AD

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007, for United States Cellular Corporation (U.S. Cellular), an 80.6%-owned subsidiary of Telephone and Data Systems, Inc. (TDS). The company operates wireless markets throughout the United States, owning or having rights to acquire interests in 236 markets as of the reporting date. The financial statements are unaudited.

Key Financial Metrics

Operating Margins: Operating income margin improved to 12.6% of service revenues in Q1 2007, compared to 9.1% in Q1 2006.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 12% year-over-year, driven by a 6% growth in the customer base (5.97 million customers) and a 5% increase in average monthly service revenue per customer ($48.69). Data product revenues surged 71% to $77.6 million.
• Profitability: Net income increased 89% to $74.4 million, primarily due to higher operating income and a $12.5 million gain from the fair value adjustment of derivative instruments (compared to $4.8 million in 2006).
• Customer Metrics: Net customer additions were 152,000, with net retail customer additions of 146,000. Postpay churn remained stable at 1.5% per month.
• Capital Expenditures: Additions to property, plant, and equipment totaled $109.7 million, including the construction of 566 new cell sites.
• Acquisitions: On February 1, 2007, the company acquired Iowa 15 Wireless, LLC for approximately $18.2 million in cash.

Guidance, Outlook, and Risks

2007 Full-Year Estimates (Updated April 23, 2007):

• Service Revenues: Approximately $3.5 billion.
• Operating Income: $375 million to $425 million.
• Net Retail Customer Additions: 375,000 to 425,000.
• Capital Expenditures: Estimated between $600 million and $615 million.

Management Commentary & Unusual Items:

• Vodafone Settlement: The company holds Vodafone Group Plc ADRs subject to forward contracts maturing in May 2007. U.S. Cellular expects to record a pre-tax gain of approximately $115 million upon settlement and disposal of these securities, with an estimated tax liability of $36 million.
• Share Repurchase: On April 4, 2007 (subsequent to the period end), the company entered into an accelerated share repurchase (ASR) agreement to purchase 670,000 shares for approximately $49.1 million.

Risks and Contingencies:

• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of March 31, 2007, due to material weaknesses in accounting personnel expertise, income tax accounting, and property, plant, and equipment accounting. These weaknesses led to prior restatements.
• Credit Ratings: Standard & Poor's lowered the credit rating to BB+ (on credit watch negative) in April 2007. Moody's and Fitch also have negative outlooks. A downgrade could increase borrowing costs.
• Regulatory & Legal: The company is subject to an IRS audit of consolidated tax returns for 2002-2005. Late SEC filings in the prior year resulted in defaults under credit facilities, though waivers were obtained.

Investor Verification Checklist

• Internal Control Remediation: Verify the progress of the multi-year program to address material weaknesses in financial reporting and the effectiveness of new controls.
• Vodafone Settlement Timing: Confirm the actual settlement date and final gain/loss recognition for the Vodafone forward contracts in May 2007.
• Credit Facility Covenants: Monitor compliance with financial covenants and the impact of credit rating downgrades on borrowing costs and renewal terms.
• Customer Acquisition Costs: Review the trend in sales and marketing cost per gross customer addition ($426 in Q1 2007) against revenue growth to ensure sustainable profitability.
• Capital Expenditure Execution: Assess whether the planned $600-$615 million capital spend is sufficient to maintain network quality and competitive positioning against larger carriers.