UNITED STATESSECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C.   20549

 

FORM 10-Q

 

[x]  QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended  September 30, 2003

OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

  YES  X       NO      

 

 

 

Indicate by check markwhether the registrant is an accelerated filer (as defined by Rule 12b-2 of theAct).

  YES  X       NO      

 

 

 

Number of common sharesoutstanding as of September 30, 2003:  312,068,829

 

 

 

The Exhibit Index is locatedon page 44.

 

 

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**ALLTELCORPORATION**

**FORM10-Q**

**TABLEOF CONTENTS**

 
| **PART I - FINANCIAL  INFORMATION** |
|-------------------------------------|
|                                |   |
| Item 1.                             | Financial Statements |
| Item  2.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item 3.                             | Quantitative and Qualitative Disclosures About  Market Risk |
| Item 4.                             | Controls and Procedures |
|                                |   |
| **PART II - OTHER INFORMATION**     |
|                                |
| Item  1.                            | Legal  Proceedings |
| Item 2.                             | Changes in  Securities* |
| Item 3.                             | Defaults Upon  Senior Securities* |
| Item 4.                             | Submission of  Matters to Vote of Security Holders* |
| Item 5.                             | Other  Information* |
| Item 6.                             | Exhibits and Reports on Form 8-K |

 

*          No reportableinformation under this item.

 

Forward-Looking Statements

This Report on Form 10-Qincludes, and future filings by the Company on Form 10-K, Form 10-Q and Form8-K and future oral and written statements by ALLTEL and its management mayinclude, certain “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements are subject to uncertainties that could causeactual future events and results to differ materially from those expressed inthe forward-looking statements.  Theseforward-looking statements are based on estimates, projections, beliefs andassumptions and are not guarantees of future events and results.  Words such as “expects”, “anticipates”,“intends”, “plans”, “believes”, “seeks”, “estimates”, and “should”, andvariations of these words and similar expressions, are intended to identifythese forward-looking statements. ALLTEL disclaims any obligation to update or revise any forward-lookingstatement based on the occurrence of future events, the receipt of newinformation, or otherwise.

 

Actual future events andresults may differ materially from those expressed in these forward-lookingstatements as a result of a number of important factors.  Representative examples of these factorsinclude (without limitation) adverse changes in economic conditions in themarkets served by ALLTEL; the extent, timing, and overall effects ofcompetition in the communications business; material changes in thecommunications industry generally that could adversely affect vendorrelationships with equipment and network suppliers and customer relationshipswith wholesale customers; material changes in communications technology; therisks associated with the integration of acquired businesses; adverse changesin the terms and conditions of the Company’s wireless roaming agreements; thepotential for adverse changes in the ratings given to ALLTEL’s debt securitiesby nationally accredited ratings organizations; the availability and cost offinancing in the corporate debt markets; the uncertainties related to ALLTEL’sstrategic investments; the effects of work stoppages; the effects oflitigation; ongoing deregulation (and the resulting likelihood of significantlyincreased price and product/service competition) in the communications businessas a result of federal and state legislation, rules, and regulations; the finaloutcome of federal, state and local regulatory initiatives and proceedingsrelated to the terms and conditions of interconnection, access charges,universal service and unbundled network elements and resale rates; and theeffects of the Federal Communications Commission’s number portability rules.

 

In addition to thesefactors, actual future performance, outcomes and results may differ materiallybecause of other, more general, factors including (without limitation) generalindustry and market conditions and growth rates, economic conditions,governmental and public policy changes.

 

1

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**ALLTELCORPORATION**

**FORM10-Q**

**PART I - FINANCIAL INFORMATION**

** **

**Item1.  FinancialStatements**

** **

**CONSOLIDATED BALANCE SHEETS (UNAUDITED)**
| (Millions, except per  share amounts)                                                                                                          |   | September 30, |       | December 31, |       |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|-------------------|------------|
| **ASSETS**                                                                                                                                     |   | 2003               |       | 2002              |       |
| **CURRENT  ASSETS:**                                                                                                                           |   |               |       |              |       |
| Cash  and short-term investments                                                                                                               |   | $                  | 566.9      |              | $          | 134.6 |   |
| Accounts  receivable (less allowance for doubtful accounts of $47.9 and $68.4,  respectively)                                                  |   | 940.2              |       | 1,018.3           |       |
| Inventories                                                                                                                                    |   | 144.0              |       | 138.5             |       |
| Prepaid  expenses and other                                                                                                                    |   | 52.1               |       | 38.8              |       |
| Assets  held for sale                                                                                                                          |   | —             |       | 538.3             |       |
| Total  current assets                                                                                                                          |   | 1,703.2            |       | 1,868.5           |       |
| Investments                                                                                                                                    |   | 628.7              |       | 325.8             |       |
| Goodwill                                                                                                                                       |   | 4,854.2            |       | 4,769.7           |       |
| Other  intangibles                                                                                                                             |   | 1,352.1            |       | 1,348.1           |       |
| **PROPERTY,  PLANT AND EQUIPMENT:**                                                                                                            |   |               | ** ** |              | ** ** |
| Land                                                                                                                                           |   | 294.2              |       | 275.3             |       |
| Buildings  and improvements                                                                                                                    |   | 1,136.1            |       | 1,074.3           |       |
| Wireline                                                                                                                                       |   | 6,434.3            |       | 6,188.5           |       |
| Wireless                                                                                                                                       |   | 5,205.9            |       | 4,798.3           |       |
| Information  processing                                                                                                                        |   | 1,109.2            |       | 1,047.7           |       |
| Other                                                                                                                                          |   | 556.8              |       | 571.0             |       |
| Under  construction                                                                                                                            |   | 367.3              |       | 365.0             |       |
| Total  property, plant and equipment                                                                                                           |   | 15,103.8           |       | 14,320.1          |       |
| Less  accumulated depreciation                                                                                                                 |   | 7,522.1            |       | 6,756.4           |       |
| Net  property, plant and equipment                                                                                                             |   | 7,581.7            |       | 7,563.7           |       |
| Other  assets                                                                                                                                  |   | 331.8              |       | 368.8             |       |
| **TOTAL  ASSETS**                                                                                                                              |   | $                  | 16,451.7   |              | $          | 16,244.6 |   |
|                                                                                                                                           |   |               |       |              |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                 |   |               | ** ** |              | ** ** |
| **CURRENT  LIABILITIES:**                                                                                                                      |   |               | ** ** |              | ** ** |
| Current  maturities of long-term debt                                                                                                          |   | $                  | 274.4      |              | $          | 494.7 |   |
| Accounts  payable                                                                                                                              |   | 426.1              |       | 413.7             |       |
| Advance  payments and customer deposits                                                                                                        |   | 205.3              |       | 214.3             |       |
| Accrued  taxes                                                                                                                                 |   | 267.9              |       | 72.3              |       |
| Accrued  dividends                                                                                                                             |   | 109.7              |       | 109.6             |       |
| Accrued  interest                                                                                                                              |   | 85.5               |       | 123.8             |       |
| Other  current liabilities                                                                                                                     |   | 146.2              |       | 136.5             |       |
| Liabilities  related to assets held for sale                                                                                                   |   | —             |       | 190.5             |       |
| Total  current liabilities                                                                                                                     |   | 1,515.1            |       | 1,755.4           |       |
| Long-term  debt                                                                                                                                |   | 5,619.5            |       | 6,145.4           |       |
| Deferred  income taxes                                                                                                                         |   | 1,305.3            |       | 1,115.4           |       |
| Other  liabilities                                                                                                                             |   | 1,211.3            |       | 1,230.3           |       |
| **SHAREHOLDERS’  EQUITY:**                                                                                                                |   |               | ** ** |              | ** ** |
| Preferred  stock, Series C, $2.06, no par value, 14,728 and 15,635 shares issued and  outstanding, respectively                                |   | 0.4                |       | 0.4               |       |
| Common  stock, par value $1 per share, 1.0 billion shares authorized, 312,068,829 and  311,182,950 shares issued and outstanding, respectively |   | 312.1              |       | 311.2             |       |
| Additional  paid-in capital                                                                                                                    |   | 726.6              |       | 695.7             |       |
| Unrealized  holding gain on investments                                                                                                        |   | 19.2               |       | —            |       |
| Foreign  currency translation adjustment                                                                                                       |   | 0.6                |       | (6.9              | )          |
| Retained  earnings                                                                                                                             |   | 5,741.6            |       | 4,997.7           |       |
| Total  shareholders’ equity                                                                                                               |   | 6,800.5            |       | 5,998.1           |       |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                           |   | $                  | 16,451.7   |              | $          | 16,244.6 |   |

 

See the accompanyingnotes to the unaudited interim consolidated financial statements.

 

2

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**CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)**
|                                                                                            |   | Three Months  Ended September 30, |    | Nine Months  Ended September 30, |   |
|-------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
| (Millions,  except per share amounts)                                                           |   | 2003                                   |    | 2002                                  |   | 2003 |   | 2002 |   |
| **REVENUES  AND SALES:**                                                                        |   |                                   |    |                                  |   |   |   |   |   |
| Service  revenues                                                                               |   | $                                      | 1,836.1 |                                  | $      | 1,691.3 |   | $ | 5,350.1 |   | $ | 4,694.5 |   |
| Product  sales                                                                                  |   | 214.1                                  |    | 176.4                                 |   | 616.1 |   | 495.1 |   |
| Total  revenues and sales                                                                       |   | 2,050.2                                |    | 1,867.7                               |   | 5,966.2 |   | 5,189.6 |   |
| **COSTS  AND EXPENSES:**                                                                        |   |                                   |    |                                  |   |   |   |   |   |
| Cost  of services (excluding depreciation of $229.3, $208.8, $674.8 and $575.5  included below) |   | 575.5                                  |    | 532.6                                 |   | 1,644.3 |   | 1,473.2 |   |
| Cost  of products sold                                                                          |   | 272.4                                  |    | 224.4                                 |   | 781.4 |   | 657.4 |   |
| Selling,  general, administrative and other                                                     |   | 403.4                                  |    | 345.4                                 |   | 1,171.2 |   | 960.6 |   |
| Depreciation  and amortization                                                                  |   | 312.2                                  |    | 285.9                                 |   | 926.4 |   | 791.2 |   |
| Integration  expenses and other charges                                                         |   | —                                 |    | 20.5                                  |   | 19.0 |   | 72.4 |   |
| Total  costs and expenses                                                                       |   | 1,563.5                                |    | 1,408.8                               |   | 4,542.3 |   | 3,954.8 |   |
| **OPERATING  INCOME**                                                                           |   | 486.7                                  |    | 458.9                                 |   | 1,423.9 |   | 1,234.8 |   |
|                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
| Equity  earnings in unconsolidated partnerships                                                 |   | 13.8                                   |    | 20.1                                  |   | 48.0 |   | 42.5 |   |
| Minority  interest in consolidated partnerships                                                 |   | (22.3                                  | )       | (21.0                                 | )      | (61.5 | ) | (54.7 | ) |
| Other  income (expense), net                                                                    |   | 3.4                                    |    | (0.8                                  | )      | 7.5 |   | 5.9 |   |
| Interest  expense                                                                               |   | (91.1                                  | )       | (107.5                                | )      | (287.7 | ) | (245.9 | ) |
| Gain  (loss) on disposal of assets, write-down of investments and other                         |   | —                                 |    | (4.8                                  | )      | (13.1 | ) | (18.5 | ) |
|                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
| Income  from continuing operations before income taxes                                          |   | 390.5                                  |    | 344.9                                 |   | 1,117.1 |   | 964.1 |   |
| Income  taxes                                                                                   |   | 147.7                                  |    | 127.1                                 |   | 422.5 |   | 359.4 |   |
|                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
| Income  from continuing operations                                                              |   | 242.8                                  |    | 217.8                                 |   | 694.6 |   | 604.7 |   |
| Discontinued  operations  (net of income taxes of $13.5, $256.2 and $42.5)                      |   | —                                 |    | 19.9                                  |   | 361.0 |   | 63.0 |   |
|                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
| Income  before cumulative effect of accounting change                                           |   | 242.8                                  |    | 237.7                                 |   | 1,055.6 |   | 667.7 |   |
| Cumulative  effect of accounting change  (net of income taxes of $10.3)                         |   | —                                 |    | —                                |   | 15.6 |   | — |   |
|                                                                                            |   |                                   |    |                                  |   |   |   |   |   |
| Net  income                                                                                     |   | 242.8                                  |    | 237.7                                 |   | 1,071.2 |   | 667.7 |   |
| Preferred  dividends                                                                            |   | —                                 |    | —                                |   | 0.1 |   | 0.1 |   |
| Net  income applicable to common shares                                                         |   | $                                      | 242.8   |                                  | $      | 237.7 |   | $ | 1,071.1 |   | $ | 667.6 |   |
| **EARNINGS  PER SHARE:**                                                                        |   |                                   |    |                                  |   |   |   |   |   |
| Basic:                                                                                          |   |                                   |    |                                  |   |   |   |   |   |
| Income  from continuing operations                                                              |   | $                                      | .78     |                                  | $      | .70 |   | $ | 2.23 |   | $ | 1.95 |   |
| Income  from discontinued operations                                                            |   | —                                 |    | .06                                   |   | 1.16 |   | .20 |   |
| Cumulative  effect of accounting change                                                         |   | —                                 |    | —                                |   | .05 |   | — |   |
| Net  income                                                                                     |   | $                                      | .78     |                                  | $      | .76 |   | $ | 3.44 |   | $ | 2.15 |   |
| Diluted:                                                                                        |   |                                   |    |                                  |   |   |   |   |   |
| Income  from continuing operations                                                              |   | $                                      | .78     |                                  | $      | .70 |   | $ | 2.23 |   | $ | 1.94 |   |
| Income  from discontinued operations                                                            |   | —                                 |    | .06                                   |   | 1.15 |   | .20 |   |
| Cumulative  effect of accounting change                                                         |   | —                                 |    | —                                |   | .05 |   | — |   |
| Net  income                                                                                     |   | $                                      | .78     |                                  | $      | .76 |   | $ | 3.43 |   | $ | 2.14 |   |
| Pro  forma amounts assuming change in accounting principle was applied  retroactively:          |   |                                   |    |                                  |   |   |   |   |   |
| Net  income                                                                                     |   | $                                      | 242.8   |                                  | $      | 238.2 |   | $ | 1,055.6 |   | $ | 668.7 |   |
| Basic  earnings per share                                                                       |   | $                                      | .78     |                                  | $      | .77 |   | $ | 3.39 |   | $ | 2.15 |   |
| Diluted  earnings per share                                                                     |   | $                                      | .78     |                                  | $      | .76 |   | $ | 3.38 |   | $ | 2.14 |   |

 

See the accompanyingnotes to the unaudited interim consolidated financial statements.

 

3

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**CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**
|                                                                                            |   | Nine Months  Ended September 30, |    |
|-------------------------------------------------------------------------------------------------|--------|---------------------------------------|---------|
| (Millions)                                                                                      |   | 2003                                  |    | 2002 |   |
|                                                                                            |   |                                  |    |   |   |
| **CASH  PROVIDED FROM OPERATIONS:**                                                             |   |                                  |    |   |   |
| Net  income                                                                                     |   | $                                     | 1,071.2 |   | $ | 667.7 |   |
| Adjustments  to reconcile net income to net cash provided from operations:                      |   |                                  |    |   |   |
| Income  from discontinued operations                                                            |   | (361.0                                | )       | (63.0 | ) |
| Cumulative  effect of accounting change                                                         |   | (15.6                                 | )       | — |   |
| Depreciation  and amortization                                                                  |   | 926.4                                 |    | 791.2 |   |
| Provision  for doubtful accounts                                                                |   | 142.5                                 |    | 198.9 |   |
| Non-cash  portion of integration expenses and other charges                                     |   | 13.2                                  |    | 12.6 |   |
| Loss  on disposal of assets, write-down of investments and other                                |   | 6.0                                   |    | 18.5 |   |
| Increase  in deferred income taxes                                                              |   | 141.5                                 |    | 134.0 |   |
| Other,  net                                                                                     |   | 20.3                                  |    | 11.0 |   |
| Changes  in operating assets and liabilities, net of effects of acquisitions and  dispositions: |   |                                  |    |   |   |
| Accounts  receivable                                                                            |   | (89.5                                 | )       | (182.6 | ) |
| Inventories                                                                                     |   | (4.7                                  | )       | 57.6 |   |
| Accounts  payable                                                                               |   | (31.9                                 | )       | 48.9 |   |
| Other  current liabilities                                                                      |   | 42.9                                  |    | 81.8 |   |
| Other,  net                                                                                     |   | (10.7                                 | )       | (38.6 | ) |
| Net  cash provided from operations                                                              |   | 1,850.6                               |    | 1,738.0 |   |
|                                                                                            |   |                                  |    |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                      |   |                                  |    |   |   |
| Additions  to property, plant and equipment                                                     |   | (806.5                                | )       | (853.6 | ) |
| Additions  to capitalized software development costs                                            |   | (44.6                                 | )       | (49.4 | ) |
| Additions  to investments                                                                       |   | (10.8                                 | )       | (6.1 | ) |
| Purchases  of property, net of cash acquired                                                    |   | (160.6                                | )       | (3,337.1 | ) |
| Proceeds  from the lease of cell site towers                                                    |   | —                                |    | 7.5 |   |
| Proceeds  from the return on investments                                                        |   | 34.3                                  |    | 31.5 |   |
| Other,  net                                                                                     |   | 16.0                                  |    | (7.7 | ) |
| Net  cash used in investing activities                                                          |   | (972.2                                | )       | (4,214.9 | ) |
|                                                                                            |   |                                  |    |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                      |   |                                  |    |   |   |
| Dividends  on preferred and common stock                                                        |   | (327.2                                | )       | (317.2 | ) |
| Reductions  in long-term debt                                                                   |   | (744.3                                | )       | (35.0 | ) |
| Distributions  to minority investors                                                            |   | (44.4                                 | )       | (41.8 | ) |
| Long-term  debt issued, net of issuance costs                                                   |   | —                                |    | 2,829.6 |   |
| Common  stock issued                                                                            |   | 30.9                                  |    | 12.4 |   |
| Net  cash provided from (used in) financing activities                                          |   | (1,085.0                              | )       | 2,448.0 |   |
|                                                                                            |   |                                  |    |   |   |
| Net  cash provided from discontinued operations                                                 |   | 638.2                                 |    | 38.0 |   |
|                                                                                            |   |                                  |    |   |   |
| Effect  of exchange rate changes on cash and short-term investments                             |   | 0.7                                   |    | 2.6 |   |
|                                                                                            |   |                                  |    |   |   |
| Increase  in cash and short-term investments                                                    |   | 432.3                                 |    | 11.7 |   |
|                                                                                            |   |                                  |    |   |   |
| **CASH  AND SHORT-TERM INVESTMENTS:**                                                           |   |                                  |    |   |   |
| Beginning  of the period                                                                        |   | 134.6                                 |    | 63.2 |   |
| End  of the period                                                                              |   | $                                     | 566.9   |   | $ | 74.9 |   |
|                                                                                            |   |                                  |    |   |   |
| **NON-CASH  INVESTING AND FINANCING ACTIVITY:**                                                 |   |                                  |    |   |   |
| Change  in fair value of interest rate swap agreements                                          |   | $                                     | (5.5    | ) | $ | 96.8 |   |

 

See the accompanyingnotes to the unaudited interim consolidated financial statements.

 

4

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS**

          

 

**1.****      General:**

Basis of Presentation— The consolidated financial statements at September 30, 2003 and 2002 andfor the three and nine month periods then ended of ALLTEL Corporation (“ALLTEL”or the “Company”) are unaudited.  Theconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial reporting andSecurities and Exchange Commission rules and regulations.  Certain information and footnote disclosureshave been condensed or omitted in accordance with those rules andregulations.  Certain prior year amountshave been reclassified to conform to the 2003 financial statement presentation,including the change in business segment reporting discussed below. Theconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments) which are, in the opinion of management,necessary for a fair presentation of the financial position and operatingresults for the interim periods presented.

 

Change in BusinessSegment Reporting — Effective January 1, 2003, ALLTELchanged its business segment presentation to reclassify the operations of thetelecom division of its information services subsidiary, ALLTEL InformationServices, Inc., to be included within the Company’s communications support servicessegment.  This segment also includesALLTEL’s long-distance and network management services, communicationsproducts, and directory publishing operations. Previously, the telecom division had been combined with the financialservices division and reported within the Company’s information servicessegment.  As further discussed in Note11 to the unaudited consolidated financial statements, on January 28,2003, ALLTEL signed a definitive agreement to sell the financial servicesdivision of ALLTEL Information Services, Inc. to Fidelity National FinancialInc. (“Fidelity National”).  ALLTELcompleted the sale transaction on April 1, 2003.  Accordingly, the financial services division has been reported inthe accompanying unaudited consolidated financial statements as discontinuedoperations.  In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 131 “Disclosures aboutSegments of an Enterprise and Related Information”, all prior period segment informationhas been reclassified to conform to this new financial reporting presentation.

 

**2.****      AccountingChanges:**

In May 2003, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity”.  SFAS No. 150,with an effective date of  July 1, 2003,requires all financial instruments included within its scope to beinitially recorded at fair value or settlement value, depending upon the natureof the financial instrument, and subsequently remeasured at each balancesheet date.  Certain of theCompany’s consolidated non-wholly owned wireless partnerships have finite livesspecified in their partnership agreements, and, accordingly, must be legallydissolved and terminated, at a specified future date, usually 50 or 99 yearsafter formation, and the proceeds distributed to the partners.  Under the provisions of SFAS No. 150, theminority interests associated with these partnerships are consideredmandatorily redeemable financial instruments, and as such, would be required tobe reported as liabilities in ALLTEL's consolidated financial statements,initially measured at settlement value, and subsequently remeasured at eachbalance sheet date with changes in settlement values reported as a component ofinterest expense.

 

On November 7, 2003, the FASB issued StaffPosition No. 150-3, “Effective Date, Disclosures, and Transition for Mandatorily Redeemable FinancialInstruments of Certain Nonpublic Entities and Certain Mandatorily RedeemableNoncontrolling Interests under FASB Statement No. 150” (“FSP No. 150-3”).  FSP No. 150-3 deferred indefinitely therecognition and measurement provisions of SFAS No. 150 applicable tomandatorily redeemable noncontrolling interests, including the minorityinterests associated with the Company’s consolidated non-wholly ownedpartnerships with finite lives. Accordingly, the adoption of SFAS No. 150 did not affect the Company’sconsolidated results of operations, financial position, or cash flows as of andfor the three and nine months ended September 30, 2003.  In accordance with FSP 150-3, the minorityinterests associated with the Company’s finite-lived partnerships continue tobe reported at book value within other liabilities in the accompanyingconsolidated balance sheets.  AtSeptember 30, 2003, the settlement value of these minority interests was$47.5 million.

 

Except for certain wireline subsidiaries as furtherdiscussed below, the Company adopted SFAS No. 143, “Accounting for Asset RetirementObligations”, effective January 1, 2003. SFAS No. 143 addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andthe associated asset retirement costs. This standard applies to legal obligations associated with theretirement of long-lived assets that result from the acquisition, construction,development, or normal use of the assets. SFAS No. 143 requires that a liability for an asset retirementobligation be recognized when incurred and reasonably estimable, recorded atfair value, and classified as a liability in the balance sheet.  When the liability is initially recorded,the entity capitalizes the cost and increases the carrying value of the relatedlong-lived asset.  The liability is thenaccreted to its present value each period, and the capitalized cost isdepreciated over the estimated useful life of the relatedasset.  At the settlement date, theentity will settle the obligation for its recorded amount and recognize a gainor loss upon settlement.

 

5

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**2.****      AccountingChanges, Continued:**

The Company has evaluated the effects of SFAS No. 143on its operations and has determined that, for telecommunications and otheroperating facilities in which the Company owns the underlying land, ALLTEL hasno contractual or legal obligation to remediate the property if the Companywere to abandon, sell or otherwise dispose of the property.  Certain of the Company’s cell site andswitch site operating lease agreements contain clauses requiring restoration ofthe leased site at the end of the lease term.  Similarly, certain of  the Company'slease agreements foroffice and retail locations require restoration of the leased site uponexpiration of the lease term. Accordingly, ALLTEL is subject to asset retirement obligationsassociated with these leased facilities under the provisions of SFAS No. 143.  Theapplication of SFAS No. 143 to theCompany’s cell site and switch site leases and leased office and retaillocations did not have a material impact on ALLTEL’s consolidated results ofoperations, financial position, or cash flows as of and for the three and ninemonths ended September 30, 2003.

 

In accordance with federal and state regulations,depreciation expense for ALLTEL’s wireline operations has historically includedan additional provision for cost of removal. Effective with the adoption of SFAS No. 143, the additional cost ofremoval provision will no longer be included in depreciation expense because itdoes not meet the recognition and measurement principles of an asset retirementobligation under SFAS No. 143.  InDecember 2002, the Federal Communications Commission (“FCC”) notifiedwireline carriers that they should not adopt the provisions of SFAS No. 143unless specifically required by the FCC in the future.  As a result of the FCC ruling, ALLTEL willcontinue to record a regulatory liability for cost of removal for its wirelinesubsidiaries that follow the accounting prescribed by SFAS No. 71 “Accountingfor the Effects of Certain Types of Regulation”.  The regulatory liability for cost of removal included inaccumulated depreciation amounted to $156.0 million and $158.6 million atSeptember 30, 2003 and 2002, respectively.  For the acquired Kentucky and Nebraska wireline operations notsubject to SFAS No. 71, effective January 1, 2003, the Company ceasedrecognition of the cost of removal provision in depreciation expense andeliminated the cumulative cost of removal included in accumulateddepreciation.  The cumulative effect ofretroactively applying these changes to periods prior to January 1, 2003,resulted in a non-cash credit of $15.6 million, net of income tax expense of$10.3 million, and was included in net income for the nine months endedSeptember 30, 2003.

 

Effective January 1, 2003, the Company adoptedEmerging Issues Task Force Issue 00-21 “Accounting for Revenue Arrangementswith Multiple Deliverables” for all new arrangements entered into on or afterthat date.  Issue 00-21 addresses theaccounting by a vendor for arrangements under which it will perform multiplerevenue-generating activities. Specifically, Issue 00-21 addresses how to determine whether anarrangement involving multiple deliverables contains one or more units ofaccounting and how arrangement consideration should be measured and allocatedto the separate units of accounting. Upon adoption, the Company ceased deferral of fees assessed to wirelesscommunications customers to activate service and direct incremental customeracquisition costs incurred in the activation of service.  The adoption of Issue 00-21 did not have amaterial impact on the Company’s consolidated results of operations for thethree and nine months ended September 30, 2003.

 

**3.****      Goodwilland Other Intangible Assets:**

Goodwill represents the excess of cost over the fairvalue of net identifiable tangible and intangible assets acquired throughvarious business combinations.  TheCompany has acquired identifiable intangible assets through its acquisitions ofinterests in various wireless and wireline properties.  The cost of acquired entities at the date ofthe acquisition is allocated to identifiable assets and the excess of the totalpurchase price over the amounts assigned to identifiable assets is recorded asgoodwill.  The changes in the carryingamount of goodwill by business segment for the nine months endedSeptember 30, 2003 were as follows:

 
|                                |   |     |    |     |   |                              |   |   |   |
|-------------------------------------|--------|----------|---------|----------|--------|-----------------------------------|--------|--------|--------|
| (Millions)                          |   | Wireless |    | Wireline |   | Communications  Support  Services |   | Total  |   |
| Balance  at December 31, 2002  |   | $        | 3,519.7 |     | $      | 1,247.7                           |   | $      | 2.3    |   | $ | 4,769.7 |   |
| Acquired  during the period         |   | 93.0     |    | —   |   | —                            |   | 93.0   |   |
| Other  adjustments                  |   | (8.4     | )       | (0.1     | )      | —                            |   | (8.5   | )      |
| Balance  at September 30, 2003 |   | $        | 3,604.3 |     | $      | 1,247.6                           |   | $      | 2.3    |   | $ | 4,854.2 |   |
|                                     |        |          |         |          |        |                                   |        |        |        |  |  |  |  |  |  |

 

6

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**3.****      Goodwilland Other Intangible Assets, Continued:**

The carrying value of indefinite-lived intangibleassets other than goodwill were as follows:

 
| (Millions)                                 |   | September 30,  2003 |    | December 31,  2002 |   |
|--------------------------------------------|--------|--------------------------|---------|-------------------------|--------|
| Cellular  licenses                         |   | $                        | 761.6   |                    | $      | 720.2 |   |
| Personal  Communications Services licenses |   | 78.5                     |    | 78.5                    |   |
| Franchise  rights — wireline          |   | 265.0                    |    | 265.0                   |   |
|                                       |   | $                        | 1,105.1 |                    | $      | 1,063.7 |   |
|                                            |        |                          |         |                         |        |  |  |  |  |  |

 

Intangible assets subject to amortization were asfollows:

 
|                    |   | September 30,  2003 |   |
|-------------------------|--------|--------------------------|--------|
| (Millions)              |   | Gross  Cost              |   | Accumulated  Amortization |   | Net Carrying  Value |   |
| Customer  lists         |   | $                        | 382.4  |   | $ | (144.9 | ) | $ | 237.5 |   |
| Franchise  rights       |   | 22.5                     |   | (13.0 | ) | 9.5 |   |
| Non-compete  agreements |   | 2.9                      |   | (2.9 | ) | — |   |
|                    |   | $                        | 407.8  |   | $ | (160.8 | ) | $ | 247.0 |   |
|                         |        |                          |        |  |  |  |  |  |  |  |  |  |  |  |

 
|                    |   | December 31,  2002 |   |
|-------------------------|--------|-------------------------|--------|
| (Millions)              |   | Gross  Cost             |   | Accumulated  Amortization |   | Net Carrying  Value |   |
| Customer  lists         |   | $                       | 374.6  |   | $ | (101.0 | ) | $ | 273.6 |   |
| Franchise  rights       |   | 22.5                    |   | (11.9 | ) | 10.6 |   |
| Non-compete  agreements |   | 2.9                     |   | (2.7 | ) | 0.2 |   |
|                    |   | $                       | 400.0  |   | $ | (115.6 | ) | $ | 284.4 |   |
|                         |        |                         |        |  |  |  |  |  |  |  |  |  |  |  |

 

Amortization expense for intangible assets subject toamortization was $15.2 million and $45.2 million for the three and nine monthperiods ended September 30, 2003, respectively, compared to $13.1 millionand $32.0 million for the same periods of 2002.  Amortization expense for intangible assets subject to amortizationis estimated to be $60.3 million in 2003, $60.3 million in 2004, $59.6 millionin 2005, $41.0 million in 2006 and $24.3 million in 2007.  (See Note 4 for a discussion of theacquisitions completed during 2003 that resulted in the recognition of goodwilland other intangible assets.)

 

**4.****      Acquisitions:**

On August 29, 2003, the Company purchased for$22.8 million in cash a wireless property with a potential service areacovering approximately 205,000 potential customers (“POPs”) in an Arizona RuralService Area (“RSA”).  During the thirdquarter of 2003, the Company also purchased for $5.7 million in cash additionalownership interests in wireless properties in Mississippi, New Mexico andVirginia in which the Company owned a majority interest.  The Company assigned the excess of theaggregate purchase price over the fair market value of the tangible net assetsacquired in these two purchases of $25.4 million to cellular licenses ($22.8million) and goodwill ($2.6 million).

 

On April 1, 2003, the Company paid $7.5 millionin cash to increase its ownership interest from 43 percent to approximately 86percent in a wireless property with a potential service area coveringapproximately 145,000 POPs in a Wisconsin RSA. During the second quarter of 2003, the Company completed the purchaseprice allocation of this acquisition based upon a fair value analysis of thetangible and identifiable intangible assets acquired. The excess of theaggregate purchase price over the fair market value of the tangible net assetsacquired of $3.0 million was assigned to customer list ($0.4 million), cellularlicenses ($1.0 million) and goodwill ($1.6 million).

 

On February 28, 2003, the Company also purchasedfor $60.0 million in cash the remaining ownership interest in wirelessproperties with a potential service area covering approximately 355,000 POPsin two Michigan RSAs.  Prior to thisacquisition, ALLTEL owned approximately 49 percent of the Michiganproperties.  During the second quarterof 2003, the Company completed the purchase price allocation of this acquisitionbased upon a fair value analysis of the tangible and identifiable intangibleassets acquired.  The excess of theaggregate purchase price over the fair market value of the tangible net assetsacquired of $46.8 million was assigned to customer list ($3.4 million),cellular licenses ($8.0 million) and goodwill ($35.4 million).  On February 28, 2003, the Company alsopurchased for $72.0 million  in cash wireless properties with a

 

7

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**NOTES TO UNAUDITED INTERIM CONSOLIDATEDFINANCIAL STATEMENTS-(Continued)**

          

 

**4.****      Acquisitions,Continued:**

potential service area covering approximately 370,000POPs in southern Mississippi, from Cellular XL Associates (“Cellular XL”), aprivately held company.  Of the totalpurchase price, ALLTEL paid $64.6 million to Cellular XL at the date ofpurchase with the remaining cash payment, subject to adjustments as specifiedin the purchase agreement, payable with interest, 12 months after the closingdate.  During the first quarter of 2003,the Company completed the purchase price allocation of this acquisition basedupon a fair value analysis of the tangible and identifiable intangible assetsacquired.  The excess of the aggregatepurchase price over the fair market value of the tangible net assets acquiredof $67.0 million was assigned to customer list ($4.0 million), cellularlicenses ($9.6 million) and goodwill ($53.4 million).

 

The accompanying consolidated financial statementsinclude the accounts and results of operations of the acquired wirelessproperties from the dates of acquisition. The customer lists recorded in connection with these transactions arebeing amortized on a straight-line basis over their estimated useful lives ofsix years.  The cellular licenses areclassified as indefinite-lived intangible assets and are not subject toamortization.

 

The purchase price paid for the wireless propertiesdiscussed above was based on estimates of future cash flows of the propertiesacquired.  ALLTEL paid a premium (i.e.,goodwill) over the fair value of the net tangible and identified intangibleassets acquired because the purchase of wireless properties expanded theCompany’s wireless footprint into new markets across Arizona, Michigan,Mississippi and Wisconsin and added a combined 147,000 new wireless customersto ALLTEL’s communications customer base. Additionally, in the wireless properties acquired, ALLTEL shouldrealize, over time, accelerated customer growth and higher average revenue percustomer as a result of the Company’s higher revenue national rate plans.

 

On August 1, 2002, ALLTEL purchased substantiallyall of the wireless assets owned by CenturyTel, Inc. (“CenturyTel”) forapproximately $1.59 billion in cash.  Inthis transaction, ALLTEL added approximately 762,000 wireless customers,minority partnership interests in cellular operations of approximately 1.8million proportionate POPs, and PCS licenses covering 1.3 million POPs inWisconsin and Iowa.  The accompanyingconsolidated financial statements include the accounts and results ofoperations of the acquired wireless properties from the date of acquisition.The excess of the aggregate purchase price over the fair market value of thetangible net assets acquired of $1.38 billion was assigned to customer list($89.0 million), cellular licenses ($215.6 million) and goodwill ($1,075.5million).  The customer list recorded inconnection with this transaction is being amortized on a straight-line basisover its estimated useful life of six years. The cellular licenses are classified as indefinite-lived intangibleassets and are not subject to amortization. Of the total amount assigned to goodwill, approximately $481.0 millionis expected to be deductible for income tax purposes.

 

On August 1, 2002, ALLTEL also completed thepurchase of local telephone properties in the state of Kentucky from VerizonCommunications, Inc. (“Verizon”) for approximately $1.93 billion in cash.  In this transaction, ALLTEL addedapproximately 589,000 wireline customers. The accompanying consolidated financial statements include the accountsand results of operations of the acquired wireline properties from the date ofacquisition.  The excess of theaggregate purchase price over the fair market value of the tangible net assetsacquired of $1.34 billion was assigned to customer list ($67.6 million),franchise rights ($265.0 million) and goodwill ($1,003.1 million).  The customer list recorded in connectionwith this transaction is being amortized on a straight-line basis over itsestimated useful life of ten years.  Thefranchise rights are classified as indefinite-lived intangible assets and arenot subject to amortization.  Of thetotal amount assigned to goodwill, approximately $1.0 billion is expected to bedeductible for income tax purposes.

 

During 2002, ALLTEL also purchased alocal telephone propertyin Georgia and acquired additional ownership interests in wireless propertiesin Arkansas, Louisiana and Texas.  Inconnection with these acquisitions, the Company paid $35.1 million in cash andassigned the excess of the aggregate purchase price over the fair market valueof the tangible net assets acquired of $30.9 million to goodwill.

 

In connection with the CenturyTel and Verizonacquisitions discussed above, the Company recorded integration expenses andother charges in 2002.  (See Note 5.)

 

8

----

 

**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**4.****      Acquisitions,Continued:**

The following unaudited pro forma consolidated resultsof operations of the Company for the three and nine months endedSeptember 30, 2002 assume that the acquisition of wireless properties fromCenturyTel and the purchase of wireline properties from Verizon were completedas of January 1, 2002:

 
| (Millions,  except per share amounts)          |   | Three  Months  Ended |    | Nine  Months  Ended |   |
|------------------------------------------------|--------|----------------------|---------|---------------------|--------|
| Revenues  and sales                            |   | $                    | 1,937.1 |                | $      | 5,680.0 |   |
| Income  from continuing operations             |   | $                    | 242.2   |                | $      | 682.9 |   |
| Earnings  per share from continuing operations |   |                 |    |                |   |
| Basic  earnings per share                      |   | $                    | .78     |                | $      | 2.20 |   |
| Diluted  earnings per share                    |   | $                    | .78     |                | $      | 2.19 |   |
| Net  income                                    |   | $                    | 262.1   |                | $      | 745.9 |   |
| Earnings  per share:                           |   |                 |    |                |   |
| Basic  earnings per share                      |   | $                    | .84     |                | $      | 2.40 |   |
| Diluted  earnings per share                    |   | $                    | .84     |                | $      | 2.39 |   |

 

The pro forma amounts represent the historicaloperating results of the properties acquired from Verizon and CenturyTel withappropriate adjustments that give effect to depreciation and amortization andinterest expense. The pro forma amounts for the three and nine months endedSeptember 30, 2002 include the effects of non-acquisition-related itemsdiscussed in Notes 5 and 6 below.  Thepro forma amounts are not necessarily indicative of the operating results thatwould have occurred if the Verizon and CenturyTel properties had been operatedby ALLTEL during the periods presented. In addition, the pro forma amounts do not reflect potential cost savingsrelated to full network optimization and the redundant effect of selling,general and administrative expenses.

 

**5.****      IntegrationExpenses and Other Charges:**

Set forth below is a summary of the integrationexpenses and other charges recorded for the three and nine month periods endedSeptember 30:

 
|                                                    |   | Three Months  Ended |   | Nine Months  Ended |   |
|---------------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions)                                              |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Severance  and employee benefit costs                   |   | $                   | — |               | $      | 1.9 |   | $ | 6.3 |   | $ | 15.3 |   |
| Lease  and contract termination costs                   |   | —              |   | 2.2                |   | (0.5 | ) | 14.6 |   |
| Write-down  of cell site equipment                      |   | —              |   | —             |   | — |   | 7.1 |   |
| Write-down  of software development costs               |   | —              |   | —             |   | 13.2 |   | 4.4 |   |
| Computer  system conversion and other integration costs |   | —              |   | 8.6                |   | — |   | 21.0 |   |
| Branding  and signage expense                           |   | —              |   | 7.8                |   | — |   | 7.8 |   |
| Equipment  removal and other disposal costs             |   | —              |   | —             |   | — |   | 2.2 |   |
| Total  integration expenses and other charges           |   | $                   | — |               | $      | 20.5 |   | $ | 19.0 |   | $ | 72.4 |   |

 

During the second quarter of 2003, the Companyrecorded a restructuring charge of $8.5 million consisting of severance andemployee benefit costs related to a planned workforce reduction, primarilyresulting from the closing of certain call center locations.  As of September 30, 2003, ALLTEL hadpaid $8.3 million in severance and employee-related expenses, and all of theemployee reductions had been completed. ALLTEL also recorded a $2.7 million reduction in the liabilitiesassociated with various restructuring activities initiated prior to 2003,consisting of $2.2 million in severance and employee benefit costs and $0.5million in lease termination costs.  Thereduction primarily reflected differences between estimated and actual costspaid in completing the previous planned workforce reductions and leaseterminations.  During the second quarterof 2003, ALLTEL also wrote off certain capitalized software development coststhat had no alternative future use or functionality.

 

During the third quarter of 2002, the Company recordeda restructuring charge of $4.1 million consisting of severance and employeebenefit costs of $1.9 million related to a planned workforce reduction and $2.2million of lease termination costs primarily related to the closing of sevenproduct distribution centers.  The leasetermination costs consisted of $1.2 million, primarily representing theestimated minimum contractual commitments over the ensuing one to four yearsfor operating locations that the Company abandoned, net of anticipated subleaseincome.  The lease termination costsalso included an additional $1.0 million to reflect the revised estimatedcosts, net of anticipated sublease income, to terminate leases associated

 

9

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**5.****      IntegrationExpenses and Other Charges, Continued:**

with four operating locations.  ALLTEL had previously recorded $9.1 millionin lease termination costs related to these four locations ($2.8 million duringthe first quarter of 2002 and $6.3 million in 1999).  The additional charge reflected a further reduction in expectedsublease income attributable primarily to softening demand in the commercialreal estate market.  The restructuringplan, completed in September 2002, provided for the elimination of 130employees primarily in the Company’s product distribution operations.  As of September 30, 2003, the Companyhad paid $1.9 million in severance and employee-related expenses, and all ofthe employee reductions had been completed.

 

In connection with the purchase of wireline propertiesin Kentucky from Verizon and wireless properties from CenturyTel, the Companyincurred branding and signage costs of $7.8 million during the third quarter of2002. In addition, the Company also incurred computer system conversion andother integration costs related to these acquisitions during each of the firstthree quarters of 2002.  These expensesincluded internal payroll and employee benefit costs, contracted services, andother computer programming costs incurred in connection with expanding ALLTEL’scustomer service and operations support functions to handle increased customervolumes resulting from the acquisitions and to convert Verizon’s customerbilling and operations support systems to ALLTEL’s internal systems.

 

In January 2002, the Company announced its plansto exit its Competitive Local Exchange Carrier (“CLEC”) operations in sevenstates.  The Company also consolidatedits call center and retail store operations during the first quarter of2002.  In connection with theseactivities, the Company recorded a restructuring charge consisting of severanceand employee benefit costs related to a planned workforce reduction, costsassociated with terminating certain CLEC transport agreements and leasetermination fees related to the closing of certain retail and call centerlocations.  In exiting the CLECoperations, the Company also incurred costs to disconnect and remove switchingand other transmission equipment from central office facilities and expenses tonotify and migrate customers to other service providers.  ALLTEL also wrote off certain capitalizedsoftware development costs that had no alternative future use orfunctionality.  The restructuring plans,completed in March 2002, provided for the elimination of 910 employeesprimarily in the Company’s sales, customer service and network operationssupport functions.  In the fourthquarter of 2002, ALLTEL reduced the liabilities associated with theserestructuring plans by $2.5 million. The reduction primarily reflected differences between estimated andactual costs to exit certain CLEC markets and consisted of $2.0 million inlease termination costs and $0.5 million in severance and employee benefitcosts.  As of September 30, 2003,the Company had paid $12.1 million in severance and employee-related expenses,and all of the employee reductions had been completed.

 

The $12.4 million of lease and contract terminationcosts recorded in the first quarter of 2002 consisted of $5.0 millionrepresenting the estimated minimum contractual commitments over the next one tofive years for 31 operating locations that the Company has abandoned, net ofanticipated sublease income.  The leaseand contract termination costs also included $3.6 million of costs to terminatetransport agreements with six interexchange carriers.  The Company also recorded an additional $2.8 million to reflectthe revised estimated costs, net of anticipated sublease income, to terminateleases associated with four operating locations.  ALLTEL had previously recorded $6.3 million in lease terminationcosts related to these four locations in 1999. The additional charge reflected a reduction in expected sublease incomeattributable primarily to softening demand in the commercial real estate marketand bankruptcy filings by two sublessees. Finally, the lease termination costs also included $1.0 million ofunamortized leasehold improvement costs related to the abandoned locations.

 

During the first quarter of 2002, the Company alsorecorded the final write-down in the carrying value of certain cell siteequipment to fair value.  In conjunctionwith a product replacement program initiated by a vendor in 2001, the Companyexchanged certain used cell site equipment for new equipment.  The exchange of cell site equipment beganduring the third quarter of 2001 and continued through the first quarter of2002.  As the equipment exchanges werecompleted, the Company recorded write-downs in the carrying value of the usedcell site equipment to fair value.

 

The following is a summary of activity related to theliabilities associated with the Company’s integration expenses and othercharges for the nine months ended September 30, 2003:

 
| (Millions)                              |   |   |   |
|-----------------------------------------|--------|--------|--------|
| Balance,  beginning of period           |   | $      | 13.1   |   |
| Integration  expenses and other charges |   | 21.7   |   |
| Reversal  of accrued liabilities        |   | (2.7   | )      |
| Non-cash  write-down of assets          |   | (13.5  | )      |
| Cash  outlays                           |   | (12.1  | )      |
| Balance,  end of period                 |   | $      | 6.5    |   |

 

10

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**5.****      IntegrationExpenses and Other Charges, Continued:**

At September 30, 2003, the remaining unpaidliability related to the Company’s integration and restructuring activitiesconsisted of severance and employee-related expenses of $1.4 million and leasetermination costs of $5.1 million and is included in other current liabilitiesin the accompanying consolidated balance sheets.

 

**6.****      Gain(Loss) on Disposal of Assets, Write-down of Investments and Other:**

In the second quarter of 2003, ALLTEL recorded pretaxwrite-downs totaling $6.0 million to reflect other-than-temporary declines inthe fair value of certain investments in unconsolidated limited partnerships.  In addition, during the second quarter of2003, the Company retired, prior to stated maturity dates, $249.1 million oflong-term debt, representing all of the long-term debt outstanding under theRural Utilities Services, Rural Telephone Bank and Federal Financing Bankprograms. In connection with the early retirement of the debt, the Companyincurred pretax termination fees of $7.1 million.

 

In the third quarter of 2002, the Company recorded apretax adjustment of $4.8 million to reduce the gain recognized from thedissolution of a wireless partnership with BellSouth Mobility, Inc.(“BellSouth”).  The gain associated withthis transaction was initially recorded by ALLTEL in 2001.  This additional adjustment reflected a trueup for cash distributions payable to BellSouth in conjunction with thedissolution of the partnership.

 

In the second quarter of 2002, ALLTEL recorded apretax write-down of $12.5 million on its investment in Hughes Tele.com Limited(“HTCL”), a public company and provider of communications services inIndia.  The Company recorded thewrite-down in connection with HTCL’s agreement to merge with a major Indiantelecommunications company and an other-than-temporary decline in the fairvalue of HTCL’s common stock. In addition, the Company also recorded a pretaxwrite-down of $1.2 million related to an other-than-temporary decline inALLTEL’s investment in Airspan Networks, Inc., a provider of wirelesstelecommunications equipment.

 

**7.****      Comprehensive Income:**

Comprehensive income was as follows for the three andnine month periods ended September 30:

 
|                                                                                |   | Three Months  Ended |   | Nine Months  Ended |   |
|-------------------------------------------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions)                                                                          |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Net  income                                                                         |   | $                   | 242.8  |               | $      | 237.7 |   | $ | 1,071.2 |   | $ | 667.7 |   |
| Other  comprehensive income (loss):                                                 |   |                |   |               |   |   |   |   |   |
| Unrealized  holding gains (losses) on investments arising in the period             |   | (7.0                | )      | (0.1               | )      | 31.5 |   | (6.2 | ) |
| Income  tax expense (benefit)                                                       |   | (2.7                | )      | —             |   | 12.3 |   | (2.3 | ) |
|                                                                                |   | (4.3                | )      | (0.1               | )      | 19.2 |   | (3.9 | ) |
| Less:  reclassification adjustments for (gains)  losses included in net income |   | —              |   | —             |   | — |   | 13.7 |   |
| Income  tax expense (benefit)                                                       |   | —              |   | —             |   | — |   | (5.3 | ) |
|                                                                                |   | —              |   | —             |   | — |   | 8.4 |   |
|                                                                                |   |                |   |               |   |   |   |   |   |
| Net  unrealized gains (losses)                                                      |   | (7.0                | )      | (0.1               | )      | 31.5 |   | 7.5 |   |
| Income  tax expense (benefit)                                                       |   | (2.7                | )      | —             |   | 12.3 |   | 3.0 |   |
|                                                                                |   | (4.3                | )      | (0.1               | )      | 19.2 |   | 4.5 |   |
|                                                                                |   |                |   |               |   |   |   |   |   |
| Foreign  currency translation adjustment                                            |   | —              |   | —             |   | 7.5 |   | 2.6 |   |
|                                                                                |   |                |   |               |   |   |   |   |   |
| Other  comprehensive income (loss) before tax                                       |   | (7.0                | )      | (0.1               | )      | 39.0 |   | 10.1 |   |
| Income  tax expense (benefit)                                                       |   | (2.7                | )      | —             |   | 12.3 |   | 3.0 |   |
| Other  comprehensive income (loss)                                                  |   | (4.3                | )      | (0.1               | )      | 26.7 |   | 7.1 |   |
| Comprehensive  income                                                               |   | $                   | 238.5  |               | $      | 237.6 |   | $ | 1,097.9 |   | $ | 674.8 |   |

 

11

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**8.****      Earnings per Share:**

Basic earnings per share of common stock was computedby dividing net income applicable to common shares by the weighted averagenumber of common shares outstanding during the period.  Diluted earnings per share reflects thepotential dilution that could occur assuming conversion or exercise of allunexercised stock options and outstanding preferred stock.  A reconciliation of the net income andnumber of shares used in computing basic and diluted earnings per share was asfollows for the three and nine month periods ended September 30:

 
|                                                                           |   | Three Months  Ended |   | Nine Months  Ended |   |
|--------------------------------------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions,  except per share amounts)                                          |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| **Basic  earnings per share:**                                                 |   |                |   |               |   |   |   |   |   |
| Income  from continuing operations                                             |   | $                   | 242.8  |               | $      | 217.8 |   | $ | 694.6 |   | $ | 604.7 |   |
| Income  from discontinued operations                                           |   | —              |   | 19.9               |   | 361.0 |   | 63.0 |   |
| Cumulative  effect of accounting change                                        |   | —              |   | —             |   | 15.6 |   | — |   |
| Less:  preferred dividends                                                     |   | —              |   | —             |   | (0.1 | ) | (0.1 | ) |
| Net  income applicable to common shares                                        |   | $                   | 242.8  |               | $      | 237.7 |   | $ | 1,071.1 |   | $ | 667.6 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| Weighted  average common shares outstanding for the period                     |   | 312.0               |   | 311.0              |   | 311.6 |   | 310.9 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| Basic  earnings per share:                                                     |   |                |   |               |   |   |   |   |   |
| From  continuing operations                                                    |   | $                   | .78    |               | $      | .70 |   | $ | 2.23 |   | $ | 1.95 |   |
| From  discontinued operations                                                  |   | —              |   | .06                |   | 1.16 |   | .20 |   |
| Cumulative  effect of accounting change                                        |   | —              |   | —             |   | .05 |   | — |   |
| Net  income                                                                    |   | $                   | .78    |               | $      | .76 |   | $ | 3.44 |   | $ | 2.15 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| **Diluted  earnings per share:**                                               |   |                |   |               |   |   |   |   |   |
| Net  income applicable to common shares                                        |   | $                   | 242.8  |               | $      | 237.7 |   | $ | 1,071.1 |   | $ | 667.6 |   |
| Adjustment  for convertible preferred stock dividends                          |   | —              |   | —             |   | 0.1 |   | 0.1 |   |
| Net  income applicable to common shares assuming conversion of preferred stock |   | $                   | 242.8  |               | $      | 237.7 |   | $ | 1,071.2 |   | $ | 667.7 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| Weighted  average common shares outstanding for the period                     |   | 312.0               |   | 311.0              |   | 311.6 |   | 310.9 |   |
| Increase  in shares resulting from the assumed:                                |   |                |   |               |   |   |   |   |   |
| Exercise  of stock options                                                     |   | 0.6                 |   | 0.7                |   | 0.7 |   | 1.1 |   |
| Conversion  of preferred stock                                                 |   | 0.3                 |   | 0.3                |   | 0.3 |   | 0.3 |   |
| Weighted  average common shares assuming conversion                            |   | 312.9               |   | 312.0              |   | 312.6 |   | 312.3 |   |
|                                                                           |   |                |   |               |   |   |   |   |   |
| Diluted  earnings per share:                                                   |   |                |   |               |   |   |   |   |   |
| From  continuing operations                                                    |   | $                   | .78    |               | $      | .70 |   | $ | 2.23 |   | $ | 1.94 |   |
| From  discontinued operations                                                  |   | —              |   | .06                |   | 1.15 |   | .20 |   |
| Cumulative  effect of accounting change                                        |   | —              |   | —             |   | .05 |   | — |   |
| Net  income                                                                    |   | $                   | .78    |               | $      | .76 |   | $ | 3.43 |   | $ | 2.14 |   |

 

**9.****      Business SegmentInformation:**

ALLTEL manages its business operations based ondifferences in products and services. The Company evaluates performance of the segments based on segmentincome, which is computed as revenues and sales less operating expenses,excluding the effects of the items discussed in Notes 2, 5 and 6.  These items are not allocated to thesegments and are included in corporate operations.

 

12

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**9.****      Business Segment Information****, Continued:**

Segment operating results were as follows for thethree and nine month periods ended September 30:

 
|                                                                    |   | Three Months  Ended |    | Nine Months  Ended |   |
|-------------------------------------------------------------------------|--------|---------------------|---------|--------------------|--------|
| (Millions)                                                              |   | 2003                |    | 2002               |   | 2003 |   | 2002 |   |
| **Revenues  and Sales from External Customers:**                        |   |                |    |               |   |   |   |   |   |
| Wireless                                                                |   | $                   | 1,233.2 |               | $      | 1,094.0 |   | $ | 3,536.4 |   | $ | 3,040.8 |   |
| Wireline                                                                |   | 568.4               |    | 537.2              |   | 1,709.8 |   | 1,457.9 |   |
| Communications  support services                                        |   | 161.0               |    | 138.8              |   | 462.5 |   | 412.9 |   |
| Total  business segments                                                |   | $                   | 1,962.6 |               | $      | 1,770.0 |   | $ | 5,708.7 |   | $ | 4,911.6 |   |
|                                                                    |   |                |    |               |   |   |   |   |   |
| **Intersegment  Revenues and Sales:**                                   |   |                |    |               |   |   |   |   |   |
| Wireless                                                                |   | $                   | —  |               | $      | — |   | $ | — |   | $ | — |   |
| Wireline                                                                |   | 36.8                |    | 38.5               |   | 110.5 |   | 114.1 |   |
| Communications  support services                                        |   | 83.0                |    | 100.2              |   | 249.4 |   | 277.8 |   |
| Total  business segments                                                |   | $                   | 119.8   |               | $      | 138.7 |   | $ | 359.9 |   | $ | 391.9 |   |
|                                                                    |   |                |    |               |   |   |   |   |   |
| **Total  Revenues and Sales:**                                          |   |                |    |               |   |   |   |   |   |
| Wireless                                                                |   | $                   | 1,233.2 |               | $      | 1,094.0 |   | $ | 3,536.4 |   | $ | 3,040.8 |   |
| Wireline                                                                |   | 605.2               |    | 575.7              |   | 1,820.3 |   | 1,572.0 |   |
| Communications  support services                                        |   | 244.0               |    | 239.0              |   | 711.9 |   | 690.7 |   |
| Total  business segments                                                |   | 2,082.4             |    | 1,908.7            |   | 6,068.6 |   | 5,303.5 |   |
| Less:  intercompany eliminations                                        |   | (32.2               | )       | (41.0              | )      | (102.4 | ) | (113.9 | ) |
| Total  revenues and sales                                               |   | $                   | 2,050.2 |               | $      | 1,867.7 |   | $ | 5,966.2 |   | $ | 5,189.6 |   |
|                                                                    |   |                |    |               |   |   |   |   |   |   |   |   |   |
| **Segment  Income:**                                                    |   |                |    |               |   |   |   |   |   |
| Wireless                                                                |   | $                   | 268.4   |               | $      | 256.8 |   | $ | 766.4 |   | $ | 701.3 |   |
| Wireline                                                                |   | 207.4               |    | 208.7              |   | 647.0 |   | 569.3 |   |
| Communications  support services                                        |   | 20.3                |    | 22.5               |   | 58.8 |   | 62.3 |   |
| Total  segment income                                                   |   | 496.1               |    | 488.0              |   | 1,472.2 |   | 1,332.9 |   |
| Corporate  expenses                                                     |   | (9.4                | )       | (8.6               | )      | (29.3 | ) | (25.7 | ) |
| Integration  expenses and other charges                                 |   | —              |    | (20.5              | )      | (19.0 | ) | (72.4 | ) |
| Equity  earnings in unconsolidated partnerships                         |   | 13.8                |    | 20.1               |   | 48.0 |   | 42.5 |   |
| Minority  interest in consolidated partnerships                         |   | (22.3               | )       | (21.0              | )      | (61.5 | ) | (54.7 | ) |
| Other  income (expense), net                                            |   | 3.4                 |    | (0.8               | )      | 7.5 |   | 5.9 |   |
| Interest  expense                                                       |   | (91.1               | )       | (107.5             | )      | (287.7 | ) | (245.9 | ) |
| Gain  (loss) on disposal of assets, write-down of investments and other |   | —              |    | (4.8               | )      | (13.1 | ) | (18.5 | ) |
| Income  from continuing operations before income taxes                  |   | $                   | 390.5   |               | $      | 344.9 |   | $ | 1,117.1 |   | $ | 964.1 |   |

 

Segment assets were as follows:

 
|                                                     |   | September 30, |     | December 31, |   |
|----------------------------------------------------------|--------|--------------------|----------|-------------------|--------|
| (Millions)                                               |   | 2003               |     | 2002              |   |
| Wireless                                                 |   | $                  | 9,563.3  |              | $      | 9,418.7 |   |
| Wireline                                                 |   | 5,227.9            |     | 5,340.4           |   |
| Communications  support services                         |   | 544.7              |     | 535.6             |   |
| Total  business segments                                 |   | 15,335.9           |     | 15,294.7          |   |
| Corporate  headquarters assets not allocated to segments |   | 1,178.6            |     | 458.2             |   |
| Assets  held for sale                                    |   | —             |     | 538.3             |   |
| Less:  elimination of intersegment receivables           |   | (62.8              | )        | (46.6             | )      |
| Consolidated  total assets                               |   | $                  | 16,451.7 |              | $      | 16,244.6 |   |

 

13

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**9.****      Business Segment Information****, Continued:**

Supplemental information pertaining to thecommunications support services segment was as follows for the three and ninemonth periods ended September 30:

 
|                                             |   | Three Months  Ended |   | Nine Months Ended |   |
|--------------------------------------------------|--------|---------------------|--------|-------------------|--------|
| (Millions)                                       |   | 2003                |   | 2002              |   | 2003 |   | 2002 |   |
| **Revenues  and Sales from External Customers:** |   |                |   |              |   |   |   |   |   |
| Product  distribution                            |   | $                   | 74.9   |              | $      | 57.1 |   | $ | 202.4 |   | $ | 155.9 |   |
| Long-distance  and network management services   |   | 51.0                |   | 44.5              |   | 150.1 |   | 134.2 |   |
| Telecommunications  information services         |   | 28.8                |   | 30.0              |   | 81.0 |   | 89.8 |   |
| Directory  publishing                            |   | 6.3                 |   | 7.2               |   | 29.0 |   | 33.0 |   |
| Total                                            |   | $                   | 161.0  |              | $      | 138.8 |   | $ | 462.5 |   | $ | 412.9 |   |
|                                             |   |                |   |              |   |   |   |   |   |
| **Intersegment  Revenues and Sales:**            |   |                |   |              |   |   |   |   |   |
| Product  distribution                            |   | $                   | 32.4   |              | $      | 45.0 |   | $ | 98.8 |   | $ | 121.1 |   |
| Long-distance  and network management services   |   | 29.0                |   | 37.3              |   | 92.0 |   | 101.9 |   |
| Telecommunications  information services         |   | —              |   | —            |   | — |   | — |   |
| Directory  publishing                            |   | 21.6                |   | 17.9              |   | 58.6 |   | 54.8 |   |
| Total                                            |   | $                   | 83.0   |              | $      | 100.2 |   | $ | 249.4 |   | $ | 277.8 |   |
|                                             |   |                |   |              |   |   |   |   |   |
| **Total  Revenues and Sales:**                   |   |                |   |              |   |   |   |   |   |
| Product  distribution                            |   | $                   | 107.3  |              | $      | 102.1 |   | $ | 301.2 |   | $ | 277.0 |   |
| Long-distance  and network management services   |   | 80.0                |   | 81.8              |   | 242.1 |   | 236.1 |   |
| Telecommunications  information services         |   | 28.8                |   | 30.0              |   | 81.0 |   | 89.8 |   |
| Directory  publishing                            |   | 27.9                |   | 25.1              |   | 87.6 |   | 87.8 |   |
| Total  revenues and sales                        |   | $                   | 244.0  |              | $      | 239.0 |   | $ | 711.9 |   | $ | 690.7 |   |

 

**10.****    Stock-Based Compensation:**

ALLTEL may grant fixed and performance-based incentiveand non-qualified stock options and other equity securities to officers and other key employees undervarious stock-based compensation plans. The Company accounts for these plans under the recognition andmeasurement principles of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” and related interpretations.  No compensation expense was recognizedrelated to stock-based compensation plans in the three and nine month periodsended September 30, 2003 or 2002.  Thefollowing table illustrates the effects on net income and earnings per sharehad the Company applied the fair value recognition provisions of SFAS No. 123,“Accounting for Stock-Based Compensation”, to its stock-based employeecompensation plans for the three and nine months ended September 30:

 
|                                                                                                                             |         | Three Months  Ended |   | Nine Months  Ended |   |
|----------------------------------------------------------------------------------------------------------------------------------|--------------|---------------------|--------|--------------------|--------|
| (Millions,  except per share amounts)                                                                                            |         | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Net  income as reported                                                                                                          |         | $                   | 242.8  |               | $      | 237.7 |   | $ | 1,071.2 |   | $ | 667.7 |   |
| Deduct  stock-based employee compensation expense determined under fair value method  for all awards, net of related tax effects |         | (7.0                | )      | (7.9               | )      | (18.3 | ) | (23.0 | ) |
| Pro  forma net income                                                                                                            |         | $                   | 235.8  |               | $      | 229.8 |   | $ | 1,052.9 |   | $ | 644.7 |   |
| Basic  earnings per share:                                                                                                       | As  reported |                | $      | .78                |   | $ | .76 |   | $ | 3.44 |   | $ | 2.15 |   |
|                                                                                                                             | Pro  forma   |                | $      | .76                |   | $ | .74 |   | $ | 3.38 |   | $ | 2.07 |   |
| Diluted  earnings per share:                                                                                                     | As  reported |                | $      | .78                |   | $ | .76 |   | $ | 3.43 |   | $ | 2.14 |   |
|                                                                                                                             | Pro  forma   |                | $      | .75                |   | $ | .74 |   | $ | 3.37 |   | $ | 2.06 |   |

 

The pro forma amounts presented above may not berepresentative of the future effects on reported net income and earnings pershare, since the pro forma compensation expense is allocated over the periodsin which options become exercisable, and new option awards may be granted eachyear.

 

14

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**11.****    Discontinued Operations:**

Pursuant to a definitive agreement datedJanuary 28, 2003, on April 1, 2003, ALLTEL sold the financialservices division of its information services subsidiary, ALLTEL InformationServices, Inc., to Fidelity National for $1.05 billion received as $775.0million in cash and $275.0 million in Fidelity National common stock.  Approximately 5,500 employees of the Companytransitioned to Fidelity National as part of the transaction.  As a result of this transaction, ALLTELrecorded an after tax gain of $323.9 million. The after-tax proceeds from the sale were used primarily to reduceborrowings outstanding under the Company’s commercial paper program and toretire all long-term debt outstanding under the Rural Utilities Services, RuralTelephone Bank and Federal Financing Bank programs.  The Fidelity National common stock acquired in this transactionrepresented an approximate eight percent interest in Fidelity National and maynot be disposed of by ALLTEL, subject to certain conditions specified in thesale agreement, for a period of one year from the closing date of thetransaction.

 

As part of this transaction, ALLTEL agreed toindemnify Fidelity National for any damages resulting from ALLTEL’s breach ofwarranty or non-fulfillment of certain covenants under the sales agreement,that exceeded 1.5 percent of the purchase price, or $15.75 million, up to amaximum of 15 percent of the purchase price, or $157.5 million.  The Company believes, because of the lowprobability of being required to pay any amount under this indemnification, thefair value of this obligation is immaterial to the consolidated results ofoperations, cash flows and financial condition of the Company.  Accordingly, the Company has not recorded aliability related to it.

 

ALLTEL also agreed to indemnify Fidelity National fromany future tax liability imposed on the financial services division related toperiods prior to the date of sale. ALLTEL’s obligation to Fidelity National under this indemnification isnot subject to a maximum amount.  TheCompany has recorded a liability for tax contingencies of approximately $34.0million related to the operations of the financial services division forperiods prior to the date of sale that management has assessed as probable andestimable, which should adequately cover any obligation under thisindemnification.

 

As a result of this transaction, the financialservices division has been reflected as discontinued operations in theCompany’s interim consolidated statements of income and cash flows for theinterim periods ended September 30, 2003 and 2002.  Assets and liabilities related to thefinancial services division have been reflected as held for sale in theaccompanying unaudited consolidated balance sheet as of December 31,2002.  The depreciation of long-livedassets related to the financial services division ceased as of January 28,2003, the date of the agreement to sell such operations.

 

In January 2003, ALLTEL also completed thetermination of its business venture with Bradford & Bingley Group.  The business venture, ALLTEL MortgageSolutions, Ltd., a majority-owned consolidated subsidiary of ALLTEL, wascreated in 2000 to provide mortgage administration and information technologyproducts in the United Kingdom.  Unfortunately,the business climate in the United Kingdom limited the venture’s ability toleverage the business across a broad base of customers.  As a result, the operations of ALLTELMortgage Solutions, Ltd. have also been reflected as discontinued operationsand as assets held for sale in the Company’s interim consolidated financialstatements for all periods presented.

 

The following table includes certain summary incomestatement information related to the financial services operations reflected asdiscontinued operations for the three and nine months ended September 30:

 
|                                            |   | Three Months  Ended |   | Nine Months  Ended |   |
|-------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions)                                      |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Revenues  and sales                             |   | $                   | — |               | $      | 214.7 |   | $ | 210.3 |   | $ | 650.1 |   |
| Operating  expenses                             |   | —              |   | 183.7              |   | 148.1 |   | 550.9 |   |
| Operating  income                               |   | —              |   | 31.0               |   | 62.2 |   | 99.2 |   |
| Minority  interest in consolidated partnerships |   | —              |   | 0.9                |   | — |   | 2.7 |   |
| Other  income (expense), net                    |   | —              |   | 1.5                |   | (0.1 | ) | 3.6 |   |
| Gain  on sale of discontinued operations        |   | —              |   | —             |   | 555.1 |   | — |   |
| Pretax  income from discontinued operations     |   | —              |   | 33.4               |   | 617.2 |   | 105.5 |   |
| Income  tax expense                             |   | —              |   | 13.5               |   | 256.2 |   | 42.5 |   |
| Income  from discontinued operations            |   | $                   | — |               | $      | 19.9 |   | $ | 361.0 |   | $ | 63.0 |   |

 

15

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**NOTES TO UNAUDITED INTERIMCONSOLIDATED FINANCIAL STATEMENTS-(Continued)**

          

 

**11.****    Discontinued Operations****, Continued:**

The following table includes certain summary cash flowstatement information related to the financial services operations reflected asdiscontinued operations for the nine months ended September 30:

 
| (Millions)                                           |   | 2003  |      | 2002   |   |
|------------------------------------------------------|--------|-------|-----------|--------|--------|
| Net  cash provided by (used in) operating activities |   | $     | (125.1    | )(a)   | $      | 130.7 |   |
| Net  cash provided by (used in) investing activities |   | 763.4 |  (b) | (92.3  | )      |
| Net  cash used in financing activities               |   | (0.1  | )         | (0.4   | )      |
| Net  cash provided by discontinued operations        |   | $     | 638.2     |   | $      | 38.0 |   |

 

(a)  Includedestimated tax payments of $154.5 million related to the gain realized from thesale of the financial services division to Fidelity National.

 

(b)  Includedcash proceeds of $784.9 million received from the sale of the financialservices division to Fidelity National. The cash proceeds included working capital adjustments of $9.9 million.

 

The following table includes the net assets of thediscontinued financial services operations that are classified as held for salein the accompanying unaudited consolidated balance sheet as ofDecember 31, 2002:

 
| (Millions)                                   |   |   |   |
|----------------------------------------------|--------|--------|--------|
| Current  assets                              |   | $      | 171.2  |   |
| Property,  plant and equipment               |   | 145.0  |   |
| Goodwill                                     |   | 25.8   |   |
| Other  assets                                |   | 196.3  |   |
| Assets  held for sale                        |   | $      | 538.3  |   |
|                                         |   |   |   |
| Current  liabilities                         |   | $      | 109.9  |   |
| Other  liabilities                           |   | 80.6   |   |
| Liabilities  related to assets held for sale |   | $      | 190.5  |   |

 

16

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**ALLTELCORPORATION**

**FORM10-Q**

**PART I -FINANCIAL INFORMATION**

 

**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

**GENERAL**

The following is adiscussion and analysis of the historical results of operations and financialcondition of ALLTEL Corporation (“ALLTEL” or the “Company”).  This discussion should be read inconjunction with the unaudited consolidated financial statements, including thenotes thereto, for the interim periods ended September 30, 2003 and 2002,and the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

**DISPOSAL OF FINANCIAL SERVICES BUSINESS**

On April 1, 2003,ALLTEL completed the sale of the financial services division of its informationservices subsidiary, ALLTEL Information Services, Inc., to Fidelity NationalFinancial Inc. (“Fidelity National”), for $1.05 billion, payable in the form of$775.0 million in cash and $275.0 million in Fidelity National commonstock.  As part of this transaction,Fidelity National acquired ALLTEL’s mortgage servicing, retail and wholesalebanking and commercial lending operations, as well as the community/regionalbank division.  Approximately 5,500employees of the Company transitioned to Fidelity National as part of thetransaction.  As a result of thistransaction, the financial services division has been reflected as discontinuedoperations and as assets held for sale in the Company’s consolidated financialstatements for all periods presented. The telecom division of ALLTEL Information Services, Inc. was retainedby the Company and was not part of the sale transaction with FidelityNational.  The operations of theretained telecom division are included in the communications support servicessegment.  In accordance with Statementof Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segmentsof an Enterprise and Related Information”, all prior period segment informationhas been reclassified to conform to this new financial reporting presentation.

 

In January 2003,ALLTEL completed the termination of its business venture with Bradford &Bingley Group.  The business venture,ALLTEL Mortgage Solutions, Ltd., a majority-owned consolidated subsidiary ofALLTEL, was created in 2000 to provide mortgage administration and informationtechnology products in the United Kingdom. Unfortunately, the business climate in the United Kingdom limited theventure’s ability to leverage the business across a broad base ofcustomers.  As a result, the operationsof ALLTEL Mortgage Solutions, Ltd. were also reflected as discontinuedoperations and as assets held for sale in the Company’s consolidated financialstatements for all periods presented. (See Note 11 to the unaudited interim consolidated financial statementsfor additional information regarding the disposal of the financial servicesoperations.)

 

**ACQUISITIONS**

On August 29, 2003,the Company purchased for $22.8 million in cash a wireless property with apotential service area covering approximately 205,000 potential customers(“POPs”) in an Arizona Rural Service Area (“RSA”).  During the third quarter of 2003, the Company also purchased for$5.7 million in cash additional ownership interests in wireless properties inMississippi, New Mexico and Virginia in which the Company owned a majorityinterest.  On April 1, 2003, theCompany paid $7.5 million to increase its ownership interest from 43 percent toapproximately 86 percent in a wireless property with a potential service areacovering about 145,000 POPs in a Wisconsin RSA.  On February 28, 2003, the Company purchased for $72.0million in cash wireless properties with a potential service area coveringapproximately 370,000 POPs in southern Mississippi, from Cellular XL Associates(“Cellular XL”), a privately held company. Of the total purchase price, ALLTEL paid $64.6 million to Cellular XL atthe date of purchase with the remaining cash payment, subject to adjustments asspecified in the purchase agreement, payable with interest, 12 months after theclosing date.  On February 28,2003, the Company also purchased for $60.0 million in cash the remainingownership interest in wireless properties with a potential service areacovering approximately 355,000 POPs in two Michigan RSAs.  Prior to this acquisition, ALLTEL ownedapproximately 49 percent of the Michigan properties.  Through the completion of these transactions, ALLTEL addedapproximately 147,000 customers.  (SeeNote 4 to the unaudited interim consolidated financial statements foradditional information regarding these acquisitions.)

 

On August 1, 2002,ALLTEL completed its purchase of local telephone properties servingapproximately 589,000 wireline customers in Kentucky from VerizonCommunications, Inc. (“Verizon”) for $1.93 billion in cash.  The acquired wireline properties overlappedALLTEL’s existing wireless service in northeastern Kentucky.  On August 1, 2002, ALLTEL alsocompleted its purchase of substantially all of the wireless properties owned byCenturyTel, Inc. (“CenturyTel”) for approximately $1.59 billion in cash.  Through the completion of this transaction,ALLTEL added properties representing approximately 8.3 million POPs, acquiredapproximately 762,000 customers, and expanded its wireless footprint into newmarkets across Arkansas, Louisiana, Michigan, Mississippi, Texas and Wisconsin.  Also included in the transaction wereminority partnership interests in cellular operations representingapproximately 1.8 million proportionate POPs, and Personal CommunicationsServices (“PCS”) licenses covering 1.3 million POPs in

 

17

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Wisconsin and Iowa.  The accounts and results of operations ofthe acquired wireless and wireline properties are included in the accompanyingconsolidated financial statements from the dates of acquisition.

 

**ACCOUNTING CHANGES**

In May 2003, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity”.  SFAS No. 150, with an effective date of  July 1, 2003, requires all financial instruments included within its scope to beinitially recorded at fair value or settlement value, depending upon the natureof the financial instrument, and subsequently remeasured at each balancesheet date.  Certain of theCompany’s consolidated non-wholly owned wireless partnerships have finite livesspecified in their partnership agreements, and, accordingly, must be legallydissolved and terminated, at a specified future date, usually 50 or 99 yearsafter formation, and the proceeds distributed to the partners.  Under the provisions of SFAS No. 150, theminority interests associated with these partnerships are consideredmandatorily redeemable financial instruments, and as such, would be required tobe reported as liabilities in ALLTEL's consolidated financial statementsinitially measured at settlement value, and subsequently remeasured at eachbalance sheet date with changes in the settlement values reported as a componentof interest expense.

 

On November 7, 2003,the FASB issued Staff Position No. 150-3, “Effective Date, Disclosures, andTransition for MandatorilyRedeemable Financial Instruments of Certain Nonpublic Entities and CertainMandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150”(“FSP No. 150-3”).  FSP No. 150-3deferred indefinitely the recognition and measurement provisions of SFAS No.150 applicable to mandatorily redeemable noncontrolling interests, includingthe minority interests associated with the Company’s consolidated non-whollyowned partnerships with finite lives. Accordingly, the adoption of SFAS No. 150 did not affect the Company’sconsolidated results of operations, financial position, or cash flows as of andfor the three and nine months ended September 30, 2003.

 

Except for certainwireline subsidiaries as further discussed below, the Company adopted SFAS No.143, “Accounting for Asset Retirement Obligations”, effective January 1,2003.  SFAS No. 143 addresses financialaccounting and reporting for obligations associated with the retirement of tangiblelong-lived assets and the associated asset retirement costs.  This standard applies to legal obligationsassociated with the retirement of long-lived assets that result from theacquisition, construction, development, or normal use of the assets.  SFAS No. 143 requires that a liability foran asset retirement obligation be recognized when incurred and reasonablyestimable, recorded at fair value and classified as a liability in the balancesheet.  When the liability is initiallyrecorded, the entity capitalizes the cost and increases the carrying value ofthe related long-lived asset.  Theliability is then accreted to its present value, and the capitalized cost isdepreciated over the estimated useful life of the related asset.  At the settlement date, the entity willrecognize a gain or loss after settlement of the obligation.

 

The Company has evaluatedthe effects of SFAS No. 143 on its operations and has determined that, fortelecommunications and other operating facilities in which the Company owns theunderlying land, ALLTEL has no contractual or legal obligation to remediate theproperty if the Company were to abandon, sell or otherwise dispose of theproperty.  Certain of the Company’s cellsite and switch site operating lease agreements contain clauses requiringrestoration of the leased site at the end of the lease term.  Similarly,certain of the Company's lease agreements for office and retail locations require restorationof the leased site upon expiration of the lease term.  Accordingly, ALLTEL is subject to assetretirement obligations associated with these leased facilities under theprovisions of SFAS No. 143.  The application of SFAS No. 143 to the cell site and switch site operatingleases and the leased office and retail locations did not have a materialimpact on ALLTEL’s consolidated results of operations, financial position orcash flows as of or for the three and nine months ended September 30,2003.

 

In accordance withfederal and state regulations, depreciation expense for the Company’s wirelineoperations has historically included an additional provision for cost ofremoval.  Effective with the adoption ofSFAS No. 143, the additional cost of removal provision will no longer beincluded in depreciation expense, because it does not meet the recognition andmeasurement principles of an asset retirement obligation under SFAS No.143.  On December 20, 2002, theFederal Communications Commission (“FCC”) notified wireline carriers that theyshould not adopt the provisions of SFAS No. 143 unless specifically required bythe FCC in the future.  As a result ofthe FCC ruling, ALLTEL will continue to record a regulatory liability for costof removal for its wireline subsidiaries that follow the accounting prescribedby SFAS No. 71 “Accounting for the Effects of Certain Types ofRegulation”.  For the acquired Kentuckyand Nebraska wireline operations not subject to SFAS No. 71, effectiveJanuary 1, 2003, the Company ceased recognition of the cost of removalprovision in depreciation expense and eliminated the cumulative cost of removalincluded in accumulated depreciation. The cumulative effect of retroactively applying these changes to periodsprior to January 1, 2003, resulted in a non-cash credit of$15.6 million, net of income tax expense of $10.3 million, and was included innet income for the nine months ended September 30, 2003.  The cessation of the cost of removalprovision in depreciation

 

18

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Effective January 1,2003, the Company adopted Emerging Issues Task Force (“EITF”) Issue 00-21“Accounting for Revenue Arrangements with Multiple Deliverables” for all newarrangements entered into on or after that date.  Issue 00-21 addresses the accounting by a vendor for arrangementsunder which it will perform multiple revenue-generating activities.  Specifically, Issue 00-21 addresses how todetermine whether an arrangement involving multiple deliverables contains oneor more units of accounting and how arrangement consideration should bemeasured and allocated to the separate units of accounting.  Upon adoption, the Company ceased deferralof fees assessed to wireless communications customers to activate service anddirect incremental customer acquisition costs incurred in the activation ofservice.  The adoption of Issue 00-21did not have a material impact on the Company’s consolidated results ofoperations for the three and nine months ended September 30, 2003.  (See Note 2 to the unaudited interimconsolidated financial statements for additional information regarding theseaccounting changes.)

 

**CONSOLIDATED RESULTS OF OPERATIONS**
|                                                                    |   | Three Months  Ended  September 30, |    | Nine Months  Ended  September 30, |   |
|-------------------------------------------------------------------------|--------|-----------------------------------------|---------|----------------------------------------|--------|
| (Millions,  except per share amounts)                                   |   | 2003                                    |    | 2002                                   |   | 2003 |   | 2002 |   |
| Revenues  and sales:                                                    |   |                                    |    |                                   |   |   |   |   |   |
| Service  revenues                                                       |   | $                                       | 1,836.1 |                                   | $      | 1,691.3 |   | $ | 5,350.1 |   | $ | 4,694.5 |   |
| Product  sales                                                          |   | 214.1                                   |    | 176.4                                  |   | 616.1 |   | 495.1 |   |
| Total  revenues and sales                                               |   | 2,050.2                                 |    | 1,867.7                                |   | 5,966.2 |   | 5,189.6 |   |
| Costs  and expenses:                                                    |   |                                    |    |                                   |   |   |   |   |   |
| Cost  of services                                                       |   | 575.5                                   |    | 532.6                                  |   | 1,644.3 |   | 1,473.2 |   |
| Cost  of products sold                                                  |   | 272.4                                   |    | 224.4                                  |   | 781.4 |   | 657.4 |   |
| Selling,  general, administrative and other                             |   | 403.4                                   |    | 345.4                                  |   | 1,171.2 |   | 960.6 |   |
| Depreciation  and amortization                                          |   | 312.2                                   |    | 285.9                                  |   | 926.4 |   | 791.2 |   |
| Integration  expenses and other charges                                 |   | —                                  |    | 20.5                                   |   | 19.0 |   | 72.4 |   |
| Total  costs and expenses                                               |   | 1,563.5                                 |    | 1,408.8                                |   | 4,542.3 |   | 3,954.8 |   |
| Operating  income                                                       |   | 486.7                                   |    | 458.9                                  |   | 1,423.9 |   | 1,234.8 |   |
| Non-operating  expense, net                                             |   | (5.1                                    | )       | (1.7                                   | )      | (6.0 | ) | (6.3 | ) |
| Interest  expense                                                       |   | (91.1                                   | )       | (107.5                                 | )      | (287.7 | ) | (245.9 | ) |
| Gain  (loss) on disposal of assets, write-down of investments and other |   | —                                  |    | (4.8                                   | )      | (13.1 | ) | (18.5 | ) |
| Income  from continuing operations before income taxes                  |   | 390.5                                   |    | 344.9                                  |   | 1,117.1 |   | 964.1 |   |
| Income  taxes                                                           |   | 147.7                                   |    | 127.1                                  |   | 422.5 |   | 359.4 |   |
| Income  from continuing operations                                      |   | 242.8                                   |    | 217.8                                  |   | 694.6 |   | 604.7 |   |
| Income  from discontinued operations, net of income taxes               |   | —                                  |    | 19.9                                   |   | 361.0 |   | 63.0 |   |
| Cumulative  effect of accounting change, net of income taxes            |   | —                                  |    | —                                 |   | 15.6 |   | — |   |
| Net  income                                                             |   | $                                       | 242.8   |                                   | $      | 237.7 |   | $ | 1,071.2 |   | $ | 667.7 |   |
| Basic  earnings per share:                                              |   |                                    |    |                                   |   |   |   |   |   |
| Income  from continuing operations                                      |   | $                                       | .78     |                                   | $      | .70 |   | $ | 2.23 |   | $ | 1.95 |   |
| Income  from discontinued operations                                    |   | —                                  |    | .06                                    |   | 1.16 |   | .20 |   |
| Cumulative  effect of accounting change                                 |   | —                                  |    | —                                 |   | .05 |   | — |   |
| Net  income                                                             |   | $                                       | .78     |                                   | $      | .76 |   | $ | 3.44 |   | $ | 2.15 |   |
| Diluted  earnings per share:                                            |   |                                    |    |                                   |   |   |   |   |   |
| Income  from continuing operations                                      |   | $                                       | .78     |                                   | $      | .70 |   | $ | 2.23 |   | $ | 1.94 |   |
| Income  from discontinued operations                                    |   | —                                  |    | .06                                    |   | 1.15 |   | .20 |   |
| Cumulative  effect of accounting change                                 |   | —                                  |    | —                                 |   | .05 |   | — |   |
| Net  income                                                             |   | $                                       | .78     |                                   | $      | .76 |   | $ | 3.43 |   | $ | 2.14 |   |

 

Revenues and salesincreased $182.5 million, or 10 percent, and $776.6 million, or 15 percent, andservice revenues increased $144.8 million, or 9 percent, and $655.6 million, or14 percent, for the three and nine month periods ended September 30, 2003,respectively, compared to the same periods of 2002.  The increases in service revenues in both 2003 periods reflectedgrowth in ALLTEL’s communications customer base resulting primarily fromacquisitions and the corresponding increase in access revenues.  The acquisitions of wireless properties fromCenturyTel, Cellular XL and in Arizona, Michigan andWisconsin, along with the wireline properties acquired from Verizon, accountedfor $87.7 million and $524.0 million of the overall increases in servicerevenues and $94.7 million and $547.1 million of the overall increases in totalrevenues and sales in the three and nine month periods ended September 30,2003, respectively.

 

19

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Product sales increased$37.7 million, or 21 percent, and $121.0 million, or 24 percent, for the threeand nine month periods ended September 30, 2003, respectively, compared tothe same periods of 2002.  The increasesin product sales in both 2003 periods primarily resulted from higher retailprices realized on the sale of wireless handsets and accessories driven bygrowth in gross customer additions and increased retention efforts by theCompany.  The wireless and wirelineacquisitions discussed above accounted for approximately $7.0 million and $23.1million of the overall increases in product sales in the three and nine monthperiods of 2003, respectively.  Productsales also reflected increased sales of telecommunications and data products tonon-affiliates of $17.9 million and $46.6 million in the three and nine monthperiods of 2003, respectively, primarily reflecting increased sales of wirelesshandsets to retailers and other distributors.  

 

Cost of servicesincreased $42.9 million, or 8 percent, and $171.1 million, or 12 percent, forthe three and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The wireless and wireline property acquisitions accounted forapproximately $43.2 million and $190.5 million of the overall increases in costof services in the three and nine month periods of 2003, respectively.  In addition to the effects of theacquisitions, cost of services for both 2003 periods also reflected increasesin network-related costs for the wireless operations resulting from increasedcustomer usage.  Cost of services forboth the three and nine months ended September 30, 2003 also includedincremental expenses of approximately $10.6 million associated with a strikethat began in early June and ended on October 1, 2003, when theCompany signed a new collective bargaining agreement impacting approximately400 ALLTEL employees in Kentucky represented by the Communications Workers ofAmerica.  The increases in cost ofservices attributable to acquisitions, increased wireless network-related costsand incremental expenses associated with the strike were partially offset byreductions in bad debt expense.  Lossessustained from bad debts decreased $18.3 million and $56.4 million in the threeand nine month periods of 2003, respectively, primarily reflecting theCompany’s continued efforts to monitor its customer credit policies, evaluateminimum deposit requirements for high-credit risk customers and improvecollection practices by adding new technologies and proactively managing theefforts of its collection agencies.

 

Cost of products soldincreased $48.0 million, or 21 percent, and $124.0 million, or 19 percent, forthe three and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The increases in cost of products sold in both 2003 periods wereconsistent with the growth in wireless customer activations and the Company’scontinued retention efforts.  Inaddition, the wireless and wireline property acquisitions accounted for $14.0million and $44.2 million of the overall increases in cost of products sold inthe three and nine month periods of 2003, respectively.

 

Selling, general,administrative and other expenses increased $58.0 million, or 17 percent, and$210.6 million, or 22 percent, for the three and nine month periods endedSeptember 30, 2003, respectively, compared to the same periods of 2002.  The wireless and wireline propertyacquisitions accounted for approximately $25.5 million and $115.0 million ofthe overall increases in selling, general, administrative and other expenses inthe three and nine month periods of 2003, respectively.  Increases in advertising costs, primarilyrelated to a new branding campaign, and higher regulatory fees,primarilyassociated with the Universal Service Fund, also contributed to the increasesin selling, general, administrative and other expenses for both 2003periods.  In addition to the effects ofthe acquisitions and increased advertising costs and regulatory fees, theincreases in the three and nine month periods of 2003 also reflected increasedwireless general and administrative expenses primarily resulting from additionalcosts incurred to complete, for various pre-2003 acquisitions, the conversionof these operations to the Company’s billing and operational support systems.

 

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Depreciation andamortization expense increased $26.3 million, or 9 percent, and $135.2 million,or 17 percent, for the three and nine month periods ended September 30,2003, respectively, compared to the same periods of 2002.  The wireless and wireline propertyacquisitions accounted for approximately $18.8 million and $93.1 million of theoverall increases in depreciation and amortization expense in the three andnine month periods of 2003, respectively. In addition to the effects of the acquisitions, depreciation andamortization expense increased $7.5 million and $42.1 million in the three andnine month periods of 2003, respectively, primarily as a result of growth incommunications plant in service.

 

Operating incomeincreased $27.8 million, or 6 percent, and $189.1 million, or 15 percent, forthe three and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The increases in operating income in both periods of 2003 primarilyreflected the growth in revenues and sales, as noted above.  The wireless and wireline propertyacquisitions accounted for approximately $104.3 million of the overall increasein operating income in the nine month period of 2003.  Operating income attributable to the acquisitions declined $6.8million in the three monthperiod of 2003, compared to the same periodof 2002.  The decrease primarilyreflected the incremental strike-related costs discussed above, the effects ofmigrating the acquired CenturyTel operations to ALLTEL’s negotiated roamingrates,increased selling-related expenses due to volume growth in newwireless customer activations, and the additional costs incurred to convert theacquired operations to the Company’s billing and operational supportsystems.  Operating income also includedthe effects of integration expenses and other charges, as further discussedbelow.

 

IntegrationExpenses and Other Charges

Set forth below is asummary of the integration expenses and other charges recorded for the threeand nine month periods ended September 30:

 

|                                                    |   | Three Months Ended |   | Nine Months  Ended |   |
|---------------------------------------------------------|--------|--------------------|--------|--------------------|--------|
| (Millions)                                              |   | 2003               |   | 2002               |   | 2003 |   | 2002 |   |
| Severance  and employee benefit costs                   |   | $                  | — |               | $      | 1.9 |   | $ | 6.3 |   | $ | 15.3 |   |
| Lease  and contract termination costs                   |   | —             |   | 2.2                |   | (0.5 | ) | 14.6 |   |
| Write-down  of cell site equipment                      |   | —             |   | —             |   | — |   | 7.1 |   |
| Write-down  of software development costs               |   | —             |   | —             |   | 13.2 |   | 4.4 |   |
| Computer  system conversion and other integration costs |   | —             |   | 8.6                |   | — |   | 21.0 |   |
| Branding  and signage expense                           |   | —             |   | 7.8                |   | — |   | 7.8 |   |
| Equipment  removal and other disposal costs             |   | —             |   | —             |   | — |   | 2.2 |   |
| Total  integration expenses and other charges           |   | $                  | — |               | $      | 20.5 |   | $ | 19.0 |   | $ | 72.4 |   |

 

During the second quarterof 2003, the Company recorded a restructuring charge of $8.5 million consistingof severance and employee benefit costs related to a planned workforce reduction,primarily resulting from the closing of certain call center locations.  As of September 30, 2003, the Companyhad paid $8.3 million in severance and employee-related expenses, and all ofthe employee reductions had been completed. The Company also recorded a $2.7 million reduction in the liabilitiesassociated with various restructuring activities initiated prior to 2003,consisting of $2.2 million in severance and employee benefit costs and $0.5million in lease termination costs.  Thereduction primarily reflected differences between estimated and actual costspaid in completing the previous planned workforce reductions and leaseterminations.  During the second quarterof 2003, ALLTEL also wrote off certain capitalized software development costs thathad no alternative future use or functionality.

 

During the third quarterof 2002, the Company recorded a restructuring charge of $4.1 million consistingof severance and employee benefit costs of $1.9 million related to a plannedworkforce reduction and $2.2 million of lease termination costs primarilyrelated to the closing of seven product distribution centers.  The lease termination costs consisted of$1.2 million, primarily representing the estimated minimum contractualcommitments over the ensuing one to four years for operating locations that theCompany abandoned, net of anticipated sublease income.  The lease termination costs also included anadditional $1.0 million to reflect the revised estimated costs, net ofanticipated sublease income, to terminate leases associated with four operatinglocations.  ALLTEL had previouslyrecorded $9.1 million in lease termination costs related to these fourlocations ($2.8 million during the first quarter of 2002 and $6.3 million in1999).  The additional charge reflecteda further reduction in expected sublease income attributable primarily tosoftening demand in the commercial real estate market.  The restructuring plan, completed inSeptember 2002, provided for the elimination of 130 employees primarily inthe Company’s product distribution operations. As of September 30, 2003, the Company had paid $1.9 million inseverance and employee-related expenses, and all of the employee reductions hadbeen completed.

 

In connection with thepurchase of wireline properties in Kentucky from Verizon and wirelessproperties from CenturyTel, the Company incurred branding and signage costs of$7.8 million during the third quarter of 2002. In addition, the Company also incurred computer system conversion andother integration costs related to these acquisitions during each of the firstthree quarters of 2002.  These expensesincluded internal payroll and employee benefit costs, contracted services,

 

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and other computer programmingcosts incurred in connection with expanding ALLTEL’s customer service andoperations support functions to handle increased customer volumes resultingfrom the acquisitions and to convert Verizon’s customer billing and operationssupport systems to ALLTEL’s internal systems.

 

During the evaluation ofits existing Competitive Local Exchange Carrier (“CLEC”) operations in 2001,ALLTEL determined that a business model that relied heavily on interconnectionwith other carriers had limited potential for profitably acquiring marketshare.  Accordingly, inJanuary 2002, the Company announced its plans to exit its CLEC operationsin seven states representing less than 20 percent of ALLTEL’s CLEC accesslines.  In the course of exiting thesemarkets, ALLTEL honored all existing customer contracts, licenses and otherobligations and worked to minimize the inconvenience to affected customers bymigrating these customers to other service providers.  In the first quarter of 2002, the Company also consolidated itscall center and retail store operations. In connection with these activities, the Company recorded arestructuring charge consisting of severance and employee benefit costs relatedto a planned workforce reduction, costs associated with terminating certainCLEC transport agreements and lease termination fees incurred with the closingof certain retail and call center locations. In exiting the CLEC operations, the Company also incurred costs todisconnect and remove switching and other transmission equipment from centraloffice facilities and expenses to notify and migrate customers to other serviceproviders.  ALLTEL also wrote offcertain capitalized software development costs that had no alternative futureuse or functionality.  The restructuringplans, completed in March 2002, provided for the elimination of 910employees primarily in the Company’s sales, customer service and networkoperations support functions.  Duringthe fourth quarter of 2002, ALLTEL reduced the liabilities associated withthese restructuring plans by $2.5 million. The reduction primarily reflected differences between estimated andactual costs to exit certain CLEC markets and consisted of $2.0 million inlease termination costs and $0.5 million in severance and employee benefit costs.  As of September 30, 2003, the Companyhad paid $12.1 million in severance and employee-related expenses, and all ofthe employee reductions had been completed.

 

The $12.4 million oflease and contract termination costs recorded in the first quarter of 2002consisted of $5.0 million representing the estimated minimum contractualcommitments over the next one to five years for 31 operating locations that theCompany has abandoned, net of anticipated sublease income.  The lease and contract termination costsalso included $3.6 million of costs to terminate transport agreements with sixinterexchange carriers.  The Companyalso recorded an additional $2.8 million to reflect the revised estimatedcosts, net of anticipated sublease income, to terminate leases associated withfour operating locations.  ALLTEL hadpreviously recorded $6.3 million in lease termination costs related to thesefour locations in 1999.  The additionalcharge reflected a reduction in expected sublease income primarily attributableto softening demand in the commercial real estate market and the bankruptcyfilings by two sublessees.  Finally, thelease termination costs also included $1.0 million of unamortized leaseholdimprovement costs related to the abandoned locations.

 

During the first quarterof 2002, the Company also recorded the final write-down to fair value of thecarrying value of certain cell site equipment. In conjunction with a product replacement program initiated by a vendorin 2001, the Company exchanged certain used cell site equipment for newequipment.  The exchange of cell siteequipment began during the third quarter of 2001 and continued through thefirst quarter of 2002.  As the equipmentexchanges were completed, the Company recorded write-downs to fair value of thecarrying value of the used cell site equipment.

 

At September 30,2003, the unpaid liability related to ALLTEL’s integration and restructuringactivities was $6.5 million, consisting of severance and employee-relatedexpenses of $1.4 million and lease cancellation costs of $5.1 million.  Cash outlays for the remaining unpaidliability are to be paid over the next 12 to 48 months out of operating cashflows.

 

Non-Operating Expense,Net

|                                            |   | Three Months  Ended September 30, |   | Nine Months  Ended September 30, |   |
|-------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
| (Millions)                                      |   | 2003                                   |   | 2002                                  |   | 2003 |   | 2002 |   |
| Equity  earnings in unconsolidated partnerships |   | $                                      | 13.8   |                                  | $      | 20.1 |   | $ | 48.0 |   | $ | 42.5 |   |
| Minority  interest in consolidated partnerships |   | (22.3                                  | )      | (21.0                                 | )      | (61.5 | ) | (54.7 | ) |
| Other  income (expense), net                    |   | 3.4                                    |   | (0.8                                  | )      | 7.5 |   | 5.9 |   |
| Non-operating  expense, net                     |   | $                                      | (5.1   | )                                     | $      | (1.7 | ) | $ | (6.0 | ) | $ | (6.3 | ) |

 

As indicated in the tableabove, non-operating expense, net increased $3.4 million, or 200 percent, anddecreased $0.3 million, or 5 percent, in the three and nine months endedSeptember 30, 2003, respectively, compared to the same periods of2002.  The decrease in equity earningsin unconsolidated partnerships in the three month period of 2003 primarilyresulted from the 2003 acquisitions of additional ownership interests inwireless properties in Michigan and Wisconsin, in which the Company previouslyheld a minority ownership interest.  Theincrease in equity earnings in unconsolidated

 

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partnerships in the ninemonth period of 2003 reflected $7.2 million of additional income resulting fromthe acquisition of certain minority partnership interests from CenturyTel, aspreviously discussed, partially offset by the effects of the acquisitions ofadditional ownership interests in the Michigan and Wisconsin wirelessproperties.  Minority interest expensefor the three and nine month periods of 2003 increased primarily due toimproved earnings in ALLTEL’s majority-owned wireless operations compared to thesame periods of 2002.  In addition, minorityinterest expense for the nine month period of 2003 included $4.0 million ofadditional expense resulting from the acquisition of certain non-wholly ownedpartnership interests from CenturyTel. Other income (expense), net for the three and nine month periods of 2003included additional dividend income of $7.1 million and $9.5 million,respectively, earned on the Company’s equity investments, including FidelityNational common stock.  The increases inother income (expense), net attributable to additional dividend income for both2003 periods were partially offset by net losses of $4.9 million related to thedisposal of certain assets. Conversely, other income (expense), net for the three and nine monthperiods of 2002 included additional interest income of $3.9 million and $8.2million, respectively, from investing the cash proceeds from ALLTEL’s 2002equity unit and long-term debt offerings, as further discussed below.  The increases in other income (expense), netattributable to additional interest income for both 2002 periods were partiallyoffset by net losses of $5.4 million related to the disposal of certain assets.

 

During the second quarterof 2002, to finance the cost of its acquisition of wireline properties inKentucky and wireless properties from CenturyTel completed in the third quarterof 2002, ALLTEL sold 27.7 million equity units and received net proceeds of$1.34 billion.  The equity units had astated amount of $50 per unit and included a purchase contract pursuant towhich the holder agreed to purchase shares of ALLTEL common stock onMay 17, 2005.  ALLTEL will makequarterly contract adjustment payments to the holders at the rate of 1.50percent of the stated amount per year. The number of shares to be purchased will be determined at the time thepurchase contracts are settled based on the then current price of ALLTEL’scommon stock and will range between 0.8280 and 1.0101 shares of ALLTEL commonstock per equity unit.  The equity unitsalso included $50 principal amount of senior notes, which bear interest at 6.25percent and mature on May 17, 2007. In June 2002, the Company also issued $1.5 billion of unsecuredlong-term debt consisting of $800.0 million of 7.0 percent senior notes dueJuly 1, 2012 and $700.0 million of 7.875 percent senior notes dueJuly 1, 2032.  Net proceeds fromthe debt issuance were $1.47 billion, after deducting the underwriting discountand other offering expenses.  The net proceedsfrom the issuance of the equity units and debt securities of $2.81 billion wereinvested until completion of the acquisitions.

 

Interest Expense

Interest expensedecreased $16.4 million, or 15 percent, and increased $41.8 million, or 17percent, in the three and nine month periods ended September 30, 2003,respectively, compared to the same periods of 2002.  The decrease in the three month period of 2003 reflected therepayment of $565.6 million of long-term debt during the second quarter of2003, primarily consisting of $310.0 million of borrowings outstanding underALLTEL’s commercial paper program and $249.1 million of long-term debtoutstanding under the Rural Utilities Services, Rural Telephone Bank andFederal Financing Bank programs.  Therepayment of long-term debt was funded primarily from the cash proceedsreceived from the sale of the financial services division to Fidelity Nationalpreviously discussed.  The increase inthe nine month period of 2003 primarily reflected the additional interestexpense resulting from ALLTEL’s equity unit and long-term debt offeringsdiscussed above, partially offset by the effects of second quarter 2003 debtrepayments.

 

Gain (Loss) onDisposal of Assets, Write-down of Investments and Other

In the second quarter of2003, ALLTEL recorded pretax write-downs totaling $6.0 million to reflect other-than-temporarydeclines in the fair value of certain investments in unconsolidated limitedpartnerships.  As previously discussed,during the second quarter of 2003, ALLTEL retired, prior to stated maturitydates, $249.1 million of long-term debt, representing all of the debtoutstanding under the Rural Utilities Services, Rural Telephone Bank andFederal Financing Bank programs. In connection with the early retirement ofthis debt, the Company incurred pretax termination fees of $7.1 million.

 

In the third quarter of2002, the Company recorded a pretax adjustment of $4.8 million to reduce thegain recognized from the dissolution of a wireless partnership with BellSouthMobility, Inc. (“BellSouth”).  This gainassociated with this transaction was initially recorded by ALLTEL in 2001.  This additional adjustment reflected atrue-up for cash distributions payable to BellSouth in conjunction with thedissolution of the partnership.

 

In the second quarter of2002, ALLTEL recorded a pretax write-down of $12.5 million on its investment inHughes Tele.com Limited (“HTCL”), a public company and provider ofcommunications services in India.  Thewrite-down was recorded in connection with HTCL’s agreement to merge with amajor Indian telecommunications company and an other-than-temporary decline inthe fair value of HTCL’s common stock. In addition, the Company also recorded a pretax write-down of $1.2million related to an other-than-temporary decline in ALLTEL’s investment inAirspan Networks, Inc., a provider of wireless telecommunications equipment.

 

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Income Taxes

Income tax expenseincreased $20.6 million, or 16 percent, and $63.1 million, or 18 percent, forthe three and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The increases in income tax expense in both periods of 2003 wereconsistent with the overall growth in the Company’s earnings from continuingoperations.

 

Average CommonShares Outstanding

The average number ofcommon shares outstanding increased slightly in the three and nine monthperiods ended September 30, 2003, compared to the same periods of2002.  The increases primarily reflectedadditional shares issued upon the exercise of options granted under ALLTEL’semployee stock-based compensation plans.

 

DiscontinuedOperations

As previously discussed,as a result of the April 1, 2003 sale of the financial services divisionto Fidelity National and the January 2003 termination of ALLTEL’s businessventure with Bradford & Bingley Group, the Company’s financial servicesoperations have been reflected as discontinued operations in ALLTEL’s interimconsolidated financial statements.  Thefollowing table includes certain summary income statement information relatedto the financial services operations reflected as discontinued operations forthe three and nine months ended September 30:

 

|                                            |   | Three Months  Ended |   | Nine Months  Ended |   |
|-------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions)                                      |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Revenues  and sales                             |   | $                   | — |               | $      | 214.7 |   | $ | 210.3 |   | $ | 650.1 |   |
| Operating  expenses                             |   | —              |   | 183.7              |   | 148.1 |   | 550.9 |   |
| Operating  income                               |   | —              |   | 31.0               |   | 62.2 |   | 99.2 |   |
| Minority  interest in consolidated partnerships |   | —              |   | 0.9                |   | — |   | 2.7 |   |
| Other  income (expense), net                    |   | —              |   | 1.5                |   | (0.1 | ) | 3.6 |   |
| Gain  on sale of discontinued operations        |   | —              |   | —             |   | 555.1 |   | — |   |
| Pretax  income from discontinued operations     |   | —              |   | 33.4               |   | 617.2 |   | 105.5 |   |
| Income  tax expense                             |   | —              |   | 13.5               |   | 256.2 |   | 42.5 |   |
| Income  from discontinued operations            |   | $                   | — |               | $      | 19.9 |   | $ | 361.0 |   | $ | 63.0 |   |

 

See Note 11 to theunaudited interim consolidated financial statements for additional informationregarding the discontinued operations.

 

**RESULTS OF OPERATIONS BY BUSINESS SEGMENT**

Communications-WirelessOperations

|                                        |   | Three Months  Ended  September 30, |    | Nine Months  Ended  September 30, |   |
|---------------------------------------------|--------|-----------------------------------------|---------|----------------------------------------|--------|
| (Millions,  except customers in thousands)  |   | 2003                                    |    | 2002                                   |   | 2003 |   | 2002 |   |
| Revenues  and sales:                        |   |                                    |    |                                   |   |   |   |   |   |
| Service  revenues                           |   | $                                       | 1,163.8 |                                   | $      | 1,053.2 |   | $ | 3,338.4 |   | $ | 2,933.5 |   |
| Product  sales                              |   | 69.4                                    |    | 40.8                                   |   | 198.0 |   | 107.3 |   |
| Total  revenues and sales                   |   | 1,233.2                                 |    | 1,094.0                                |   | 3,536.4 |   | 3,040.8 |   |
| Costs  and expenses:                        |   |                                    |    |                                   |   |   |   |   |   |
| Cost  of services                           |   | 335.6                                   |    | 328.1                                  |   | 960.0 |   | 893.4 |   |
| Cost  of products sold                      |   | 141.7                                   |    | 102.5                                  |   | 405.4 |   | 315.8 |   |
| Selling,  general, administrative and other |   | 318.5                                   |    | 257.2                                  |   | 909.1 |   | 712.1 |   |
| Depreciation  and amortization              |   | 169.0                                   |    | 149.4                                  |   | 495.5 |   | 418.2 |   |
| Total  costs and expenses                   |   | 964.8                                   |    | 837.2                                  |   | 2,770.0 |   | 2,339.5 |   |
| Segment  income                             |   | $                                       | 268.4   |                                   | $      | 256.8 |   | $ | 766.4 |   | $ | 701.3 |   |
| Customers                                   |   | 7,928.1                                 |    | 7,558.9                                |   | — |   | — |   |
| Gross  customer additions (a)               |   | 705.8                                   |    | 1,362.9                                |   | 2,159.9 |   | 2,490.6 |   |
| Net  customer additions (a)                 |   | 55.8                                    |    | 715.5                                  |   | 326.4 |   | 876.0 |   |
| Market  penetration                         |   | 13.1                                    | %       | 12.7                                   | %      | — |   | — |   |
| Postpaid  customer churn                    |   | 2.20                                    | %       | 2.18                                   | %      | 2.13 | % | 2.23 | % |
| Total  churn                                |   | 2.75                                    | %       | 2.42                                   | %      | 2.62 | % | 2.40 | % |
| Average  revenue per customer per month     |   | $                                       | 49.10   |                                   | $      | 47.84 |   | $ | 47.59 |   | $ | 46.96 |   |
| Cost  to acquire a new customer (b)         |   | $                                       | 305     |                                   | $      | 310 |   | $ | 304 |   | $ | 315 |   |

 

24

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Notesto Communications-Wireless Operations Table:

(a)  Includesthe effects of acquisitions and dispositions. Excludes reseller customers for all periods presented.

 

(b)  Costto 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”) by the number of internal grosscustomer additions during the period. Customer acquisition costs exclude amounts related to the Company’scustomer retention efforts.  A reconciliationof the revenues, expenses and customer additions used in computing cost toacquire a new customer was as follows for the three and nine month periodsended September 30:

 

|                                              |   | Three Months  Ended |   | Nine Months  Ended |   |
|---------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions,  except customers in thousands)        |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Product  sales                                    |   | $                   | (48.1  | )                  | $      | (30.3 | ) | $ | (131.0 | ) | $ | (82.3 | ) |
| Cost  of products sold                            |   | 79.9                |   | 63.3               |   | 219.8 |   | 204.7 |   |
| Sales  and marketing expense                      |   | 181.8               |   | 153.1              |   | 523.2 |   | 422.7 |   |
| Total  costs incurred to acquire new customers    |   | $                   | 213.6  |               | $      | 186.1 |   | $ | 612.0 |   | $ | 545.1 |   |
| Gross  customer additions, excluding acquisitions |   | 699.7               |   | 601.2              |   | 2,012.5 |   | 1,728.9 |   |
| Cost  to acquire a new customer                   |   | $                   | 305    |               | $      | 310 |   | $ | 304 |   | $ | 315 |   |

 

The total number ofwireless customers served by ALLTEL increased by more than 369,000 customers,or 5 percent, during the twelve month period ended September 30,2003.  As previously discussed, during2003, the Company has purchased wireless properties in Arizona, Michigan,Mississippi and Wisconsin.  Theseacquisitions accounted for approximately 147,000 of the overall increase inwireless customers that occurred during the foregoing twelve month period endedSeptember 30, 2003.  Overall, theCompany’s wireless market penetration rate (number of customers as a percent ofthe total population in ALLTEL’s service areas) increased to 13.1 percent as ofSeptember 30, 2003.

 

Excluding the effects ofthe acquisitions, net customer additions were approximately 50,000 and 179,000for the three and nine month periods ended September 30, 2003,respectively, compared to approximately 68,000 and 228,000 for thecorresponding periods in 2002. Heightened competition and increased penetration levels continued toaffect customer growth rates in the wireless industry during the first ninemonths of 2003.  The level of customergrowth during the balance of 2003 will be dependent upon the Company’s abilityto attract new customers in an increasingly competitive marketplace currentlysupporting up to seven competitors in each market.  The Company will continue to focus its efforts on sustainingvalue-added customer growth by managing its distribution channels and customersegments, offering attractively priced rate plans and enhanced services andother features, selling additional phone lines and services to existingcustomers and pursuing strategic acquisitions.

 

The Company continues tofocus its efforts on lowering postpaid customer churn (average monthly rate ofcustomer disconnects).  During thesecond quarter of 2003, the Company launched a new advertising campaign focusedon ALLTEL’s commitment to improve overall service quality to itscustomers.  To improve customerretention, the Company offers competitively priced rate plans, proactivelyanalyzes customer usage patterns and migrates customers to digitalhandsets.  The Company also continues toupgrade its telecommunications network in order to offer expanded networkcoverage and quality and to provide enhanced service offerings to itscustomers.  Postpaid customer churnremained flat in the three month period and decreased in the nine month periodended September 30, 2003, compared to the same periods of 2002.  The decrease in the nine month period of2003 primarily resulted from lower disconnects among the Company’s nationalrate plan customers, fewer involuntary disconnects and the effects of the newadvertising campaign.  Total churnincreased in both 2003 periods primarily resulting from an increase in theactual number of prepaid customer disconnects during the three and nine monthperiods ended September 30, 2003, as compared to the same periods in 2002,primarily driven by the Company’s decision to phase-out offering unlimitedprepaid service in 11 markets. Customers subscribing to these prepaid plans represent less than onepercent of the Company’s total wireless customer base.

 

Wireless revenues andsales increased $139.2 million, or 13 percent, and $495.6 million, or 16percent, for the three and nine months ended September 30, 2003,respectively, compared to the same periods of 2002.  Service revenues increased $110.6 million, or 11 percent, and$404.9 million, or 14 percent, and product sales revenues increased $28.6million, or 70 percent, and $90.7 million, or 85 percent, in the three and ninemonth periods ended September 30, 2003, respectively, when compared to thesame periods of 2002.

 

Service revenuesincreased in both 2003 periods primarily resulting from growth in ALLTEL’scustomer base and the resulting increases in access revenues.  The acquisitions of wireless properties inArizona, Michigan, Mississippi, Wisconsin and from CenturyTel accounted forapproximately $54.7 million and $277.0 million of the overall increases inservice revenues for the three and nine month periods ended September 30,2003, respectively.  In addition to theeffects of the acquisitions, access revenues increased $63.4 million and $159.7million in the three and nine month periods of 2003,

 

25

----

 

respectively, primarilybecause of nonacquisition-related customer growth, increased sales of the Company’shigher-yield Total and National Freedom rate plans and continued growth inaverage monthly minutes of use per customer. Service revenues in both 2003 periods also reflected increases inrevenues earned from data messaging services and from the sale of enhancedservices, including call identification, voicemail and equipment protectionplans.  Revenues from data and enhancedservices increased $11.3 million and $32.3 million in the three and nine monthperiods ended September 30, 2003, respectively, reflecting increaseddemand for these service offerings.  Inaddition, service revenues for both 2003 periods reflected increases in theamounts billed to customers to offset costs related to certain regulatory mandates,including universal service funding, primarily resulting from changes in FCCregulations applicable to universal service fees that were effective onApril 1, 2003.

 

Service revenue growth inthe three and nine month periods ended September 30, 2003 attributable tocustomer growth, acquisitions, increased access revenues and regulatory fees,and additional revenues earned from data and enhanced services was partiallyoffset by lower airtime and retail roaming revenues of $26.3 million and $91.0million, respectively.  The decreases inairtime and retail roaming revenues primarily reflected the expansion of local,regional and national calling areas and a decrease in wholesale roaming rates.

 

Average revenue percustomer per month in the three and nine month periods ended September 30,2003 increased 3 percent and 1 percent, respectively, compared to thecorresponding periods of 2002.  Theincreases in both 2003 periods primarily resulted from increased sales of theCompany’s higher-yield Total and National Freedom rate plans and growth in averageminutes of use per customer per month, partially offset by decreased wholesaleroaming rates and slightly dilutive effects of migrating the acquiredCenturyTel markets to ALLTEL’s roaming rate structure.  The increase in regulatory mandate feesbilled to customers did not have a significant impact on average revenue percustomer per month for the three and nine month periods endedSeptember 30, 2003.  Growth inservice revenues and average revenue per customer per month during 2003 willdepend upon ALLTEL’s ability to maintain market share in an increasinglycompetitive marketplace by adding new customers, retaining existing customers,increasing customer usage, and selling data and additional enhanced services.

 

The increases in productsales in both 2003 periods primarily resulted from higher retail prices, growthin gross customer additions and increased retention efforts by the Companyfocused on migrating existing wireless customers to new digitaltechnologies.  In addition, theacquisitions of wireless properties discussed above accounted for approximately$6.5 million and $18.1 million of the overall increases in product sales in thethree and nine month periods ended September 30, 2003, respectively.

 

Cost of servicesincreased $7.5 million and $66.6 million, or 2 percent and 7 percent, for thethree and nine month periods ended September 30, 2003, respectively,compared to the same periods in 2002. The wireless property acquisitions accounted for $17.5 million and $87.1million of the overall increases in cost of services in the three and ninemonth periods ended September 30, 2003, respectively.  In addition to the effects of theacquisitions, cost of services reflected increases in network-related costs of$7.9 million and $31.4 million in the three and nine months endedSeptember 30, 2003, respectively, primarily as a result of increasednetwork traffic from customer growth and expansion of calling areas. Theincreases in cost of services in both 2003 periods attributable to acquisitionsand increased network-related costs were partially offset by decreases in baddebt expense.  Compared to the sameperiods of 2002, bad debt expense decreased $20.5 million and $53.3 million inthe three and nine month periods ended September 30, 2003, respectively.  The reductions in bad debt expense in both2003 periods primarily resulted from the Company’s continued efforts to reducelosses sustained from bad debts by monitoring its customer credit policies,evaluating minimum deposit requirements for high-credit risk customers, andimproving collection practices by adding new technologies and proactivelymanaging the efforts of the Company’s collection agencies.

 

Cost of products soldincreased $39.2 million and $89.6 million, or 38 percent and 28 percent, for thethree and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The acquisitions of wireless properties accounted for approximately$13.1 million and $39.5 million of the overall increases in cost of products soldin the three and nine month periods ended September 30, 2003,respectively.  In addition to theeffects of the acquisitions, cost of products sold increased in both 2003periods primarily as a result of growth in gross customer activations, theselling of higher-priced digital phones and the Company’s continuing efforts tomigrate customers from analog to digital equipment as part of ALLTEL’s customerretention efforts.

 

Selling, general,administrative and other expenses increased $61.3 million and $197.0 million,or 24 percent and 28 percent, for the three and nine month periods endedSeptember 30, 2003, respectively, compared to the same periods of2002.  The acquisitions of wirelessproperties accounted for approximately $23.1 million and $90.5 million of theoverall increases in selling, general, administrative and other expenses in thethree and nine month periods ended September 30,

 

26

----

 

2003, respectively.  In addition to the effects of the acquisitions,selling, general, administrative and other expenses for the three and ninemonth periods of 2003 also reflected increases in regulatory fees, advertisingcosts, data processing charges and general and administrative expenses.  Costs associated with regulatory fees,principally related to the Universal Service Fund, increased $14.4 million and$24.3 million in the three and nine month periods of 2003, respectively,primarily due to changes in FCC regulations effective April 1, 2003.  Advertising costs also increased $9.1million and $19.7 million in the three and nine month periods endedSeptember 30, 2003, respectively, primarily due to increased promotionalactivities, including the launch of a new advertising campaign, as previouslydiscussed.  Data processing costs alsoincreased $3.6 million and $10.4 million in the three and nine month periods of2003, respectively, consistent with non-acquisition-related customergrowth.  General and administrativeexpenses increased $10.7 million and $37.6 million in the three and nine monthperiods of 2003, respectively, primarily due to additional costs incurred tocomplete, for various pre-2003 acquisitions, the conversion of these operationsto ALLTEL’s billing and operational support systems.

 

Depreciation andamortization expense increased $19.6 million and $77.3 million, or 13 percentand 18 percent, for the three and nine month periods ended September 30,2003, respectively, compared to the same periods of 2002.  The acquisitions of wireless properties accountedfor approximately $9.7 million and $35.8 million of the overall increases indepreciation and amortization expense in the three and nine month periods endedSeptember 30, 2003, respectively. In addition to the effects of the acquisitions, depreciation andamortization expense increased in both 2003 periods primarily as a result ofgrowth in wireless plant in service consistent with ALLTEL’s plans to expandand upgrade its network facilities.

 

Primarily as a result ofgrowth in revenues and sales as discussed above, wireless segment incomeincreased $11.6 million and $65.1 million, or 5 percent and 9 percent, for thethree and nine month periods ended September 30, 2003, respectively,compared to the same periods of 2002. The wireless property acquisitions accounted for approximately $42.2million of the overall increase in wireless segment income in the nine monthperiod ended September 30, 2003. Although revenues and sales attributable to the wireless propertyacquisitions increased $61.2 million in the three month period of 2003,the corresponding increase in operating expenses of $63.4 million more thanoffset the growth in revenues.  Thereduction in operating margin in the three month period of 2003 attributable tothe acquisitions primarily reflected the effects of transitioning the acquiredCenturyTel properties to ALLTEL’s negotiated wholesale roaming rates, increasedselling-related expenses due to volume growth in new customer activations andthe additional costs incurred to convert the acquired operations toALLTEL’s billing and operational support systems.

 

Cost to acquire a newcustomer is used to measure the average cost of adding a new customer andrepresents sales, marketing and advertising costs and the net equipment cost,if any, for each new customer added. Cost to acquire a new customer decreased in both the three and ninemonth periods ended September 30, 2003 primarily due to the effects ofspreading the customer acquisition costs over a proportionately higher numberof gross customer additions as compared to the corresponding periods of2002.  In addition, reduced subsidies onthe sale of wireless handsets to new customers, partially offset by theincrease in advertising costs previously discussed also contributed to theoverall decreases in cost to acquire a new customer in both 2003 periods.  The improved margins on the sale of wirelesshandsets primarily reflected increased retail prices associated with theselling of higher-priced digital phones and the effects of increased vendorrebates and purchase volume discounts received by ALLTEL.

 

Set forth below is asummary of the integration expenses and other charges related to the wirelessoperations that were not included in the determination of segment income forthe three and nine months ended September 30:

 

|                                                    |   | Three Months  Ended |   | Nine Months  Ended |   |
|---------------------------------------------------------|--------|---------------------|--------|--------------------|--------|
| (Millions)                                              |   | 2003                |   | 2002               |   | 2003 |   | 2002 |   |
| Severance  and employee benefit costs                   |   | $                   | — |               | $      | 0.2 |   | $ | 1.3 |   | $ | 6.4 |   |
| Lease  and contract termination costs                   |   | —              |   | (0.3               | )      | — |   | 5.2 |   |
| Write-down  of cell site equipment                      |   | —              |   | —             |   | — |   | 7.1 |   |
| Write-down  of software development costs               |   | —              |   | —             |   | 7.6 |   | 0.3 |   |
| Branding  and signage expense                           |   | —              |   | 4.1                |   | — |   | 4.1 |   |
| Computer  system conversion and other integration costs |   | —              |   | 2.2                |   | — |   | 4.1 |   |
| Total  integration expenses and other charges           |   | $                   | — |               | $      | 6.2 |   | $ | 8.9 |   | $ | 27.2 |   |

 

RegulatoryMatters-Wireless Operations

The Company is subject toregulation by the FCC as a provider of wireless communications services.  The Telecommunications Act of 1996 (the “96Act”) provides wireless carriers numerous opportunities to provide analternative to the long-distance and local exchange services provided by localexchange telephone companies and interexchange carriers.  Wireless carriers are also entitled tocompensation from other telecommunications carriers for

 

27

----

 

calls transmitted fromthe other carriers’ networks and terminated on the wireless carriers’networks.  Presently, the Company’swireless operations do not bill access charges to interexchange carriers,although a FCC decision issued on referral from the U.S. District Court for theWestern District Court of Missouri (the “State District Court”) noted thatwireless operators are not precluded from billing these access charges.  Oral arguments in the State District Courtproceeding concerning the collection of access charges by wireless carriersfrom interexchange carriers are scheduled for later this year.  In April 2001, the FCC released anotice of proposed rulemaking addressing inter-carrier compensationissues.  Under this rulemaking, the FCChas proposed a “bill and keep” compensation method that would overhaul theexisting rules governing reciprocal compensation and access charge regulation.  A further notice of proposed rulemaking onthis matter is expected in the first quarter of 2004.  Individual wireless carriers have filed a number of petitionswith the FCC seeking determinations as to the type and amount of compensationdue to and from local exchange carriers and/or interexchange carriers for thetermination of traffic.  Further,various wireline companies have initiated a number of state proceedings toaddress inter-carrier compensation for traffic that originates or terminates onwireless carriers’ networks.  Theoutcome of the FCC and state proceedings could change the way ALLTEL receivescompensation from and pays compensation to other carriers as well as itswireless customers.  At this time,ALLTEL cannot estimate whether any such changes will occur or, if they do, whatthe effect of the changes would be on its wireless revenues and expenses.

 

Under rules establishedby the FCC, Cellular Radiotelephone Service (“CRS”) and PCS providers wererequired, as of November 24, 2002, to participate in a nationwide numberconservation program known as thousand block number pooling in accordance withroll-out schedules established by the FCC. These providers must modify their networks to comply with FCC andindustry performance criteria for number pooling, including support for roamingcustomers.  Number pooling is aFCC-mandated program intended to alleviate the shortage of available telephonenumbers by requiring carriers to return unused numbers in their inventory to acentrally administered pool and taking assignment of new numbers in blocks of1,000 instead of the 10,000 number blocks previously assigned.  In a decision released June 18, 2003,the FCC affirmed that all carriers must participate in the nationwide poolingroll-out.  The FCC exempted small andrural Commercial Mobile Radio Services (“CMRS”) and local exchange carriersfrom the pooling requirement until such time as they implement local numberportability in response to a specific request from another carrier.

 

FCC rules also requirethat CMRS providers implement wireless local number portability (“WLNP”), topermit customers to retain their existing telephone number when moving from onetelecommunications carrier to another. On July 26, 2002, the FCC extended the date for compliance with theFCC requirements for WLNP by one year to November 24, 2003.  The FCC, on June 18, 2003, released therules governing the number of Metropolitan Statistical Areas (“MSAs”) in whichWLNP must be deployed, as well as the process for triggering a carrier’sobligation to provide WLNP in markets both within those MSAs andotherwise.  The FCC retained therequirement that carriers implement WLNP based upon the specific request ofanother carrier and gave the state public service commissions authority torequire CMRS carriers to implement WLNP in any market within the top 100 MSAsin which they provide service and for which a request was not received from acompeting carrier.

 

On October 7, 2003,the FCC released a decision providing guidance to carriers on certain WLNPimplementation issues that had been raised in two petitions for declaratoryrulings filed by the Cellular Telecommunications Industry Association (“CTIA”)and to resolve related issues raised through the appeal of a July 3, 2003letter from the Chief of the Wireless Telecommunications Bureau of theFCC.  In general, the FCC decision noted that porting numbers between carriersshould be performed without obstruction, including any delay related toefforts to collect outstanding balances; porting intervals should be governed bya “reasonableness standard” using the industry’s suggested 2.5 hour portinginterval as the reference point; written interconnection agreements between carriersinvolved in porting are not required; and carriers must continue to supportnationwide roaming.  

 

On June 6, 2003, theU.S. Court of Appeals for the District of Columbia Circuit (the “U.S. DistrictCourt”) ruled on the appeal of the FCC’s decision denying Verizon Wireless’petition seeking forbearance of the CMRS carriers’ obligation to provideWLNP.  The U.S. District Court foundthat the FCC’s refusal to forbear was reasonable inasmuch as WLNP was usefuland necessary to further the public interest under Section 10 of theCommunications Act of 1934 (the “34 Act”). The U.S. District Court, however, did not rule on whether the FCC wasempowered by Congress to require WLNP, finding that challenge to the FCC’sauthority was not properly placed before it. Since the U.S. District Court’sdecision, numerous petitions, including the CTIA petitions for declaratoryruling, were filed with the FCC seeking guidance on the terms and conditionsunder which carriers will implement WLNP, as well as questioning the FCC’sunderlying authority to require implementation.  In response to the FCC inaction on the petitions, the petitionerssought mandamus orders from the U.S. District Court to compel FCC action.  On October 28, 2003, the U.S.DistrictCourt denied the carrier’s petition for mandamus asserting that the FCClacked authority to impose WLNP obligations on wireless carriers.  The petitionfor mandamus filed by CTIA remains pending before the U.S. District Court. 

 

28

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OnNovember 10, 2003, the FCC released a decision addressing the CTIA petitions andproviding guidance on wireline to wireless porting, which is referred to as"intermodal porting". The FCC stated that number porting from awireline carrier to a wireless carrier is required where the coverage area ofthe wireless carrier (i.e. the area in which the wireless carrier providesservice) overlaps the geographic location in which the wireline number wasprovisioned. Further, while the FCC required the wireless carrier to maintainthe rate center designation of the number, it also noted that wireless carriers were not required to have either direct connections or interconnectionagreements with wireline carriers nor were wireless carriers required to havenumbering resources in the rate center in which the wireline number is locatedin order to subject the wireline number to intermodal porting. The Companybelieves the FCC's guidance requires that wireline numbers be portedto wireless carriers across traditional wireline rate centers, although the FCCleft issues governing the payment of call routing costs to another pendingproceeding. This requirement will take effect on November 24, 2003 for wirelinecarriers in the top 100 MSAs, and on May 24, 2003 for wireline carriersoperating in markets below the top 100 MSAs. While the CTIA petition formandamus remains pending before the U.S. District Court, the Company believesthat the recent FCC action effectively renders it moot, although theU.S. District Court could rule on the petition at any time. At this time, theCompany cannot determine whether any carrier will appeal the FCC's decision,what the basis of any such appeal would be, or the potential outcome of any suchappeal.  The Company at this time cannot fully quantify the effects on itscommunications operations of implementing WLNP, although it is likely that these requirements wouldresult in a significant increase in both its operating costs and customer churnrates.
 

In addition, wirelessservice carriers must also provide enhanced 911 emergency service (“E-911”) ina two-phased approach.  In phase one,carriers must, within six months of receiving a request from a phase oneenabled Public Safety Answering Point (“PSAP”), deliver both the caller’snumber and the location of the cell site to the PSAP serving the geographicterritory from which the E-911 call originated.  A phase one enabled PSAP is generally one that is capable ofreceiving and utilizing the number and location data transmitted by thecarrier.  ALLTEL has generally compliedwith the phase one requirements and provides service to phase one capablePSAPs.  Due to the status of the PSAPs,as well as other technology and deployment issues, the six month window inwhich service is to be provided under the FCC rules has, in certain instances,been extended by mutual agreement between ALLTEL and the particular PSAPsinvolved.  In phase two, CMRS carriersopting for a handset-based solution, as the Company has, must determine fororiginated calls the location of the caller within fifty meters for 67 percentof the originated calls and 150 meters for 95 percent of the originated calls.The phase two requirements were set to begin by October 1, 2001, but, dueto technology unavailability and other factors, the Company requested a limitedwaiver of these requirements, as did virtually every other carrier.  On July 26, 2002, the FCC released anorder granting a temporary stay of the E-911 emergency implementation rules asthey applied to the Company.  The FCCorder provides for a phased-in deployment of Automatic Location Identification(“ALI”) capable network or handset-based technology that began on March 1,2003.  ALI capability will permitimmediate identification of the caller’s location by PSAPs.  Under the FCC order, the Company, which haschosen to employ handset-based ALI technology, (1) is selling and activating ALI-capable handsets; (2) is ensuring thatat least 25 percent of all new handsets activated are ALI-capable; (3) willensure that at least 50 percent of all new handsets activated are ALI-capableno later than November 30, 2003; (4) will ensure that 100 percent of itsdigital handsets activated are ALI-capable by May 31, 2004; and (5) willensure that penetration of ALI-capable handsets among its customers reaches 95percent no later than December 31, 2005. ALLTEL began selling ALI-capable handsets in June 2002 and hascomplied with the handset deployment thresholds under the FCC’s order.  ALLTEL fully expects to comply with theremaining requirements.  Although atthis time, the Company cannot fully quantify the effects on its communicationsoperations of implementing ALI technology, ALLTEL believes these requirements,when fully implemented, could result in a significant increase in its operatingcosts.

 

On April 14, 2003,the Company filed petitions with the FCC seeking status as an EligibleTelecommunications Carrier (“ETC”) in the states of Alabama and Virginia inorder to obtain high cost loop support for both rural and non-rural areas fromthe federal Universal Service Fund (“USF”). Various carriers and associations have submitted comments to the FCC onthese applications both in support and opposition to ALLTEL’s requested ETCstatus.  Additional filings with the FCC for ETC status in the states of Georgia and North Carolina were made onAugust 26, 2003, and an application for ETC status in the State of Floridais expected to be filed shortly.  ALLTELhas filed and received approval of applications for ETC designation inMichigan, Wisconsin and West Virginia. Further, ALLTEL is currently pursuing ETC designation by the statecommission in six other states in which the Company provides wireless service,and anticipates filing in other states very soon.  Although status as an ETC would qualify the Company for USFfunds, any resulting subsidies would likely not commence until thebeginning of 2004.  The FCC, in conjunctionwith the Federal/State Joint Board on Universal Service, is considering changesto the USF program, including the services qualified for USF support and thequalifications of ETCs.  At this time,ALLTEL cannot estimate whether any such changes will occur or, if they do, whatthe effect of the changes on its wireless revenues and expenses would be.

 

 

29
In July 2003, theFCC unanimously adopted an order modifying the wireless phone exemption to theHearing Aid Compatibility Act and adopted requirements governing thecompatibility of hearing aids and wireless phones.  The decision requires that interference to hearing aids fromdigital wireless phones be reduced, and that carriers make available wirelessphone models engineered to reduce radio frequency interference to hearingaids.  In October 2003, the FCCissued its long awaited order in the proceeding governing the sale or leasingof spectrum in the secondary market. The decision revises standards for transfer of control and provides newoptions for the lease of spectrum to providers of new wirelesstechnologies.  At this time, ALLTEL hasnot fully evaluated the effects, if any, that these orders may have on ALLTEL’sexisting wireless operations.
 

Communications-WirelineOperations

 

 

Three Months  Ended  September 30,

 

Nine Months  Ended  September 30,

 

(Millions,  access lines in thousands)

 

2003

 

2002

 

2003

 

2002

 

Revenues  and sales:

 

 

 

 

 

 

 

 

 

Local  service

 

$

283.9

 

$

269.5

 

$

854.1

 

$

732.3

 

Network  access and long-distance

 

260.3

 

249.8

 

784.0

 

681.7

 

Miscellaneous

 

61.0

 

56.4

 

182.2

 

158.0

 

Total  revenues and sales

 

605.2

 

575.7

 

1,820.3

 

1,572.0

 

Costs  and expenses:

 

 

 

 

 

 

 

 

 

Cost  of services

 

195.7

 

171.2

 

563.3

 

469.5

 

Cost  of products sold

 

7.4

 

6.5

 

21.6

 

17.5

 

Selling,  general, administrative and other

 

63.5

 

65.9

 

193.9

 

181.9

 

Depreciation  and amortization

 

131.2

 

123.4

 

394.5

 

333.8

 

Total  costs and expenses

 

397.8

 

367.0

 

1,173.3

 

1,002.7

 

Segment  income

 

$

207.4

 

$

208.7

 

$

647.0

 

$

569.3

 

Access  lines in service (excludes DSL lines)

 

3,121.7

 

3,188.9

 

—

 

—

 

 

Wireline operationsconsist of the Company’s Incumbent Local Exchange Carrier (“ILEC”), CLEC andInternet operations.  Wireline revenuesand sales increased $29.5 million, or 5 percent, and $248.3 million, or 16percent, in the three and nine months ended September 30, 2003,respectively, compared to the same periods in 2002.  Customer access lines decreased approximately 2 percent duringthe twelve months ended September 30, 2003, reflecting declines in bothprimary and secondary access lines and ALLTEL’s decision to exit CLEC marketsin seven states, as previously discussed. The Company lost approximately 12,000and 45,000 access lines during the three and nine months endedSeptember 30, 2003, respectively. The declines in access lines in both 2003 periods reflected the effectsof wireless and broadband substitution for the Company’s wirelineservices.  The Company expects accessline growth during the balance of 2003 to continue to be affected by wirelessand broadband substitution.

 

To maintain revenuegrowth in 2003, the Company will continue to emphasize sales of enhancedservices and bundling of its various product offerings including Internet,long-distance and high-speed data transport services (digital subscriber lineor “DSL”).  Deployment of DSL service isan important strategic initiative for ALLTEL. Currently, DSL service is available to approximately 1.9 million of theCompany’s wireline customers.  Duringthe third quarter of 2003, the Company added approximately 25,000 DSLcustomers, continuing a year-long trend of strong growth in this serviceoffering.  For the twelve months endedSeptember 30, 2003, the number of DSL customers has more than doubled toapproximately 130,000 customers, or 7 percent of the Company’s addressableaccess lines.  The growth rate in theCompany’s DSL customers significantly outpaced the rate of decline in customeraccess lines discussed above.

 

Local service revenuesincreased $14.4 million, or 5 percent, and $121.8 million, or 17 percent, inthe three and nine months ended September 30, 2003, respectively, comparedto the same periods in 2002.  The acquisitionof wireline properties in Kentucky accounted for $15.4 million and $122.1million of the overall increases in local service revenues in the three andnine months ended September 30, 2003, respectively.  In addition to the effects of the acquisition,local service revenues in both 2003 periods also reflected growth in revenuesderived from the sales of enhanced products and services, reflecting increaseddemand for these services.  Revenuesfrom these enhanced services increased $2.4 million and $7.3 million in thethree and nine months ended September 30, 2003, respectively, compared tothe same periods of 2002.  The increasesin local service revenues in the three and nine month periods of 2003attributable to the Kentucky acquisition and additional revenues earned fromenhanced products and services were partially offset by the effects of theoverall decline in primary and secondary access lines noted above.

 

 

 

30
Network access andlong-distance revenues increased $10.5 million, or 4 percent, and $102.3million, or 15 percent, in the three and nine months ended September 30,2003, respectively, compared to the same periods of 2002.  The acquisition of wireline properties inKentucky accounted for $15.8 million and $111.2 million of the overallincreases in network access and long-distance revenues in the three and ninemonths ended September 30, 2003, respectively.  In addition to the effects of the acquisition, network access andlong-distance revenues in 2003 also reflected growth in revenues from dataservices of $3.9 million and $9.6 million in the three and nine months endedSeptember 30, 2003, respectively, reflecting increased demand for theseservices.  The increases in networkaccess and long-distance revenues attributable to the acquisition and growth indata services were partially offset by reductions in intrastate network accessusage and toll revenues, which decreased $5.9 million and $16.8 million in thethree and nine months ended September 30, 2003, respectively, consistentwith the overall decline in primary and secondary access lines discussed above.
 

Miscellaneous revenuesprimarily consist of charges for billing and collections services provided tolong-distance companies, customer premise equipment sales, directory advertisingand revenues derived from Internet services. Miscellaneous revenues increased$4.6 million, or 8 percent, and $24.2 million, or 15 percent, in the three andnine month periods ended September 30, 2003, respectively, compared to thesame periods of 2002.  The acquisitionof wireline properties in Kentucky accounted for $2.3 million and $18.7 millionof the overall increases in miscellaneous revenues in the three and nine monthsended September 30, 2003, respectively. In addition to the effects of the acquisition, miscellaneous revenuesfor both 2003 periods also reflected growth in revenues derived from Internetservices, partially offset by a decrease in revenues earned from billing andcollection services.  Revenues fromInternet services increased $3.8 million and $9.0 million in the three and ninemonths ended September 30, 2003, respectively, primarily due to customergrowth.  The decreases in revenues frombilling and collection services for both 2003 periods were consistent with theoverall decline in toll revenues previously discussed.

 

Cost of servicesincreased $24.5 million, or 14 percent, and $93.8 million, or 20 percent, inthe three and nine months ended September 30, 2003, respectively, comparedto the same periods of 2002.  Theacquisition of wireline properties in Kentucky accounted for $25.7 million and$103.4 million of the overall increases in cost of services in the three andnine months ended September 30, 2003, respectively.  Included in cost of services for theacquired wireline properties in Kentucky were $6.0 million of additionalmaintenance costs incurred during the first quarter of 2003 to repair damagecaused by severe winter storms.  Inaddition, cost of services for both the three and nine months endedSeptember 30, 2003 included incremental expenses of approximately $10.6million associated with a strike that began in early June and ended onOctober 1, 2003, when the Company signed a new collective bargainingagreement impacting approximately 400 ALLTEL employees in Kentucky representedby the Communications Workers of America. The Company expects to incur an additional $2.0 million of incrementalexpenses in the fourth quarter of 2003 in transitioning these employees backinto the workforce.  Cost of servicesfor the nine months ended September 30, 2002 included a $10.9 millionwrite-down of receivables due to an interexchange carrier’s bankruptcy filing.

 

Compared to the sameperiods of 2002, cost of products sold increased slightly in the three monthperiod and increased $4.1 million, or 23 percent, in the nine month periodended September 30, 2003.  Theacquisition of wireline properties in Kentucky accounted for $4.7 million ofthe overall increase in cost of products sold in the nine month period of 2003.

 

Selling, general,administrative and other expenses decreased $2.4 million, or 4 percent, in thethree month period and increased $12.0 million, or 7 percent, in the nine monthperiod ended September 30, 2003 compared to the same periods of 2002.  The acquisition of wireline properties inKentucky accounted for $2.4 million and $24.5 million of the overall increasesin selling, general, administrative and other expenses in the three and ninemonth periods of 2003, respectively. The increases attributable to the acquisition were partially offset byreductions in data processing charges, which decreased $4.7 million and $13.5million in the three and nine months ended September 30, 2003,respectively.  Depreciation and amortizationexpense increased $7.8 million, or 6 percent, and $60.7 million, or 18 percent,in the three and nine months ended September 30, 2003, respectively,compared to the same periods of 2002. Depreciation expense increased in both periods of 2003 due to growth inwireline plant in service and additional depreciation attributable to theacquisition of wireline properties in Kentucky.  The acquisition accounted for $9.1 million and $57.3 million ofthe overall increases in depreciation and amortization expense in the three andnine months ended September 30, 2003, respectively.

 

Wireline segment incomedecreased $1.3 million, or 1 percent, and increased $77.7 million, or 14percent, in the three and nine months ended September 30, 2003,respectively, compared to the same periods of 2002.  The acquisition of wireline properties in Kentucky accounted for$4.6 million of the overall decrease and $62.1 million of the overall increasein segment income in the three and nine month periods of 2003,respectively.  The decrease in segmentincome in the three month period of 2003 attributable to the acquisitionprimarily reflected the effect of the incremental strike-related expensesdiscussed above.  The adverse effects ofthe strike-related costs on wireline segment income were partially offset inboth 2003 periods by cost savings resulting from the Company’s continuedefforts to control operating expenses.

 

31

 

Set forth below is asummary of the integration expenses and other charges related to the wirelineoperations that were not included in the determination of segment income forthe three and nine months ended September 30:

 

 

 

Three Months  Ended

 

Nine Months  Ended

 

(Millions)

 

2003

 

2002

 

2003

 

2002

 

Severance  and employee benefit costs

 

$

—

 

$

0.1

 

$

7.0

 

$

7.1

 

Lease  and contract termination costs

 

—

 

1.7

 

—

 

5.8

 

Write-down  of software development costs

 

—

 

—

 

1.8

 

4.1

 

Computer  system conversion and other integration costs

 

—

 

6.5

 

—

 

17.0

 

Branding  and signage expense

 

—

 

3.7

 

—

 

3.7

 

Equipment  removal and other disposal costs

 

—

 

—

 

—

 

2.2

 

Total  integration expenses and other charges

 

$

—

 

$

12.0

 

$

8.8

 

$

39.9

 

 

Regulatory Matters- Wireline Operations

Except for the Kentuckyproperties acquired from Verizon and the Nebraska operations acquired in 1999,ALLTEL’s ILEC operations follow the accounting for regulated enterprisesprescribed by SFAS No. 71, “Accounting for the Effects of Certain Types ofRegulation”.  Criteria that would giverise to the discontinuance of SFAS No. 71 include (1) increasing competitionrestricting the ILEC subsidiaries’ ability to establish prices to recoverspecific costs and (2) significant changes in the manner in which rates are setby regulators from cost-based regulation to another form of regulation.  The Company periodically reviews thecriteria to determine whether the continuing application of SFAS No. 71 isappropriate.  ALLTEL’s ILEC operationshave begun to experience some competition in their local service areas.  Sources of competition to ALLTEL’s localexchange business include, but are not limited to, resellers of local exchangeservices, interexchange carriers, satellite transmission services, wirelesscommunications providers, cable television companies, and competitive serviceproviders including those utilizing Unbundled Network Elements-Platform(“UNE-P”).  Through September 30,2003, this competition has not had a material adverse effect on the results ofoperations of ALLTEL’s ILEC operations.

 

Although the Companybelieves that the application of SFAS No. 71 continues to be appropriate, it ispossible that changes in regulation, legislation or competition could result inthe Company’s ILEC operations no longer qualifying for the application of SFASNo. 71 in the future.  If ALLTEL’s ILECoperations no longer qualified for the application of SFAS No. 71, theaccounting impact to the Company would be an extraordinary non-cash credit tooperations.  The non-cash credit wouldconsist primarily of the reversal of the regulatory liability for cost ofremoval included in accumulated depreciation, which amounted to $156.0 millionas of September 30, 2003.  ALLTELdoes not expect to record any impairment charge related to the carrying valueof its ILEC plant.  Under SFAS No. 71,ALLTEL currently depreciates its ILEC plant based upon asset lives approved byregulatory agencies or as otherwise allowed by law.  Upon discontinuance of SFAS No. 71, ALLTEL would be required torevise the lives of its property, plant and equipment to reflect the estimateduseful lives of the assets.  The Companydoes not expect any revisions in asset lives to have a material adverse effecton its ILEC operations.

 

Most states in which theCompany’s ILEC subsidiaries operate have adopted alternatives to rate-of-returnregulation, either through legislative or state public service commissionactions.  The Company has electedalternative regulation for certain of its ILEC subsidiaries in Alabama,Arkansas, Florida, Georgia, Kentucky, Missouri, Nebraska, North Carolina,Pennsylvania, South Carolina and Texas. The Company continues to evaluate alternative regulation options inother states where its ILEC subsidiaries operate.  The Nebraska ILEC properties and the recently acquired Kentuckyproperties operate under interstate price cap regulation pursuant to waiversgranted by the FCC.  On April 17,2002, the FCC extended ALLTEL’s waiver of the “all or nothing” rule withrespect to the Nebraska ILEC properties, and in the same order, the FCC granteda waiver of the “all or nothing” rule with respect to the acquired Kentuckyproperties.  The waivers permit pricecap regulation for these two properties while retaining rate-of-returnregulation for the Company’s other ILEC properties.  Both waivers will remain in effect until the FCC completes itspending review to either modify or eliminate the “all-or-nothing” rule.  The “all-or-nothing” rule was originallyintended to ensure that all study areas of a carrier and its affiliates aresubject to a single form of pricing regulation.

 

A number of carriers havebegun offering voice telecommunications services utilizing the Internet as themeans of transmitting those calls.  Thisservice, commonly know as voice-over-Internet-protocol (“VoIP”) telephony, ischallenging existing regulatory definitions. Several state public utility commissions have initiated proceedings toanalyze VoIP and its regulatory classification.  The U.S. District Court for the District of Minnesota reversed aMinnesota Public Utility Commission (“Minnesota PUC”) decision and found thatVoIP is an information service rather than a telecommunications service and isnot subject to state regulation.  TheMinnesota PUC is seeking reconsideration of the court decision.  The VoIP provider involved in this MinnesotaPUC case has asked the FCC to also overrule the Minnesota PUC decision.  In response to the request from the VoIPprovider and other requests for determination of VoIP-related issues, the FCCis

 

32

 

expected to initiate arulemaking with respect to VoIP that will likely address the effect of VoIP onuniversal service, inter-carrier compensation and emergency services.  At this time ALLTEL cannot determine theresults of these proceedings or evaluate the impact that such decisions willhave upon ALLTEL’s operations.

 

In April 2001, theFCC released a notice of proposed rulemaking addressing inter-carriercompensation.  Under this rulemaking,the FCC asked for comment on a “bill and keep” compensation method that wouldoverhaul the existing rules governing reciprocal compensation and access chargeregulation.  A number of stateproceedings have been initiated by various wireline companies to addresscompensation with respect to traffic that originates or terminates on wirelesscarriers. The outcome of the FCC and state proceedings could change the wayALLTEL receives compensation from, and remits compensation to, other carriersand its end users.  ALLTEL cannotestimate whether or when any such changes will occur or, if they occur, whatwould be the impact of the changes on its ILEC revenues and expenses.

 

In May 2001, the FCCadopted the Rural Task Force Order that established an interim universalservice mechanism that will govern compensation for rural telephone companiesfor the ensuing five years.  The interimmechanism has allowed rural carriers to continue receiving high-cost fundingbased on embedded costs.  At this time,ALLTEL cannot estimate the effect of the changes to its universal servicesupport, if any, that may occur once the FCC adopts a permanent plan for ruralcarriers.  On December 13, 2002,the FCC released its interim USF contribution report and order and furthernotice of proposed rulemaking.  Underthis ruling, the method for providing federal USF contributions changed fromthe historical interstate revenue-based arrangement to contributions based onprojected revenues.  In addition, onApril 1, 2003, the USF line item on the customer bill was adjusted toreflect only the USF contribution obligation of the carrier.  In the further notice of proposedrulemaking, the FCC has indicated it continues to consider adopting a permanentplan for USF contributions and assessment methodology.  Three “connections-based” proposals havebeen offered as long-term replacements in addition to the continuation of arevenue-based assessment methodology. The proposed connection-based methods would establish a universalservice charge based either on the number of customer connections, the capacityand nature of the connection, or on working telephone numbers.  The interim universal service changes havenot had a material adverse effect on the Company’s wireline operations.  ALLTEL cannot predict at this time theimpact to its wireline operations of any permanent USF contribution plan thatthe FCC might adopt.

 

On November 8, 2002,the FCC requested that the Federal/State Joint Board on Universal Service (the“Joint Board”) review certain of the FCC’s rules relating to the high-costuniversal support mechanism and the process by which carriers are designatedETCs.  On February 7, 2003, theJoint Board sought comment on these matters, but has yet to issue a recommendeddecision.  At this time, ALLTEL cannotestimate what impact, if any, this proceeding may have on its universal servicefunding.

 

On July 10, 2002,the Joint Board recommended that the FCC not modify the existing list ofservices supported by universal service. On July 10, 2003, the FCC adopted the Joint Board’s recommendationto retain the existing list of services supported by universal service.  The FCC decided to consider whether equalaccess should be included in the list of USF supported services as part of thehigh-cost universal service support and ETC designation proceeding pendingbefore the Joint Board.

 

In October 2001, theFCC adopted rate-of-return access charge reform and initiated a further roundof rulemaking to consider other rate-of-return carrier issues.  The order lowered traffic sensitive switchedaccess rates, increased the subscriber line charge (“SLC”) over time to bringit in line with SLCs adopted for price cap carriers, phased out carrier commonline charges in favor of a new portable “Interstate Common Line Support”universal service mechanism, and retained the authorized 11.25 percent rate ofreturn.  The residential and single-linebusiness SLC cap phase-in began on January 1, 2002.  The final scheduled increase occurred onJuly 1, 2003.  The Company does notexpect that this order will have a material adverse effect on its consolidatedfinancial results during 2003.

 

On December 20,2001, the FCC released a notice of proposed rulemaking initiating the firsttriennial review of the FCC’s policies on unbundled network elements (“UNEs”)including UNE-P.  UNE-P is created when acompeting carrier obtains all the network elements needed to provide servicefrom the ILEC at a discounted rate.  Therulemaking asks whether the FCC should retain, modify, or eliminate itsexisting definitions and requirements for unbundled network elements.  On February 20, 2003, and in responseto the remand of the United States Court of Appeals for the District ofColumbia circuit (the “U.S. District Court”), the FCC indicated it was adoptingnew rules governing the obligations of ILECs to unbundle the elements of theirlocal networks for use by competitors. On August 21, 2003, and in response to the remand of the U.S.District Court, the FCC released new rules governing the obligations of ILECsto unbundle the elements of their local networks for use by competitors. TheFCC made national findings of impairment or non-impairment for loops, transportand, most significantly, switching.  TheFCC delegated to the states the authority to engage in additional fact findingand make alternative impairment findings based on a more granular impairmentanalysis including evaluation of

 

33

 

applicability ofFCC-established “triggers.” The FCC created “mass market” and “enterprisemarket” customer classifications that generally correspond to the residentialand business markets respectively.  TheFCC found that CLECs were not impaired without access to local circuitswitching when serving digital signals supporting 24 voice conversations or“DS1” and higher “enterprise market” customers on a national level.  CLECs, however, were found to be impaired ona national level without access to local switching when serving “mass market”customers.  State commissions will have90 days to ask the FCC to waive the finding of no impairment without switchingfor “enterprise market” customers served by DS1 capacity lines.  The FCC presumption that CLECs are impairedwithout access to transport, high capacity loops and “mass market” switching issubject to a more granular nine month review by state commissions pursuant toFCC-established triggers and other economic and operational criteria. The FCCalso opened a further notice of proposed rulemaking to consider the “pick andchoose” rules under which a competing carrier may select from among the variousterms of interconnection offered by an ILEC in its various interconnectionagreements, and has released a second, separate notice of proposed rulemakingto review the rules that establish the wholesale pricing of UNEs.

 

In addition, the FCCindicated it would take the following actions:

 

•      ILECs would not be required to unbundle packetswitching as a stand-alone network element.

 

•      The order clarified two key components of theFCC’s total element long-run incremental cost methodology (“TELRIC”) pricingrules.  First, the FCC clarified thatthe risk-adjusted cost of capital used in calculating UNE prices should reflectthe risks associated with a competitive market.  Second, the FCC declined to mandate the use of any particular setof asset lives for depreciation, but clarified that the use of an accelerateddepreciation mechanism may present a more accurate method of calculatingeconomic depreciation.

 

•      The FCC continued its prior position of notpermitting CLECs to avoid any liability under contractual early terminationclauses in the event a competitive local exchange carrier converts a specialaccess circuit to an UNE.

 

ALLTEL is monitoring thestate commissions (and will participate in proceedings as needed) as theyundertake the 90 day and nine month analyses where necessary to establish rulesor make determinations as directed by the triennial review order.  Additionally, numerous suits and petitionshave been filed in the courts and with the FCC challenging many of the findingsin the triennial review order and seeking a stay on certain portions of theorder.  Until all of these proceedingsare concluded, the impact of this order, if any, on ALLTEL’s ILEC operationscannot be determined.

 

During the first quarterof 2002, the FCC initiated a rulemaking to evaluate the appropriate frameworkfor broadband access to the Internet over wireline facilities.  In the notice of proposed rulemaking, theFCC tentatively concluded that wireline broadband Internet access should beclassified as an “information service” rather than a telecommunications serviceand, therefore, should not be subject to common carrier regulation.  The FCC sought comments on their tentativeconclusion, but has not reached a final order. In a related proceeding released March 15, 2002, the FCC issued adeclaratory ruling concluding that cable modem service was an interstate“information service” and not a cable service or a telecommunicationsservice.  The FCC sought comment onwhether there are legal or policy reasons why it should reach differentconclusions with respect to wireline broadband Internet access and cable modemservice, but has not reached a final order. On October 6, 2003, however, the U.S. Court of Appeals for theNinth Circuit rejected the FCC’s classification of cable modem service assolely an unregulated “information service” finding a portion of the service tobe “telecommunications service”.  Atthis time, ALLTEL cannot estimate what impact, if any, these broadbandproceedings may have on its ILEC operations.

 

Section 251(b) of the 34 Act,as amended, requires, in part, that local exchange carriers provide local numberportability to any requesting telecommunications carrier. Wireless carriers aregenerally defined as "telecommunications carriers" under the 34 Act,and are therefore eligible to port numbers with wireline carriers, which isreferred to as "intermodal porting". The terms and conditions forintermodal porting were the subject of CTIA's petitions for declaratory rulingand related petition for mandamus before the U.S. District Court seeking tocompel FCC action on CTIA's petitions. Most significantly, the CTIA petitionssought rulings on: 1) the ability of wireline carriers to port numbers towireless carriers across traditional rate center boundaries; 2) the portinginterval for such ports; and 3) the absence of any need for directinterconnection arrangements between wireline carriers porting number out andwireless carriers receiving the number. As previously discussed, on November 10,2003, the FCC released a decision providing guidance on intermodal portingissues and addressing the CTIA petitions. The FCC stated that number portingfrom a wireline carrier to a wireless carrier is required where the coveragearea of the wireless carrier (i.e. the area in which the wireless carrierprovides service) overlaps the geographic location in which the wireline numberwas provisioned. Further, while the FCC required the wireless carrier tomaintain the rate center designation of the number, it also noted that wirelesscarriers were not required to have either direct connections or interconnectionagreements with wireline carriers nor were wireless carriers

 

34
required to have numbering resources in the rate center in whichthe wireline number is located in order to subject the wireline number tointermodal porting. The Company believes the FCC's guidance requiresthat wireline numbers be ported to wireless carriers across traditional wirelinerate centers, although the FCC left issues governing the payment of call routingcosts to another pending proceeding. This requirement will take effect onNovember 24, 2003 for wireline carriers in the top 100 MSAs, and on May 24, 2003for wireline carriers operating in markets below the top 100 MSAs. While theCTIA petition for mandamus remains pending before the U.S. District Court, theCompany believes that the recent FCC action effectively renders it moot, although the U.S. District Court could rule on the petition at anytime. The Company operates both wireline and wireless businesses and cannotforecast the net effect of intermodal porting on its business as a whole. Themajority of the Company's wireline operations are conducted in markets belowthe top 100 MSAs that will be subject to the later, May 24, 2004 implementationdate for intermodal porting. The Company cannot determine at this time whetherany carrier will appeal the FCC's decision, what the basis of any such appealwould be, or the outcome of any such appeal.  Futhermore, the Company atthis time cannot fully quantify the effects on its wireline operations ofimplementing intermodal porting, although it is likely that these requirementswill adversely affect both its operating costs and customer growth rates. 
 

Because certain of theregulatory matters discussed above are under FCC or judicial review, resolutionof these matters continues to be uncertain, and ALLTEL cannot predict at thistime the specific effects, if any, that the 96 Act, regulatory decisions andrulemakings, and future competition will ultimately have on its ILECoperations.

 

Communications SupportServices

 

 

Three Months  Ended  September 30,

 

Nine Months  Ended  September 30,

 

(Millions,  except customers in thousands)

 

2003

 

2002

 

2003

 

2002

 

Revenues  and sales:

 

 

 

 

 

 

 

 

 

Product  distribution

 

$

107.3

 

$

102.1

 

$

301.2

 

$

277.0

 

Long-distance  and network management services

 

80.0

 

81.8

 

242.1

 

236.1

 

Telecommunications  information services

 

28.8

 

30.0

 

81.0

 

89.8

 

Directory  publishing

 

27.9

 

25.1

 

87.6

 

87.8

 

Total  revenues and sales

 

244.0

 

239.0

 

711.9

 

690.7

 

Costs  and expenses:

 

 

 

 

 

 

 

 

 

Cost  of services

 

75.3

 

72.7

 

220.0

 

219.5

 

Cost  of products sold

 

123.6

 

116.3

 

355.4

 

326.7

 

Selling,  general, administrative and other

 

15.9

 

17.9

 

50.7

 

54.1

 

Depreciation  and amortization

 

8.9

 

9.6

 

27.0

 

28.1

 

Total  costs and expenses

 

223.7

 

216.5

 

653.1

 

628.4

 

Segment  income

 

$

20.3

 

$

22.5

 

$

58.8

 

$

62.3

 

Long-distance  customers

 

1,669.8

 

1,461.7

 

—

 

—

 

 

Communications supportservices revenues and sales increased $5.0 million, or 2 percent, and $21.2million, or 3 percent, for the three and nine month periods endedSeptember 30, 2003, respectively, compared to the same periods of2002.  As noted in the table above, theincreases in revenues and sales in the three and nine month periods of 2003primarily reflected growth in sales of telecommunications and dataproducts.  Sales of telecommunicationsand data products increased $5.2 million and $24.2 million in the three andnine month periods of 2003, respectively, compared to the same periods of2002.  Sales to non-affiliates increased$17.9 million and $46.6 million, in the three and nine month periods of 2003,respectively, primarily reflecting increased sales of wireless handsets to retailersand other distributors.  Conversely, thegeneral reduction in capital spending by telecommunications companies adverselyaffected sales to non-affiliates in both 2003 periods, reflecting currenteconomic conditions and the industry’s emphasis on controlling costs.  For the three and nine month periods of2003, sales to affiliates decreased $12.6 million and $22.3 million,respectively, primarily due to timing differences in the purchases of materialsand equipment related to long-term construction projects.  Compared to the same periods of 2002,revenues from long-distance and network management services decreased $1.8million and increased $6.0 million in the three and nine month periods of 2003,respectively.  The decrease in the threemonth period of 2003 primarily reflected declines in customer billing rates dueto competition, the effects of which were more than offset in the nine monthperiod of 2003 by the 14 percent growth in ALLTEL’s customer base forlong-distance services. Telecommunications information services revenues decreased $1.2 millionand $8.8 million in the three and nine month periods of 2003, respectively,compared to the same periods of 2002. The decreases reflected a reduction in programming services provided toone customer, lost operations resulting from a contract termination and thecompletion in 2002 of customer specific conversion projects and othertransitional services.  Directorypublishing revenues increased $2.8 million in the three month period of 2003and decreased slightly in the nine month period of 2003, as compared to thesame periods of 2002.  Directorypublishing revenues for the three and nine month periods of 2003 includedadditional revenues  

 

35

 of $2.9 million and $3.7 million, respectively, resultingfrom growth in the number of directory contracts published.  The revenues earned from these additionalcontracts were partially offset in the three month period and fully offset inthe nine month period due to a change in accounting for directory contracts inwhich the Company has a secondary delivery obligation.  ALLTEL began deferring a portion of itsrevenues and related costs to provide for secondary deliveries effectiveJanuary 1, 2003.

 

Although revenues andsales increased in both the three and nine month periods of 2003 compared tothe same periods of 2002, communications support services segment incomedecreased in both 2003 periods primarily due to lower profit margins realizedby the product distribution and directory publishing operations.  Profit margins for the product distributionoperations decreased in both 2003 periods due to a shift in the mix of productssold to non-affiliates, as a proportionately higher percentage of these salesconsisted of lower margin wireless handsets as noted above.  Profit margins for the directory publishingoperations reflected increased selling, marketing and other start-up costsincurred in order for the Company’s publishing subsidiary to begin providingall directory publishing services, except printing, for a limited number ofdirectory contracts to be published in 2003. Currently, these directory publishing services are contracted out to athird party.

 

Set forth below is asummary of the integration expenses and other charges related to thecommunications support services operations that were not included in thedetermination of segment income for the three and nine months endedSeptember 30:

 

 

 

Three Months  Ended

 

Nine Months  Ended

 

(Millions)

 

2003

 

2002

 

2003

 

2002

 

Severance  and employee benefit costs

 

$

—

 

$

1.6

 

$

—

 

$

1.8

 

Lease  and contract termination costs

 

—

 

0.8

 

(0.5

)

3.6

 

Write-down  of software development costs

 

—

 

—

 

3.8

 

—

 

Total  integration expenses and other charges

 

$

—

 

$

2.4

 

$

3.3

 

$

5.4

 

 

Corporate Operations

 

 

Three Months  Ended September 30,

 

Nine Months  Ended September 30,

 

(Millions)

 

2003

 

2002

 

2003

 

2002

 

Corporate  expenses

 

$

9.4

 

$

8.6

 

$

29.3

 

$

25.7

 

Integration  expenses and other charges

 

—

 

20.5

 

19.0

 

72.4

 

Total  corporate operations

 

$

9.4

 

$

29.1

 

$

48.3

 

$

98.1

 

 

As indicated in the tableabove, corporate operations included integration expenses and other chargesthat are not allocated to the Company’s business segments, as previously discussed.  Corporate expenses increased in the threeand nine month periods of 2003 primarily resulting from increases inemployee-related benefit costs.

 

**FINANCIAL CONDITION, LIQUIDITY ANDCAPITAL RESOURCES**

 

 

Nine Months  Ended  September 30,

 

(Millions,  except per share amounts)

 

2003

 

2002

 

Cash  flows from (used in):

 

 

 

 

 

Operating  activities

 

$

1,850.6

 

$

1,738.0

 

Investing  activities

 

(972.2

)

(4,214.9

)

Financing  activities

 

(1,085.0

)

2,448.0

 

Discontinued  operations

 

638.2

 

38.0

 

Effect  of exchange rate changes

 

0.7

 

2.6

 

Change  in cash and short-term investments

 

$

432.3

 

$

11.7

 

Total  capital structure (a)

 

$

12,695.4

 

$

12,732.9

 

Percent  of equity to total capital (b)

 

53.6

%

45.9

%

Book  value per share (c)

 

$

21.79

 

$

18.79

 

 

Notes:

(a)  Computedas the sum of long-term debt including current maturities, redeemable preferredstock and total shareholders’ equity.

(b)  Computedby dividing total shareholders’ equity by total capital structure as computedin (a) above.

(c)  Computedby dividing total shareholders’ equity less preferred stock by the total numberof common shares outstanding at the end of the period.

 

 

36

OperatingActivities

Cash provided fromoperations continued to be ALLTEL’s primary source of liquidity.  The increase in the nine month period endedSeptember 30, 2003 reflected growth in earnings of the Company beforedepreciation and amortization, interest expense and income taxes.  The increase in cash provided from operationsresulting from earnings growth in 2003 was partially offset by changes inworking capital requirements, including timing differences in the billingand collection of accounts receivable and the payment of trade payables andother accrued liabilities.

 

InvestingActivities

Capital expenditures continuedto be ALLTEL’s primary use of capital resources.  Capital expenditures for the nine months ended September 30,2003 were $806.5 million compared to $853.6 million for the same period in2002.  Capital expenditures for 2003were incurred by ALLTEL to construct additional network facilities, to deploydigital wireless technology in the Company’s existing and newly acquiredwireless markets and to upgrade ALLTEL’s telecommunications network in order tooffer other communications services, including long-distance, Internet, DSL andlocal competitive access services. ALLTEL funded most of its capital expenditures through internallygenerated funds.  Investing activities alsoincluded outlays for capitalized software development costs.  Additions to capitalized software for thenine months ended September 30, 2003 were $44.6 million compared to $49.4million for the same period in 2002. Capitalized software development costs for 2002 included additionalspending for the development and enhancement of internal use software tosupport the Company’s retail operations. Spending levels in 2003 for capitalized software development costsreflected the completion of these projects during 2002.  The Company expects capital expendituresincluding capitalized software development costs to be approximately $1.2 to$1.3 billion for 2003, which will be funded primarily from internally generatedfunds.

 

Cash outlays for thepurchase of property were $160.6 million for the nine months endedSeptember 30, 2003, compared to $3,337.1 million for the same period of2002.  During the first nine months of2003, ALLTEL purchased wireless properties in Arizona and Mississippi for $87.4million in cash, acquired the remaining ownership interest in two wirelessproperties in Michigan for $60.0 million in cash, and purchased additionalownership interests in wireless properties in Mississippi, New Mexico, Virginiaand Wisconsin for $13.2 million in cash. Conversely, during the first nine months of 2002, ALLTEL completed thepurchase of wireline properties in Kentucky from Verizon for $1,733.7 million($1,927.2 million total purchase price less $193.5 million deposit includingaccrued interest paid in October 2001) and the wireless assets ofCenturyTel for $1,568.3 million.  Inaddition, ALLTEL purchased a wireline property in Georgia for $18.0 million andacquired additional ownership interests in wireless properties in Arkansas,Louisiana and Texas for $17.1 million.

 

Cash flows from investingactivities for the nine months ended September 30, 2002 included $7.5million of advance lease payments received from American Tower for the leasingof cell site towers.  InDecember 2000, ALLTEL signed an agreement to lease American Tower certainof the Company’s cell site towers in exchange for cash paid in advance.  In turn, ALLTEL is obligated to pay AmericanTower a monthly fee per tower for management and maintenance services for theduration of the fifteen-year lease agreement. During February 2002, the Company closed on the remaining towersunder this agreement.  Upon completionof this transaction, ALLTEL had leased 1,773 cell site towers to AmericanTower.

 

Investing activities forthe nine months ended September 30, 2003 and 2002 also included proceedsfrom the return on investments of $34.3 million and $31.5 million,respectively.  These amounts primarilyconsisted of cash distributions received from ALLTEL’s wireless minorityinvestments.  The decrease in 2003primarily reflected ALLTEL’s acquisitions of the remaining ownership interestin two wireless properties in Michigan and of a controlling interest in aWisconsin wireless partnership completed during the first nine months of 2003,as previously discussed.

 

FinancingActivities

Dividend payments remaina significant use of capital resources for ALLTEL.  Common and preferred dividend payments were $327.2 million forthe nine months ended September 30, 2003 compared to $317.2 million forthe same period in 2002.  The increasein dividend payments in 2003 primarily reflected growth in the annual dividendrate on ALLTEL’s common stock.  OnOctober 23, 2003, the Company’s Board of Directors increased the quarterlycommon stock dividend rate 6 percent from $.35 to $.37 per share.  This action raised the annual dividend rateto $1.48 per share and marked the 43rd consecutive year in which ALLTEL hasincreased its common stock dividend. The Company expects to continue the payment of cash dividends during thebalance of 2003.

 

ALLTEL’s maximumborrowing capacity under its commercial paper program is $1.5 billion.  ALLTEL classifies commercial paperborrowings as long-term debt, because they are intended to be maintained on along-term basis and are supported by the Company’s revolving creditagreements.  ALLTEL has a $1.0 billionline of credit under a revolving credit agreement of which $50.0 million wasset to expire in October 2003 and $950.0 million would expire inOctober 

 

37

2005.  OnAugust 29, 2003, the Company amended this revolving credit agreement suchthat the expiration date of the entire $1.0 billion line of credit is nowOctober 1, 2005.  On July 31,2002, the Company entered into an additional $500.0 million, 364-day revolvingcredit agreement that expired on July 30, 2003.  On July 30, 2003, the Company entered into a new $500.0million, 364-day revolving credit agreement that will expire on July 28,2004, and allows the Company to convert any outstanding borrowings under thisagreement into term loans maturing in 2005. No borrowings were outstanding under the revolving credit agreements asof September 30, 2003, December 31, 2002 or September 30, 2002.

 

Under the commercialpaper program, commercial paper borrowings are fully supported by the availableborrowings under the revolving credit agreements.  Accordingly, the total amount outstanding under the commercialpaper program and the indebtedness incurred under the revolving creditagreements may not exceed $1.5 billion. No commercial paper borrowings were outstanding at September 30,2003.  Commercial paper borrowingsoutstanding at December 31, 2002, September 30, 2002 andDecember 31, 2001 were $25.0 million, $250.6 million and $230.1 million,respectively.  During 2003, the Companyincurred additional commercial paper borrowings to fund the wireless propertyacquisitions in Arizona, Mississippi and Michigan, as previously discussed, andto retire a $450.0 million, 7.125 percent senior unsecured note that was dueMarch 1, 2003.  As previouslydiscussed, during the second quarter of 2003, the Company repaid all borrowingsoutstanding under its commercial paper program utilizing a portion of the cashproceeds ALLTEL received in connection with the April 1, 2003, sale of thefinancial services division of its information services subsidiary to FidelityNational.  ALLTEL used a portion of thecash proceeds from the sale to retire all long-term debt outstanding under theRural Utilities Services, Rural Telephone Bank and Federal Financing Bankprograms as further discussed below.

 

Retirements of long-termdebt were $744.3 million and $35.0 million for the nine months endedSeptember 30, 2003 and 2002, respectively.  Retirements of long-term debt in 2003 included the repayment of a$450.0 million unsecured note due March 1, 2003 and the retirement of$249.1 million of long-term debt outstanding under the Rural UtilitiesServices, Rural Telephone Bank and Federal Financing Bank programs.  Retirements of long-term debt in 2003 alsoincluded the net reduction from December 31, 2002 in commercial paperborrowings of $25.0 million.  Additionalscheduled long-term debt retirements, net of commercial paper activity and theprepayment of long-term debt, amounted to $20.2 million for the nine monthperiod of 2003 compared to $35.0 million for the same period of 2002.

 

As previously discussed,during May 2002, the Company sold 27.7 million equity units under thisshelf registration statement and received net proceeds of $1.34 billion.  In June 2002, the Company issued $1.5billion of unsecured long-term debt consisting of $800.0 million of 7.0 percentsenior notes due July 1, 2012 and $700.0 million of 7.875 percent seniornotes due July 1, 2032.  Netproceeds from the debt issuance were $1.47 billion, after deducting theunderwriting discount and other offering expenses.  The net proceeds from the issuance of the equity units and debtsecurities of $2.81 billion and the net increase from December 31, 2001 incommercial paper borrowings of $20.5 million represented all of the long-termdebt issued during the nine months ended September 30, 2002.

 

Cash flows from financingactivities also included distributions to minority investors, which amounted to$44.4 million and $41.8 million for the nine months ended September 30,2003 and 2002, respectively.

 

Liquidity andCapital Resources

The Company believes ithas sufficient cash and short-term investments on hand ($566.9 million atSeptember 30, 2003) and has adequate operating cash flows to finance itsongoing operating requirements including capital expenditures and the paymentof dividends.  Additional sources offunding available to ALLTEL include (1) borrowings available to the Companyunder 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 millionremained available for issuance at September 30, 2003 and (3) additionaldebt securities issued in the private placement market.

 

ALLTEL’s commercial paperand long-term credit ratings with Moody’s Investors Service (“Moody’s”),Standard & Poor’s Corporation (“Standard & Poor’s”) and Fitch Ratingswere unchanged from December 31, 2002 and were as follows:

 

Description

 

Moody’s

 

Standard  & 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 affectALLTEL’s short and long-term credit ratings would include, but not be limitedto, a material decline in the Company’s operating results and increased debtlevels relative to operating cash flows resulting from future acquisitions orincreased 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 theCompany’s access to the public capital markets could be adverselyaffected.  A downgrade in ALLTEL’scurrent short or long-term credit ratings would not accelerate scheduledprincipal payments of ALLTEL’s existing long-term debt.

 

During 2002, the Companyamended its $1.0 billion revolving credit agreement to conform certain of itsprovisions to corresponding provisions of the Company’s 364-day revolvingcredit agreement.  The revolving creditagreements contain various covenants and restrictions including a requirementthat, as of the end of each calendar quarter, ALLTEL maintain a total debt-to-capitalizationratio of less than 65 percent.  Forpurposes of calculating this ratio under the revolving credit agreements, totaldebt would include amounts classified as long-term debt (excludingmark-to-market adjustments for interest rate swaps), current maturities oflong-term debt outstanding, short-term debt and any letters of credit or otherguarantee obligations.  As ofSeptember 30, 2003, the Company’s total debt to capitalization ratio was46.1 percent.

 

At September 30,2003, current maturities of long-term debt were $274.4 million and included a$250.0 million, 7.25 percent senior unsecured note due April 1, 2004.  The Company expects to fund the payment ofthis note at maturity through either operating cash flows, available cash onhand or refinancing all or a portion of the obligation through the issuance ofadditional commercial paper borrowings or other unsecured long-term debt.

 

In connection with theleasing of 1,773 cell site towers to American Tower during 2001 and 2002, the Companyreceived $531.9 million of cash in advance as prepaid rent and is recognizingthe proceeds as revenue on a straight-line basis over the fifteen-year leaseterm.  Participants in thetelecommunications and cell tower industry currently are experiencing a moredifficult operating and financial environment than when the tower transactionwith ALLTEL was completed.  Accordingly,although ALLTEL currently considers the likelihood to be remote, in the eventALLTEL’s tower lessee were to file or become subject to bankruptcy proceedings,it is possible that the bankruptcy court could require that the towertransaction be rescinded and ALLTEL be required to refund the unutilizedportion of the prepaid rent.  At September 30,2003, deferred rental income was $455.5 million and was included in otherliabilities in the accompanying unaudited consolidated balance sheet.

 

Under the Company’slong-term debt borrowing agreements, acceleration of principal payments wouldoccur upon payment default, violation of debt covenants or breach of certainother conditions set forth in the borrowing agreements. At September 30,2003, the Company was in compliance with all of its debt covenants.  There are no provisions within the Company’sleasing agreements that would trigger acceleration of future leasepayments.  The Company does not usesecuritization of trade receivables, affiliation with special purpose entitiesor synthetic leases to finance its operations. Additionally, the Company has not entered into any material arrangementrequiring the Company to guarantee payment of third party debt or to fundlosses of an unconsolidated special purpose entity.

 

Critical AccountingPolicies

ALLTEL prepares itsconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States. In its Annual Report on Form 10-K for the year ended December 31,2002, ALLTEL identified the critical accounting policies which affect its moresignificant estimates and assumptions used in preparing the Company’sconsolidated financial statements. These critical accounting policies include accounting for servicerevenues, evaluating the collectibility of trade receivables, assessing therecoverability of capitalized software development costs, accounting for pensionand other postretirement benefits, and calculating depreciation andamortization expense.  There have beenno material changes to ALLTEL’s critical accounting policies during the ninemonth period ended September 30, 2003, except for the January 1, 2003adoption of SFAS No. 143 and EITF Issue 00-21, and the July 1, 2003adoption of SFAS No. 150, as previously discussed under the caption “AccountingChanges”.

 

39

 

**ALLTELCORPORATION**

**FORM10-Q**

**PART I —FINANCIAL INFORMATION**

 

**Item 3****.  Quantitative and Qualitative DisclosuresAbout Market Risk**

The Company’s marketrisks at September 30, 2003 are similar to the market risks discussed inALLTEL’s Annual Report on Form 10-K for the year ended December 31, 2002.  The Company is exposed to market risk fromchanges in marketable equity security prices, interest rates, and foreignexchange rates.  The Company hasestimated its market risk using sensitivity analysis.  For marketable equity securities, market risk is defined as thepotential change in fair value attributable to a hypothetical adverse change inmarket prices.  For all other financialinstruments, market risk is defined as the potential change in earningsresulting from a hypothetical adverse change in market prices or interestrates.  The results of the sensitivityanalysis used to estimate market risk are presented below, although the actualresults may differ from these estimates.

 

Equity Price Risk

Changes in equity pricesprimarily affect the fair value of ALLTEL’s investments in marketable equitysecurities.  Fair value for investmentswas determined using quoted market prices, if available, or the carrying amountof the investment, if no quoted market price was available.  At September 30, 2003, investments ofthe Company were recorded at fair value of $628.7 million, compared to $325.8million at December 31, 2002.  Theincrease in fair value primarily reflected the value of the Fidelity Nationalcommon stock acquired by ALLTEL in connection with the April 1, 2003 saleof its financial services division, as previously discussed.  Marketable equity securities amounted to$306.7 million and included unrealized holding gains of $19.2 million atSeptember 30, 2003.  A hypothetical10 percent decrease in quoted market prices would result in a $30.7 milliondecrease in the fair value of these securities at September 30, 2003.

 

Interest Rate Risk

The Company’s earningsare affected by changes in variable interest rates related to ALLTEL’s issuanceof short-term commercial paper and interest rate swap agreements.  The Company enters into interest rate swapagreements to obtain a targeted mixture of variable and fixed-interest-ratedebt such that the portion of debt subject to variable rates does not exceed 30percent of ALLTEL’s total debt outstanding. The Company has established policies and procedures for risk assessmentand the approval, reporting, and monitoring of interest rate swap activity.  ALLTEL does not enter into interest rateswap agreements, or other derivative financial instruments, for trading orspeculative purposes.  Managementperiodically reviews ALLTEL’s exposure to interest rate fluctuations andimplements strategies to manage the exposure.

 

As of September 30,2003, the Company had no borrowings outstanding under its commercial paperprogram.  The Company has entered intosix, pay variable receive fixed, interest rate swap agreements on notionalamounts totaling $1.0 billion to convert fixed interest rate payments tovariable as of September 30, 2003. The maturities of the six interest rate swaps range from March 1,2006 to November 1, 2013.  Theweighted 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-InterbankOffered Rate).  The weighted averagevariable rate paid by ALLTEL was 1.1 percent at September 30, 2003.  A hypothetical increase of 100 basis pointsin variable interest rates would reduce annual pre-tax earnings byapproximately $10.0 million. Conversely, a hypothetical decrease of 100 basis points in variableinterest rates would increase annual pre-tax earnings by approximately $10.0million.

 

Foreign Exchange Risk

The Company’s businessoperations in foreign countries are not material to the Company’s consolidatedoperations, financial condition and liquidity. Foreign currency translation gains and losses were not material to theCompany’s consolidated results of operations for the three and nine monthsended September 30, 2003 and 2002.  Additionally, the Company is not currently subject to materialforeign currency exchange rate risk from the effects that exchange ratemovements of foreign currency would have on the Company’s future costs or on futurecash flows it would receive from its foreign subsidiaries.  The Company has not entered into anysignificant foreign currency forward exchange contracts or other derivativefinancial instruments to hedge the effects of adverse fluctuations in foreign currencyexchange rates.

 

40

 

**ALLTELCORPORATION**

**FORM10-Q**

**PART I —FINANCIAL INFORMATION**

 

**Item 4****.****    Controlsand Procedures**

 

(a)       Evaluationof disclosure controls and procedures.

 

The term “disclosurecontrols and procedures” (defined in SEC Rule 13a-15(e)) refers to the controlsand other procedures of a company that are designed to ensure that informationrequired to be disclosed by a company in the reports that it files under theSecurities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed,summarized and reported within required time periods. ALLTEL’s management, withthe participation of the Chief Executive Officer and Chief Financial Officer,have evaluated the effectiveness of the Company’s disclosure controls andprocedures as of the end of the period covered by this quarterly report (the“Evaluation Date”).  Based on thatevaluation, ALLTEL’s Chief Executive Officer and Chief Financial Officer haveconcluded that, as of the Evaluation Date, such controls and procedures wereeffective.

 

(b)      Changesin internal controls.

 

The term “internalcontrol over financial reporting” (defined in SEC Rule 13a-15(f)) refers to theprocess of a company that is designed to provide reasonable assurance regardingthe reliability of financial reporting and the preparation of financialstatements for external purposes in accordance with generally acceptedaccounting principles.  ALLTEL’smanagement, with the participation of the Chief Executive Officer and ChiefFinancial Officer, have evaluated any changes in the Company’s internal controlover financial reporting that occurred during the period covered by thisquarterly report, and they have concluded that there was no change to ALLTEL’sinternal control over financial reporting that has materially affected, or isreasonably likely to materially affect, ALLTEL’s internal control overfinancial reporting.

 

**PART II****— OTHER INFORMATION**

 

**Item1.****    LegalProceedings**

On October 3, 2002,the Environmental Protection Agency (“EPA”) served the Company with Notices ofViolation of the federal Clean Air Act, theClean Water Act and the Emergency Planning and Community Right to KnowAct.  These notices resulted from anindustry-wide investigation into environmental practices conducted by the EPAduring 1998 to 2000 and alleged violations by the Company, dating from 1997,regarding filing and record-keeping requirements for fuel storage tanks, aswell as generators and batteries used to supply emergency power at certainALLTEL facilities.  On October 2,2003, the Company and the EPA entered into a consent decree that requires theCompany to pay penalties of $1.06 million, to implement a centralizedenvironmental management system and to verify compliance at its facilities.

 

The Company is party tovarious other legal proceedings arising from the ordinary course ofbusiness.  Although the ultimateresolution of these various proceedings cannot be determined at this time,management of ALLTEL does not believe that such proceedings, individually or inthe aggregate, will have a material adverse effect on the future consolidatedresults of operations or financial condition of the Company.  To the knowledge of ALLTEL’s management, noother material legal proceedings, either private or governmental, currently arecontemplated or threatened.

 

41

 

**ALLTELCORPORATION**

**FORM10-Q**

**PART II— OTHER INFORMATION**

 

**Item  6.**

 

**Exhibits and Reports on Form 8-K**

 

 

 

(a)

 

See the exhibits  specified on the Index of Exhibits located at Page 44.

 

 

 

(b)

 

Reports on Form  8-K:

 

 

 

 

 

Current Report  on Form 8-K dated July 24, 2003, reporting under Item 9, Regulation FD  Disclosure, that the Company furnished under Item 12 “Disclosure of Results  of Operations and Financial Condition”, the Company’s Press Release  announcing ALLTEL’s second quarter 2003 unaudited consolidated results of  operations.  

 

 

 

 

 

Current Report  on Form 8-K dated October 23, 2003, reporting under Item 12 “Disclosure  of Results of Operations and Financial Condition”, the Company’s Press  Release announcing ALLTEL’s third quarter 2003 unaudited consolidated results  of operations.

 

 

 

 

 

No other reports  on Form 8-K have been filed during the quarter for which this report is  filed.

 

42

 

SIGNATURE

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 

 

 

ALLTEL CORPORATION

 

 

 

(Registrant)

 

 

 

 

 

 

/s/ Jeffery R. Gardner

 

 

 

Jeffery R. Gardner

 

 

Executive Vice President — Chief Financial Officer

 

 

(Principal Financial Officer)

 

 

November 13, 2003

 

 

43

 

**ALLTELCORPORATION**

**FORM10-Q**

**INDEX OFEXHIBITS**

 

Form 10-QExhibit No.

 

Description of  Exhibits

(10)(a)(3)

 

Amendment No. 2 to  Amended and Restated Credit Agreement dated as of August 29, 2003  between ALLTEL Corporation and Bank of America, N.A., Bank One, NA, Citibank,  N.A., Merrill Lynch Bank USA, PNC Bank, National Association, Union Bank of  California, N.A., Wachovia Bank, National Association.

 

 

 

(10)(c)(9)

 

Employment Agreement by  and between ALLTEL Corporation and Scott T. Ford effective as of  July 24, 2003.

 

 

 

(10)(c)(10)

 

Amendment to Change in  Control Agreement by and between the Company and Scott T. Ford effective as  of July 24, 2003.

 

 

 

31(a)

 

Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.

 

 

 

31(b)

 

Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.

 

 

 

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.

 

 

 

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.

 

44