Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2009

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to

 

Commission File Number 1-9712

 

UNITED STATES CELLULAR CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

62-1147325

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

8410 West Bryn Mawr, Suite 700, Chicago, Illinois  60631

(Address of principal executive offices)  (Zip Code)

 

Registrant’s telephone number, including area code: (773) 399-8900

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

 

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

 

Class

 

Outstanding at June 30, 2009

Common Shares, $1 par value

 

53,865,256 Shares

Series A Common Shares, $1 par value

 

33,005,877 Shares

 

 

 



Table of Contents

 

United States Cellular Corporation

 

Quarterly Report on Form 10-Q

For the Period Ended June 30, 2009

 

Index

 

 

 

 

Page No.

 

 

 

Part I.

Financial Information

3

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

3

 

 

 

 

 

 

Consolidated Statement of Operations Three and Six Months Ended June 30, 2009 and 2008

3

 

 

 

 

 

 

Consolidated Statement of Cash Flows Six Months Ended June 30, 2009 and 2008

4

 

 

 

 

 

 

Consolidated Balance Sheet June 30, 2009 and December 31, 2008

5

 

 

 

 

 

 

Consolidated Statement of Changes in Equity Six Months Ended June 30, 2009 and 2008

7

 

 

 

 

 

 

Notes to Consolidated Financial Statements

9

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

 

 

 

 

 

Overview

21

 

 

Results of Operations

24

 

 

Recent Accounting Pronouncements

33

 

 

Financial Resources

34

 

 

Liquidity and Capital Resources

35

 

 

Application of Critical Accounting Policies and Estimates

40

 

 

Safe Harbor Cautionary Statement

41

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

45

 

 

 

 

 

Item 4.

Controls and Procedures

46

 

 

 

 

Part II.

Other Information

47

 

 

 

 

 

Item 1.

Legal Proceedings

47

 

 

 

 

 

Item 1A.

Risk Factors

47

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

50

 

 

 

 

 

Item 5.

Other Information

51

 

 

 

 

 

Item 6.

Exhibits

52

 

 

 

 

Signatures

 

 

 

 



Table of Contents

 

Part I.  Financial Information

Item 1.  Financial Statements

 

United States Cellular Corporation

 

Consolidated Statement of Operations

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

(Dollars and shares in thousands, except per share amounts)

 

Operating revenues

 

 

 

 

 

 

 

 

 

Service

 

$

974,755

 

$

987,352

 

$

1,956,629

 

$

1,949,446

 

Equipment sales

 

67,795

 

73,240

 

138,685

 

149,002

 

Total operating revenues

 

1,042,550

 

1,060,592

 

2,095,314

 

2,098,448

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

System operations (excluding Depreciation, amortization and accretion reported below)

 

194,806

 

196,652

 

394,809

 

387,668

 

Cost of equipment sold

 

156,055

 

176,145

 

341,756

 

354,190

 

Selling, general and administrative
(including charges from affiliates of $26.2 million and $26.4 million, respectively, for the three months, and $54.9 million and $54.9 million, respectively, for the six months)

 

410,070

 

418,416

 

822,518

 

822,042

 

Depreciation, amortization and accretion

 

138,614

 

145,258

 

276,265

 

287,788

 

Loss on asset disposals, net

 

2,086

 

6,219

 

4,277

 

9,892

 

Total operating expenses

 

901,631

 

942,690

 

1,839,625

 

1,861,580

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

140,919

 

117,902

 

255,689

 

236,868

 

 

 

 

 

 

 

 

 

 

 

Investment and other income (expense)

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated entities

 

24,794

 

22,807

 

50,121

 

44,042

 

Interest and dividend income

 

751

 

1,429

 

1,228

 

3,334

 

Interest expense

 

(19,387

)

(20,774

)

(38,409

)

(40,889

)

Other, net

 

(2

)

600

 

278

 

718

 

Total investment and other income (expense)

 

6,156

 

4,062

 

13,218

 

7,205

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

147,075

 

121,964

 

268,907

 

244,073

 

Income tax expense

 

57,748

 

44,016

 

88,980

 

91,556

 

 

 

 

 

 

 

 

 

 

 

Net income

 

89,327

 

77,948

 

179,927

 

152,517

 

Less: Net income attributable to noncontrolling interests, net of tax

 

(5,969

)

(5,346

)

(11,977

)

(9,358

)

Net income attributable to U.S. Cellular

 

$

83,358

 

$

72,602

 

$

167,950

 

$

143,159

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

86,992

 

87,571

 

87,093

 

87,571

 

Basic earnings per share attributable to U.S. Cellular shareholders

 

$

0.96

 

$

0.83

 

$

1.93

 

$

1.63

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average shares outstanding

 

87,177

 

87,872

 

87,308

 

87,963

 

Diluted earnings per share attributable to U.S. Cellular shareholders

 

$

0.96

 

$

0.83

 

$

1.92

 

$

1.63

 

 

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

 

3



Table of Contents

 

United States Cellular Corporation

 

Consolidated Statement of Cash Flows

(Unaudited)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

179,927

 

$

152,517

 

Add (deduct) adjustments to reconcile net income to net cash flows from operating activities

 

 

 

 

 

Depreciation, amortization and accretion

 

276,265

 

287,788

 

Bad debts expense

 

39,028

 

32,426

 

Stock-based compensation expense

 

7,974

 

6,481

 

Deferred income taxes, net

 

19,604

 

27,231

 

Equity in earnings of unconsolidated entities

 

(50,121

)

(44,042

)

Distributions from unconsolidated entities

 

12,997

 

45,569

 

Loss on asset disposals, net

 

4,277

 

9,892

 

Excess tax benefit from stock awards

 

(4

)

(896

)

Noncash interest expense

 

1,213

 

886

 

Changes in assets and liabilities from operations

 

 

 

 

 

Accounts receivable

 

(63,510

)

(50,059

)

Inventory

 

(10,391

)

(19,816

)

Accounts payable - trade

 

(41,378

)

2,838

 

Accounts payable - affiliate

 

4,137

 

171

 

Customer deposits and deferred revenues

 

(5,372

)

10,406

 

Accrued taxes

 

64,851

 

1,471

 

Accrued interest

 

450

 

455

 

Other assets and liabilities

 

(66,824

)

(36,486

)

 

 

373,123

 

426,832

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Additions to property, plant and equipment

 

(228,902

)

(249,500

)

Cash received from divestitures

 

50

 

6,838

 

Cash paid for acquisitions and licenses

 

(12,327

)

(312,615

)

Other investing activities

 

1,107

 

(1,215

)

 

 

(240,072

)

(556,492

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Issuance of notes payable

 

 

100,000

 

Repayment of notes payable

 

 

(50,000

)

Common shares reissued for benefit plans, net of tax payments

 

(405

)

(1,878

)

Common shares repurchased

 

(19,332

)

(14,516

)

Excess tax benefit from stock awards

 

4

 

896

 

Payment of debt issuance costs

 

(4,309

)

 

Distributions to noncontrolling interests

 

(4,060

)

(6,022

)

Other financing activities

 

(25

)

(2,198

)

 

 

(28,127

)

26,282

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

104,924

 

(103,378

)

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

Beginning of period

 

170,996

 

204,533

 

End of period

 

$

275,920

 

$

101,155

 

 

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

 

4



Table of Contents

 

United States Cellular Corporation

 

Consolidated Balance Sheet — Assets

 

 

 

June 30,

 

 

 

 

 

2009

 

December 31,

 

 

 

(Unaudited)

 

2008

 

 

 

(Dollars in thousands)

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

275,920

 

$

170,996

 

Accounts receivable

 

 

 

 

 

Customers, less allowances of $8,383 and $8,222, respectively

 

344,812

 

330,390

 

Roaming

 

30,411

 

34,841

 

Affiliated

 

2,545

 

1,579

 

Other, less allowances of $313 and $150, respectively

 

69,753

 

52,809

 

Inventory

 

125,578

 

116,564

 

Prepaid income taxes

 

 

22,515

 

Prepaid expenses

 

49,040

 

51,645

 

Net deferred income tax asset

 

19,481

 

19,481

 

Other current assets

 

54,705

 

14,227

 

 

 

972,245

 

815,047

 

Investments

 

 

 

 

 

Licenses

 

1,445,501

 

1,433,415

 

Goodwill

 

494,737

 

494,279

 

Customer lists, net of accumulated amortization of $90,447 and $87,976, respectively

 

6,465

 

8,936

 

Investments in unconsolidated entities

 

192,445

 

156,637

 

Notes and interest receivable – long-term

 

4,231

 

4,297

 

 

 

2,143,379

 

2,097,564

 

Property, plant and equipment

 

 

 

 

 

In service and under construction

 

5,602,245

 

5,884,383

 

Less: accumulated depreciation

 

3,024,243

 

3,264,007

 

 

 

2,578,002

 

2,620,376

 

 

 

 

 

 

 

Other assets and deferred charges

 

37,621

 

33,055

 

 

 

 

 

 

 

Total assets

 

$

5,731,247

 

$

5,566,042

 

 

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

 

5



Table of Contents

 

United States Cellular Corporation

 

Consolidated Balance Sheet — Liabilities and Shareholders’ Equity

 

 

 

June 30,

 

 

 

 

 

2009

 

December 31,

 

 

 

(Unaudited)

 

2008

 

 

 

(Dollars in thousands)

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt

 

$

10,088

 

$

10,258

 

Accounts payable

 

 

 

 

 

Affiliated

 

13,750

 

9,613

 

Trade

 

210,826

 

248,785

 

Customer deposits and deferred revenues

 

145,710

 

151,082

 

Accrued taxes

 

58,433

 

17,643

 

Accrued compensation

 

41,976

 

55,969

 

Other current liabilities

 

91,149

 

108,533

 

 

 

571,932

 

601,883

 

 

 

 

 

 

 

Deferred liabilities and credits

 

 

 

 

 

Net deferred income tax liability

 

498,823

 

478,106

 

Other deferred liabilities and credits

 

243,258

 

233,619

 

 

 

742,081

 

711,725

 

 

 

 

 

 

 

Long-term debt

 

997,651

 

996,636

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interests with mandatory redemption features

 

640

 

589

 

 

 

 

 

 

 

Equity

 

 

 

 

 

U.S. Cellular shareholders’ equity

 

 

 

 

 

Common Shares, par value $1 per share; authorized 140,000,000 shares; issued 55,068,000 shares

 

55,068

 

55,068

 

Series A Common Shares, par value $1 per share; authorized 50,000,000 shares; issued and outstanding 33,006,000 shares

 

33,006

 

33,006

 

Additional paid-in capital

 

1,348,664

 

1,340,146

 

Treasury shares, at cost, 1,203,000 and 794,000 Common Shares, respectively

 

(60,104

)

(50,258

)

Retained earnings

 

1,985,876

 

1,828,680

 

Total U.S. Cellular shareholders’ equity

 

3,362,510

 

3,206,642

 

 

 

 

 

 

 

Noncontrolling interests

 

56,433

 

48,567

 

 

 

 

 

 

 

Total equity

 

3,418,943

 

3,255,209

 

 

 

 

 

 

 

Total liabilities and equity

 

$

5,731,247

 

$

5,566,042

 

 

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

 

6



Table of Contents

 

United States Cellular Corporation

 

Consolidated Statement of Changes in Equity

(Unaudited)

 

 

 

U.S. Cellular Shareholders

 

 

 

 

 

(Dollars in thousands)

 

Common
Shares

 

Series A
Common
Shares

 

Additional
Paid-In
Capital

 

Treasury
Shares

 

Retained
Earnings

 

Total
Shareholders’
Equity

 

Noncontrolling
Interests

 

Total Equity

 

Balance, December 31, 2008

 

$

55,068

 

$

33,006

 

$

1,340,146

 

$

(50,258

)

$

1,828,680

 

$

3,206,642

 

$

48,567

 

$

3,255,209

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Add (Deduct)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income excluding portion attributable to noncontrolling interests with mandatory redemption features

 

 

 

 

 

167,950

 

167,950

 

11,926

 

179,876

 

Repurchase of Common Shares

 

 

 

 

(19,332

)

 

(19,332

)

 

(19,332

)

Incentive and compensation plans

 

 

 

1,444

 

9,486

 

(10,754

)

176

 

 

176

 

Stock-based compensation awards

 

 

 

7,974

 

 

 

7,974

 

 

7,974

 

Tax windfall (shortfall) from stock awards

 

 

 

(900

)

 

 

(900

)

 

(900

)

Distributions to noncontrolling interests

 

 

 

 

 

 

 

(4,060

)

(4,060

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2009

 

$

55,068

 

$

33,006

 

$

1,348,664

 

$

(60,104

)

$

1,985,876

 

$

3,362,510

 

$

56,433

 

$

3,418,943

 

 

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

 

7



Table of Contents

 

United States Cellular Corporation

 

Consolidated Statement of Changes in Equity

(Unaudited)

 

 

 

U.S. Cellular Shareholders

 

 

 

 

 

(Dollars in thousands)

 

Common
Shares

 

Series A
Common
Shares

 

Additional
Paid-In
Capital

 

Treasury
Shares

 

Accumulated
Other
Comprehensive
Income

 

Retained
Earnings

 

Total
Shareholders’
Equity

 

Noncontrolling
Interests

 

Total Equity

 

Balance, December 31, 2007

 

$

55,068

 

$

33,006

 

$

1,316,785

 

$

(41,859

)

$

10,134

 

$

1,823,022

 

$

3,196,156

 

$

46,831

 

$

3,242,987

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Add (Deduct)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income excluding portion attributable to noncontrolling interests with mandatory redemption features

 

 

 

 

 

 

143,159

 

143,159

 

10,478

 

153,637

 

Net unrealized losses on securities

 

 

 

 

 

99

 

 

99

 

 

99

 

Repurchase of Common Shares

 

 

 

4,554

 

(19,070

)

 

 

(14,516

)

 

(14,516

)

Incentive and compensation plans

 

 

 

548

 

14,750

 

 

(16,369

)

(1,071

)

 

(1,071

)

Stock-based compensation awards

 

 

 

6,481

 

 

 

 

6,481

 

 

6,481

 

Tax windfall (shortfall) from stock awards

 

 

 

1,587

 

 

 

 

1,587

 

 

1,587

 

Distributions to noncontrolling interests

 

 

 

 

 

 

 

 

(6,022

)

(6,022

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, June 30, 2008

 

$

55,068

 

$

33,006

 

$

1,329,955

 

$

(46,179

)

$

10,233

 

$

1,949,812

 

$

3,331,895

 

$

51,287

 

$

3,383,182

 

 

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

 

8



Table of Contents

 

United States Cellular Corporation

 

Notes to Consolidated Financial Statements

 

1.     Basis of Presentation

 

United States Cellular Corporation (“U.S. Cellular®”), a Delaware Corporation, is an 81%-owned subsidiary of Telephone and Data Systems, Inc. (“TDSTM”).

 

The accounting policies of U.S. Cellular conform to accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of U.S. Cellular, its majority-owned subsidiaries since acquisition, general partnerships in which U.S. Cellular has a majority partnership interest and any entity in which U.S. Cellular has a variable interest that requires U.S. Cellular to recognize a majority of the entity’s expected gains or losses. All material intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the 2009 presentation.

 

The consolidated financial statements included herein have been prepared by U.S. Cellular, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, U.S. Cellular believes that the disclosures included herein are adequate to make the information presented not misleading.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in U.S. Cellular’s Annual Report on Form 10-K for the year ended December 31, 2008.

 

The accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring items unless otherwise disclosed) necessary to present fairly the financial position as of June 30, 2009 and December 31, 2008, the results of operations for the three and six months ended June 30, 2009 and 2008, and cash flows and changes in equity for the six months ended June 30, 2009 and 2008.  The results of operations for the three and six months ended June 30, 2009, and cash flows and changes in equity for the six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year.

 

2.     Summary of Significant Accounting Policies

 

Amounts Collected from Customers and Remitted to Governmental Authorities

 

If the tax is assessed upon the customer and U.S. Cellular merely acts as an agent in collecting the tax on behalf of the governmental authority imposing such tax, the amounts collected from customers and remitted to governmental authorities are recorded net in Accrued taxes in the Consolidated Balance Sheet.  If the tax is assessed upon U.S. Cellular, the amounts collected from customers as recovery of the tax are recorded in Service revenues and the amounts remitted to governmental authorities are recorded in Selling, general and administrative expenses in the Consolidated Statement of Operations.  The amounts recorded in Service revenues that are billed to customers and remitted to governmental authorities totaled $27.2 million and $53.1 million for the three and six months ended June 30, 2009, respectively, and $36.3 million and $69.5 million for the three and six months ended June 30, 2008, respectively.

 

Implementation of SFAS No. 141(R)

 

Effective January 1, 2009, U.S. Cellular adopted the provisions of FASB Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations — a replacement of FASB Statement No. 141 (“SFAS 141(R)”), which replaces SFAS No. 141, Business Combinations (“SFAS 141”).  Although SFAS 141(R) retains the underlying concept of SFAS 141 in that all business combinations are still required to be accounted for at fair value in accordance with the acquisition method, SFAS 141(R) requires U.S. Cellular to revise its application of the acquisition method in a number of significant aspects, such as requiring the expensing of transaction costs and requiring the acquirer to recognize 100% of the acquiree’s assets and liabilities, rather than a proportional share, for acquisitions of less than 100% of a business.  In addition, SFAS 141(R) eliminates the step acquisition model and provides that all business combinations, whether full, partial or step acquisitions, will result in all assets and liabilities of an acquired business being recorded at their fair values at the acquisition date.

 

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In April 2009, the FASB issued FASB Staff Position FAS 141(R)-1, Accounting for Assets and Liabilities Assumed in a Business Combination That Arise from Contingencies (“FSP FAS 141(R)-1”), which amends the initial and subsequent measurement guidance and disclosure requirements in SFAS 141(R) for assets and liabilities arising from contingencies in a business combination. FSP FAS 141(R)-1 is effective on a prospective basis for all business combinations for which the acquisition date is on or after January 1, 2009.  U.S. Cellular did not have any business combinations accounted for under SFAS 141(R) during the six months ended June 30, 2009.

 

Implementation of SFAS No. 160

 

See Note 3 — Noncontrolling Interests for information related to U.S. Cellular’s adoption of SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements an amendment of ARB No. 51 (“SFAS 160”).

 

Recent Accounting Pronouncements

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”).  SFAS 167 changes how U.S. Cellular will determine when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated.  U.S. Cellular has several variable interest entities within the scope of SFAS 167 (see Note 6 — Variable Interest Entities).  SFAS 167 is effective for U.S. Cellular on January 1, 2010.  U.S. Cellular is currently reviewing the requirements of SFAS 167 and has not yet determined the impact of adoption, if any, on its financial position or results of operations.

 

3.     Noncontrolling Interests

 

Implementation of SFAS No. 160

 

Effective January 1, 2009, U.S. Cellular adopted the provisions of SFAS 160.

 

Pursuant to SFAS 160, the following provisions were applied retrospectively to all periods presented in the financial statements:

 

·      U.S. Cellular reclassified noncontrolling interests, formerly known as “minority interests,” from a separate caption between liabilities and shareholders’ equity (“mezzanine section”) to a component of equity, with the exception of noncontrolling interests with redemption features, which require mezzanine section presentation in accordance with Emerging Issues Task Force Topic No. D-98, Classification and Measurement of Redeemable Securities.  Previously, minority interests generally were reported in the balance sheet in the mezzanine section.

 

·      Consolidated net income and comprehensive income include amounts attributable to both U.S. Cellular and the noncontrolling interests. Previously, net income attributable to the noncontrolling interests was reported as a deduction in arriving at consolidated net income.  This presentation change does not impact the calculation of basic or diluted earnings per share, which continue to be calculated based on Net income attributable to U.S. Cellular.

 

·      Shares of U.S. Cellular held by its subsidiary are reflected as treasury shares in the consolidated financial statements.  Previously, these shares were not reflected as issued shares and treasury shares in the consolidated financial statements.  As a result, 22,534 Common Shares were added to both Common Shares issued and Treasury Shares in the Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008.

 

Pursuant to SFAS 160, the following provisions were applied prospectively effective January 1, 2009:

 

·      SFAS 160 provides that all earnings and losses of a subsidiary should be attributed to the parent and the noncontrolling interest, even if the losses attributable to the noncontrolling interest result in a deficit noncontrolling interest balance.  Previously, any losses exceeding the noncontrolling interest’s investment in the subsidiary were attributed to the parent.  This change did not have a significant impact on U.S. Cellular’s financial statements for the six months ended June 30, 2009.

 

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·      SFAS 160 also establishes that, once control of a subsidiary is obtained, changes in ownership interests in that subsidiary that do not result in a loss of control shall be accounted for as equity transactions.  Previously, decreases in ownership interest in a subsidiary were accounted for as equity transactions, while increases in ownership interests of a subsidiary were accounted for as step acquisitions under the provisions of SFAS 141.  U.S. Cellular did not enter into any transactions in the six months ended June 30, 2009 that changed its ownership interest in its consolidated subsidiaries.  During the six months ended June 30, 2008, U.S. Cellular purchased noncontrolling interests in a consolidated subsidiary.  U.S. Cellular accounted for this transaction as a step acquisition under the provisions of SFAS 141.  The amounts recorded in this transaction are reflected in the changes in the balances of Licenses, Goodwill and Customer lists.

 

Mandatorily Redeemable Noncontrolling Interests in Subsidiaries

 

Under SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, certain noncontrolling interests in consolidated entities with finite lives may meet the definition of a mandatorily redeemable financial instrument. U.S. Cellular’s consolidated financial statements include certain noncontrolling interests that meet the definition of mandatorily redeemable financial instruments.  These mandatorily redeemable noncontrolling interests represent interests held by third parties in consolidated partnerships and limited liability companies (“LLCs”), where the terms of the underlying partnership or LLC agreement provide for a defined termination date at which time the assets of the subsidiary are to be sold, the liabilities are to be extinguished and the remaining net proceeds are to be distributed to the noncontrolling interest holders and U.S. Cellular in accordance with the respective partnership and LLC agreements.  The termination dates of U.S. Cellular’s mandatorily redeemable noncontrolling interests range from 2085 to 2094.

 

The settlement value of U.S. Cellular’s mandatorily redeemable noncontrolling interests was estimated to be $147.4 million at June 30, 2009.  This amount represents the estimate of cash that would be due and payable to settle these noncontrolling interests assuming an orderly liquidation of the finite-lived consolidated partnerships and LLCs on June 30, 2009, net of estimated liquidation costs.  This amount is being disclosed pursuant to the requirements of FSP No. FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under SFAS 150.  U.S. Cellular has no current plans or intentions to liquidate any of the related partnerships or LLCs prior to their scheduled termination dates.  The corresponding carrying value of the mandatorily redeemable noncontrolling interests in finite-lived consolidated partnerships and LLCs at June 30, 2009 was $53.1 million, and was included in Noncontrolling interests in the Consolidated Balance Sheet. The excess of the aggregate settlement value over the aggregate carrying value of the mandatorily redeemable noncontrolling interests of $94.3 million was due primarily to the unrecognized appreciation of the noncontrolling interest holders’ share of the underlying net assets in the consolidated partnerships and LLCs.  Neither the noncontrolling interest holders’ share, nor U.S. Cellular’s share, of the appreciation of the underlying net assets of these subsidiaries was reflected in the consolidated financial statements. The estimate of settlement value was based on certain factors and assumptions which are subjective in nature.  Changes in those factors and assumptions could result in a materially larger or smaller settlement amount.

 

4.     Fair Value Measurements

 

SFAS No. 157, Fair Value Measurements, (“SFAS 157”) defines “fair value”, establishes a framework for measuring fair value in the application of GAAP, and expands disclosures about fair value measurements.  SFAS 157 does not expand the use of fair value measurements in financial statements, but standardizes its definition and application in GAAP.  SFAS 157 provides that fair value is a market-based measurement. This pronouncement establishes a fair value hierarchy that distinguishes between assumptions developed based on market data obtained from independent external sources and the reporting entity’s own assumptions. Further, SFAS 157 specifies that fair value measurements should consider adjustments for risk, such as the risk inherent in a valuation technique or its input.  For assets and liabilities measured at fair value on a recurring basis, SFAS 157 expands the required disclosures concerning the inputs used to measure fair value.

 

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As of June 30, 2009 and December 31, 2008, U.S. Cellular did not have any financial assets or liabilities that were required to be recorded at fair value on a recurring basis in its Consolidated Balance Sheet. However, U.S. Cellular has applied the provisions of SFAS 157 for purposes of computing the fair value of financial instruments for disclosure purposes.  The fair value of financial instruments was as follows:

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

 

 

Book Value

 

Fair Value

 

Book Value

 

Fair Value

 

 

 

(Dollars in thousands)

 

Cash and cash equivalents

 

$

275,920

 

$

275,920

 

$

170,996

 

$

170,996

 

Current portion of long-term debt(1)

 

10,000

 

9,825

 

10,000

 

9,887

 

Long-term debt(1)

 

992,975

 

856,426

 

992,748

 

663,432

 

 


(1)   Excludes capital lease obligations

 

The fair value of cash equivalents included in Cash and cash equivalents approximates their book value due to the short-term nature of these financial instruments.  The fair value of U.S. Cellular’s Current portion of long-term debt, excluding capital lease obligations, was estimated using a discounted cash flow analysis.  The fair value of U.S. Cellular’s Long-term debt, excluding capital lease obligations, was estimated using market prices for the 7.5% and 8.75% senior notes and discounted cash flow analysis for the remaining debt.

 

As of June 30, 2009, U.S. Cellular did not have any nonfinancial assets or liabilities that required the application of SFAS 157 for purposes of reporting such amounts in its Consolidated Balance Sheet.

 

5.     Income Taxes

 

U.S. Cellular is included in a consolidated federal income tax return and in certain state income or franchise tax returns with other members of the TDS consolidated group.  For financial statement purposes, U.S. Cellular and its subsidiaries compute their income tax expense as if they comprised a separate affiliated group and were not included in the TDS consolidated group.

 

U.S. Cellular’s overall effective tax rate on Income before income taxes for the three and six months ended June 30, 2009 was 39.3% and 33.1%, respectively, and for the three and six months ended June 30, 2008 was 36.1% and 37.5%, respectively.

 

·      The effective tax rate for the six months ended June 30, 2009 was lower than the rate for the three months ended June 30, 2009 and the six months ended June 30, 2008 primarily due to a state tax benefit resulting from a state tax law change.  A tax benefit associated with the state tax law change was recognized as a discrete item in the three months ended March 31, 2009.  This benefit, along with other minor discrete benefits in the period, decreased income tax expense for the three months ended March 31, 2009 and the six months ended June 30, 2009 by $14.6 million and $12.4 million, respectively; absent these benefits, the effective tax rate for the three and six months ended June 30, 2009 would have been 37.8% and 37.7%, respectively.  The state tax law change is not expected to provide any incremental benefit in future periods.

 

·      The effective tax rate for the three months ended June 30, 2009 was higher than the rate for the three months ended June 30, 2008 primarily due to discrete income tax expense (benefit) items which aggregated $2.2 million and ($0.2) million in the three months ended June 30, 2009 and 2008, respectively.

 

In 2008, upon completion of the audit of the TDS consolidated group’s federal income tax returns for the years 2002 through 2005, the Internal Revenue Service (“IRS”) issued an assessment of income tax.  TDS protested the assessment and it is under appeal.  Pursuant to a provision of the Internal Revenue Code, TDS made a $38 million deposit with the IRS in order to eliminate any potential interest expense subsequent to the deposit.  U.S. Cellular then paid TDS a $34 million deposit in March 2009, which represented its proportionate share of the deposit that TDS paid to the IRS. This deposit is included in Other current assets in U.S. Cellular’s Consolidated Balance Sheet at June 30, 2009.

 

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6.     Variable Interest Entities

 

From time to time, the Federal Communications Commission (“FCC”) conducts auctions through which additional spectrum is made available for the provision of wireless services.  U.S. Cellular participated in spectrum auctions indirectly through its limited partnership interests in Aquinas Wireless L.P. (“Aquinas Wireless”), King Street Wireless L.P. (“King Street Wireless”), Barat Wireless L.P. (“Barat Wireless”) and Carroll Wireless L.P. (“Carroll Wireless”), collectively, the “limited partnerships.”  Each entity qualified as a “designated entity” and thereby was eligible for bid credits with respect to licenses purchased in accordance with the rules defined by the FCC for each auction. In most cases, the bidding credits resulted in a 25% discount from the gross winning bid.  Some licenses were “closed licenses,” for which no credit was received, but bidding was restricted to bidders qualifying as “entrepreneurs,” which are small businesses that have a limited amount of assets and revenues.

 

A summary of the auctions in which each entity participated and the auction results for each of these entities are shown in the table below.

 

 

 

FCC
Auction

 

Auction End Date

 

Date Applications
Granted by FCC

 

Number of
Licenses Won

 

Aquinas Wireless

 

78

 

August 20, 2008

 

 

(1)

5

(2)

King Street Wireless

 

73

 

March 20, 2008

 

 

(1)

152

(2)

Barat Wireless

 

66

 

September 18, 2006

 

April 30, 2007

 

17

 

Carroll Wireless

 

58

 

February 15, 2005

 

January 6, 2006

 

16

 

 


(1)   As of June 30, 2009, the FCC had not granted licenses to Aquinas Wireless and King Street Wireless for Auctions 78 and 73, respectively.

(2)   Provisionally won.

 

Consolidated Variable Interest Entities

 

As of June 30, 2009, U.S. Cellular consolidates the following variable interest entities (“VIEs”):

 

·      Aquinas Wireless;

·      King Street Wireless and King Street Wireless, Inc., the general partner of King Street Wireless;

·      Barat Wireless and Barat Wireless, Inc., the general partner of Barat Wireless; and

·      Carroll Wireless and Carroll PCS, Inc., the general partner of Carroll Wireless.

 

FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (“FIN 46(R)”), establishes certain criteria for consolidation when voting control is not present.  Specifically, for a variable interest entity, as such term is defined by FIN 46(R), an entity, referred to as the primary beneficiary, that absorbs a majority of the variable interest entity’s expected gains or losses is required to consolidate such a variable interest entity.  U.S. Cellular holds a variable interest in the entities listed above due to capital contributions and/or advances it has provided to these entities.  Given the significance of these contributions and/or advances in relation to the equity investment at risk, U.S. Cellular was deemed to be the primary beneficiary of these VIEs.  Accordingly, these VIEs are consolidated pursuant to FIN 46(R) because U.S. Cellular anticipates benefiting from or absorbing a majority of these VIEs’ expected gains or losses.

 

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Following is a summary of the capital contributions and advances made to each entity by U.S. Cellular as of June 30, 2009 (dollars in thousands).  The amounts shown in the table below exclude funds provided to these entities solely from the shareholder of the general partner.

 

Aquinas Wireless

 

$

2,132

 

King Street Wireless & King Street Wireless, Inc.

 

300,604

 

Barat Wireless & Barat Wireless, Inc.

 

127,485

 

Carroll Wireless & Carroll PCS, Inc.

 

130,094

 

 

 

$

 560,315

 

 

The following table presents the classification of the consolidated VIEs’ assets and liabilities in U.S. Cellular’s Consolidated Balance Sheet.

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Assets

 

 

 

 

 

Cash

 

$

361

 

$

684

 

Other current assets

 

367

 

63

 

Licenses

 

487,962

 

487,962

 

Total assets

 

$

488,690

 

$

488,709

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Customer deposits and deferred revenues

 

110

 

63

 

Total liabilities

 

$

110

 

$

63

 

 

Other Related Matters

 

U.S. Cellular may agree to make additional capital contributions and/or advances to the VIEs discussed above and/or to their general partners to provide additional funding for the development of licenses granted in the various auctions.  U.S. Cellular may finance such amounts with a combination of cash on hand, borrowings under its revolving credit agreement and/or long-term debt.  There is no assurance that U.S. Cellular will be able to obtain additional financing on commercially reasonable terms or at all to provide such financial support.

 

The general partner of each of these VIEs has the right to manage and operate the limited partnerships; however, the general partner needs consent of the limited partner, a subsidiary of U.S. Cellular, in certain limited circumstances, such as to make certain large expenditures, admit other partners, or liquidate the limited partnerships.

 

See Note 12 — Commitments and Contingencies for additional information related to the participation of Carroll Wireless, Barat Wireless and King Street Wireless in Auction 58, Auction 66 and Auction 73, respectively.

 

These VIEs are in the process of developing long-term business and financing plans.  These entities were formed to participate in FCC auctions of wireless spectrum and to fund, establish and provide wireless service with respect to any FCC licenses won in the auctions.  As such, these entities have risks similar to those described in the “Risk Factors” in U.S. Cellular’s Form 10-K for the year ended December 31, 2008.

 

7.     Earnings Per Share

 

Basic earnings per share is computed by dividing Net income attributable to U.S. Cellular by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing Net income attributable to U.S. Cellular by the weighted average number of common shares adjusted to include the effects of potentially dilutive securities. Potentially dilutive securities include incremental shares issuable upon exercise of outstanding stock options and the vesting of restricted stock units.

 

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The amounts used in computing Earnings per Common and Series A Common Share and the effects of potentially dilutive securities on the weighted average number of Common and Series A Common Shares are as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

(Dollars and shares in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to U.S. Cellular

 

$

83,358

 

$

72,602

 

$

167,950

 

$

143,159

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares used in basic earnings per share

 

86,992

 

87,571

 

87,093

 

87,571

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options(1)

 

21

 

181

 

32

 

227

 

Restricted stock units(2)

 

164

 

120

 

183

 

165

 

Weighted average number of shares used in diluted earnings per share

 

87,177

 

87,872

 

87,308

 

87,963

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share attributable to U.S. Cellular shareholders

 

$

0.96

 

$

0.83

 

$

1.93

 

$

1.63

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share attributable to U.S. Cellular shareholders

 

$

0.96

 

$

0.83

 

$

1.92

 

$

1.63

 

 


(1)   Stock options exercisable into 2,270,687 and 1,848,256 Common Shares in the three and six months ended June 30, 2009, respectively, and 597,695 and 336,683 Common Shares in the three and six months ended June 30, 2008, respectively, were not included in computing Diluted Earnings per Share because their effects were antidilutive.

 

(2)   Restricted stock units issuable upon vesting into 151,386 and 126,360 Common Shares in the three and six months ended June 30, 2009, respectively, were not included in computing Diluted Earnings per Share because their effects were antidilutive.  There were no antidilutive restricted stock units for the comparable periods in 2008.

 

8.     Acquisitions, Divestitures and Exchanges

 

U.S. Cellular assesses its existing wireless interests on an ongoing basis with a goal of improving the competitiveness of its operations and maximizing its long-term return on investment. As part of this strategy, U.S. Cellular reviews attractive opportunities to acquire additional operating markets and wireless spectrum. In addition, U.S. Cellular may seek to divest outright or include in exchanges for other wireless interests those markets and wireless interests that are not strategic to its long-term success.

 

Significant transactions pending as of June 30, 2009

 

The FCC auction of spectrum in the PCS and AWS-1 bands, designated by the FCC as Auction 78, closed on August 20, 2008. U.S. Cellular participated in Auction 78 indirectly through its interest in Aquinas Wireless.  Aquinas Wireless paid $2.1 million to the FCC in 2008 for five licenses for which it was the provisional winning bidder in the auction.

 

U.S. Cellular also participated in the FCC auction of spectrum in the 700 megahertz band, designated as Auction 73, which closed on March 20, 2008. U.S. Cellular participated in Auction 73 indirectly through its interest in King Street Wireless.  King Street Wireless paid $300.5 million to the FCC in 2008 for 152 licenses for which it was the provisional winning bidder in the auction.

 

There is no prescribed timeframe for the FCC to review the qualifications of the various winning bidders and grant licenses related to Auctions 78 and 73. As of June 30, 2009, the FCC had not granted the licenses to Aquinas Wireless or King Street Wireless. See Note 6—Variable Interest Entities, for further details on Aquinas Wireless and King Street Wireless and the licenses provisionally won in Auctions 78 and 73.

 

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9.     Licenses and Goodwill

 

Changes in U.S. Cellular’s licenses and goodwill for the six months ended June 30, 2009 and 2008 are presented below.

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Licenses

 

 

 

 

 

Balance, beginning of period

 

$

1,433,415

 

$

1,482,446

 

Acquisitions

 

12,250

 

310,282

 

Other

 

(164

)

 

Balance, end of period

 

$

1,445,501

 

$

1,792,728

 

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Goodwill

 

 

 

 

 

Balance, beginning of period

 

$

494,279

 

$

491,316

 

Acquisitions

 

 

2,602

 

Other

 

458

 

 

Balance, end of period

 

$

494,737

 

$

493,918

 

 

Licenses and goodwill must be reviewed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. U.S. Cellular has historically performed the required annual impairment assessment of its licenses and goodwill in the second quarter of the year.

 

As a result of the deterioration in the credit and financial markets and the decline of the overall economy in the fourth quarter of 2008, U.S. Cellular performed an interim impairment assessment of licenses and goodwill as of December 31, 2008.  The assessment resulted in an impairment loss of $386.7 million on licenses, which was recognized in December 2008, and no impairment of goodwill.  U.S. Cellular assessed whether an interim impairment assessment was also required at June 30, 2009, and concluded that such an impairment assessment was not required.

 

As noted above, since the adoption of SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), U.S. Cellular’s annual impairment review of goodwill and indefinite-lived intangible assets has been completed as of April 1 of each year. Effective April 1, 2009, U.S. Cellular adopted a new accounting policy whereby its annual impairment review of goodwill and indefinite-lived intangible assets will be performed as of November 1 instead of April 1 of each year.  As indicated above, an impairment analysis of goodwill and indefinite-lived intangible assets was last completed as of December 31, 2008.  The change in the annual goodwill and indefinite-lived intangible asset impairment testing date was made to better align the annual impairment test with the timing of U.S. Cellular’s annual strategic planning process, which allows for a better estimate of the future cash flows used in discounted cash flow models to test for impairment.  This change in accounting policy does not delay, accelerate or avoid an impairment charge. Accordingly, U.S. Cellular management believes that this accounting change is preferable under the circumstances.

 

10.  Investment in Unconsolidated Entities

 

Investments in unconsolidated entities consist of amounts invested in wireless entities in which U.S. Cellular holds a noncontrolling interest. These investments are accounted for using either the equity or cost method.

 

Equity in earnings of unconsolidated entities totaled $24.8 million and $22.8 million in the three months ended June 30, 2009 and 2008, respectively, and $50.1 million and $44.0 million in the six month periods then ended, respectively.  Of those amounts, U.S. Cellular’s investment in the Los Angeles SMSA Partnership (“LA Partnership”) contributed $17.1 million and $18.2 million in the three months ended June 30, 2009 and 2008, respectively, and $34.0 million and $34.0 million in the six months ended June 30, 2009 and 2008, respectively.  U.S. Cellular held a 5.5% ownership interest in the LA Partnership during these periods.

 

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The following table summarizes the combined results of operations of U.S. Cellular’s equity method investments:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,197,000

 

$

1,169,000

 

$

2,369,000

 

$

2,346,000

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

834,000

 

812,000

 

1,648,000

 

1,630,000

 

Operating income

 

363,000

 

357,000

 

721,000

 

716,000

 

Other income (expense)

 

12,000

 

6,000

 

21,000

 

11,000

 

Net Income

 

$

375,000

 

$

363,000

 

$

742,000

 

$

727,000

 

 

11.  Notes Payable

 

Prior to June 30, 2009, U.S. Cellular had a $700 million revolving credit facility available for general corporate purposes.  On June 30, 2009, U.S. Cellular entered into a new $300 million revolving credit agreement with certain lenders and other parties.  As a result, U.S. Cellular’s $700 million revolving credit agreement, which was due to expire in December 2009, was terminated on June 30, 2009 as a condition of entering into the new agreement.  The new revolving credit agreement provides U.S. Cellular with a $300 million senior revolving credit facility for working capital, non-hostile acquisitions and other corporate purposes and to refinance any existing debt of U.S. Cellular.  Amounts under the new revolving credit facility may be borrowed, repaid and reborrowed from time to time from and after June 30, 2009 until maturity in June 2012.

 

At June 30, 2009, there were no outstanding borrowings and $0.3 million of outstanding letters of credit, leaving $299.7 million available for use.  Borrowings under the new revolving credit facility bear interest at the London InterBank Offered Rate (“LIBOR”) (or, at U.S. Cellular’s option, an alternate “Base Rate” as defined in the new revolving credit agreement) plus a contractual spread based on U.S. Cellular’s credit rating.  U.S. Cellular may select borrowing periods of either one, two, three or six months (or other period of twelve months or less requested by U.S. Cellular if approved by the lenders).  At June 30, 2009, the one-month LIBOR was 0.31% and the contractual spread was 300 basis points.  If U.S. Cellular provides less than three business days notice of intent to borrow, interest on borrowings is the Base Rate plus the contractual spread (the Base Rate was 3.25% at June 30, 2009).

 

U.S. Cellular’s interest cost on its new revolving credit facility is subject to increase if its current credit rating from Standard & Poor’s Rating Service, Moody’s Investors Service and/or Fitch Ratings is lowered, and is subject to decrease if the rating is raised. The new credit facility would not cease to be available nor would the maturity date accelerate solely as a result of a downgrade in U.S. Cellular’s credit rating. However, a downgrade in U.S. Cellular’s credit rating could adversely affect its ability to renew the new credit facility or obtain access to other credit facilities in the future.

 

The new revolving credit facility has a commitment fee based on the senior unsecured debt rating assigned to U.S. Cellular by certain rating agencies. The range of the commitment fee is 0.25% to 0.75% of the unused portion of the new revolving credit facility.

 

U.S. Cellular incurred debt issuance costs of $4.3 million in conjunction with obtaining the new credit facility, and such costs will be amortized on a straight line basis over the three year term of the facility.

 

The maturity date of any borrowings under U.S. Cellular’s new revolving credit facility would accelerate in the event of a change in control.

 

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The continued availability of the new revolving credit facility requires U.S. Cellular to comply with certain negative and affirmative covenants, maintain certain financial ratios and make representations regarding certain matters at the time of each borrowing.  U.S. Cellular believes it was in compliance as of June 30, 2009 with all covenants and other requirements set forth in its new revolving credit facility.

 

In connection with U.S. Cellular’s new revolving credit facility, TDS and U.S. Cellular entered into a subordination agreement dated June 30, 2009 together with the administrative agent for the lenders under U.S. Cellular’s new revolving credit agreement.  Pursuant to this subordination agreement, (a) any consolidated funded indebtedness from U.S. Cellular to TDS will be unsecured and (b) any (i) consolidated funded indebtedness (other than “refinancing indebtedness” as defined in the subordination agreement) in excess of $105,000,000, and (ii) refinancing indebtedness in excess of $250,000,000, will be subordinated and made junior in right of payment to the prior payment in full of obligations to the lenders under U.S. Cellular’s new revolving credit agreement.  The aggregate outstanding principal amount of consolidated funded indebtedness of U.S. Cellular that was subordinated pursuant to this subordination agreement was zero as of June 30, 2009.

 

12.  Commitments and Contingencies

 

Indemnifications

 

U.S. Cellular enters into agreements in the normal course of business that provide for indemnification of counterparties.  These agreements include certain asset sales and financings with other parties.  The terms of the indemnification vary by agreement.  The events or circumstances that would require U.S. Cellular to perform under these indemnities are transaction specific; however, these agreements may require U.S. Cellular to indemnify the counterparty for costs and losses incurred from any litigation or claims arising from the underlying transaction.  U.S. Cellular is unable to estimate the maximum potential liability for these types of indemnifications as the amounts are dependent on the outcome of future events, the nature and likelihood of which cannot be determined at this time.  Historically, U.S. Cellular has not made any significant indemnification payments under such agreements.

 

Legal Proceedings

 

The United States Department of Justice (“DOJ”) has notified U.S. Cellular and its parent, TDS, that each is a named defendant in a civil action brought by a private party in the U.S. District Court for the District of Columbia under the “qui tam” provisions of the federal False Claims Act.  TDS and U.S. Cellular were advised that the complaint seeks return of approximately $165 million of bid credits from certain FCC auctions and requests treble damages.  The complaint remains under seal pending the DOJ’s consideration as to whether to intervene in the proceeding.  The DOJ has not yet made any decision as to whether it will intervene.  However, as a result of the complaint, the DOJ is investigating TDS’ and U.S. Cellular’s participation in certain spectrum auctions conducted by the FCC between 2005 and 2008, through Carroll Wireless, L.P., Barat Wireless, L.P., and King Street Wireless, L.P.  These limited partnerships were winning bidders in Auction 58, Auction 66 and Auction 73, respectively, and received a 25% bid credit in the applicable auction price under FCC rules.  The DOJ is investigating whether these limited partnerships qualified for the 25% bid credit in auction price considering their arrangements with TDS and U.S. Cellular. TDS and U.S. Cellular are cooperating with the DOJ’s review.  TDS and U.S. Cellular believe that U.S. Cellular’s arrangements with these limited partnerships and the limited partnerships’ participation in the FCC auctions complied with applicable law and FCC rules and each of TDS and U.S. Cellular intends to vigorously defend itself against any claim that it violated applicable law or FCC rules.  At this time, U.S. Cellular cannot predict the outcome of this review or any proceeding.  The FCC sent a letter to King Street Wireless, L.P. requesting that it submit to the FCC a written response to the allegations in the complaint.  King Street Wireless, L.P. made this submission as requested by the FCC.

 

U.S. Cellular is involved or may be involved from time to time in legal proceedings before the FCC, other regulatory authorities, and/or various state and federal courts.  If U.S. Cellular believes that a loss arising from such legal proceedings is probable and can be reasonably estimated, an amount is accrued in the financial statements for the estimated loss.  If only a range of loss can be determined, the best estimate within that range is accrued; if none of the estimates within that range is better than another, the low end of the range is accrued.  The assessment of the expected outcomes of legal proceedings is a highly subjective process that requires judgments about future events.  The legal proceedings are reviewed at least quarterly to determine the adequacy of accruals and related financial statement disclosures.  The ultimate outcomes of legal proceedings could differ materially from amounts accrued in the financial statements.

 

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13.  Common Share Repurchases

 

Prior to November 18, 2008, the Board of Directors of U.S. Cellular had authorized the repurchase of up to 1% of the outstanding U.S. Cellular Common Shares held by non-affiliates in each three-month period, primarily for use in employee benefit plans (the “Limited Authorization”).  On November 18, 2008, the Board of Directors of U.S. Cellular amended the Limited Authorization to permit the repurchase of up to 5% of the outstanding U.S. Cellular Common Shares held by persons other than TDS affiliates in each twelve-month period.  This authorization does not have an expiration date.

 

During the six months ended June 30, 2009, U.S. Cellular repurchased 507,000 Common Shares for $19.3 million, or an average of $38.13 per Common Share.  During the six months ended June 30, 2008, U.S. Cellular repurchased 300,000 Common Shares for $19.1 million, or an average of $63.57 per Common Share.  In addition, U.S. Cellular received $4.6 million in cash during the six months ended June 30, 2008 as a final settlement payment of 2007 Common Share repurchases executed through accelerated share repurchase agreements with an investment banking firm.  As of June 30, 2009, U.S. Cellular had repurchased the maximum number of Common Shares permitted to be repurchased for the twelve months then ended under the Limited Authorization.

 

14. Accumulated Other Comprehensive Income

 

The cumulative balance of unrealized gains on securities and related income tax effects included in Accumulated other comprehensive income was zero at June 30, 2009 and December 31, 2008.  Changes in such cumulative balance during the six months ended June 30, 2009 and June 30, 2008 were $0 and $99,000, respectively.

 

Comprehensive income for the six months ended June 30, 2009 and 2008 was as follows:

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Comprehensive Income

 

 

 

 

 

Net income

 

$

179,927

 

$

152,517

 

Net change in accumulated other comprehensive income

 

 

99

 

Comprehensive income

 

179,927

 

152,616

 

Less: Comprehensive income attributable to the noncontrolling interests

 

(11,977

)

(9,358

)

Comprehensive income attributable to U.S. Cellular

 

$

167,950

 

$

143,258

 

 

15.  Supplemental Cash Flow Disclosures

 

The following represents cash flow information related to the issuance of Common Shares pursuant to stock-based compensation awards:

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2009

 

2008

 

 

 

(Dollars in thousands)

 

Common Shares withheld(1)

 

33,565

 

217,535

 

 

 

 

 

 

 

Aggregate value of Common Shares withheld

 

$

1,213

 

$

12,841

 

 

 

 

 

 

 

Cash receipts upon exercise of stock options

 

$

808

 

$

1,920

 

Cash disbursements for payment of taxes(2)

 

(1,213

)

(3,798

)

Net cash receipts (disbursements) from exercise of stock options and vesting of other stock awards

 

$

(405

)

$

(1,878

)

 


(1)   Such shares were withheld to cover the exercise price of stock options, if applicable, and required tax withholdings.

(2)   In certain situations, U.S. Cellular withholds shares that are issuable upon the exercise of stock options or the vesting of restricted shares to cover, and with a value equivalent to, the exercise price and/or the amount of taxes required to be withheld from the stock award holder at the time of the exercise or vesting.  U.S. Cellular then pays the amount of the required tax withholdings to the taxing authorities in cash.

 

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16.  Subsequent Events

 

U.S. Cellular evaluated subsequent events from June 30, 2009 through the issuance date (August 6, 2009) of these financial statements.  No significant subsequent events have occurred during this period that require adjustment to the June 30, 2009 financial statements or disclosure.

 

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

 

United States Cellular Corporation (“U.S. Cellular®”) owns, operates and invests in wireless markets throughout the United States. U.S. Cellular is an 81%-owned subsidiary of Telephone and Data Systems, Inc. (“TDS™”) as of June 30, 2009.

 

The following discussion and analysis should be read in conjunction with U.S. Cellular’s interim consolidated financial statements included in Item 1 above, and with its audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in its Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2008.

 

OVERVIEW

 

The following is a summary of certain selected information contained in the comprehensive Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows. The overview does not contain all of the information that may be important. You should carefully read the entire Management’s Discussion and Analysis of Financial Condition and Results of Operations and not rely solely on the overview.

 

U.S. Cellular provides wireless telecommunications services to approximately 6.2 million customers in five geographic market areas in 26 states. As of June 30, 2009, U.S. Cellular’s average penetration rate in its consolidated operating markets, calculated by dividing U.S. Cellular’s total customers by the total population of 46.3 million in such markets, was 13.3%. U.S. Cellular operates on a customer satisfaction strategy, meeting customer needs by providing a comprehensive range of wireless products and services, excellent customer support, and a high-quality network. U.S. Cellular’s business development strategy is to operate controlling interests in wireless licenses in areas adjacent to or in proximity to its other wireless licenses, thereby building contiguous operating market areas. U.S. Cellular believes that operating in contiguous market areas will continue to provide it with certain economies in its capital and operating costs. Financial and operating highlights in the first six months of 2009 included the following:

 

·      Total customers were 6,155,000 at June 30, 2009, including 5,711,000 retail customers.

 

·      Retail customer net additions were 4,000 in the first six months of 2009 (comprised of 63,000 net additions in the first quarter and 59,000 net defections in the second quarter) compared to 119,000 in 2008. The decrease year-over-year reflected both lower gross additions and higher churn rates, due to the weak economy and very competitive industry conditions including the increased impacts of unlimited prepay service providers in certain of U.S. Cellular’s markets.

 

·      Postpay customers comprised approximately 95% of U.S. Cellular’s retail customer base as of June 30, 2009. Postpay net additions were 28,000 in the first six months of 2009 (comprised of 60,000 net additions in the first quarter and 32,000 net defections in the second quarter) compared to 105,000 in 2008. The postpay churn rate was 1.6% in 2009.

 

·      Service revenues of $1,956.6 million increased $7.2 million year-over-year, despite a $34.7 million (22%) decrease in inbound roaming revenues.  Retail service revenues grew by $32.4 million (2%) due to increases in the average number of customers and the average monthly retail service revenue per customer.

 

·      Cash flows from operating activities were $373.1 million. At June 30, 2009, Cash and cash equivalents totaled $275.9 million and there were no outstanding borrowings under the revolving credit facility.

 

·      On June 30, 2009, U.S. Cellular entered into a new $300 million revolving credit agreement with certain lenders and other parties.  As a result, U.S. Cellular’s $700 million revolving credit agreement, which was due to expire in December 2009, was terminated on June 30, 2009 as a condition of entering into the new agreement.  The new revolving credit agreement provides U.S. Cellular with a $300 million senior revolving credit facility for working capital, non-hostile acquisitions and other corporate purposes and to refinance any existing debt of U.S. Cellular.

 

·      Additions to property, plant and equipment totaled $228.9 million, including expenditures to construct cell sites, increase capacity in existing cell sites and switches, expand mobile broadband services based on third generation Evolution Data Optimized technology (“3G”) to additional markets, outfit new and remodel existing retail stores and continue the development and enhancement of U.S. Cellular’s office systems. Total cell sites in service increased 7% year-over-year to 7,043.

 

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·      As a further proof point of its customer satisfaction strategy and Believe in Something BetterTM brand message, U.S. Cellular launched its new Battery Swap program. Under this program, a customer can go to any store and exchange a battery that is dead or dying for one that is fully charged, at no cost to the customer. U.S. Cellular is the first wireless company to offer this service in the United States.

 

·      U.S. Cellular began efforts on a number of multi-year initiatives including the development of: a new point-of-sale system to consolidate billing on one platform; an Electronic Data Warehouse/Customer Relationship Management System to collect and analyze information more efficiently to build and improve customer relationships; and a new Internet/Web platform to enable customers to complete a wide range of transactions and, eventually, to manage their accounts online.

 

·      Operating income increased $18.8 million, or 8%, to $255.7 million in 2009 from $236.9 million in 2008.

 

U.S. Cellular anticipates that future growth in its operating income will be affected by the following factors:

 

·      Uncertainty related to current economic conditions and their impact on demand for U.S. Cellular’s products and services;

 

·      Increasing penetration in the wireless industry;

 

·      Increased competition in certain markets, including competition from carriers offering low-priced, unlimited prepay service;

 

·      Costs of customer acquisition and retention, such as equipment subsidies and advertising;

 

·      Industry consolidation and the resultant effects on roaming revenues, service and equipment pricing and other effects of competition;

 

·      Providing service in recently launched areas or potential new market areas;

 

·      Potential increases or decreases in prepay and reseller customers as a percentage of U.S. Cellular’s customer base;

 

·      Costs of developing and introducing new products and services;

 

·      Costs of developing and enhancing office and customer support systems, including costs and risks associated with the completion of important multi-year initiatives such as those described above;

 

·      Continued enhancements to its wireless networks, including expansion of 3G services and potential deployments of new technology;

 

·      Increasing costs of regulatory compliance; and

 

·      Uncertainty in future eligible telecommunication carrier (“ETC”) funding.

 

·      Net income attributable to U.S. Cellular increased $24.8 million, or 17%, to $168.0 million in 2009 compared to $143.2 million in 2008, due primarily to higher operating income and a lower effective income tax rate.  Basic earnings per share was $1.93 in 2009, which was $0.30 higher than in 2008, and Diluted earnings per share was $1.92, which was $0.29 higher than in 2008.

 

Cash Flows and Investments

 

U.S. Cellular believes that cash on hand, expected future cash flows from operating activities and sources of external financing provide financial flexibility and are sufficient to permit U.S. Cellular to finance its contractual obligations and anticipated capital expenditures for the foreseeable future. U.S. Cellular continues to seek to maintain a strong balance sheet and an investment grade credit rating.

 

See “Financial Resources” and “Liquidity and Capital Resources” below for additional information related to cash flows and investments, including information related to U.S. Cellular’s new revolving agreement and the impacts of recent economic events.

 

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Recent Developments

 

Congress recently enacted the American Recovery and Reinvestment Act of 2009, or the Recovery Act, which provides, among other things, for an aggregate appropriation of $7.2 billion to fund grants and loans to provide broadband infrastructure, access and equipment to consumers residing in rural, unserved or underserved areas of the United States. A significant portion of these funds is expected to be made available in 2009 and 2010. The application deadline for the first portion of the grants and loans is August 14, 2009. U.S. Cellular is currently assessing the eligibility requirements for the grants and loans and potential qualifying broadband projects, and may apply for the Recovery Act funds.  There is no assurance that U.S. Cellular, if it applies, will receive the Recovery Act funds. The distribution of these grants and loans to other telecommunications service providers could impact competition in certain of U.S. Cellular’s service areas.

 

2009 Estimates

 

U.S. Cellular expects the factors described above to impact revenues and operating income for the next several quarters. Any changes in the above factors, as well as the effects of other drivers of U.S. Cellular’s operating results, may cause revenues and operating income to fluctuate over the next several quarters.

 

U.S. Cellular’s estimates of full-year 2009 results for: service revenues; operating income; depreciation, amortization and accretion expenses; and capital expenditures, are shown below. Such estimates represent U.S. Cellular’s views as of the date of filing of U.S. Cellular’s Form 10-Q for the six months ended June 30, 2009. Such forward-looking statements should not be assumed to be accurate as of any future date. U.S. Cellular undertakes no duty to update such information whether as a result of new information, future events or otherwise. There can be no assurance that final results will not differ materially from such estimated results.

 

 

 

2009

 

2008

 

 

 

Estimated Results

 

Actual Results

 

Net retail customer additions (1)

 

 

149,000

 

Service revenues

 

$3,900 - $3,950 million

 

$3,940.3 million

 

Operating income(2) (3)

 

$300 - $375 million

 

$27.7 million

 

Depreciation, amortization and accretion expenses(2) (3)

 

Approx. $600 million

 

$987.0 million

 

Capital expenditures

 

Approx. $575 million

 

$585.6 million

 

 


(1)   U.S. Cellular has withdrawn its net retail customer additions guidance for the remainder of 2009 due to uncertainty related to the weak economy and consumer purchasing intentions.

 

(2)   2008 Actual Results include losses on disposals of $23.4 million and impairment of assets of $386.7 million. The 2009 Estimated Results include only the estimate for Depreciation, amortization and accretion expenses and losses on disposals of assets, and do not include any estimate for losses on impairment of assets since these cannot be predicted.

 

(3)   The 2008 loss on impairment of assets of $386.7 million is not expected to have an impact on future operating results and liquidity.  In addition, historical operating results, including the 2008 impairment, are not necessarily indicative of future operating results.

 

U.S. Cellular management currently believes that the foregoing estimates represent a reasonable view of what is achievable considering actions that U.S. Cellular has taken and will be taking. However, the current general economic conditions have created a challenging business environment that could significantly impact actual results. U.S. Cellular expects to continue its focus on customer satisfaction by delivering a high quality network, attractively priced service plans, a broad line of handsets and other products, and outstanding customer service in its company-owned and agent retail stores and customer care centers. U.S. Cellular believes that future growth in its revenues will result primarily from selling additional products and services to its existing customers, increasing the number of multi-device users among its existing customers, and attracting wireless users switching from other wireless carriers, rather than by adding users that are new to wireless service. U.S. Cellular is focusing on opportunities to increase revenues, pursuing cost reduction initiatives in various areas and implementing a number of initiatives to enable future growth. The initiatives are intended, among other things, to allow U.S. Cellular to accelerate its introduction of new products and services, better segment its customers for new services and retention, sell additional services such as data, expand its Internet sales and customer service capabilities, and improve its prepay products and services.

 

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RESULTS OF OPERATIONS

 

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008

 

Following is a table of summarized operating data for U.S. Cellular’s consolidated operations.

 

As of June 30,(1)

 

2009

 

2008

 

Total market population of consolidated operating markets(2)

 

46,306,000

 

45,493,000

 

Customers(3)

 

6,155,000

 

6,194,000

 

Market penetration(2)

 

13.3

%

13.6

%

Total full-time equivalent employees

 

8,673

 

8,386

 

Cell sites in service

 

7,043

 

6,596

 

 

For the Six Months Ended June 30,(4)

 

2009

 

2008

 

Net retail customer additions(5)

 

4,000

 

119,000

 

Net customer additions (losses)(5)

 

(41,000

)

90,000

 

Average monthly service revenue per customer(6)

 

$

52.51

 

$

52.78

 

Postpay churn rate (7)

 

1.6

%

1.4

%

 


(1)   Amounts include results for U.S. Cellular’s consolidated operating markets as of June 30.

 

(2)   Calculated using 2008 and 2007 Claritas population estimates for 2009 and 2008, respectively. “Total market population of consolidated operating markets” is used only for the purposes of calculating market penetration of consolidated operating markets, which is calculated by dividing customers by the total market population (without duplication of population in overlapping markets).

 

The total market population and penetration measures for consolidated operating markets apply to markets in which U.S. Cellular provides wireless service to customers. For comparison purposes, total market population and penetration related to all consolidated markets in which U.S. Cellular owns an interest were 83,726,000 and 7.4%, and 82,875,000 and 7.5%, as of June 30, 2009 and 2008, respectively.

 

(3)   U.S. Cellular’s customer base consists of the following types of customers:

 

 

 

June 30,

 

 

 

2009

 

2008

 

Customers on postpay service plans in which the end user is a customer of U.S. Cellular (“postpay customers”)

 

5,448,000

 

5,367,000

 

Customers on prepay service plans in which the end user is a customer of U.S. Cellular (“prepay customers”)

 

263,000

 

310,000

 

Total retail customers

 

5,711,000

 

5,677,000

 

 

 

 

 

 

 

End user customers acquired through U.S. Cellular’s agreements with third parties (“reseller customers”)

 

444,000

 

517,000

 

Total customers

 

6,155,000

 

6,194,000

 

 

(4)   Amounts include results for U.S. Cellular’s consolidated operating markets for the period January 1 through June 30; operating markets acquired during a particular period are included as of the acquisition date.

 

(5)   “Net retail customer additions” represents the number of net customers added to U.S. Cellular’s retail customer base through its marketing distribution channels; this measure excludes activity related to reseller customers and customers transferred through acquisitions, divestitures or exchanges.  “Net customer additions (losses)” represents the number of net customers added to (or deducted from) U.S. Cellular’s overall customer base through its marketing distribution channels; this measure includes activity related to reseller customers but excludes activity related to customers transferred through acquisitions, divestitures or exchanges.

 

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(6)   Management uses this measurement to assess the amount of service revenue that U.S. Cellular generates each month on a per customer basis. Variances in this measurement are monitored and compared to variances in expenses on a per customer basis. Average monthly service revenue per customer is calculated as follows:

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2009

 

2008

 

Service revenues per Consolidated Statements of Operations (000s)

 

$

1,956,629

 

$

1,949,446

 

Divided by average customers during period (000s)*

 

6,210

 

6,156

 

Divided by number of months in each period

 

6

 

6

 

Average monthly service revenue per customer

 

$

52.51

 

$

52.78

 

 


* “Average customers during period” is calculated by adding the number of total customers, including reseller customers, at the beginning of the first month of the period and at the end of each month in the period and dividing by the number of months in the period plus one. Acquired and divested customers are included in the calculation on a prorated basis for the amount of time U.S. Cellular included such customers during each period.

 

(7)   Postpay churn rate represents the percentage of the postpay customer base that disconnects service each month.

 

Components of Operating Income

 

Six Months Ended June 30,

 

2009

 

2008

 

Increase/
(Decrease)

 

Percentage
Change

 

 

 

(Dollars in thousands)

 

Retail service

 

$

1,745,307

 

$

1,712,862

 

$

32,445

 

2

%

Inbound roaming

 

122,280

 

156,956

 

(34,676

)

(22

)%

Other

 

89,042

 

79,628

 

9,414

 

12

%

Service revenues

 

1,956,629

 

1,949,446

 

7,183

 

 

Equipment sales

 

138,685

 

149,002

 

(10,317

)

(7

)%

Total operating revenues

 

2,095,314

 

2,098,448

 

(3,134

)

 

 

 

 

 

 

 

 

 

 

 

System operations (excluding Depreciation, amortization and accretion reported below)

 

394,809

 

387,668

 

7,141

 

2

%

Cost of equipment sold

 

341,756

 

354,190

 

(12,434

)

(4

)%

Selling, general and administrative

 

822,518

 

822,042

 

476

 

 

Depreciation, amortization and accretion

 

276,265

 

287,788

 

(11,523

)

(4

)%

Loss on asset disposals, net

 

4,277

 

9,892

 

(5,615

)

(57

)%

Total operating expenses

 

1,839,625

 

1,861,580

 

(21,955

)

(1

)%

Operating income

 

$

255,689

 

$

236,868

 

$

18,821

 

8

%

 

Operating Revenues

 

Service revenues

 

Service revenues consist primarily of: (i) charges for access, airtime, roaming, recovery of regulatory costs and value-added services, including data products and services and long distance, provided to U.S. Cellular’s retail customers and to end users through third-party resellers (“retail service”); (ii) charges to other wireless carriers whose customers use U.S. Cellular’s wireless systems when roaming, including long-distance roaming (“inbound roaming”); and (iii) amounts received from the Federal Universal Service Fund (“USF”).

 

Retail service revenues

 

The increase in Retail service revenues in 2009 was due to increases in both the average number of customers and the average monthly retail service revenue per customer.  The average number of customers increased to 6,210,000 in 2009 from 6,156,000 in 2008.  Average monthly retail service revenue per customer increased 1% to $46.84 in 2009 from $46.37 in 2008, as a significant increase in revenues from data products and services more than offset a decline in revenues from voice services.

 

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Revenues from data products and services totaled $318.9 million in 2009 and $239.4 million in 2008, and represented 16% of total service revenues in 2009 compared to 12% of total service revenues in 2008. Such growth, which positively impacted average monthly retail service revenue per customer, reflected customers’ continued and increasing usage of U.S. Cellular’s text, picture, and video messaging services, easyedgeSM service and applications, premium mobile Internet services, and smart phone handsets and services.  During the six months ended June 30, 2009, U.S. Cellular introduced unlimited messaging plans and unlimited messaging and mobile Internet plans that further drove data usage and revenues.  U.S. Cellular expects that the growth in revenues from data products and services will continue as customers migrate to the new unlimited plans and as U.S. Cellular’s 3G network expands to cover 70% of its customers by the end of 2009.

 

Revenues from voice services declined year-over-year primarily due to a reduction in average voice revenue per customer.  The reduction in average voice revenue per customer reflects industry competition which has resulted in lower pricing overall as well as growth in family plans and service plans with enhanced coverage areas and value (such as free incoming calls and unlimited minutes).  Also, decreases in the prepay customer base and the average revenue per prepay customer contributed to a decline in prepay voice revenues. U.S. Cellular expects continued pressure on revenues from voice services in the foreseeable future due to industry competition related to service plan offerings.

 

Inbound roaming revenues

 

The decrease in Inbound roaming revenues in 2009 was due primarily to a decline in roaming revenues from the combined entity of Verizon Wireless (“Verizon”) and Alltel Corporation (“Alltel”). In January 2009, Verizon acquired Alltel. As a result of this transaction, the network footprints of Verizon and Alltel were combined.  This has resulted in a decrease in inbound roaming revenues for U.S. Cellular, since the combined Verizon and Alltel entity has reduced its usage of U.S. Cellular’s network in certain coverage areas that were used by Verizon and Alltel (as separate entities).  U.S. Cellular anticipates that this trend will increase over the next several quarters and will more than offset the positive impact of the trends of increasing minutes of use and increasing data usage from U.S. Cellular’s other roaming partners.

 

Additional changes in the network footprints of other carriers due to additional consolidation or network expansions also could have an adverse effect on U.S. Cellular’s inbound roaming revenues.  U.S. Cellular also anticipates that its roaming revenue per minute of use will decline over time due to the renegotiation of existing contracts.  The foregoing could have an adverse effect on U.S. Cellular’s business, financial condition or results of operations.

 

Other revenues

 

The growth in Other revenues was due primarily to an increase in USF revenues, which represent amounts received from the USF for states in which U.S. Cellular has been designated as an Eligible Telecommunications Carrier (“ETC”).  U.S. Cellular was eligible to receive ETC funds in sixteen states at June 30, 2009 and eleven states at June 30, 2008; the ETC revenue amounts were $68.9 million in 2009 and $61.9 million in 2008.

 

The Federal Communications Commission (“FCC”) is considering significant changes to the USF.  U.S. Cellular is not able to predict what changes, if any, will be adopted by the FCC. Such changes could have a material adverse impact on U.S. Cellular’s financial condition and results of operations.

 

Equipment sales revenues

 

Equipment sales revenues include revenues from sales of handsets and related accessories to both new and existing customers, as well as revenues from sales of handsets and accessories to agents. All equipment sales revenues are recorded net of anticipated rebates.

 

U.S. Cellular strives to offer a competitive line of quality handsets to both new and existing customers. U.S. Cellular’s customer retention efforts include offering new handsets at discounted prices to existing customers as the expiration date of the customer’s service contract approaches. U.S. Cellular also continues to sell handsets to agents; this practice enables U.S. Cellular to provide better control over the quality of handsets sold to its customers, establish roaming preferences and earn quantity discounts from handset manufacturers which are passed along to agents. U.S. Cellular anticipates that it will continue to sell handsets to agents in the future.

 

The decrease in 2009 equipment sales revenues was driven primarily by a decline of 6% in average revenue per handset sold as the overall mix of handsets purchased by customers shifted to lower priced phones.

 

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Operating Expenses

 

System operations expenses (excluding Depreciation, amortization and accretion)

 

System operations expenses (excluding Depreciation, amortization, and accretion) include charges from wireline telecommunications service providers for U.S. Cellular’s customers’ use of their facilities, costs related to local interconnection to the wireline network, charges for maintenance of U.S. Cellular’s network, long-distance charges, outbound roaming expenses and payments to third-party data product and platform developers.

 

Key components of the overall increase in system operations expenses were as follows:

 

·      Maintenance, utility and cell site expenses increased $5.9 million, or 4%, in 2009, primarily driven by increases in the number of cell sites within U.S. Cellular’s network and rent expense per cell site. The number of cell sites totaled 7,043 in 2009 and 6,596 in 2008, as U.S. Cellular continued to expand and enhance coverage in its existing markets; and

 

·      Expenses incurred when U.S. Cellular’s customers used other carriers’ networks while roaming increased $1.9 million, or 2%, in 2009, due primarily to higher roaming minutes of use as more customers migrated to national and wide area plans.

 

U.S. Cellular expects total system operations expenses to increase in the foreseeable future, driven by the following factors:

 

·      Increases in the number of cell sites and other network facilities within U.S. Cellular’s systems as it continues to add capacity and enhance quality;

 

·      Continued expansion of 3G services to additional markets; and

 

·      Increases in total voice, text messaging and other data usage, both on U.S. Cellular’s network and by U.S. Cellular’s customers on other carriers’ networks when roaming.

 

Cost of equipment sold

 

Cost of equipment sold decreased in 2009 due primarily to a 4% decline in cost per handset sold as the overall mix of handsets purchased by customers shifted to lower priced phones.

 

U.S. Cellular expects loss on equipment, defined as equipment sales revenues less cost of equipment sold, to continue to be a significant cost and perhaps to increase in the foreseeable future as wireless carriers continue to use handset availability and pricing as a means of competitive differentiation. New handsets with expanded capabilities, particularly smart phones and premium touch screen phones, generally have higher purchase costs for carriers which, due to competitive market conditions, generally cannot be recovered through proportionately higher selling prices to customers.

 

Selling, general and administrative expenses

 

Selling, general and administrative expenses include salaries, commissions and expenses of field sales and retail personnel and facilities; telesales department salaries and expenses; agent commissions and related expenses; corporate marketing and merchandise management; and advertising expenses. Selling, general and administrative expenses also include bad debts expense, costs of operating customer care centers and corporate expenses.

 

Key components of the net increase in Selling, general and administrative expenses in 2009 were as follows:

 

·      Selling and marketing expenses decreased $2.6 million, or 1%, in 2009, primarily due to lower commissions resulting from a reduction in customer gross additions; and

 

·      General and administrative expenses increased $3.0 million, or 1%, in 2009, due primarily to higher sales taxes, employee related expenses and bad debts expense (reflecting higher bad debts experience as a percent of revenues), partially offset by lower universal service fund contributions.

 

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U.S. Cellular expects Selling, general and administrative expenses to increase in the foreseeable future driven primarily by increases in expenses associated with acquiring, serving and retaining customers, as well as costs related to its multi-year initiatives discussed previously.

 

Depreciation, amortization, and accretion

 

Total Depreciation, amortization and accretion expense decreased $11.5 million, or 4%, in 2009. Depreciation decreased $10.5 million, or 4%, in 2009, primarily due to fully depreciating Time Division Multiple Access (“TDMA”) and analog network equipment in 2008. U.S. Cellular discontinued its TDMA-based service during the six months ended June 30, 2009; in connection with such discontinuance, property, plant and equipment in service and accumulated depreciation of $452.0 million were eliminated from the Consolidated Balance Sheet.

 

See “Financial Resources” and “Liquidity and Capital Resources” for a discussion of U.S. Cellular’s capital expenditures.

 

Loss on asset disposals, net

 

These amounts represent charges related to disposals of assets, trade-ins of older assets for replacement assets and other retirements of assets from service.

 

Components of Other Income (Expense)

 

 

 

 

 

 

 

Increase/

 

Percentage

 

Six Months Ended June 30,

 

2009

 

2008

 

(Decrease)

 

Change

 

 

 

(Dollars in thousands, except per share amounts)

 

Operating income

 

$

255,689

 

$

236,868

 

$

18,821

 

8

%

 

 

 

 

 

 

 

 

 

 

Equity in earnings from unconsolidated entities

 

50,121

 

44,042

 

6,079

 

14

%

Interest and dividend income

 

1,228

 

3,334

 

(2,106

)

(63

)%

Interest expense

 

(38,409

)

(40,889

)

2,480

 

6

%

Other, net

 

278

 

718

 

(440

)

(61

)%

Total investment and other income (expense)

 

13,218

 

7,205

 

6,013

 

83

%

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

268,907

 

244,073

 

24,834

 

10

%

Income tax expense

 

(88,980

)

(91,556

)

2,576

 

3

%

 

 

 

 

 

 

 

 

 

 

Net income

 

179,927

 

152,517

 

27,410

 

18

%

Less: Net income attributable to noncontrolling interests, net of tax

 

(11,977

)

(9,358

)

(2,619

)

(28

)%

Net income attributable to U.S. Cellular

 

$

167,950

 

$

143,159

 

$

24,791

 

17

%

 

 

 

 

 

 

 

 

 

 

Basic earnings per share attributable to U.S. Cellular shareholders

 

$

1.93

 

$

1.63

 

$

0.30

 

18

%

Diluted earnings per share attributable to U.S. Cellular shareholders

 

$

1.92

 

$

1.63

 

$

0.29

 

18

%

 

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Equity in earnings from unconsolidated entities

 

Equity in earnings of unconsolidated entities represents U.S. Cellular’s share of net income from the markets in which it has an interest and follows the equity method of accounting. U.S. Cellular follows the equity method of accounting for unconsolidated entities over which it has the ability to exercise significant influence, generally entities in which its ownership interest is less than or equal to 50% but equals or exceeds 20% for corporations and 3% for partnerships and limited liability companies.

 

U.S. Cellular’s investment in the Los Angeles SMSA Limited Partnership (“LA Partnership”) contributed $34.0 million to Equity in earnings of unconsolidated entities in 2009 and 2008.

 

Income tax expense

 

See Note 5 — Income Taxes in the Notes to Consolidated Financial Statements for a discussion of income tax expense and the overall effective tax rate on Income before income taxes.

 

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Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008

 

Components of Operating Income

 

Three Months Ended June 30,

 

2009

 

2008

 

Increase/ (Decrease)

 

Percentage
Change

 

 

 

(Dollars in thousands)

 

Retail service

 

$

871,209

 

$

862,392

 

$

8,817

 

1

%

Inbound roaming

 

62,223

 

84,201

 

(21,978

)

(26

)%

Other

 

41,323

 

40,759

 

564

 

1

%

Service revenues

 

974,755

 

987,352

 

(12,597

)

(1

)%

Equipment sales

 

67,795

 

73,240

 

(5,445

)

(7

)%

Total operating revenues

 

1,042,550

 

1,060,592

 

(18,042

)

(2

)%

 

 

 

 

 

 

 

 

 

 

System operations (excluding Depreciation, amortization and accretion reported below)

 

194,806

 

196,652

 

(1,846

)

(1

)%

Cost of equipment sold

 

156,055

 

176,145

 

(20,090

)

(11

)%

Selling, general and administrative

 

410,070

 

418,416

 

(8,346

)

(2

)%

Depreciation, amortization and accretion

 

138,614

 

145,258

 

(6,644

)

(5

)%

Loss on asset disposals, net

 

2,086

 

6,219

 

(4,133

)

(66

)%

Total operating expenses

 

901,631

 

942,690

 

(41,059

)

(4

)%

Operating income

 

$

140,919

 

$

117,902

 

$

23,017

 

20

%

 

Operating Revenues

 

Retail service revenues

 

The increase in retail service revenues in 2009 was due to increases in both the average number of customers and average monthly retail service revenue per customer. The average number of customers increased to 6,199,000 from 6,178,000 in 2008. Average monthly retail service revenue per customer increased 1% to $46.85 in 2009 from $46.53 in 2008, as a significant increase in revenues from data products and services more than offset a decline in revenues from voice services.

 

Revenues from data products and services totaled $162.0 million in 2009 and $123.7 million in 2008, and represented 17% of total service revenues in 2009 compared to 13% of total service revenues in 2008. Such growth, which positively impacted average monthly retail service revenue per customer, reflected customers’ continued and increasing usage of U.S. Cellular’s text, picture, and video messaging services, easyedgeSM service and applications, premium mobile Internet services, and smart phone handsets and services.  In 2009, U.S. Cellular introduced unlimited messaging plans and unlimited messaging and mobile Internet plans that further drove data usage and revenues.

 

Revenues from voice services declined year-over-year primarily due to a reduction in average voice revenue per customer.  The reduction in average voice revenue per customer reflects industry competition which has resulted in lower pricing overall as well as growth in family plans and service plans with enhanced coverage areas and value (such as free incoming calls and unlimited minutes).  Also, decreases in the prepay customer base and the average revenue per prepay customer contributed to a decline in prepay voice revenues. U.S. Cellular expects continued pressure on revenues from voice services in the foreseeable future due to industry competition related to service plan offerings.

 

Inbound roaming revenues

 

The decrease in Inbound roaming revenues in 2009 was due primarily to a decline in roaming revenues from the combined entity of Verizon and Alltel, partially offset by an increase in data roaming.