AD

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2003, for United States Cellular Corporation (U.S. Cellular), a wireless communications provider and 82.2% subsidiary of Telephone and Data Systems, Inc. (TDS). The company operates in 150 consolidated markets, including the recently acquired Chicago market. A significant event during the period was the announcement of a definitive agreement to exchange wireless properties with AT&T Wireless (AWE), with the transaction closing on August 1, 2003.

Key Financial Metrics

Note: 2002 figures are restated to reflect accounting changes.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 23% ($232.9 million) driven by a 22% increase in the customer base (4.34 million customers) and the inclusion of the Chicago market acquired in late 2002.
• Operating Income Decline: Operating income fell 73% to $48.3 million. This was primarily due to a $27.0 million loss on assets held for sale related to the pending AWE exchange, increased general and administrative expenses (up 50%), and higher depreciation and amortization costs.
• Expense Increases: Total operating expenses rose 44% ($365.6 million). Key drivers included system operations (up 26%) due to network expansion, marketing costs (up 31%) for customer acquisition, and cost of equipment sold (up 82%) due to a change in handset distribution methods.
• Investment Losses: The 2002 period included a massive $244.7 million "other than temporary" loss on marketable equity securities (Vodafone), which is not present in the 2003 period, making the year-over-year net income comparison favorable despite lower operating income.

Guidance, Outlook, and Risks

2003 Full-Year Outlook

• Net Customer Additions: 475,000 – 500,000
• Service Revenues: $2.35 billion – $2.4 billion
• Operating Income: $170 million – $190 million (includes the $27 million loss on assets held for sale)
• Capital Spending: $650 million – $670 million

Management Commentary

Management anticipates slower customer growth due to increased competition and market maturation. Average revenue per minute is expected to decline. The company expects to incur additional expenses in the remainder of 2003 related to the Chicago market transition and the buildout of new PCS licensed areas acquired in the AWE exchange.

Risks and Contingencies

• Asset Exchange: The AWE transaction involves transferring 10 markets in Florida and Georgia while acquiring licenses in 13 states. A $27 million loss was recorded, with potential adjustments in Q3 2003.
• Regulatory Changes: Implementation of wireless number portability (Nov 2003) may impact churn rates. New FCC regulations increased universal service funding costs.
• Capital Markets: Moody's placed the company's debt ratings under review for possible downgrade due to capital expenditure requirements and slowing subscriber growth.
• Impairment Risk: Significant intangible assets (licenses and goodwill) are subject to annual impairment testing; future write-downs are possible if fair values decline.

Investor Verification Checklist

• AWE Transaction Closing: Verify the final terms and any adjustments to the $27 million loss on assets held for sale upon the August 1, 2003 closing.
• Chicago Market Integration: Monitor the timeline and cost efficiency of integrating the Chicago billing system and network, which is driving G&A expense increases.
• Capital Expenditure Execution: Track actual capital spending against the $650-$670 million guidance, specifically regarding the migration to a single digital platform (CDMA).
• Debt Covenants and Ratings: Review the impact of the Moody's rating review on borrowing costs and the availability of the $220 million in unused revolving credit facilities.
• Customer Churn: Assess the impact of wireless number portability on postpay churn rates (currently 1.5%) in the latter half of 2003.