $118.0 million or $.38 per share in the three and six month
periods ended June 30, 2005.
10.
Comprehensive Income:
Comprehensive income was as follows for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Net income
$
402.1
$
262.6
$
715.1
$
452.4
Other comprehensive income (loss):
Unrealized holding gains (losses) on investments:
Unrealized holding gains (losses) arising in the period
(18.4
)
(25.4
)
(161.0
)
23.7
Income tax expense (benefit)
(6.5
)
(8.9
)
(56.4
)
3.5
(11.9
)
(16.5
)
(104.6
)
20.2
Reclassification adjustments for gains included
in net income for the period
(75.8
)
-
(75.8
)
-
Income tax expense
26.5
-
26.5
-
(49.3
)
-
(49.3
)
-
Net unrealized gains (losses) in the period
(94.2
)
(25.4
)
(236.8
)
23.7
Income tax expense (benefit)
(33.0
)
(8.9
)
(82.9
)
3.5
(61.2
)
(16.5
)
(153.9
)
20.2
Foreign currency translation adjustment
-
(0.3
)
-
(0.1
)
Other comprehensive income (loss) before tax
(94.2
)
(25.7
)
(236.8
)
23.6
Income tax expense (benefit)
(33.0
)
(8.9
)
(82.9
)
3.5
Other comprehensive income (loss)
(61.2
)
(16.8
)
(153.9
)
20.1
Comprehensive income
$
340.9
$
245.8
$
561.2
$
472.5
11.
Earnings per Share:
Basic earnings per share was computed by dividing net income applicable to common shares by
the weighted average number of common shares outstanding during the period. Diluted earnings
per share reflects the potential dilution that could occur assuming conversion or exercise of
all dilutive unexercised stock options and outstanding preferred stock. For both the three
and six months ended June 30, 2005, stock options totaling 7.1 million shares were not
included in the computation of diluted earnings per share because the exercise price of the
stock options was greater than the average market price of the common stock. The number of
stock options not included in the computation of diluted earnings per share was 11.1 million
for both the three and six months ended June 30, 2004. A reconciliation of the net income
and number of shares used in computing basic and diluted earnings per share was as follows
for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions, except per share amounts)
2005
2004
2005
2004
Basic earnings per share:
Net income
$
402.1
$
262.6
$
715.1
$
452.4
Less preferred dividends
(0.1
)
(0.1
)
(0.1
)
(0.1
)
Net income applicable to common shares
$
402.0
$
262.5
$
715.0
$
452.3
Weighted average common shares outstanding for the period
314.5
308.2
308.3
309.8
Basic earnings per share
$1.28
$.85
$2.32
$1.46
11
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
11.
Earnings per Share, Continued:
Three Months Ended
Six Months Ended
(Millions, except per share amounts)
2005
2004
2005
2004
Diluted earnings per share:
Net income applicable to common shares
$
402.0
$
262.5
$
715.0
$
452.3
Adjustment for convertible preferred stock dividends
0.1
0.1
0.1
0.1
Net income applicable to common shares
assuming conversion of preferred stock
$
402.1
$
262.6
$
715.1
$
452.4
Weighted average common shares outstanding for the period
314.5
308.2
308.3
309.8
Increase in shares resulting from:
Assumed exercise of stock options
1.0
0.6
1.0
0.6
Assumed conversion of preferred stock
0.2
0.3
0.2
0.3
Non-vested restricted stock awards
0.1
-
0.1
-
Weighted average common shares assuming conversion
315.8
309.1
309.6
310.7
Diluted earnings per share
$1.27
$.85
$2.31
$1.46
12.
Commitments and Contingencies:
The Company currently has outstanding various indemnifications related to the April 1, 2003
sale of the financial services division to Fidelity National. In conjunction with the sale,
Alltel agreed to indemnify Fidelity National for any damages resulting from Alltel’s breach
of warranty or non-fulfillment of certain covenants under the sales agreement, that exceed
1.5 percent of the purchase price, or $15.75 million, up to a maximum of 15 percent of the
purchase price, or $157.5 million. Because of the low probability of being required to pay
any amount under this indemnification, Alltel determined the fair value of this obligation
to be immaterial to the consolidated results of operations, cash flows and financial
condition of the Company. Accordingly, the Company has not recorded a liability related to
it. Alltel also agreed to indemnify Fidelity National from any future tax liability imposed
on the financial services division related to periods prior to the date of sale. Alltel’s
obligation to Fidelity National under this indemnification is not subject to a maximum
amount. The Company has recorded a liability for tax contingencies of approximately $8.3
million related to the operations of the financial services division for periods prior to
the date of sale that management has assessed as probable and estimable, which should
adequately cover any obligation under this indemnification.
13.
Business Segment Information:
Alltel manages its business operations based on differences in products and services. The
Company evaluates performance of the segments based on segment income, which is computed as
revenues and sales less operating expenses, excluding the effects of the items discussed in
Notes 7, 8 and 9, respectively. These items are not allocated to the segments and are
included in corporate operations. Segment operating results were as follows for the three
and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Revenues and Sales from External Customers:
Wireless
$
1,455.3
$
1,253.1
$
2,807.3
$
2,437.6
Wireline
555.9
564.7
1,111.9
1,126.1
Communications support services
202.8
179.0
375.1
337.8
Total business segments
$
2,214.0
$
1,996.8
$
4,294.3
$
3,901.5
Intersegment Revenues and Sales:
Wireless
$
-
$
-
$
-
$
-
Wireline
39.2
44.9
76.8
83.0
Communications support services
58.4
50.2
110.8
110.4
Total business segments
$
97.6
$
95.1
$
187.6
$
193.4
Total Revenues and Sales:
Wireless
$
1,455.3
$
1,253.1
$
2,807.3
$
2,437.6
Wireline
595.1
609.6
1,188.7
1,209.1
Communications support services
261.2
229.2
485.9
448.2
Total business segments
2,311.6
2,091.9
4,481.9
4,094.9
Less intercompany eliminations
(51.5
)
(49.8
)
(95.8
)
(91.6
)
Total revenues and sales
$
2,260.1
$
2,042.1
$
4,386.1
$
4,003.3
12
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
13.
Business Segment Information, Continued:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Segment Income:
Wireless
$
306.9
$
261.6
$
578.5
$
472.5
Wireline
215.3
234.4
429.8
462.6
Communications support services
11.6
20.8
23.5
37.3
Total segment income
533.8
516.8
1,031.8
972.4
Corporate expenses
(11.6
)
(9.0
)
(40.3
)
(18.0
)
Restructuring and other charges
-
-
-
(51.8
)
Equity earnings in unconsolidated partnerships
15.2
15.9
25.9
29.2
Minority interest in consolidated partnerships
(18.9
)
(21.6
)
(37.2
)
(37.2
)
Other income, net
8.0
2.9
128.7
7.5
Interest expense
(76.3
)
(86.6
)
(163.0
)
(178.3
)
Gain on exchange or disposal of assets and other
188.3
-
188.3
-
Income before income taxes
$
638.5
$
418.4
$
1,134.2
$
723.8
Segment assets were as follows:
June 30,
December 31,
(Millions)
2005
2004
Wireless
$
10,297.5
$
9,881.5
Wireline
4,937.7
5,042.8
Communications support services
496.4
495.8
Total business segments
15,731.6
15,420.1
Corporate headquarters assets not allocated to segments
2,212.6
1,201.2
Less elimination of intersegment receivables
(29.3
)
(17.6
)
Total consolidated assets
$
17,914.9
$
16,603.7
Supplemental information pertaining to the communications support services segment was as
follows for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Revenues and Sales from External Customers:
Product distribution
$
103.2
$
72.1
$
197.0
$
141.5
Long-distance and network management services
48.8
46.5
95.8
95.0
Directory publishing
47.3
48.7
73.6
74.9
Telecommunications information services
3.5
11.7
8.7
26.4
Total
$
202.8
$
179.0
$
375.1
$
337.8
Intersegment Revenues and Sales:
Product distribution
$
32.9
$
23.8
$
59.7
$
53.5
Long-distance and network management services
25.5
26.4
51.1
56.9
Directory publishing
-
-
-
-
Telecommunications information services
-
-
-
-
Total
$
58.4
$
50.2
$
110.8
$
110.4
Total Revenues and Sales:
Product distribution
$
136.1
$
95.9
$
256.7
$
195.0
Long-distance and network management services
74.3
72.9
146.9
151.9
Directory publishing
47.3
48.7
73.6
74.9
Telecommunications information services
3.5
11.7
8.7
26.4
Total revenues and sales
$
261.2
$
229.2
$
485.9
$
448.2
13
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
14.
Subsequent Events:
On July 29, 2005, Alltel and Cingular completed the exchange of wireless partnership
interests. Primarily due to certain minority partners’ rights-of-first-refusal, three of
the wireless partnership interests to be exchanged between Alltel and Cingular were not
completed by June 30, 2005. As a result of completing the exchange transactions, Alltel
expects to record an additional pretax gain of approximately $29.0 million during the
third quarter of 2005.
On August 1, 2005, Alltel and Western Wireless completed the merger of Western Wireless
with and into a wholly-owned subsidiary of Alltel (the “Merger”). As a result of the
Merger, Alltel added approximately 1.2 million domestic wireless customers (excluding
reseller customers) in 19 midwestern and western states that are contiguous to the
Company’s existing wireless properties, increasing the number of wireless customers served
by Alltel to more than 10 million customers in 34 states. Through this transaction, Alltel
added wireless operations in nine new states, including California, Idaho, Minnesota,
Montana, Nevada, North Dakota, South Dakota, Utah and Wyoming, and expanded its wireless
operations in Arizona, Colorado, New Mexico and Texas.
In the Merger, each share of Western Wireless common stock was exchanged for 0.535 shares
of Alltel common stock and $9.25 in cash unless the shareholder made an all-cash election,
in which case the shareholder received $40 in cash. Western Wireless shareholders making
an all-stock election were subject to proration and received approximately 0.539 shares of
Alltel common stock and $9.18 in cash. In the aggregate, Alltel issued approximately 54.3
million shares of stock valued at $3.4 billion and paid approximately $933.4 million in
cash. Through its wholly-owned subsidiary that merged with Western Wireless, Alltel also
assumed debt of approximately $2.1 billion. As a condition of receiving approval for the
Merger from the U.S. Department of Justice and Federal Communications Commission, Alltel
agreed to divest certain wireless operations of Western Wireless in 16 markets in Arkansas,
Kansas and Nebraska, as well as the “Cellular One” brand used in those markets.
On July 25, 2005, Western Wireless announced a definitive agreement to sell its
international operations in Ireland to a subsidiary of eircom Group plc, the Irish
fixed-line telecommunications operator (“eircom”), for approximately $500 million at
current exchange rates and also stated it had received conditional and
non-binding bids to sell its Austrian business. Completion of the sale of
the Irish operations is conditioned, among other things,
on approval by eircom’s shareholders of the transaction and of an eircom
share issuance pursuant to a rights offering; closing of the rights
offering, the proceeds of which would be used to pay the purchase price; and
approval from Irish regulatory authorities. Assuming receipt of these
approvals and completion of the rights offering, the transaction is expected
to close in October 2005. Alltel is pursuing the disposition of the
Austrian business and intends to pursue the disposition of all remaining international
operations and interests acquired from Western Wireless.
On the date of closing, Alltel repaid approximately $1.3 billion of term loans
representing all borrowings outstanding under Western Wireless’ credit facility that, as a
result of a change in control, became due and payable immediately upon the closing of the
merger. Alltel utilized available cash on hand and commercial paper borrowings to fund
the cash portion of the merger consideration paid to Western Wireless shareholders and to
finance the repayment of the term loans outstanding under the Western Wireless credit
facility. On August 1, 2005, Alltel also announced a tender offer to purchase all of the
issued and outstanding 9.25 percent senior notes due July 15, 2013 of Western Wireless,
representing an aggregate principal amount of $600.0 million, as well as a related consent
solicitation to amend the indenture governing the senior notes.
On August 1, 2005, Alltel entered into an additional $700.0 million, 364-day revolving
credit agreement that expires on July 31, 2006, if not extended at the option of the
Company, and allows Alltel to convert any outstanding borrowings under this agreement into
term loans maturing in 2007.
14
ALLTEL CORPORATION
FORM 10-Q
PART I — FINANCIAL INFORMATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
GENERAL
The following is a discussion and analysis of the historical results of operations and financial
condition of ALLTEL Corporation (“Alltel” or the “Company”). This discussion should be read in
conjunction with the unaudited consolidated financial statements, including the notes thereto, for
the interim periods ended June 30, 2005 and 2004, and the Company’s Amendment No. 1 to Annual
Report on Form 10-K/A for the year ended December 31, 2004.
EXECUTIVE SUMMARY
Alltel is a customer-focused communications company providing wireless, local telephone,
long-distance, Internet and high-speed data services to nearly 14 million residential and business
customers in 27 states. Among the highlights in the second quarter of 2005:
•
Wireless revenues and sales increased 16 percent over 2004 driven
by a 15 percent increase in retail service revenues, reflecting
Alltel’s continued focus on quality customer growth, improvements
in data revenues and additional Eligible Telecommunications
Carrier (“ETC”) subsidies. Wireless wholesale revenues also
increased 22 percent year-over-year due to solid growth in CDMA
minutes of use and stability in the volumes of TDMA and analog
minutes of use by other carriers’ customers roaming on Alltel’s
wireless network. The exchange of wireless properties with
Cingular Wireless LLC (“Cingular”) also contributed to the overall
growth in both retail and wholesale revenues during the second
quarter of 2005. Average revenue per customer increased 6 percent
from a year ago to $50.55, the highest quarterly amount in 5
years, while retail revenue per customer increased to $46.42, a 5
percent increase from a year ago. Retail minutes of use per
wireless customer per month increased to 593 minutes, a 21 percent
increase from the same period of 2004.
•
Excluding the effects of the Cingular transaction, wireless gross
customer additions were 593,000 for the quarter, a 9 percent
decrease from the same period a year ago, primarily due to the
Company focusing its advertising efforts on rebranding and less on
sales promotions in an effort to strengthen Alltel’s brand
position in the wireless marketplace, as well as lower than
expected sales of prepay plans. Excluding the effects of
acquisitions, Alltel added 105,000 net postpay wireless customers
during the second quarter of 2005. As a result of approximate net
losses of 24,000 prepay customers and 27,000 customers in the
acquired markets, mostly in those properties acquired from Cingular, net
customer additions for the quarter were 54,000. Wireless postpay
churn was 1.58 percent and total churn, which includes prepay
customer losses, was 1.99 percent, both flat from a year ago
despite an increase in contract expirations.
•
Wireless segment income increased 17 percent from a year ago,
reflecting the growth in revenues and sales noted above, solid
expense management and, to a lesser extent, the decline in gross
customer additions (excluding acquisitions) from the same period a
year ago.
•
In its wireline business, Alltel added more than 36,000 broadband
customers, increasing Alltel’s broadband customer base to more
than 319,000. During the quarter, the Company lost approximately
30,000 wireline access lines, a year-over-year decline of
approximately 3.7 percent. Average revenue per wireline customer
increased 1 percent from a year ago to $66.83 due primarily to
growth in broadband revenues and selling additional services and
features to existing wireline customers. Wireline segment income
decreased 8 percent from a year ago reflecting a 2 percent decline
in wireline revenues and sales attributable to the loss of access
lines and additional costs related to the growth in broadband
customers, specifically the costs associated with subsidizing
broadband-capable modems.
•
Alltel strengthened its financial position through (1) the sale of
its investment in Fidelity National Financial Inc. (“Fidelity
National”) common stock for $350.8 million in cash, (2) the early
retirement of $450.0 million of long-term debt scheduled to mature
in 2006 and (3) the issuance of approximately 24.5 million of its
common shares to settle the purchase contract obligation related
to the Company’s equity units. Alltel received approximately $1.4
billion in cash from the stock issuance and had more than $2.0
billion of available cash on hand at June 30, 2005.
As further discussed below, Alltel positioned its wireless business for future growth opportunities
as a result of the Company’s August 1, 2005 merger with Western Wireless Corporation (“Western
Wireless”). This transaction is significant to Alltel in several ways. First, it will increase
Alltel’s wireless revenue mix to nearly 70 percent of the
Company’s total consolidated revenues. Second, the transaction will increase the Company’s retail
position in markets where Alltel can bring significant value to customers by offering competitive
national rate plans. Third, this transaction will diversify Alltel’s wireless roaming revenue
sources, and, as a result of offering multiple technologies, the Company will become the leading
independent roaming partner for the four national carriers in the markets served by Alltel.
Finally, Alltel will enhance its strategic options as the wireless industry continues to
restructure while preserving the Company’s strong financial position.
During the second quarter of 2005, Alltel launched a rebranding initiative that involved changing
the Company logo, improving the design in Alltel’s retail stores to be more customer friendly and
an advertising campaign focused on proof points highlighting Alltel’s commitment to customer
satisfaction. Alltel began the new advertising campaign in early May and, as of June 30, 2005 had
completed the redesign of approximately 45 percent of its retail stores, with the balance of the
retail stores, including those in acquired Cingular and Western Wireless markets, to be completed
later this year. Alltel also began selling portable BlackBerry® devices in its retail stores and
offering national coverage for the BlackBerry® device and other 1XRTT data services through a
roaming agreement with Verizon Wireless. Alltel also continued to expand its 1XRTT data footprint
and expects to cover substantially all of its total potential customers (“POPs”) by year-end.
Through June 30, 2005, Alltel had launched EV-DO service in five markets and expects to have this
service available in 10-12 markets by the end of the year.
Throughout the remainder of 2005, the Company will continue to face significant challenges
resulting from competition in the telecommunications industry and changes in the regulatory
environment, including the effects of potential changes to the rules governing universal service
and inter-carrier compensation. In addressing these challenges, Alltel will continue to focus its
efforts on improving customer service, enhancing the quality of its networks, expanding its product
and service offerings, and conducting vigorous advocacy efforts in favor of governmental policies
that will benefit Alltel’s business and its customers.
ACQUISITIONS
Completed During the Twelve Months Ended June 30, 2005
On April 15, 2005, Alltel and Cingular exchanged certain wireless assets. Under the terms of the
agreement, Alltel acquired former AT&T Wireless properties, including licenses, network assets, and
subscribers, in selected markets in Kentucky, Oklahoma, Texas, Connecticut and Mississippi
representing approximately 2.7 million POPs. Alltel also acquired 20MHz of spectrum and network
assets formerly owned by AT&T Wireless in Kansas and wireless spectrum in several counties in
Georgia and Texas. In addition, Alltel and Cingular exchanged partnership interests, with Cingular
receiving interests in markets in Kansas, Missouri and Texas, and Alltel receiving more ownership
in majority-owned markets it manages in Michigan, Louisiana, and Ohio. Alltel also paid Cingular
approximately $165.0 million in cash. In connection with this transaction, Alltel recorded a
pretax gain of $127.5 million and added approximately 212,000 customers. On February 28, 2005,
Alltel completed the purchase of wireless properties, representing approximately 900,000 POPs in
Alabama and Georgia, from Public Service Cellular, Inc. (“PS Cellular”) for $48.3 million in cash.
Through the completion of this transaction, Alltel added approximately 54,000 customers. During
the first six months of 2005, Alltel also acquired additional ownership interests in wireless
properties in Michigan, Ohio and Wisconsin in which the Company owned a majority interest. In
connection with these acquisitions, the Company paid $10.4 million in cash. (See Note 2 to the unaudited interim consolidated financial statements for additional information regarding these
acquisitions.)
On December 1, 2004, Alltel completed the purchase of certain wireless assets from United States
Cellular Corporation and TDS Telecommunications Corporation for $148.2 million in cash, acquiring
wireless properties with a potential service area covering approximately 584,000 POPs in Florida
and Ohio. The Company also purchased partnership interests in seven Alltel-operated markets in
Georgia, Mississippi, North Carolina, Ohio and Wisconsin. Prior to this acquisition, Alltel owned
an approximate 42 percent interest in the Georgia market, with a potential service area covering
approximately 229,000 POPs, and Alltel owned a majority interest in the Mississippi, North
Carolina, Ohio and Wisconsin markets. On November 2, 2004, the Company purchased for $35.6 million
in cash wireless properties with a potential service area covering 275,000 POPs in south Louisiana
from SJI, a privately held company. During the fourth quarter of 2004, Alltel also acquired
additional ownership interests in wireless properties in Louisiana and Wisconsin in which the
Company owned a majority interest in exchange for $1.4 million in cash and a portion of the
Company’s ownership interest in a wireless partnership serving the St. Louis, Missouri market.
Through these transactions, Alltel added approximately 92,000 wireless customers.
Completion of Western Wireless Merger
On August 1, 2005, Alltel and Western Wireless completed the merger of Western Wireless with and
into a wholly-owned subsidiary of Alltel (the “Merger”). In the Merger, each share of Western
Wireless common stock was exchanged for 0.535 shares of Alltel common stock and $9.25 in cash
unless the shareholder made an all-cash election, in which case the
shareholder received $40 in cash. Western Wireless shareholders making an all-stock election were
subject to proration and received approximately 0.539 shares of Alltel common
stock and $9.18 in cash. In the aggregate, Alltel issued approximately
54.3 million shares of stock valued at $3.4 billion and paid approximately
$933.4 million in cash. Through its wholly-owned subsidiary that merged with
Western Wireless, Alltel also assumed debt of approximately $2.1 billion. As a
condition of receiving approval for the Merger from the U.S. Department of
Justice (“DOJ”) and Federal Communications Commission (“FCC”), Alltel agreed
to divest certain wireless operations of Western Wireless in Arkansas, Kansas
and Nebraska, as well as the “Cellular One” brand used in those markets. On
July 25, 2005, Western Wireless announced a definitive agreement to sell its
international operations in Ireland for approximately $500 million at current
exchange rates and also stated that it had received conditional and
non-binding bids to sell its Austrian business. The sale of the Irish
operations is expected to close during the fourth quarter of 2005. Alltel is
pursuing the disposition of the
Austrian business and intends to pursue the disposition of all remaining international
operations and interests acquired from Western Wireless.
As a result of the Merger, Alltel added approximately 1.2 million domestic wireless customers
(excluding reseller customers) in 19 midwestern and western states that are contiguous to the
Company’s existing wireless properties, increasing the number of wireless customers served by
Alltel to more than 10 million customers in 34 states. Operating results for the wireless
properties acquired from Western Wireless will first be included in Alltel’s consolidated results
of operations for the interim periods ending September 30, 2005. (See Note 14 to the unaudited
interim consolidated financial statements for additional information regarding this acquisition.)
CONSOLIDATED RESULTS OF OPERATIONS
Three Months Ended
Six Months Ended
June 30,
June 30,
(Millions, except per share amounts)
2005
2004
2005
2004
Revenues and sales:
Service revenues
$
1,989.2
$
1,825.9
$
3,887.5
$
3,591.5
Product sales
270.9
216.2
498.6
411.8
Total revenues and sales
2,260.1
2,042.1
4,386.1
4,003.3
Costs and expenses:
Cost of services
660.9
584.2
1,287.2
1,145.0
Cost of products sold
308.1
256.0
589.9
513.3
Selling, general, administrative and other
420.6
372.9
828.0
748.1
Depreciation and amortization
348.3
321.2
689.5
642.5
Restructuring and other charges
-
-
-
51.8
Total costs and expenses
1,737.9
1,534.3
3,394.6
3,100.7
Operating income
522.2
507.8
991.5
902.6
Non-operating income, net
4.3
(2.8
)
117.4
(0.5
)
Interest expense
(76.3
)
(86.6
)
(163.0
)
(178.3
)
Gain on exchange or disposal of assets and other
188.3
-
188.3
-
Income before income taxes
638.5
418.4
1,134.2
723.8
Income taxes
236.4
155.8
419.1
271.4
Net income
$
402.1
$
262.6
$
715.1
$
452.4
Earnings per share:
Basic
$1.28
$.85
$2.32
$1.46
Diluted
$1.27
$.85
$2.31
$1.46
Total revenues and sales increased 11 percent, or $218.0 million, and 10 percent, or $382.8
million, for the three and six month periods ended June 30, 2005, respectively, compared to the
same periods of 2004. Service revenues also increased by 9 percent, or $163.3 million, and 8
percent, or $296.0 million, in the 2005 periods as compared to the prior year. The acquisitions of
wireless properties in the fourth quarter of 2004 and the first six months of 2005 previously
discussed accounted for approximately $56.9 million and $74.1 million of the overall increases in
service revenues in the three and six month periods of 2005, respectively. In addition to the
effects of the acquisitions, service revenues increased due to nonacquisition-related growth in
Alltel’s wireless customer base and the corresponding increases in wireless access revenues, which
increased $73.5 million and $155.3 million in the three and six month periods ended June 30, 2005,
respectively. Service revenues for both 2005 periods also reflected growth in revenues derived
from wireless and wireline data services, which increased $37.6 million and $73.9 million in the
three and six month periods of 2005, respectively, primarily reflecting strong demand for these
services and the effects of two large-scale promotions aimed at increasing text messaging usage.
Wireless services revenues also included increases in regulatory and other fees of $36.5 million
and $73.1 million in the three and six month periods of 2005, respectively, due to additional
Universal Service Fund (“USF”)
17
support received by Alltel reflecting an increase in the contribution factor, and additional
revenues attributable to Alltel’s certification in twelve states as an ETC, which accounted for
$19.5 million and $40.5 million of the overall increases in regulatory fees in the three and six
month periods of 2005, respectively.
The above increases in service revenues were partially offset by lower wireless airtime revenues,
reductions in revenues derived from telecommunications information services and decreases in
wireline access and toll service revenues. Compared to the same periods of 2004, wireless airtime
and retail roaming revenues decreased $16.9 million and $25.8 million in the three and six month
periods of 2005, respectively. The decreases in wireless airtime and retail roaming revenues
primarily reflected the effects of customers migrating to rate plans with a larger number of
packaged minutes. Such rate plans, for a flat monthly service fee, provide customers with a
specified number of airtime minutes and include unlimited weekend, nighttime and mobile-to-mobile
minutes at no extra charge. Wireline local access service and intrastate network access and toll
revenues decreased $21.7 million and $35.9 million in the three and six month periods of 2005,
respectively, primarily as a result of the loss of wireline access lines due, in part, to broadband
and wireless substitution. Telecommunications information services revenues decreased $8.2 million
and $17.7 million in the three and six month periods of 2005, respectively, compared to the same
periods of 2004, due to the loss of one of Alltel’s remaining unaffiliated wireline services
customers during the fourth quarter of 2004.
Product sales increased $54.7 million, or 25 percent, and $86.8 million, or 21 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The increases in product sales in both 2005 periods were primarily driven by higher retail
prices realized on the sale of wireless handsets that include advanced features, such as picture
messaging, and that are capable of downloading games, entertainment content, weather and office
applications.
Cost of services increased $76.7 million, or 13 percent, and $142.2 million, or 12 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The wireless property acquisitions accounted for $29.0 million and $36.5 million of the
overall increases in cost of services in 2005. In addition to the effects of the acquisitions,
cost of services for the three and six month periods of 2005 reflected increases in wireless
network-related costs of $13.3 million and $31.5 million, respectively, compared to the same
periods of 2004, primarily due to increased network traffic resulting from customer growth,
increased customer minutes of use and expansion of network facilities. In addition, payments to
data content providers increased $9.3 million and $18.5 million for the three and six months ended
June 30, 2005, respectively, as compared to the prior year periods, consistent with the growth in
wireless revenues derived from data services in those periods. Cost of services for the three and
six month periods of 2005 also reflected increases in wireless customer service expenses of $7.9
million and $17.9 million, respectively, primarily reflecting additional costs associated with
Alltel’s retention efforts focused on improving customer satisfaction and reducing postpay churn.
In addition, cost of services for the three and six months ended June 30, 2005 included increased
regulatory fees of $8.8 million and $15.8 million, respectively, related primarily to an increase
in the contribution factor applicable to universal service funding. Cost of services for the six
month period of 2005 also included $19.8 million of incremental costs primarily related to a change
in accounting for operating leases. Certain of the Company’s operating lease agreements for cell
sites and for office and retail locations include scheduled rent escalations during the initial
lease term and/or during succeeding optional renewal periods. Prior to January 1, 2005, the
Company had not recognized the scheduled increases in rent expense on a straight-line basis in
accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 13,
“Accounting for Leases”, and Financial Accounting Standards Board (“FASB”) Technical Bulletin No.
85-3, “Accounting for Operating Leases with Scheduled Rent Increases”. The effects of this change,
which are included in corporate expenses, were not material to the Company’s previously reported
consolidated results of operations, financial position or cash flows.
Cost of products sold increased $52.1 million, or 20 percent, and $76.6 million, or 15 percent, in
the three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The increase in both periods of 2005 was consistent with the overall growth in product sales
noted above and reflected the sales of higher-priced wireless handsets and increased sales to
resellers and other distributors. In addition, the wireless property additions discussed above
contributed $3.7 million and $6.2 million, respectively, of the overall increase in cost of
products sold for the three and six month periods ended June 30, 2005.
Selling, general, administrative and other expenses increased $47.7 million, or 13 percent, and
$79.9 million, or 11 percent, in the three and six month periods ended June 30, 2005, respectively,
compared to the same periods of 2004. The acquisitions of wireless properties accounted for $11.5
million and $17.2 million, respectively, of the overall increase in selling, general,
administrative and other expenses in the three and six month periods of 2005. Selling, general,
administrative and other operating expenses also reflected increased advertising costs of $6.7
million and $9.4 million in the three and six month periods of 2005, respectively, associated with
two large-scale promotions aimed at increasing text
18
messaging usage, as well as additional costs associated with Alltel’s rebranding initiative
previously discussed. Alltel incurred $9.5 million of incremental expenses associated with the
rebranding initiative during the second quarter of 2005 and expects to incur approximately $8.6
million of incremental expenses during the third quarter of 2005 to complete the redesign of its
retail stores. Increased insurance premiums related to the Company’s employee medical and dental
plans, additional costs associated with write-offs identified as a result of system improvements in
the Company’s cash processing procedures and higher audit fees and internal staffing costs incurred
to comply with the Section 404 internal control reporting requirements of the Sarbanes-Oxley Act of
2002 also contributed to the increase in selling, general, administrative and other operating
expenses in the six month period of 2005.
Depreciation and amortization expense increased $27.1 million, or 8 percent, and $47.0 million, or
7 percent, in the three and six month periods ended June 30, 2005, respectively, compared to the
same periods of 2004, primarily due to growth in wireless plant in service and the effects of a
third quarter 2004 prospective change in the depreciable lives of certain wireless
telecommunications equipment. The depreciable lives were shortened in response to the rapid pace
of technological development and the increasing demands of Alltel’s customers for new products and
services. The effects of the wireless property acquisitions also accounted for $5.4 million and
$7.6 million, respectively, of the overall increase in depreciation and amortization expense in the
three and six months ended June 30, 2005 as compared to the same periods of 2004.
Operating income increased $14.4 million, or 3 percent, and $88.9 million, or 10 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The increases in both 2005 periods primarily reflected growth in wireless segment income
resulting from the nonacquisition-related growth in revenues and sales discussed above, as well as
the effects of the wireless property acquisitions, which accounted for $9.2 million and $9.9
million of the overall increases in operating income for the three and six month periods of 2005,
respectively. A reduction in total customer acquisition costs due to the effects of vendor rebates
and a 9 percent decline in gross wireless customer additions (excluding acquisitions) also
contributed to the growth in operating income in the six month period of 2005. The increases in
both 2005 periods attributable to the wireless operations were partially offset by reductions in
wireline and communications support services segment income, reflecting the decline in wireline
access lines and the loss of one of Alltel’s remaining unaffiliated telecommunications information
services customers discussed above. Operating income comparisons for the six month period of 2005
were also favorably affected by the effects of restructuring and other charges incurred during the
first quarter of 2004, as further discussed below. The changes in wireless, wireline and
communications support services segment income in 2005 are further discussed below under “Results
of Operations by Business Segment”.
Restructuring and Other Charges
A summary of the restructuring and other charges recorded during the six months ended June 30, 2004
was as follows:
(Millions)
2004
Severance and employee benefit costs
$
22.6
Relocation costs
4.8
Lease and contract termination costs
(1.5
)
Write-down in carrying value of certain facilities
24.8
Other exit costs
1.1
Total restructuring and other charges
$
51.8
In January 2004, the Company announced its plans to reorganize its operations and support teams.
Also, during February 2004, the Company announced its plans to exit its competitive local exchange
carrier (“CLEC”) operations in the Jacksonville, Florida market due to the continued
unprofitability of these operations. In connection with these activities, Alltel recorded a
restructuring charge of $29.3 million consisting of $22.9 million in severance and employee benefit
costs related to a planned workforce reduction, $4.8 million of employee relocation expenses, $0.5
million in lease termination costs and $1.1 million of other exit costs. The severance and
employee benefit costs included a $1.2 million payment to a former employee of the Company’s sold
financial services division that became payable in the first quarter of 2004 pursuant to the terms
of a change in control agreement between the employee and Alltel. During the fourth quarter of
2004, the Company recorded a $0.9 million reduction in the liabilities associated with the
restructuring efforts initiated in the first quarter of 2004, consisting of $0.7 million in
employee relocation expenses and $0.2 million in severance and employee benefit costs. The
reductions primarily reflected differences between estimated and actual costs paid in completing
the employee relocations and terminations. As of June 30, 2005, the Company had paid $22.6 million
in severance and employee-related expenses, and all of the employee reductions and relocations had
been completed. During the first quarter of 2004, Alltel also recorded a $2.3 million reduction in
the liabilities associated with various restructuring activities initiated prior to 2003,
consisting of $2.0 million in lease and contract termination costs and $0.3 million in severance
and employee benefit costs. The reductions primarily reflected differences between estimated and
actual costs
19
paid in completing the previous planned workforce reductions and lease and contract terminations.
In the first quarter of 2004, the Company also recorded a write-down in the carrying value of
certain corporate and regional facilities to fair value in conjunction with the 2004
reorganizational changes and the 2003 sale of the Company’s financial services division to Fidelity
National.
At June 30, 2005, the remaining unpaid liability related to Alltel’s first quarter 2004
restructuring activities was $0.3 million, primarily consisting of lease and contract termination
costs. Cash outlays for the remaining unpaid liability will be disbursed over the next 12 to 24
months and will be funded from operating cash flows. (See Note 7 to the unaudited interim
consolidated financial statements for additional information regarding the restructuring and other
charges.)
Non-Operating Income, Net
Three Months
Six Months
Ended June 30,
Ended June 30,
(Millions)
2005
2004
2005
2004
Equity earnings in unconsolidated partnerships
$
15.2
$
15.9
$
25.9
$
29.2
Minority interest in consolidated partnerships
(18.9
)
(21.6
)
(37.2
)
(37.2
)
Other income, net
8.0
2.9
128.7
7.5
Non-operating income, net
$
4.3
$
(2.8
)
$
117.4
$
(0.5
)
As indicated in the table above, non-operating income, net increased $7.1 million and $117.9
million in the three and six months ended June 30, 2005, respectively, compared to the same periods
of 2004. The decreases in equity earnings of $0.7 million and $3.3 million in the three and six
month periods of 2005, respectively, primarily reflected the effects of the wireless property
exchange with Cingular and Alltel’s December 1, 2004 acquisition of a majority ownership interest
in a Georgia market in which the Company previously owned a minority interest. The decrease in
minority interest expense of $2.7 million in the three month period of 2005 was primarily due to
the effects of Alltel’s acquisitions during the fourth quarter of 2004 and the first six months of
2005 of additional ownership interests in wireless properties in Louisiana, Michigan, Mississippi,
North Carolina, Ohio and Wisconsin in which the Company owned a majority interest. This decrease in
the six month period of 2005 was offset by the effects of the growth in wireless segment income, as
further discussed below under “Results of Operations by Business Segment”. The increase of $121.2
million in other income, net for the six month period of 2005 primarily reflected increased
dividend income earned on the Company’s investment in Fidelity National common stock. On March 28,
2005, Alltel received a special $10 per share cash dividend from Fidelity National totaling $111.0
million. Other income, net for the six months ended June 30, 2005 also included a $2.4 million
gain on the sale of investments in certain limited partnerships. Compared to the same periods of
2004, other income, net for both 2005 periods included additional interest income earned on the
Company’s cash and short-term investments of $6.9 million and $8.2 million, respectively, due to
significant growth in Alltel’s available cash on hand following the May 17, 2005 issuance of common
stock to settle the purchase contract obligation related to the equity units previously discussed.
Interest Expense
Interest expense decreased $10.3 million, or 12 percent, and $15.3 million, or 9 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The decreases in both 2005 periods primarily reflected the effects of the April 8, 2005
redemption of $450.0 million, 7.50 percent senior notes, as further discussed below. Interest
expense for the three and six month periods of 2005 also reflected the effects of the February 17,
2005 remarketing of the senior note portion of Alltel’s equity units that reset the annual interest
rate on the notes to 4.656 percent from 6.25 percent for periods subsequent to May 17, 2005.
Interest expense for the six month period of 2005 was also favorably affected by the April 1, 2004
repayment of a $250.0 million, 7.25 percent senior unsecured note.
Gain on Exchange or Disposal of Assets and Other
On April 6, 2005, Alltel completed the sale of all of its shares of Fidelity National common stock
to Goldman Sachs for approximately $350.8 million and recognized a pretax gain of approximately
$75.8 million. Proceeds from the stock sale were used to fund a substantial portion of the cost to
redeem, on April 8, 2005, all of the issued and outstanding 7.50 percent senior notes due March 1,
2006, representing an aggregate principal amount of $450.0 million. Concurrent with the debt
redemption, Alltel also terminated the related pay variable/receive fixed, interest rate swap
agreement that had been designated as a fair value hedge against the $450.0 million senior notes.
In connection with the early termination of the debt and interest rate swap agreement, Alltel
incurred net pretax termination fees of approximately $15.0 million. In addition, as previously
discussed, on April 15, 2005, Alltel and Cingular exchanged certain wireless assets. In connection
with this transaction, Alltel recorded a pretax gain of approximately $127.5 million. These
transactions increased net income $118.0 million or $.38 per share in the three and six month
periods ended June 30, 2005.
20
Primarily due to certain minority partners’ rights-of-first-refusal, three of the wireless
partnership interests to be exchanged between Alltel and Cingular were not completed by June 30,
2005. The exchanges were completed on July 29, 2005, and, as a result, Alltel expects to record an
additional pretax gain of approximately $29.0 million during the third quarter of 2005 in
connection with this transaction.
Income Taxes
Income tax expense increased $80.6 million, or 52 percent, and $147.7 million, or 54 percent, for
the three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The increase in income tax expense in both periods of 2005 was consistent with the overall
growth in the Company’s income before income taxes. The Company’s effective income tax rates
decreased slightly to 37.0 percent for both the three and six months ended June 30, 2005, compared
to 37.2 percent and 37.5 percent for the corresponding periods of 2004, respectively. The
favorable income tax treatment related to both the special cash dividend received from Fidelity
National and the gain realized from the sale of the Fidelity National stock contributed to the
overall decrease in the effective income tax rate in the six month period ended June 30, 2005. In
determining its quarterly provision for income taxes, Alltel uses an estimated annual effective tax
rate, which is based on the Company’s expected annual income, statutory rates and tax planning
opportunities and reflects Alltel’s best estimate of the ultimate outcome of tax examinations and
assessments. Significant or unusual items, such as the taxes related to the special cash dividend
received from Fidelity National and from the sale of the Fidelity National stock discussed above,
are separately recognized in the quarter in which they occur.
Net Income and Earnings per Share
Net income increased $139.5 million, or 53 percent, and $262.7 million, or 58 percent, for the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. Basic earnings per share increased 51 percent and 59 percent and diluted earnings per share
increased 49 percent and 58 percent, for the three and six month periods ended June 30, 2005,
respectively, compared to the same periods of 2004. The increases in net income and earnings per
share in the three and six month periods of 2005 primarily reflected the gains realized from the
exchange of wireless assets with Cingular and the sale of the Company’s investment in Fidelity
National common stock and growth in wireless segment income. These increases were partially offset
by a reduction in wireline and communications support services segment income, reflecting the
decline in wireline access lines and the loss of one of Alltel’s remaining unaffiliated
telecommunications information services customers. In addition to these factors, the increases in
net income and earnings per share in the six month period of 2005 also reflected the special cash
dividend received from Fidelity National and the favorable comparative effects of restructuring and
other charges recorded in the first quarter of 2004 as previously discussed. For a further
discussion of the wireless, wireline and communications support services segment operating results,
see “Results of Operations by Business Segment” below.
Weighted Average Common Shares Outstanding
The weighted average number of common shares outstanding increased 2 percent in the three month
period ended June 30, 2005, compared to the same period of 2004. The increase primarily reflected
the effects of the issuance of approximately 24.5 million Alltel common shares to settle the
purchase contract portion of the Company’s equity units on May 17, 2005. The weighted average
number of common shares outstanding decreased slightly in the six month period ended June 30, 2005
compared to the same period of 2004. The decrease primarily reflected the effects of Alltel’s
repurchase of approximately 11.2 million of its common shares during 2004, partially offset by the
additional shares issued upon settlement of the equity unit purchase contracts and upon the
exercise of options granted under Alltel’s employee stock-based compensation plans.
21
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
Communications-Wireless Operations
Three Months Ended
Six Months Ended
June 30,
June 30,
(Millions, customers in thousands)
2005
2004
2005
2004
Revenues and sales:
Service revenues
$
1,371.1
$
1,183.6
$
2,645.5
$
2,299.1
Product sales
84.2
69.5
161.8
138.5
Total revenues and sales
1,455.3
1,253.1
2,807.3
2,437.6
Costs and expenses:
Cost of services
453.8
382.1
859.5
737.8
Cost of products sold
150.3
135.0
299.1
279.6
Selling, general, administrative and other
331.8
293.0
654.2
588.8
Depreciation and amortization
212.5
181.4
416.0
358.9
Total costs and expenses
1,148.4
991.5
2,228.8
1,965.1
Segment income
$
306.9
$
261.6
$
578.5
$
472.5
Customers
9,067.5
8,336.5
-
-
Average customers
9,040.3
8,256.0
8,869.9
8,171.8
Gross customer additions (a)
805.6
650.1
1,529.3
1,387.5
Net customer additions (a)
266.2
155.3
441.0
313.0
Market penetration
13.7
%
13.6
%
-
-
Postpay customer churn
1.58
%
1.57
%
1.65
%
1.75
%
Total churn
1.99
%
2.00
%
2.05
%
2.20
%
Retail minutes of use per customer per month (b)
593
490
571
461
Retail revenue per customer per month (c)
$46.42
$44.08
$45.89
$43.33
Average revenue per customer per month (d)
$50.55
$47.79
$49.71
$46.89
Cost to acquire a new customer (e)
$355
$313
$329
$305
Notes:
(a)
Includes the effects of acquisitions. Excludes reseller customers for all periods
presented.
(b)
Represents the average monthly minutes that Alltel’s customers use on both the Company’s
network and while roaming on other carriers’ networks.
(c)
Retail revenue per customer is calculated by dividing wireless retail revenues by average
customers for the period. A reconciliation of the revenues used in computing retail revenue
per customer per month was as follows for the three and six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions)
2005
2004
2005
2004
Service revenues
$
1,371.1
$
1,183.6
$
2,645.5
$
2,299.1
Less wholesale revenues
(112.2
)
(91.7
)
(203.3
)
(174.4
)
Total retail revenues
$
1,258.9
$
1,091.9
$
2,442.2
$
2,124.7
(d)
Average revenue per customer per month is calculated by dividing wireless service revenues
by average customers for the period.
(e)
Cost to acquire a new customer is calculated by dividing the sum of product sales, cost of
products sold and sales and marketing expenses (included within “Selling, general,
administrative and other”), as reported above, by the number of internal gross customer
additions in the period. Customer acquisition costs exclude amounts related to the Company’s
customer retention efforts. A reconciliation of the revenues, expenses and customer
additions used in computing cost to acquire a new customer was as follows for the three and
six month periods ended June 30:
Three Months Ended
Six Months Ended
(Millions, customers in thousands)
2005
2004
2005
2004
Product sales
$
(51.0
)
$
(51.8
)
$
(100.9
)
$
(104.1
)
Cost of products sold
62.5
77.4
132.2
164.2
Sales and marketing expense
198.9
177.9
383.9
363.8
Total costs incurred to acquire new customers
$
210.4
$
203.5
$
415.2
$
423.9
Gross customer additions, excluding acquisitions
593.0
650.1
1,262.7
1,387.5
Cost to acquire a new customer
$355
$313
$329
$305
22
The total number of wireless customers served by Alltel increased by more than 730,000 customers,
or 9 percent, during the twelve month period ended June 30, 2005. As previously discussed, during
the first six months of 2005, Alltel exchanged certain wireless properties with Cingular and
purchased wireless properties from PS Cellular. During the fourth quarter of 2004, Alltel
purchased wireless properties in Florida, Georgia, Louisiana and Ohio. The acquired properties accounted for approximately 360,000 of the overall increase in
wireless customers during the twelve month period ended June 30, 2005. Excluding the effects of
acquisitions, Alltel added 105,000 net postpay wireless customers during the second quarter of
2005. As a result of approximate net losses of 24,000 prepay customers and 27,000 customers in the
acquired markets, mostly in those properties acquired from Cingular, net customer additions for the quarter
were 54,000 and totaled approximately 175,000 in the six months ended June 30, 2005. Sales of
Alltel’s higher-yield Total and National Freedom rate plans accounted for approximately 37 percent
and 35 percent of the gross additions during the three and six month periods of 2005, respectively.
At June 30, 2005, customers on the Company’s Total and National Freedom rate plans represented
approximately 41 percent of Alltel’s wireless customer base. Overall, the Company’s wireless
market penetration rate (number of customers as a percent of the total population in Alltel’s
service areas) increased slightly to 13.7 percent as of June 30, 2005.
In terms of the acquired Cingular markets, the customer losses were within Alltel’s expectations
and primarily resulted from transition issues, such as rebranding and deploying a CDMA network to
replace the existing GSM/TDMA network in those markets. By mid-July 2005, Alltel completed
deployment of a CDMA network in all but one of the acquired markets and plans to transition the
entire customer base to CDMA handsets in the second half of 2005, because Alltel’s use of the
existing Cingular GSM/TDMA network will be discontinued by year-end. In completing these
integration efforts, Alltel expects to incur approximately $30.0 million in incremental handset
subsidies during the third and fourth quarters of 2005.
The level of customer growth throughout the remainder of 2005 will be dependent upon the Company’s
ability to attract new customers and retain existing customers in a competitive marketplace, which
is currently supporting up to seven competitors in each market. The Company will continue to focus
its efforts on sustaining value-added customer growth by improving service quality and customer
satisfaction, managing its distribution channels and customer segments, offering attractively
priced rate plans and new or enhanced services and other features, selling additional services to
existing customers and pursuing strategic acquisitions, such as the merger with Western Wireless
previously discussed.
The Company continues to focus its efforts on lowering postpay customer churn (average monthly rate
of customer disconnects). To improve customer retention, Alltel continues to upgrade its
telecommunications network in order to offer expanded network coverage and quality and to provide
enhanced service offerings to its customers. In addition, the Company has increased the number of
its customers under contract through the offering of competitively priced rate plans, proactively
analyzing customer usage patterns and migrating customers to newer digital handsets. The Company
believes that its improvements in customer service levels, digital network expansion and proactive
retention efforts contributed to the decrease in postpay customer churn in the six month period of
2005 compared to the same period of 2004. Primarily due to the declines in postpay churn, total
churn also decreased in the six month period of 2005 compared to the same period of 2004. Postpay
customer and total churn for the three month period of 2005 were both substantially unchanged from
the same period a year ago despite an increase in contract expirations.
Wireless revenues and sales increased $202.2 million, or 16 percent, and $369.7 million, or 15
percent, for the three and six month periods ended June 30, 2005, respectively, compared to the
same periods of 2004. Service revenues also increased 16 percent and 15 percent, or $187.5 million
and $346.4 million, in the three and six month periods of 2005, respectively, compared to the same
periods of 2004. The acquisitions of wireless properties previously discussed accounted for
approximately $58.9 million and $77.3 million of the increases in wireless revenues and sales, and
$56.9 million and $74.1 million of the increase in service revenues in the three and six month
periods of 2005, respectively. In addition to the effects of the acquisitions, service revenues
also reflected increases in wireless access revenues, which increased $73.5 million and $155.3
million in the three and six month periods ended June 30, 2005, respectively, as compared to the
same prior year periods, primarily driven by nonacquisition-related customer growth. Service
revenues for both 2005 periods also reflected growth in revenues derived from wireless data
services, including text and picture messaging and downloadable applications, such as games,
ringtones, wallpaper and office applications. Revenues from data services increased by 150
percent, or $31.1 million, and nearly 170 percent, or $61.4 million, in the three and six month
periods of 2005, respectively, reflecting strong demand for these services and the effects of a
large-scale promotion surrounding Super Bowl XXXIX and the “Txt2Win $1 Million Home Sweepstakes”
promotion completed in July 2005, both aimed at increasing text messaging usage. During 2005,
Alltel also launched several operational initiatives, including offering an industry-first pricing
plan for wireless data services which allows customers to combine video, picture and text messaging
services for one flat rate, selling portable BlackBerry® devices in its retail stores and offering
national coverage for the BlackBerry® device and other 1XRTT data services through a roaming
agreement with Verizon Wireless. In addition, Alltel expanded its 1XRTT data footprint and through
June 30,2005 had deployed EV-DO services in five markets.
23
Wireless service revenues also included increases in regulatory and other fee revenues of $36.5
million and $73.1 million in the three and six month periods of 2005, respectively, compared to the
same periods in 2004. Regulatory fees in 2005 included USF support received by Alltel pursuant to
its certification in twelve states as an ETC, and accounted for $19.5 million and $40.5 million of
the overall increases in regulatory fees in the three and six month periods of 2005, respectively.
After deducting the portion of USF subsidies distributed to its partners in wireless markets
operated in partnership with other companies, Alltel expects to receive in 2005, on a quarterly
basis, net USF subsidies in its wireless business of approximately $25.0 million to $30.0 million.
The increase in regulatory fees in both periods of 2005 also reflected additional amounts billed to
customers to offset costs related to certain regulatory mandates, which have increased consistent
with the overall growth in customers and also reflected an increase in the contribution factor
applicable to universal service funding. Growth in revenues from the sale of wireless equipment
protection plans and automotive roadside assistance services also contributed to the growth in
service revenues during the three and six months ended June 30, 2005. Revenues from these services
increased $8.3 million and $16.5 million, respectively, compared to the same prior year periods,
reflecting continued demand for these services. Wholesale wireless revenues also increased $9.2
million and $15.7 million in the three and six month periods of 2005, respectively, from the same
periods in 2004, primarily due to strong growth in CDMA minutes of use and stability in the volumes
of TDMA and analog minutes of use by other carriers’ customers roaming on Alltel’s wireless
network.
The increase in service revenues in the three and six month periods of 2005 attributable to
increased access revenues from customer growth including the effects of acquisitions, additional
revenues earned from data services, increased regulatory and other fees, and growth in wholesale
revenues were partially offset by declines of $16.9 million and $25.8 million, respectively, in
airtime and retail roaming revenues. In addition, revenues derived from sales of enhanced
features, including caller identification, call waiting and voice mail, decreased by $8.0 million
and $18.0 million, respectively, in the three and six month periods of 2005 as compared to the same
periods in 2004. The decreases in airtime, retail roaming and feature revenues primarily reflected
the effects of customers migrating to rate plans with a larger number of packaged minutes that, for
a flat monthly service fee, provide customers with a specified number of airtime minutes and
include at no extra charge unlimited weekend, nighttime and mobile-to-mobile minutes and certain
enhanced features.
Primarily due to Alltel’s continued focus on quality customer growth, improvements in data revenues
and additional ETC subsidies, average revenue per customer per month and retail revenue per
customer per month both increased in the three and six month periods of 2005 compared to the same
periods of 2004. Retail revenue per customer per month increased 5 percent in the three month
period of 2005, to $46.42, and 6 percent in the six month period of 2005, to $45.89. Average
revenue per customer per month increased 6 percent in both 2005 periods, to $50.55 and $49.71,
respectively. Growth in service revenues and average revenue per customer per month for the
remainder of 2005 will depend upon Alltel’s ability to effectively integrate acquired operations
and maintain market share in a competitive marketplace by adding new customers, retaining existing
customers, increasing customer usage, and continuing to sell data services.
Product sales increased $14.7 million, or 21 percent, and $23.3 million, or 17 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The acquisitions previously discussed accounted for $2.0 million and $3.2 million of the
overall increases in product sales in the three and six months of 2005, respectively. In addition
to the effects of acquisitions, product sales increased in both 2005 periods primarily due to
higher retail prices for wireless handsets that include advanced features, such as picture
messaging, and that are capable of downloading games, entertainment content, weather and office
applications. The increases in product sales in both 2005 periods also reflected the continued
retention efforts by the Company focused on migrating existing wireless customers to new wireless
technologies.
Cost of services increased $71.7 million, or 19 percent, and $121.7 million, or 16 percent, in the
three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The wireless property acquisitions accounted for $29.0 million and $36.5 million of the
overall increases in cost of services in the three and six month periods of 2005, respectively. In
addition to the effects of acquisitions, cost of services for the three and six month periods of
2005 also reflected higher network-related costs of $13.3 million and $31.5 million, respectively,
compared to the same periods of 2004, resulting from increased network traffic due to
nonacquisition-related customer growth, increased minutes of use and expansion of network
facilities. Compared to the same prior year periods, payments to data content providers increased
$9.3 million and $18.5 million for the three and six months ended June 30, 2005, respectively,
consistent with the growth in revenues derived from data services discussed above. Cost of
services for the three and six month periods of 2005 also included increased regulatory fees of
$7.0 million and $12.8 million, respectively, primarily related to various regulatory mandates,
including USF, consistent with the growth in revenues derived from regulatory fees discussed above.
When compared to the same periods of 2004, cost of services for the three and six month periods of
2005 also reflected increases in customer service expenses of $7.9 million and $17.9 million,
respectively, primarily reflecting additional costs associated with Alltel’s retention efforts
focused on improving customer satisfaction and reducing postpay churn.
24
Cost of products sold increased $15.3 million, or 11 percent, and $19.5 million, or 7 percent, for
the three and six month periods ended June 30, 2005, respectively, compared to the same periods of
2004. The wireless acquisitions accounted for $3.7 million and $6.2 million of the overall
increases in cost of products sold in the three and six month periods of 2005, respectively. In
addition to the affects of the acquisitions, cost of products sold for both 2005 periods also
reflected sales of higher-priced wireless handsets and the Company’s continuing customer retention
efforts, which include subsidizing the cost of new handsets provided to existing customers before
the expiration of their service contracts. These increases were partially offset by the effects of
additional vendor rebates earned by Alltel for attaining specified purchase volumes with the
Company’s wireless handset vendors.
Selling, general, administrative and other expenses increased $38.8 million, or 13 percent, and
$65.4 million, or 11 percent, for the three and six month periods ended June 30, 2005,
respectively, compared to the same periods of 2004. The wireless property acquisitions accounted
for $11.5 million and $17.2 million of the overall increases in these expenses in the three and six
month periods of 2005, respectively. In addition to the effects of acquisitions, selling, general,
administrative and other operating expenses also reflected increased advertising costs of $6.7
million and $9.4 million in the three and six month periods of 2005, respectively, associated with
two large-scale promotions aimed at increasing text messaging usage, as discussed above, as well as
additional costs associated with Alltel’s rebranding initiative previously discussed. Alltel
incurred $9.5 million of incremental expenses associated with the rebranding initiative during the
second quarter of 2005 and expects to incur approximately $8.6 million of incremental expenses
during the third quarter of 2005 to complete the redesign of its retail stores. Increased
insurance premiums related to the Company’s employee medical and dental plans, additional costs
associated with write-offs identified as a result of system improvements in the Company’s cash
processing procedures and higher audit fees and internal staffing costs incurred in complying with
the Section 404 internal control reporting requirements of the Sarbanes-Oxley Act of 2002 also
contributed to the increase in selling, general, administrative and other expenses in the six month
period of 2005.
Depreciation and amortization expense increased $31.1 million, or 17 percent, and $57.1 million, or
16 percent, for the three and six month periods ended June 30, 2005, respectively, compared to the
same periods of 2004. Depreciation and amortization expense increased in both 2005 periods
primarily due to growth in wireless plant in service and the effects of a third quarter 2004
prospective change in the depreciable lives of certain wireless telecommunications equipment. The
depreciable lives were shortened in response to the rapid pace of technological development and the
increasing demands of Alltel’s customers for new products and services. Additionally, the wireless
property acquisitions accounted for $5.4 million and $7.6 million of the overall increase in
depreciation and amortization expense in the three and six month periods ended June 30, 2005,
respectively.
Wireless segment income increased $45.3 million, or 17 percent, and $106.0 million, or 22 percent,
for the three and six month periods ended June 30, 2005, respectively, compared to the same periods
of 2004, driven primarily by the nonacquisition-related growth in revenues and sales discussed
above. The wireless property acquisitions accounted for $9.2 million and $9.9 million,
respectively, of the overall increases in wireless segment income in the three and six month
periods of 2005. In addition, wireless segment income comparisons for the six month period of 2005
also reflected the favorable effects on customer acquisition costs due to vendor rebates and a 9
percent decline in gross customer additions (excluding acquisitions) from the same period a year
ago, as further discussed below.
The cost to acquire a new wireless customer represents sales, marketing and advertising costs and
the net equipment cost, if any, for each new customer added. The increases in cost to acquire a
new customer in the three and six month periods of 2005 primarily reflected the additional
advertising costs and incremental expenses related to Alltel’s rebranding initiative discussed
above and the unfavorable effects of spreading the total customer acquisition costs over a smaller
number of gross customer additions as compared to the same periods of 2004. The increases in cost
to acquire a new customer resulting from higher advertising costs, incremental rebranding expenses
and proportionately lower gross customer additions were partially offset by improved margins on the
sales of wireless handsets primarily attributable to the effects of vendor rebates. For the six
months ended June 30, 2005 and 2004, approximately 62 percent and 66 percent, respectively, of the
wireless gross customer additions came through Alltel’s internal distribution channels. Alltel’s
internal distribution channels include Company retail stores and kiosks located in shopping malls,
other retail outlets and mass merchandisers. Incremental sales costs at a Company retail store or
kiosk are significantly lower than commissions paid to dealers. Although Alltel intends to manage
the costs of acquiring new customers throughout the remainder of 2005 by continuing to enhance its
internal distribution channels, the Company will also continue to utilize its large dealer network.
25
Set forth below is a summary of the restructuring and other charges related to the wireless
operations that were not included in the determination of segment income for the six months ended
June 30, 2004:
(Millions)
Severance and employee benefit costs
$
8.8
Relocation costs
3.2
Lease and contract termination costs
0.5
Write-down in carrying value of certain facilities
0.7
Other exit costs
0.4
Total restructuring and other charges
$
13.6
Regulatory Matters-Wireless Operations
Regulatory Oversight
Alltel is subject to regulation by the FCC as a provider of Commercial Mobile Radio Services
(“CMRS”). The FCC’s regulatory oversight consists of ensuring that wireless service providers are
complying with the Communications Act of 1934, as amended (the “Communications Act”), and the FCC’s
regulations governing technical standards, spectrum usage, license requirements, market structure,
consumer protection, including public safety issues like enhanced 911 emergency service (“E-911”)
and the Communications Assistance for Law Enforcement Act (“CALEA”), and environmental matters
governing tower siting. State public service commissions are pre-empted under the Communications
Act from regulatory oversight of wireless carriers’ market entry and retail rates, but, they are
entitled to address certain consumer protection matters concerning wireless service providers.
Recently, various state public service commissions have attempted to expand their role in
regulating wireless service beyond basic consumer protection to include, for example, billing
practices. At this time, the Company cannot estimate the impact that increased state regulatory
oversight would have on its operations in the event state public service commissions are
successful.
Telecommunications Law Modernization
In 1996, Congress passed the Telecommunications Act of 1996 (“the 96 Act”), which significantly
changed the existing laws and regulations governing the telecommunications industry. The primary
goal of the 96 Act was to create competition in the wireline market by requiring incumbent local
exchange carriers (“ILECs”) to sell portions of their networks to competitors at reduced wholesale
rates. The 96 Act also established rules for interconnecting wireline and wireless service
providers’ networks. Unfortunately, the 96 Act failed to contemplate the rapid evolution of
technology and the associated consumer demand for wireless services, the Internet and
voice-over-Internet-protocol (“VoIP”). Today, providers of communications services are regulated
differently depending primarily upon the network technology used to deliver service. This
“patchwork” regulatory approach unfairly advantages certain companies and disadvantages others,
which impedes market-based competition where service providers, regardless of technology, exchange
telecommunications traffic between their networks and are competing for the same customers.
In an effort to reform the “patchwork” regulatory approach, two separate telecommunications bills
were recently introduced in the U.S. Senate. The first bill, entitled the “Broadband Investment
and Consumer Choice Act”, was introduced on July 27, 2005. This bill reduces the level of
government regulation within the telecommunications industry in favor of market-based competition
and provides for parity in the remaining rules for functionally equivalent services, like broadband
access to the Internet via DSL, cable modem and other means. Another bill, entitled “the Universal
Service for the 21st Century Act”, was introduced on July 29, 2005. This bill changes the way
telecommunications companies contribute to the universal service fund, establishes limited support
for broadband investment in unserved areas and calls for the FCC to establish inter-carrier
compensation reform within six months of enactment. There will likely be additional bills
submitted for consideration in the future as Congress evaluates changing the regulatory environment
in the telecommunications industry. Alltel strongly supports telecommunications modernization but,
at this time, cannot predict the outcome of these efforts.
Universal Service
To ensure affordable access to telecommunications services throughout the United States, the FCC
and many state commissions administer universal service programs. CMRS providers are required to
contribute to the federal USF and are required to contribute to some state universal service funds.
Under FCC rules, CMRS providers also are eligible to receive support from the federal USF if they
obtain certification as an ETC.
In 2004, the Company received ETC approval for certain of its properties in Alabama, Arkansas,
Florida, Georgia, Kansas, Louisiana, Michigan, Mississippi, North Carolina, Virginia, West Virginia
and Wisconsin. The Company began receiving USF support associated with ETC certifications in
Arkansas, Michigan, Mississippi, West Virginia and
Wisconsin in the first quarter of 2004, and for Alabama, Florida, Georgia, Kansas, Louisiana, North
Carolina and Virginia in the fourth quarter of 2004. The Communications Act and FCC regulations
require that universal service receipts be used to provision, maintain and upgrade the networks
that provide the supported services. Additionally, the Company accepted certain federal and state
reporting requirements as a condition of the ETC certifications. As of June 30, 2005, the Company
is compliant with the FCC regulations and all of the federal and state reporting requirements.
Alltel received approximately $31.0 million of gross USF subsidies in the second quarter of 2005
related to the ETC certifications and net USF subsidies of approximately $29.0 million after
deducting the portion of USF subsidies distributed to its unaffiliated partners in certain markets.
Alltel expects to receive net USF subsidies of between $25.0 million and $30.0 million for each of
the remaining quarters in 2005. Alltel anticipates seeking ETC certification in additional markets
before the end of 2005.
The federal universal service program is under legislative, regulatory and industry scrutiny as a
result of growth in the fund and structural changes within the telecommunications industry. The
structural changes include an increase in the number of ETCs receiving support from the USF and a
migration of customers from wireline service providers to providers using alternative technologies,
like VoIP that, today, are not required to contribute to the universal service program. There are
several FCC proceedings underway that are likely to change the way universal service programs are
funded and the way these funds are disbursed to program recipients. The specific proceedings are
discussed in greater detail below.
On March 17, 2005, the FCC issued an Order strengthening the conditions for telecommunications
carriers to receive and maintain ETC designation. The new standards are mandatory when the FCC is
responsible for evaluating ETC applications and recommended when state regulatory agencies are
responsible for evaluating ETC applications. Effective October 1, 2006, the new standards require
ETCs to: (1) provide a five-year plan demonstrating how support will be used to improve coverage,
service quality or capacity, including annual progress reports; (2) demonstrate the network’s
ability to remain functional in emergencies; (3) demonstrate how they will satisfy consumer and
quality standards; (4) offer “local-usage” plans comparable to the ILEC; and (5) acknowledge that
they may be required to provide equal access to interexchange carriers in the event they become the
sole ETC within a designated service area. The new standards are not expected to affect the
Company’s universal service receipts.
On June 14, 2005, the FCC issued a Notice of Proposed Rulemaking (“NPRM”) initiating a broad
inquiry into the management and administration of the universal service programs. The NPRM seeks
comment on ways to streamline the application process for federal support and whether and how to
increase audits of fund contributors and fund recipients to deter waste and fraud. The FCC is also
considering proposals regarding the contribution methodology, which could change the category of
service providers that contribute to the fund and the basis upon which they contribute. At this
time, Alltel cannot estimate the impact that the potential changes, if any, would have on its
operations.
Finally, the FCC mandated that, effective October 1, 2004, the Universal Service Administrative
Company (“USAC”) begin accounting for the USF program in accordance with generally accepted
accounting principles for federal agencies, rather than the accounting rules that USAC formerly
used. This change in accounting method subjected USAC to the Anti-Deficiency Act (the “ADA”), the
effect of which could have caused delays in payments to USF program recipients and significantly
increased the amount of USF regulatory fees charged to wireline and wireless consumers. In
December 2004, Congress passed legislation to exempt USAC from the ADA for one year to allow for a
more thorough review of the impact the ADA would have on the universal service program. In April
2005, the FCC tentatively concluded that the high-cost and low-income programs of the universal
service fund comply with ADA requirements, and has asked the Office of Management and Budget
(“OMB”) to make a final determination on this issue. Additionally, congress is contemplating a
permanent solution to alleviate the ADA issues and the related negative impact to the universal
service program.
E-911
Wireless service providers are required by the FCC to provide E-911 in a two-phased approach. In
phase one, carriers must, within six months after receiving a request from a phase one enabled
Public Safety Answering Point (“PSAP”), deliver both the caller’s number and the location of the
cell site to the PSAP serving the geographic territory from which the E-911 call originated. A
phase one-enabled PSAP is generally one that is capable of receiving and utilizing the number and
cell site location data transmitted by the carrier. Alltel has generally complied with the phase
one requirements and provides service to phase one capable PSAPs. As a result of certain
technology and deployment issues, the six month window in which service is to be provided under the
FCC rules has, in certain instances and in accordance with the rules, been extended by mutual
agreement between Alltel and the particular PSAPs.
In phase two, CMRS carriers like Alltel that have opted for a handset-based solution must determine
the location of the caller within 50 meters for 67 percent of the originated calls and 150 meters
for 95 percent of the originated calls and deploy Automatic Location Identification (“ALI”) capable
handsets according to specified thresholds. The phase two handset deployment requirements were set
to begin by October 1, 2001, but, because of certain technology and other
27
factors, the Company requested a limited waiver of these requirements, as did virtually every other
carrier. On July 26, 2002, the FCC released an order granting a temporary stay of the E-911 rules
as they applied to the Company (the “FCC Order”). The FCC Order provides for a phased-in
deployment of ALI-capable handsets that began on March 1, 2003. ALI capability permits more
accurate identification of the caller’s location by PSAPs. Under the FCC Order, the Company was
required to: (1) begin selling and activating ALI-capable handsets prior to March 1, 2003; (2)
ensure that, as of May 31, 2003, at least 25 percent of all new handsets activated were
ALI-capable; (3) ensure that, as of November 30, 2003, at least 50 percent of all new handsets
activated were ALI-capable; (4) ensure that, as of May 31, 2004, 100 percent of its new digital
handsets activated were ALI-capable; and (5) ensure that at least 95 percent of its customers have
ALI-capable handsets by December 31, 2005.
On April 1, 2005, the FCC released an order disposing of numerous E-911 waiver requests filed by a
group of Tier III wireless carriers (no more than 500,000 customers as of December 31, 2001)
requesting the FCC to extend the December 31, 2005, deadline for meeting the 95 percent handset
requirement. While stressing the importance of E-911 compliance, the FCC provided certain of these
carriers with greater latitude to comply with handset deployment dates and to accommodate
transitions to alternative digital technologies. While it is uncertain how the April 1, 2005, order
may affect the FCC’s consideration of waiver requests filed by larger carriers, the order indicates
FCC flexibility on E-911 compliance matters where the requesting carrier makes a detailed showing
of special circumstances and provides a detailed proposal outlining a realistic path to future
compliance.
On June 30, 2005, CTIA-The Wireless Association (“CTIA”) and Rural Cellular Association filed a
Joint Petition for Suspension or Waiver of the Location-Capable Handset Penetration Deadline with
the FCC. The petition recommends that the FCC adopt a framework for individual carriers to use in
order to streamline potential future waiver requests. While the joint petition requested an
overall suspension of the December 31, 2005 deadline, it also outlined several factors and
circumstances for the FCC to consider in evaluating future waiver requests. The Company cannot
determine if the FCC will take any action on this petition, or the related impact of its action.
Alltel began selling ALI-capable handsets in June 2002 and, to date, has complied with the handset
deployment thresholds under the FCC’s Order or otherwise obtained short-term relief from the FCC to
facilitate certain recent acquisitions. However, based on the current pace of customer migration
to ALI-capable handsets and lower than forecasted churn, it is unlikely that Alltel will meet the
FCC’s 95 percent requirement by December 31, 2005. The Company expects to file a waiver request
with the FCC during the third quarter of 2005 that will include an explanation of its compliance
efforts and the expected future date when it will achieve compliance. Additionally, the Company
expects other wireless carriers will file similar waiver requests with the FCC prior to the end of
2005.
CALEA
CALEA requires wireless and wireline carriers to ensure that their networks are capable of
accommodating lawful intercept requests received from law enforcement agencies. The FCC has
imposed various obligations and compliance deadlines, with which Alltel has either complied or, in
accordance with CALEA, filed a request for an extension of time. On August 18, 2004, the DOJ
objected to Alltel’s pending extension request relating to the Company’s packet-mode services
because the DOJ erroneously thought that Alltel’s “Touch2Talk” walkie-talkie service was delivered
via packet-mode technology. However, the Company’s “Touch2Talk” service does not use packet-mode
technology and is compliant with CALEA standards. Alltel is coordinating further testing with the
Federal Bureau of Investigation to demonstrate Alltel’s “Touch2Talk” CALEA compliance.
In response to a petition filed by the DOJ and other federal agencies, the FCC initiated a
rulemaking in August 2004, to adopt new rules under CALEA pertaining to wireless and wireline
carriers’ packet mode communications services, including Internet protocol (“IP”) based services.
The FCC concurrently issued a declaratory ruling concerning the appropriate treatment of
push-to-talk services under CALEA. Rules or precedents adopted as a result of these proceedings
could impose new costs and obligations on Alltel and other carriers. The Company’s packet services
network requires a modest upgrade to be fully compliant with CALEA standards. The cost of the
upgrade is immaterial and will not adversely affect the Company’s operations.
Finally, Alltel received notification from certain of its vendors that they will no longer support
the particular elements required for CALEA compliance in Alltel’s network. The Company is
considering various proposals for replacing these elements to maintain continuous compliance with
the CALEA requirements. The cost of these upgrades is not expected to be material and will not
adversely affect the Company’s operations.
28
Inter-carrier Compensation
Under the 96 Act and the FCC’s rules, CMRS providers are entitled to receive compensation from
local exchange carriers (“LECs”) for calls transmitted from the LECs’ customers to customers of the
CMRS provider. Additionally, CMRS providers are not precluded from receiving compensation from
inter-exchange carriers for CMRS originated inter-exchange traffic pursuant to contract. However,
presently, the Company’s wireless operations do not bill inter-exchange carriers for this traffic.
In April 2001, the FCC released a notice of proposed rulemaking addressing inter-carrier
compensation. Under this rulemaking, the FCC proposed a “bill and keep” compensation method that
would overhaul the existing rules governing inter-carrier compensation. On March 3, 2005, the FCC
issued a further notice of proposed rulemaking on inter-carrier compensation matters in which the
FCC solicited comment on a number of alternative compensation proposals submitted by various
industry participants. In addition, various LECs have initiated a number of state proceedings to
address inter-carrier compensation for traffic that originates or terminates on wireless carriers’
networks. The outcome of the FCC and state proceedings could change the way Alltel receives
compensation from, and remits compensation to, other carriers as well as its wireless customers.
At this time, Alltel cannot determine the extent and timing of the changes and the related
financial impact the changes would have on its wireless revenues and expenses.
Wireless Spectrum
The FCC conducts proceedings through which additional spectrum is made available for the provision
of wireless communications services, including broadband services. Additional spectrum is
generally made available to carriers through auctions conducted by the FCC. In October 2003, the
FCC issued an order adopting rules that allow CMRS licensees to lease spectrum to others. The FCC
further streamlined its rules to facilitate spectrum leasing in a subsequent order issued in
September 2004. The FCC’s spectrum leasing rules revise the standards for transfer of control and
provide new options for the lease of spectrum to providers of new and existing wireless
technologies. The FCC also deleted the rule prohibiting ownership of both A and B block cellular
systems in the same rural service area. The FCC decisions provide increased flexibility to
wireless companies with regard to obtaining additional spectrum through leases and retaining
spectrum acquired in conjunction with wireless company acquisitions. The Company’s evaluation of
opportunities as a result of these proceedings and decisions is ongoing.
Customer Billing
In response to a petition filed by the National Association of State Utility Consumer Advocates,
the FCC issued an order and further rulemaking on its truth in billing and billing format
proceeding. In the order, the FCC applied to CMRS carriers the obligation to ensure that the
descriptions of line items on customer bills are clear and not misleading and to reiterate that the
representation of a discretionary item on a bill as a tax or government-mandated charge is
misleading. The FCC also made a declaratory ruling that state regulations requiring or prohibiting
the use of line items on CMRS carriers’ bills were preempted in favor of federal authority pursuant
to Section 332 (c) of the Communications Act. In the further rulemaking, the FCC will consider
additional CMRS billing regulations that would require: (1) government-mandated charges to be
segregated from discretionary charges; (2) the combination of certain charges into single
categories; and (3) that carriers must disclose the full rate for service, including discretionary
charges and charges imposed by government mandates, to consumers at the point of sale prior to the
execution of a service contract. Additionally, the FCC is considering whether states should be
preempted from regulation of wireless carrier’s customer bills. The Company expects the outcome of
the FCC’s further rulemaking to have a minimal impact on its billing and marketing efforts,
although it supports efforts to formulate a nationwide standard.
Communications-Wireline Operations
Three Months Ended
Six Months Ended
June 30,
June 30,
(Millions)
2005
2004
2005
2004
Revenues and sales:
Local service
$
272.8
$
280.7
$
545.5
$
560.7
Network access and long-distance
257.1
262.8
518.0
523.5
Miscellaneous
65.2
66.1
125.2
124.9
Total revenues and sales
595.1
609.6
1,188.7
1,209.1
Costs and expenses:
Cost of services
182.7
178.6
363.7
351.5
Cost of products sold
9.0
7.1
16.0
12.3
Selling, general, administrative and other
62.7
60.9
126.5
121.8
Depreciation and amortization
125.4
128.6
252.7
260.9
Total costs and expenses
379.8
375.2
758.9
746.5
Segment income
$
215.3
$
234.4
$
429.8
$
462.6
29
Three Months Ended
Six Months Ended
June 30,
June 30,
(Access lines in thousands)
2005
2004
2005
2004
Access lines in services (excludes broadband lines)
2,953.0
3,066.1
-
-
Average access lines in service
2,968.0
3,079.6
2,981.1
3,085.4
Average revenue per customer per month (a)
$66.83
$65.99
$66.46
$65.31
Notes:
(a)
Average revenue per customer per month is calculated by dividing total wireline revenues by
average access lines in service for the period.
Wireline operations consist of Alltel’s ILEC, CLEC and Internet operations. Wireline revenues and
sales decreased 2 percent in both the three and six month periods ended June 30, 2005 as compared
to the prior year, or $14.5 million and $20.4 million, respectively. Customer access lines
decreased nearly 4 percent during the twelve months ended June 30, 2005, reflecting declines in
both primary and secondary access lines. The Company lost approximately 30,000 and 56,000 access
lines during the three and six month periods ended June 30, 2005, respectively, compared to 24,000
and 30,000 access lines lost during the same periods a year ago. The declines in access lines
primarily resulted from the effects of wireless and broadband substitution for the Company’s
wireline services. Alltel expects access line growth for the remainder of 2005 to continue to be
impacted by the effects of wireless and broadband substitution.
To slow the decline of revenue during the remainder of 2005, the Company will continue to emphasize
sales of enhanced services and bundling of its various product offerings including Internet,
long-distance and broadband data transport services. Deployment of broadband service is an
important strategic initiative for Alltel. During the three and six month periods ended June 30,
2005, Alltel added 36,000 and 76,000 broadband customers, respectively, increasing its broadband
customer base to more than 319,000 customers, or 16 percent of the Company’s addressable access
lines. The growth in the Company’s broadband customers more than offset the decline in customer
access lines noted above.
Local service revenues decreased 3 percent in both the three and six months ended June 30, 2005, or
$7.9 million and $15.2 million, respectively, compared to the same periods of 2004. Local service
revenues reflected reductions in basic service access line revenues of $8.6 million and $16.5
million in the three and six month periods of 2005, respectively, compared to the same periods of
2004, consistent with the overall decline in access lines discussed above. The declines in local
service revenues attributable to access line loss were partially offset by growth in revenues
derived from the sales of enhanced features and equipment protection plans, which increased $1.6
million and $3.2 million in the three and six month periods of 2005, respectively, compared to the
same periods of 2004, reflecting continued demand for these products and services.
Network access and long-distance revenues decreased $5.7 million, or 2 percent, and $5.5 million,
or 1 percent, in the three and six months ended June 30, 2005, respectively, compared to the same
periods of 2004. Primarily due to the overall decline in access lines discussed above, network
access usage and toll revenues decreased $13.1 million and $19.4 million in the three and six month
periods of 2005, respectively, compared to the same periods of 2004. The declines in network
access and long-distance revenues attributable to access line loss were partially offset by a
slight increase in federal USF funding and growth in revenues from data services, which increased
$6.5 million and $12.5 million in the three and six month periods of 2005, respectively, reflecting
increased demand for high-speed data transport services.
Miscellaneous revenues primarily consist of charges for Internet services, directory advertising,
customer premise equipment sales and rentals, and billing and collections services provided to
long-distance companies. Miscellaneous revenues decreased by $0.9 million, or 1 percent, in the
three months ended June 30, 2005, and increased slightly in the six months ended June 30, 2005,
compared to the same periods of 2004. Primarily driven by growth in broadband customers, revenues
from the Company’s Internet operations increased $2.9 million and $6.8 million in the three and six
month periods of 2005, respectively. In addition, sales and rentals of customer premise equipment
increased $1.0 million and $2.9 million in the three and six month periods of 2005, respectively,
as compared to the same prior year periods, reflecting continued customer demand for these
products. Offsetting the increases in miscellaneous revenues in both 2005 periods due to growth in
the Company’s Internet operations and sales and rentals of customer premise equipment were
decreases in directory advertising revenues of $3.7 million and $7.8 million in the three and six
month periods of 2005, respectively, primarily due to a change in the number and mix of directories
published.
30
Primarily due to the broadband customer growth and increased sales of enhanced features, average
revenue per customer per month increased 1 percent and 2 percent in the three and six month periods
of 2005, respectively, compared to the same periods in 2004. Future growth in average revenue per
customer per month will depend on the Company’s success in sustaining growth in sales of broadband
and other enhanced services to new and existing customers.
Cost of services increased 2 percent, or $4.1 million, and 3 percent, or $12.2 million, in the
three and six months ended June 30, 2005, respectively, compared to the prior year periods. Cost
of services for the six month period in 2005 included approximately $3.2 million of incremental
costs incurred during the first quarter of 2005 related to work force reductions in the Company’s
wireline business, as well as higher overtime and maintenance costs due to inclement weather. Cost
of services in both periods of 2005 included additional customer service expenses attributable to
the growth in broadband customers, specifically the costs associated with subsidizing
broadband-capable modems. In addition, cost of services in the three and six months ended June 30,
2005 included increased regulatory fees of $1.8 million and $3.0 million, respectively, related to
an increase in the contribution factor applicable to universal service funding.
Cost of products sold increased $1.9 million, or 27 percent, and $3.7 million, or 30 percent, in
the three and six months ended June 30, 2005, respectively, compared to the same periods of 2004,
consistent with the increase in sales and rentals of customer premise equipment discussed above.
Selling, general, administrative and other expenses increased $1.8 million, or 3 percent, and $4.7
million, or 4 percent, in the three and six months ended June 30, 2005, respectively, compared to
the same periods of 2004, primarily resulting from higher audit fees and internal staffing costs
incurred in complying with the Section 404 internal control reporting requirements of the
Sarbanes-Oxley Act of 2002 and higher insurance premiums related to the Company’s employee medical
and dental plans. Depreciation and amortization expense decreased $3.2 million, or 2 percent, and
$8.2 million, or 3 percent, in the three and six months ended June 30, 2005, respectively, compared
to the same periods of 2004. The decreases in depreciation and amortization expense in both 2005
periods primarily resulted from a reduction in depreciation rates for the Company’s Nebraska
operations, reflecting the results of a triennial study of depreciable lives completed by Alltel in
the second quarter of 2004 as required by the Nebraska Public Service Commission.
Wireline segment income decreased $19.1 million, or 8 percent, and $32.8 million, or 7 percent, in
the three and six months ended June 30, 2005, respectively, compared to the same periods of 2004.
The decreases in segment income in both 2005 periods primarily resulted from the decline in
revenues and sales due to the loss of access lines and the adverse affects of increased operating
expenses related to the growth in broadband customers and higher employee benefit costs discussed
above. In addition, the decrease in wireline segment income during the six month period ended June
30, 2005 was also attributable to the incremental expenses associated with work force reductions
and higher overtime costs incurred in the first quarter of 2005 discussed above.
Set forth below is a summary of the restructuring and other charges related to the wireline
operations that were not included in the determination of segment income for the six months ended
June 30, 2004:
(Millions)
Severance and employee benefit costs
$
11.2
Relocation costs
1.4
Lease and contract termination costs
(1.9
)
Other exit costs
0.7
Total restructuring and other charges
$
11.4
Accounting for Regulated Entities
Except for the Kentucky properties acquired in 2002 and the Nebraska operations acquired in 1999,
Alltel’s ILEC operations follow the accounting for regulated enterprises prescribed by SFAS No. 71,
“Accounting for the Effects of Certain Types of Regulation”. Criteria that would give rise to the
discontinuance of SFAS No. 71 include (1) increasing competition restricting the regulated ILEC
subsidiaries’ ability to establish prices to recover specific costs and (2) significant changes in
the manner in which rates are set by regulators from cost-based regulation to another form of
regulation. On a quarterly basis, Alltel reviews the criteria to determine whether the continuing
application of SFAS No. 71 is appropriate. Many of the Company’s ILEC operations have begun to
experience competition in their local service areas. Sources of competition to Alltel’s local
exchange business include, but are not limited to, resellers of local exchange services,
interexchange carriers, satellite transmission services, wireless communications providers, cable
television companies, and competitive access service providers including those utilizing Unbundled
Network Elements-Platform (“UNE-P”), VoIP providers and providers using other emerging
technologies. Through June 30, 2005, this competition has not had a material adverse effect on the
results of operations of Alltel’s ILEC operations.
31
Although the Company believes that the application of SFAS No. 71 continues to be appropriate, it
is possible that changes in regulation, legislation or competition could result in the Company’s
ILEC operations no longer qualifying for the application of SFAS No. 71 in the near future. If
Alltel’s ILEC operations no longer qualified for the application of SFAS No. 71, the accounting
impact to the Company would be an extraordinary non-cash credit to operations. The non-cash credit
would consist primarily of the reversal of the regulatory liability for cost of removal included in
accumulated depreciation, which amounted to $177.9 million as of June 30, 2005. At this time,
Alltel does not expect to record any impairment charge related to the carrying value of its ILEC
plant. Under SFAS No. 71, Alltel currently depreciates its ILEC plant based upon asset lives
approved by regulatory agencies or as otherwise allowed by law. Upon discontinuance of SFAS No.
71, Alltel would be required to revise the lives of its property, plant and equipment to reflect
the estimated useful lives of the assets. The Company does not expect any revisions in asset lives
to have a material adverse effect on its ILEC operations.
Regulatory Matters-Wireline Operations
Alltel’s ILECs are regulated by both federal and state agencies. Certain of Alltel’s products and
services (interstate) and the related earnings are subject to federal regulation and others (local
and intrastate) are subject to state regulation. With the exception of the acquired Nebraska and
Kentucky operations, Alltel’s ILEC operations are subject to rate-of-return regulation federally by
the FCC. The acquired Nebraska and Kentucky operations are subject to price-cap regulation by the
FCC, that allows a greater degree of pricing flexibility than is afforded to Alltel’s
rate-of-return operations. Companies meeting certain criteria had the option to elect price-cap
regulation as part of an FCC order issued in May 2000 (the “CALLS plan”). The CALLS plan expired
on June 30, 2005, and to date, the FCC had not established a successor mechanism for regulating
price-cap companies. Nonetheless, the existing rules and regulations for price-cap companies
remain effective until the FCC modifies or otherwise replaces them with a successor mechanism.
Telecommunications Law Modernization
In 1996, Congress passed the 96 Act, which significantly changed the existing laws and regulations
governing the telecommunications industry. The primary goal of the 96 Act was to create
competition in the wireline market by requiring ILECs to sell portions of their networks to
competitors at reduced wholesale rates. The 96 Act also established rules for interconnecting
wireline and wireless service providers’ networks. Unfortunately, the 96 Act failed to contemplate
the rapid evolution of technology and the associated consumer demand for wireless services, the
Internet and VoIP. Today, providers of communications services are regulated differently depending
primarily upon the network technology used to deliver service. This “patchwork” regulatory
approach unfairly advantages certain companies and disadvantages others, which impedes market-based
competition where service providers, regardless of technology, exchange telecommunications traffic
between their networks and are competing for the same customers.
In an effort to reform the “patchwork” regulatory approach, two separate telecommunications bills
were recently introduced in the U.S. Senate. The first bill, entitled the “Broadband Investment
and Consumer Choice Act”, was introduced on July 27, 2005. This bill reduces the level of
government regulation within the telecommunications industry in favor of market-based competition
and provides for parity in the remaining rules for functionally equivalent services, like broadband
access to the Internet via DSL, cable modem and other means. Another bill, entitled “the Universal
Service for the 21st Century Act”, was introduced on July 29, 2005. This bill changes the way
telecommunications companies contribute to the universal service fund, establishes limited support
for broadband investment in unserved areas and calls for the FCC to establish inter-carrier
compensation reform within six months of enactment. There will likely be additional bills
submitted for consideration in the future as Congress evaluates changing the regulatory environment
in the telecommunications industry. Alltel strongly supports telecommunications modernization but,
at this time, cannot predict the outcome of these efforts.
State Regulation
Most states in which Alltel’s ILEC subsidiaries operate have alternatives to rate-of-return
regulation for local and intrastate services, either through legislative or state public service
commission (“PSC”) rules. The Company utilizes alternative regulation for certain of its ILEC
subsidiaries in Alabama, Arkansas, Florida, Georgia, Kentucky, Nebraska, North Carolina, Ohio,
Pennsylvania, South Carolina, and Texas. The staff of the Kentucky PSC challenged the small
company alternative regulation plan under which a subsidiary of the Company presently operates;
however, on April 28, 2005, the Kentucky PSC ruled that the subsidiary would remain regulated under
the small company alternative regulation plan. The Missouri PSC has ruled that the Company is not
eligible for alternative regulation. However on May 5, 2005, the Missouri legislature passed an
alternative regulation plan that would allow the Company to elect alternative regulation without
Missouri PSC approval. The legislation will become law on August 28, 2005, whereupon the Company
will likely withdraw its appeal of the Missouri PSC’s previous decision. The Company continues to
evaluate alternative regulation options in markets where its ILEC subsidiaries remain subject to
rate-of-return regulation.
32
Inter-carrier Compensation
In April 2001, the FCC released a notice of proposed rulemaking addressing inter-carrier
compensation. Under this rulemaking, the FCC proposed a “bill and keep” compensation method that
would overhaul the existing rules governing inter-carrier compensation. On October 8, 2004, the
FCC granted in part and denied in part a petition filed by Core Communications requesting that the
FCC forbear from enforcing provisions of the FCC’s 2001 Internet Service Provider (“ISP”) Remand
Order. The FCC granted forbearance from the ISP Remand Order’s growth caps and new market rule
finding they were no longer in the public interest. The FCC denied forbearance from the ISP Remand
Order’s rate cap and mirroring rules. Various parties have filed for reconsideration with the FCC
and have appealed the decision to the U.S. Court of Appeals for the District of Columbia Circuit.
If the FCC’s decision in this Order is upheld, the Company is likely to incur additional costs for
delivering ISP-bound traffic to competitive wireline service providers. Although Alltel has not
fully quantified the effects of this Order, the Company believes that the additional expense would
not likely exceed $10.0 million annually.
On March 3, 2005, the FCC released a further notice of proposed rulemaking addressing inter-carrier
compensation. Under this proposed rulemaking, the FCC requested comment on several alternative
inter-carrier compensation proposals. Although the further notice draws no tentative conclusion,
both the original rulemaking and views of the FCC staff favor a “bill and keep” compensation
methodology under which each telecommunications carrier would be required to recover all of its
costs to originate and terminate telecommunications traffic from its end-user customers rather than
charging other carriers. The outcome of this proceeding is likely to change the way Alltel
receives compensation from, and remits compensation to, other carriers and its end user customers.
Until this proceeding concludes and the changes to the existing rules are established, if any,
Alltel cannot estimate the impact of the changes on its ILEC revenues and expenses or when the
changes would occur.
On July 6, 2005, a recommended order was issued by a hearing examiner for the Georgia PSC that, if
adopted, would prospectively preclude LECs from assessing access charges for certain intrastate
calls that were previously allowed. The Company, along with other LECs in Georgia, will request
that the Georgia PSC reject the recommended order and find that access charges continue to apply to
these calls. If the recommended order were ultimately adopted by the Georgia PSC as proposed, the
Company would incur a reduction in revenues of approximately $12.0 million. A final order will not
likely become effective before the fourth quarter of 2005.
Universal Service
The federal universal service program is under legislative, regulatory and industry scrutiny as a
result of growth in the fund and structural changes within the telecommunications industry. The
structural changes include the increase in the number of ETCs receiving money from the USF and a
migration of customers from wireline service providers to providers using alternative technologies
like VoIP that, today, are not required to contribute to the universal service program. There are
several FCC proceedings underway that are likely to change the way universal service programs are
funded and the way these funds are disbursed to program recipients. The specific proceedings are
discussed in greater detail below.
In May 2001, the FCC adopted the Rural Task Force Order that established an interim universal
service mechanism governing compensation for rural telephone companies for the ensuing five years.
The interim mechanism has allowed rural carriers to continue receiving high-cost funding based on
their embedded costs. On June 2, 2004, the FCC asked the Federal/State Joint Board on Universal
Service (the “Joint Board”) to review the FCC’s rules as they pertain to rural telephone companies
and to determine what changes, if any, should be made to the existing high-cost support mechanism
when the interim funding program expires in June 2006. The Joint Board sought comment on such a
mechanism on August 16, 2004, but has taken no further action. In the event a new mechanism is not
established for rural carriers prior to the expiration of the plan, the FCC will likely extend the
interim mechanism currently in place. In addition, the Joint Board sought comment on whether
companies operating multiple distinct geographic market areas within a state should consolidate
them for purposes of calculating universal service support. If the FCC implements this proposal,
Alltel’s universal service revenues would be reduced from their current level by approximately
$15.0 million annually. The Company cannot estimate the impact of the potential change from
embedded cost to another methodology until a specific alternative methodology is determined.
On March 17, 2005, the FCC issued an Order strengthening the standards required for
telecommunications carriers to receive and maintain ETC designation. The new standards are
mandatory when the FCC is responsible for evaluating ETC applications. When state regulatory
agencies are responsible for evaluating ETC applications, the FCC encouraged them to follow the new
standards. Effective October 1, 2006, the new standards require ETCs to: (1) provide five-year
plans demonstrating how support will be used to improve coverage, service quality or capacity,
including annual progress reports; (2) demonstrate the network’s ability to remain functional in
emergencies; (3) demonstrate how they will satisfy consumer and quality standards; (4) offer
“local-usage” plans comparable to the ILEC; and (5) acknowledge that they may be required
to provide equal access to inter-exchange carriers in the event they become the sole ETC within a
designated service area. The new standards will not have any financial impact on Alltel’s wireline
universal service funding.
On June 14, 2005, the FCC issued a NPRM initiating a broad inquiry into the management and
administration of the universal service programs. The NPRM seeks comment on ways to streamline the
application process for federal support and whether and how to increase audits of fund contributors
and fund recipients in an effort to deter waste and fraud. The FCC is also considering proposals
regarding the contribution methodology, which could change the category of service providers
required to contribute to the fund and the basis on which they contribute. At this time, Alltel
cannot estimate the impact that the potential changes, if any, would have on its operations.
As previously discussed under “Regulatory Matters—Wireless Operations”, the FCC mandated that,
effective October 1, 2004, USAC begin accounting for the USF program in accordance with generally
accepted accounting principles for federal agencies, rather than the accounting rules that USAC
formerly used. This change in accounting method subjected USAC to the ADA, the effect of which
could have caused delays in payments to USF program recipients and significantly increased the
amount of USF regulatory fees charged to wireline and wireless consumers. In December 2004,
Congress passed legislation to exempt USAC from the ADA for one year to allow for a more thorough
review of the impact the ADA would have on the universal service program. In April 2005, the FCC
tentatively concluded that the high-cost and low-income programs of the universal service fund
comply with ADA requirements, and has asked the OMB to make a final determination on this issue.
Additionally, Congress is contemplating a permanent solution to alleviate the ADA issues and the
related negative impact to the universal service program.
Emerging Competitive Technologies - VoIP
Voice telecommunications services utilizing IP as the underlying transmission technology, (“VoIP”),
are challenging existing regulatory definitions and raising questions concerning how IP-enabled
services should be regulated, if at all. Several state commissions have attempted to assert
jurisdiction over VoIP services, but federal courts in New York and Minnesota have ruled that the
FCC preempts the states with respect to jurisdiction. On March 10, 2004, the FCC released a notice
of proposed rulemaking seeking comment on the appropriate regulatory treatment of IP-enabled
communications services. The FCC indicated that the cost of the public switched telephone network
should be borne equitably by the users and requested comment on the specific regulatory
requirements that should be extended to IP-enabled service providers, including requirements
relating to E-911, accessibility for the disabled, inter-carrier compensation and universal
service. Although the FCC’s rulemaking regarding IP-enabled services remains pending, the FCC has
adopted a series of related orders establishing broad parameters for the regulation of those
services. Specifically, on February 12, 2004, the FCC released an order declaring Pulver.com’s
“free” IP-based, peer-to-peer service that requires specialized telephone equipment or software for
computers was not a telecommunications service, but rather was an unregulated information service
subject to federal jurisdiction. On April 21, 2004, the FCC denied a waiver petition filed by AT&T
requesting that its IP telephony service be exempt from paying access compensation to wireline
local service providers. The FCC ruled that AT&T’s IP telephony service, which converted voice
calls to an IP format for some portion of the routing over the public switched telephone network
prior to converting the calls back to their original format, was a regulated telecommunications
service subject to payment of interstate access compensation to LECs. On November 12, 2004, the
FCC ruled that Internet-based service provided by Vonage Holdings Corporation (“Vonage”) should be
subject to federal rather than state jurisdiction. The FCC has not yet determined how Vonage’s
service should be classified for regulatory purposes, but is likely to address the “information
service” vs. “telecommunications service” debate in its pending rulemaking regarding IP-enabled
services. Several state commissions have appealed the FCC’s Vonage decision, and these appeals are
presently pending before various federal appellate courts. In 2004, the FCC initiated a rulemaking
regarding the regulatory framework for implementing CALEA and tentatively concluded that CALEA
should also apply to VoIP services.
On June 3, 2005, the FCC took swift action in response to several incidents where VoIP customers
were unable to complete calls to their emergency dispatch center. The FCC ordered all VoIP service
providers whose service is interconnected with the public switched telephone network to provide
E-911 services to their customers no later than November 28, 2005. Specifically, the FCC Order
requires VoIP service providers to ensure that E-911 calls initiated by their customers are routed
to the appropriate public service answering point and must notify their customers of the specific
E-911 capabilities and limitations inherent with the VoIP service purchased.
If the FCC ultimately determines that IP-enabled services are not subject to regulatory
requirements currently applicable to inter-exchange and local exchange service providers, including
contributions to federal and state universal service programs, inter-carrier compensation
obligations, federal and state tax obligations and service quality metrics, the Company’s regulated
local exchange operations will be competitively disadvantaged. However, until the FCC issues its
decision in these proceedings, the Company cannot determine the extent of the impact on its
operations, if any.
34
Broadband
In the first quarter of 2002, the FCC issued a declaratory ruling concluding that broadband
Internet access service delivered via cable modems was an interstate “information service” and not
a cable service or a “telecommunications service”. The FCC sought comment on whether there were
legal or policy reasons why it should reach different conclusions with respect to wireline
broadband Internet access service and cable modem service. On October 6, 2003, the U.S. Court of
Appeals for the Ninth Circuit (the “Ninth Circuit Court”) rejected the FCC’s classification of
cable modem service as solely an unregulated “information service”, finding a portion of the
service to be a “telecommunications service”. The FCC appealed the Ninth Circuit Court decision to
the Supreme Court. On June 27, 2005, the Supreme Court reversed the Ninth Circuit Court and found
the FCC’s classification of broadband cable modem service as an “information service” was lawful.
As a result of the Supreme Court decision, broadband cable modem service will remain largely
deregulated. On August 5, 2005, the FCC ruled that wireline broadband Internet access service
(DSL) was an “information service” functionally integrated with a telecommunications component and
no longer subject to the higher level of regulation existing for “telecommunications services.”
This order, coupled with the Ninth Circuit Court decision classifying cable modem service as an
“information service” puts the Company’s DSL service in regulatory parity with cable modem service.
The order requires wireline broadband service providers to continue offering broadband access on a
stand-alone basis to competing unaffiliated Internet Service Providers for one year, after which
the Company will no longer be required to do so. Additionally, the order preserves the current
method of assessing universal service contributions on DSL revenues for a 270-day period after the
effective date of the order, or until the FCC adopts a new contribution methodology to the
universal service fund. The Company will benefit from the decreased regulatory oversight of its
DSL service through retail pricing flexibility as its DSL products are experiencing significant
growth throughout its service areas and its primary competitor is the less regulated cable modem
service.
Because certain of the regulatory matters discussed above are under FCC or judicial review,
resolution of these matters continues to be uncertain, and Alltel cannot predict at this time the
specific effects, if any, that the 96 Act, regulatory decisions and rulemakings, and future
competition will ultimately have on its ILEC operations.
Communications Support Services
Three Months Ended
Six Months Ended
June 30,
June 30,
(Millions, except customers in thousands)
2005
2004
2005
2004
Revenues and sales:
Product distribution
$
136.1
$
95.9
$
256.7
$
195.0
Long-distance and network management services
74.3
72.9
146.9
151.9
Directory publishing
47.3
48.7
73.6
74.9
Telecommunications information services
3.5
11.7
8.7
26.4
Total revenues and sales
261.2
229.2
485.9
448.2
Costs and expenses:
Cost of services
62.8
58.6
119.1
124.6
Cost of products sold
161.3
127.9
294.4
242.7
Selling, general, administrative and other
17.0
13.1
31.9
26.3
Depreciation and amortization
8.5
8.8
17.0
17.3
Total costs and expenses
249.6
208.4
462.4
410.9
Segment income
$
11.6
$
20.8
$
23.5
$
37.3
Long-distance customers
1,779.8
1,717.6
-
-
Communications support services revenues and sales increased $32.0 million, or 14 percent, and
$37.7 million, or 8 percent, for the three and six month periods ended June 30, 2005, respectively,
compared to the same periods of 2004. As noted in the table above, the increase in revenues and
sales in both 2005 periods reflected growth in sales of telecommunications equipment and data
products, partially offset by declines in revenues earned from telecommunications information
services. Sales of telecommunications and data products increased $40.2 million and $61.7 million
in the three and six months ended June 30, 2005, respectively, compared to the same periods in
2004. Sales to non-affiliates increased $31.1 million and $55.5 million in the three and six month
periods of 2005, respectively, primarily reflecting increased sales to retailers
and other distributors of higher priced wireless
handsets that include advanced features and that are capable of various data applications. In addition, compared to the same periods of 2004, sales to
affiliates increased $9.1 million and $6.2 million in the three and six months ended June 30, 2005,
respectively, primarily due to an increase in capital expenditures by the Company’s wireline
operations.
Revenues derived from directory publishing declined $1.4 million and $1.3 million in the three and
six month periods ended June 30, 2005, as compared to the same periods in 2004, primarily due to a
change in the number and mix of
35
directories published during the second quarter of 2005. Telecommunications information services
revenues decreased $8.2 million and $17.7 million in the three and six months ended June 30, 2005,
respectively, due to the loss of one of Alltel’s remaining unaffiliated wireline services customers
during the fourth quarter of 2004. Revenues attributable to long-distance and network management
services increased $1.4 million and decreased $5.0 million in the three and six month periods ended
June 30, 2005, respectively, as compared to the same periods in 2004. In the three and six month
periods ended June 30, 2005, revenues earned from affiliates for network management services
decreased $0.9 million and $5.8 million, respectively, primarily due to reductions in intercompany
billing rates, which took effect January 1, 2005 and April 1, 2004, respectively. Conversely,
revenues derived from external customers increased $2.3 million and $0.8 million in the three and
six month periods of 2005, respectively, primarily due to an increase in customer billing rates
initiated during the second quarter of 2005 on one of Alltel’s most popular billing plans.
This increase in rates was partially offset by the effects of customers migrating to packaged rate
plans. In response to competitive pressures, Alltel has introduced in its long-distance markets
packaged rate plans that provide customers with unlimited calling for one flat monthly rate.
Although revenues and sales increased in the three and six months ended June 30, 2005 as compared
to 2004, communications support services segment income decreased in both periods primarily due to
lower profit margins realized by the long-distance and network management and telecommunications
services operations. Profit margins for the long-distance and network management operations
decreased in both 2005 periods primarily due to the effects of the reduction in intercompany
billing rates and migration of external customers to packaged rate plans discussed above. Profit
margins for the telecommunications information services operations were adversely affected by the
loss of a customer during 2004, as the associated revenue decline outpaced the corresponding
reduction in operating expenses due to the continuance of overhead and other fixed operating costs.
Set forth below is a summary of the restructuring and other charges related to the communications
support services operations that were not included in the determination of segment income for the
six months ended June 30, 2004:
(Millions)
Severance and employee benefit costs
$
0.5
Relocation costs
0.1
Total restructuring and other charges
$
0.6
FINANCIAL
CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Six Months Ended
June 30,
(Millions, except per share amounts)
2005
2004
Cash flows from (used in):
Operating activities
$
1,243.6
$
1,248.1
Investing activities
(449.5
)
(465.1
)
Financing activities
748.7
(753.3
)
Effect of exchange rate changes
-
(0.1
)
Increase in cash and short-term investments
$
1,542.8
$
29.6
Total capital structure (a)
$
14,032.6
$
12,608.4
Percent of equity to total capital (b)
63.1
%
55.8
%
Book value per share (c)
$27.05
$22.81
Notes:
(a)
Computed as the sum of long-term debt including current maturities, redeemable preferred
stock and total shareholders’ equity.
(b)
Computed by dividing total shareholders’ equity by total capital structure as computed in
(a) above.
(c)
Computed by dividing total shareholders’ equity less preferred stock by the total number of
common shares outstanding at the end of the period.
Cash Flows-Operating Activities
Cash provided from operations continued to be Alltel’s primary source of liquidity. Cash provided
from operations for the six months ended June 30, 2005 reflected growth in earnings from Alltel’s
wireless operations and receipt of the $111.0 million special dividend on the Company’s investment
in Fidelity National common stock previously discussed. Cash flows from operations in 2005 also
reflected changes in working capital requirements, including timing differences in the billing and
collection of accounts receivable, purchase of inventory and payment of accounts payable and income
taxes. During the first half of 2005, Alltel generated sufficient cash flows from operations to
fund its capital expenditure requirements, dividend payments and scheduled long-term payments as
further discussed below. The Company expects to generate sufficient cash flows from operations to
fund its operating requirements during the balance of 2005.
36
Cash Flows-Investing Activities
Capital expenditures continued to be Alltel’s primary use of capital resources. Capital
expenditures for the six months ended June 30, 2005 were $611.1 million compared to $480.5 million
for the same period in 2004. Capital expenditures in both years were incurred to construct
additional network facilities, to deploy 1XRTT data technology in the Company’s wireless markets
and to expand Alltel’s network coverage of its Internet, broadband, and “Touch2Talk” communications
service offerings. Capital expenditures for the six months ended June 30, 2005 also included
incremental spending by Alltel to deploy CDMA technology in the properties acquired from Cingular
as previously discussed. In addition, capital expenditures in 2005 also included the Company’s
investment in wireless EV-DO technology. Through June 30, 2005, Alltel had launched EV-DO service
in five markets and expects to deploy EV-DO technology in five to seven additional markets during
the second half of 2005. The Company funded substantially all of its capital expenditures through
internally generated funds. Investing activities also included outlays for capitalized software
development costs. Additions to capitalized software for the six months ended June 30, 2005 were
$26.9 million compared to $14.8 million for the same period in 2004. Including the investments
needed to deploy CDMA technology in the acquired Cingular markets and the ongoing capital
expenditure requirements within the Western Wireless markets, Alltel expects capital expenditures,
including capitalized software development costs, to be approximately $1.4 to $1.5 billion for
2005. The Company expects to fund substantially all of its capital expenditures primarily from
internally generated funds.
Cash outlays for the purchase of property in the six months ended June 30, 2005 were $223.7
million, of which $165.0 million related to the exchange of wireless properties with Cingular and
$48.3 million related to the purchase of wireless properties in Alabama and Georgia from PS
Cellular, as previously discussed. During the first six months of 2005, Alltel also purchased for
$10.4 million in cash additional ownership interests in wireless properties in Michigan, Ohio and
Wisconsin in which the Company owned a majority interest. Conversely, there were no cash outlays
for the purchase of property during the six months ended June 30, 2004.
Investing activities for the six months ended June 30, 2005 included proceeds from the sale of
investments of $353.4 million, principally consisting of $350.8 million received from the sale of
Alltel’s investment in Fidelity National common stock previously discussed. Investing activities
for the six months ended June 30, 2005 and 2004 also included proceeds from the return on
investments of $20.4 million and $36.9 million, respectively. These amounts primarily consisted of
cash distributions received from Alltel’s wireless minority investments. The significant decrease
in distributions received during the first six months of 2005 compared to the same period a year
ago primarily reflected the exchange of certain minority investments with Cingular, as previously
discussed. Cash flows from investing activities for the six months ended June 30, 2005 also
included proceeds of $36.2 million received in connection with the disposal of an office building,
which had previously been written down to fair value during the first quarter of 2004 (see
“Consolidated Results of Operations — Restructuring and Other Charges”).
Cash Flows-Financing Activities
Dividend payments remain a significant use of capital resources for Alltel. Common and preferred
dividend payments were $220.7 million for the six months ended June 30, 2005 compared to $231.3
million for the same period in 2004. The decrease in dividend payments in 2005 primarily reflected
Alltel’s prefunding of $9.2 million of the first quarter 2005 dividend payments on December 30,
2004. The remaining portion of the first quarter 2005 dividend payments of $105.7 million was
funded by Alltel on January 3, 2005. In October 2004, the Company’s Board of Directors approved an
increase in the quarterly common stock dividend rate from $.37 to $.38 per share, raising the
annual dividend rate to $1.52 per share. The Company expects to continue the payment of cash
dividends during the balance of 2005.
The Company has a five-year, $1.5 billion unsecured line of credit under a revolving credit
agreement with an expiration date of July 28, 2009. The Company incurred no borrowings under the
revolving credit agreement during either the six months ended June 30, 2005 or 2004. The Company
also has established a commercial paper program with a maximum borrowing capacity of $1.5 billion.
Alltel classifies commercial paper borrowings as long-term debt, because they are intended to be
maintained on a long-term basis and are supported by the Company’s revolving credit agreement.
Under the commercial paper program, commercial paper borrowings are fully supported by the
available borrowings under the revolving credit agreement. Accordingly, the total amount
outstanding under the commercial paper program and the indebtedness incurred under the revolving
credit agreement may not exceed $1.5 billion. During the first six months of 2005, the maximum
amount of borrowings outstanding under the commercial paper program was $100.0 million, of which
$50.0 million remained outstanding at June 30, 2005. Conversely, Alltel incurred no borrowings
under the commercial paper program during the first six months of 2004, and there were no
commercial paper borrowings outstanding at either December 31, 2004 or 2003. Commercial paper
borrowings were incurred during the first half of 2005 to fund general corporate requirements. The
net increase in commercial paper borrowings from December 31, 2004 of $50.0 million represented all
of the long-term debt issued during the six months ended June 30, 2005.
37
On August 1, 2005, Alltel entered into an additional $700.0 million, 364-day revolving credit
agreement that expires on July 31, 2006, if not extended at the option of the Company, and allows
Alltel to convert any outstanding borrowings under this agreement into term loans maturing in 2007.
As previously discussed, a wholly-owned subsidiary of Alltel had assumed all outstanding debt of
Western Wireless upon closing of the Merger. On August 1, 2005, Alltel also announced a tender
offer to purchase all of the issued and outstanding Western Wireless 9.25 percent senior notes due
July 15, 2013, representing an aggregate principal amount of $600.0 million, as well as a related
solicitation to amend the indenture governing the senior notes. Alltel expects to fund the
repurchase of the $600.0 million senior notes through either commercial paper or borrowings under
the 364-day revolving credit agreement.
Retirements of long-term debt were $452.9 million and $252.9 million for the six months ended June
30, 2005 and 2004, respectively. Retirements of long-term debt in 2005 primarily consisted of the
early redemption of $450.0 million of 7.50 percent senior notes due March 1, 2006, as previously
discussed. Conversely, retirements of long-term debt in 2004 primarily consisted of the repayment of a $250.0
million unsecured note due April 1, 2004.
Proceeds from the issuance of Alltel’s common stock were $1,399.3 million for the six months ended
June 30, 2005, principally consisting of proceeds from the settlement of the purchase contracts
related to the Company’s equity units on May 17, 2005. As previously discussed, upon settlement of
the contracts, the Company received proceeds of approximately $1,385.0 million and delivered
approximately 24.5 million shares of Alltel common stock. (See Note 4 to the unaudited interim
consolidated financial statements for additional information regarding the settlement of the
purchase contracts.)
On January 22, 2004, Alltel’s Board of Directors adopted a stock repurchase plan authorizing the
Company to repurchase up to $750.0 million of its outstanding common stock over a two-year period
ending December 31, 2005. Under the repurchase plan, Alltel may repurchase shares, from time to
time, on the open market or in negotiated transactions, as circumstances warrant, depending upon
market conditions and other factors. Sources of funding the stock buyback program include
available cash on hand, operating cash flows and borrowings under Alltel’s commercial paper
program. During 2004, Alltel repurchased 11.2 million of its common shares at a total cost of
$595.3 million under this plan, of which 4.8 million shares were repurchased during the six months
ended June 30, 2004 at a cost of $243.0 million. Alltel did not repurchase any of its common
shares during the six months ended June 30, 2005.
Cash flows from financing activities also included distributions to minority investors, which
amounted to $27.0 million and $32.7 million for the six months ended June 30, 2005 and 2004,
respectively.
Liquidity and Capital Resources
Alltel believes it has sufficient cash and short-term investments on hand ($2.0 billion at June 30,
2005) and has adequate operating cash flows to finance its ongoing operating requirements,
including capital expenditures, repayment of long-term debt, payment of dividends and funding the
stock repurchase plan. As previously discussed, on August 1, 2005, Alltel completed the merger of
Western Wireless with and into a wholly-owned subsidiary. In conjunction with the merger
transaction with Western Wireless, Alltel paid $933.4 million in cash to the holders of Western
Wireless common stock and repaid approximately $1.3 billion of term loans outstanding under the
Western Wireless credit facility that became due immediately upon the closing of the merger. These
payments were funded by cash on hand and borrowings under the Company’s commercial paper program.
Additional sources of funding available to Alltel include (1) additional borrowings available to
the Company under its commercial paper program and revolving credit agreements, (2) additional debt
or equity securities under the Company’s March 28, 2002, $5.0 billion shelf registration statement,
of which approximately $730 million remained available for issuance at June 30, 2005 and (3)
additional debt securities issued in the private placement market.
Alltel’s commercial paper and long-term credit ratings with Moody’s Investors Service (“Moody’s”),
Standard & Poor’s Corporation (“Standard & Poor’s”) and Fitch Ratings (“Fitch”) were unchanged from
December 31, 2004 and were as follows:
Standard
Description
Moody's
& Poor's
Fitch
Commercial paper credit rating
Prime-1
A-1
F1
Long-term debt credit rating
A2
A
A
Outlook
Stable
Negative
Stable
38
Factors that could affect Alltel’s short and long-term credit ratings would include, but not be
limited to, a material decline in the Company’s operating results and increased debt levels
relative to operating cash flows resulting from future acquisitions or increased capital
expenditure requirements. If Alltel’s credit ratings were to be downgraded from current levels,
the Company would incur higher interest costs on new borrowings, and the Company’s access to the
public capital markets could be adversely affected. A downgrade in Alltel’s current short or
long-term credit ratings would not accelerate scheduled principal payments of Alltel’s existing
long-term debt.
The revolving credit agreements contain various covenants and restrictions including a requirement
that, as of the end of each calendar quarter, Alltel maintain a total debt-to-capitalization ratio
of less than 65 percent. For purposes of calculating this ratio under the revolving credit
agreements, total debt would include amounts classified as long-term debt (excluding mark-to-market
adjustments for interest rate swaps), current maturities of long-term debt outstanding, short-term
debt and any letters of credit or other guarantee obligations. As of June 30, 2005, the Company’s
total debt to capitalization ratio was 36.8 percent. In addition, the indentures and borrowing
agreements, as amended, provide, among other things, for various restrictions on the payment of
dividends by the Company. Retained earnings unrestricted as to the payment of dividends by the
Company amounted to $6,617.8 million at June 30, 2005. There are no restrictions on the payment of
dividends among members of Alltel’s consolidated group.
Under the Company’s long-term debt borrowing agreements, acceleration of principal payments would
occur upon payment default, violation of debt covenants not cured within 30 days or breach of
certain other conditions set forth in the borrowing agreements. At June 30, 2005, the Company was
in compliance with all of its debt covenants. There are no provisions within the Company’s leasing
agreements that would trigger acceleration of future lease payments.
At June 30, 2005, current maturities of long-term debt were $222.8 million and included a $200.0
million, 6.75 percent senior unsecured note due September 15, 2005. The Company expects to fund
the payment of the $200.0 million note at maturity through either available cash on hand, operating
cash flows, commercial paper or borrowings under the 364-day revolving credit agreement.
Alltel does not use securitization of trade receivables, affiliation with special purpose entities,
variable interest entities or synthetic leases to finance its operations. Additionally, the
Company has not entered into any material arrangement requiring Alltel to guarantee payment of
third party debt or to fund losses of an unconsolidated special purpose entity.
Critical Accounting Policies
Alltel prepares its consolidated financial statements in accordance with accounting principles
generally accepted in the United States. In Alltel’s Amendment No. 1 to Annual Report on Form
10-K/A for the year ended December 31, 2004, the Company identified the critical accounting
policies which affect its more significant estimates and assumptions used in preparing its
consolidated financial statements. These critical accounting policies include accounting for
service revenues, evaluating the collectibility of trade receivables, accounting for pension and
other postretirement benefits, calculating depreciation and amortization expense, determining the
fair values of goodwill and other indefinite-lived intangible assets and accounting for current and
deferred income taxes. There have been no material changes to Alltel’s critical accounting
policies during the six month period ended June 30, 2005.
Legal Proceedings
Alltel is party to various legal proceedings arising in the ordinary course of business. Although
the ultimate resolution of these various proceedings cannot be determined at this time, management
of the Company does not believe that such proceedings, individually or in the aggregate, will have
a material adverse effect on the future results of operations or financial condition of Alltel. In
addition, management of the Company is currently not aware of any environmental matters that,
individually or in the aggregate, would have a material adverse effect on the consolidated
financial condition or results of operations of the Company.
Other Matters
As the Company previously disclosed in a press release and Current Report on Form 8-K dated May 3,
2005, the Company has advised the staff of the Securities and Exchange Commission (“SEC”) and the
DOJ of an independent investigation being conducted by the audit and governance committees of the
Company’s board of directors regarding alleged improper payments by the international division of
the Company’s former information services subsidiary. The allegations of improper payments are
contained in a lawsuit filed by a Chinese company, Grace & Digital Information Technology Co.,
Ltd., against the former subsidiary and several other parties. Alltel is not a party to the
lawsuit.
The audit and governance committees retained independent legal counsel to conduct their
investigation and to facilitate their cooperation with any related government inquiries. The SEC
staff has informed the committees’ counsel that it has opened an informal inquiry relating to the
alleged improper payments. The DOJ has also advised the Company that it intends to interview a
former employee of the Company in connection with this matter. The committees’ internal
investigation is continuing.
Recently Issued Accounting Pronouncements
On December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”, which is a revision
of SFAS No. 123 and supercedes Accounting Principles Board Opinion No. 25, “Accounting for Stock
Issued to Employees” and related Interpretations. SFAS No. 123(R) requires all share-based
payments to employees, including grants of employee stock options, to be valued at fair value on
the date of grant, and to be expensed over the applicable vesting period. Pro forma disclosure of
the income statement effects of share-based payments is no longer an alternative. SFAS No. 123(R)
is effective for all stock-based awards granted on or after July 1, 2005. In addition, companies
must also recognize compensation expense related to any awards that are not fully vested as of the
effective date. Compensation expense for the unvested awards will be measured based on the fair
value of the awards previously calculated in developing the pro forma disclosures in accordance
with the provisions of SFAS No. 123. On March 25, 2005, the SEC staff issued Staff Accounting
Bulletin (“SAB”) 107, which summarizes the staff’s views regarding the interaction between SFAS No.
123(R) and certain SEC rules and regulations and provides additional guidance regarding the
valuation of share-based payment arrangements for public companies. On April 15, 2005, the SEC
amended Rule 4-01(a) of Regulation S-X regarding the date public companies are required to comply
with the provisions of SFAS No. 123(R), such that calendar year companies will now be required to
comply with the standard beginning January 1, 2006. Alltel is currently assessing the impact of
adopting SFAS No. 123(R), as interpreted by SAB 107, to its consolidated results of operations.
On March 31, 2005, the FASB issued Interpretation No. (“FIN”) 47, “Accounting for Conditional Asset
Retirement Obligations”, which is an interpretation of SFAS No. 143, “Accounting for Asset
Retirement Obligations”. FIN 47 clarifies that the recognition and measurement provisions of SFAS
No. 143 apply to asset retirement obligations in which the timing and/or method of settlement may
be conditional on a future event, including obligations to remediate asbestos at the end of a
building’s useful life and obligations to dispose of chemically-treated telephone poles at the end
of their useful lives. FIN 47 is effective for fiscal years ending after December 15, 2005.
Alltel is currently assessing the impact of adopting FIN 47 to its consolidated results of
operations.
ALLTEL
CORPORATION
FORM 10-Q
PART I — FINANCIAL INFORMATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s market risks at June 30, 2005 are similar to the market risks discussed in Alltel’s
Amendment No. 1 to Annual Report on Form 10-K/A for the year ended December 31, 2004. Following
the April 6, 2005 sale of its investment in Fidelity National common stock, Alltel does not hold
any material investments in marketable equity securities. Accordingly, Alltel no longer has
significant market risk exposure resulting from changes in marketable equity security prices.
Alltel continues to be exposed to market risk from changes in interest rates and foreign exchange
rates. The Company has estimated its market risk using sensitivity analysis. Market risk is
defined as the potential change in earnings resulting from a hypothetical adverse change in market
prices or interest rates. The results of the sensitivity analysis used to estimate market risk are
presented below, although the actual results may differ from these estimates.
Interest Rate Risk
The Company’s earnings are affected by changes in variable interest rates related to Alltel’s
issuance of short-term commercial paper and interest rate swap agreements. The Company enters into
interest rate swap agreements to obtain a targeted mixture of variable and fixed-interest-rate debt
such that the portion of debt subject to variable rates does not exceed 30 percent of Alltel’s
total debt outstanding. The Company has established policies and procedures for risk assessment
and the approval, reporting, and monitoring of interest rate swap activity. Alltel does not enter
into interest rate swap agreements, or other derivative financial instruments, for trading or
speculative purposes. Management periodically reviews Alltel’s exposure to interest rate
fluctuations and implements strategies to manage the exposure.
As of June 30, 2005, Alltel has entered into five, pay variable receive fixed, interest rate swap
agreements on notional amounts totaling $925.0 million to convert fixed interest rate payments to
variable. The maturities of the five interest rate swaps range from January 15, 2008 to November
1, 2013. The weighted average fixed rate received by Alltel on these swaps is 5.5 percent, and the
variable rate paid by Alltel is the three month LIBOR (London-Interbank Offered Rate). The
weighted average variable rate paid by Alltel was 3.2 percent at June 30, 2005. A hypothetical
increase of 100 basis points in variable interest rates would reduce annual pre-tax earnings by
approximately $9.8 million. Conversely, a hypothetical decrease of 100 basis points in variable
interest rates would increase annual pre-tax earnings by approximately $9.8 million.
Foreign Exchange Risk
Alltel’s business operations in foreign countries are not material to the Company’s consolidated
operations, financial condition and liquidity. Foreign currency translation gains and losses were
not material to the Company’s consolidated results of operations for the three and six months ended
June 30, 2005 and 2004. Additionally, Alltel is not currently subject to material foreign currency
exchange rate risk from the effects that exchange rate movements of foreign currency would have on
the Company’s future costs or on future cash flows it would receive from its foreign subsidiaries.
Alltel has not entered into any significant foreign currency forward exchange contracts or other
derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency
exchange rates.
ALLTEL CORPORATION
FORM 10-Q
PART I — FINANCIAL INFORMATION
Item 4. Controls and Procedures
(a)
Evaluation of disclosure controls and procedures.
The term “disclosure controls and procedures” (defined in SEC Rule 13a-15(e)) refers to the
controls and other procedures of a company that are designed to ensure that information
required to be disclosed by a company in the reports that it files under the Securities
Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported
within required time periods. Disclosure controls and procedures (as defined in SEC Rule
13a-15(e)) include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by a company in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the company’s management,
including the company’s principal executive and financial officers, as appropriate to allow
timely decisions regarding required disclosure. Alltel’s management, with the
participation of the Chief Executive Officer and Chief Financial Officer, have evaluated
the effectiveness of the Company’s disclosure controls and procedures as of the end of the
period covered by this quarterly report
(the “Evaluation Date”). Based on that evaluation, Alltel’s Chief Executive Officer and
Chief Financial Officer have concluded that, as of the Evaluation Date, such controls and
procedures were effective.
(b)
Changes in internal controls.
The term “internal control over financial reporting” (defined in SEC Rule 13a-15(f)) refers
to the process of a company that is designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Alltel’s management,
with the participation of the Chief Executive Officer and Chief Financial Officer, have
evaluated any changes in the Company’s internal control over financial reporting that
occurred during the period covered by this quarterly report, and they have concluded that
there was no change to Alltel’s internal control over financial reporting that has
materially affected, or is reasonably likely to materially affect, Alltel’s internal
control over financial reporting.
PART II — OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c)
On January 23, 2004, Alltel announced a $750.0 million stock repurchase plan that expires
on December 31, 2005. During 2004, the Company repurchased 11.2 million shares of its common
stock at a total cost of $595.3 million, or an average cost of $52.93 per share. No
repurchases were made under the stock repurchase plan during the first six months of 2005.
As of June 30, 2005, remaining amounts that may be purchased under this plan were $154.7
million.
Item 4. Submission of Matters to a Vote of Security Holders
The Company’s 2005 Annual Meeting of Stockholders was held on April 21, 2005. At the meeting, the
following items were submitted to a vote of stockholders:
(1)
The election of three directors, constituting the class of the Board of Directors who will
serve a three-year term expiring at the 2008 Annual Meeting of Stockholders:
Nominee
Votes For
Votes Withheld
John R. Belk
261,459,369
2,909,820
Gregory W. Penske
258,719,742
5,649,447
Warren A. Stephens
254,126,864
10,242,325
(2)
The appointment of PricewaterhouseCoopers LLP to audit Alltel’s consolidated financial
statements for the year ending December 31, 2005 was ratified with 261,501,796 votes for,
951,765 votes against and 1,899,653 abstentions.
Item 6. Exhibits
See the exhibits specified on the Index of Exhibits located at Page 44.
42
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
ALLTEL CORPORATION
(Registrant)
/s/ Jeffery R. Gardner
Jeffery R. Gardner
Executive Vice President — Chief Financial Officer
(Principal Financial Officer)
August 9, 2005
43
ALLTEL
CORPORATION
FORM 10-Q
INDEX OF EXHIBITS
Form 10-Q
Exhibit No.
Description of Exhibits
(10)(a)(1)
364-Day Revolving Credit Agreement dated as of August
1, 2005 between ALLTEL Corporation and Bank of
America, N.A., JPMorgan Chase Bank, N.A., Banc of
America Securities LLC and
J.P. Morgan Securities Inc., Citicorp USA, Inc.,
KeyBank National Association, Wachovia Bank, National
Association, and Barclays Bank PLC. (incorporated
herein by reference to Exhibit 10.1 to Current Report
on Form 8-K dated August 1, 2005).
*
31(a)
Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(a)
31(b)
Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(a)
32(a)
Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(a)
32(b)
Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(a)
* Incorporated herein by reference as indicated.
(a) Filed herewith.
44