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Business Context and Reporting Period

Company: United States Cellular Corporation (U.S. Cellular), an 81.2%-owned subsidiary of Telephone and Data Systems, Inc. (TDS).

Reporting Period: Quarterly Report (Form 10-Q) for the three months ended March 31, 2006.

Business Overview: U.S. Cellular operates as a regional wireless provider, owning or having rights to acquire interests in 241 wireless markets. The company focuses on customer satisfaction, network quality, and building contiguous operating areas. As of March 31, 2006, the company served approximately 5.63 million customers across 5,438 cell sites.

Key Financial Metrics

Margins: Operating income margin (as a percent of service revenues) improved to 9.3% in Q1 2006 from 5.9% in Q1 2005.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 18% ($126.1 million) year-over-year. Service revenues rose 15% driven by a 10% increase in the customer base and a 4% increase in average monthly service revenue per customer ($46.22 vs. $44.46). Equipment sales revenues surged 70% ($27.8 million) due to higher handset sales volume and mix changes.
• Profitability: Operating income increased 81% ($32.2 million) and Net Income increased 92% ($17.9 million). This was primarily due to revenue growth outpacing expense increases.
• Expense Increases: Total operating expenses rose 14% ($94.0 million). Selling, general, and administrative (SG&A) expenses increased 17% ($47.3 million), driven by higher employee costs, advertising in new markets, and a $4.6 million increase in stock-based compensation due to the adoption of SFAS 123(R).
• Accounting Change: Effective January 1, 2006, the company adopted SFAS 123(R) for stock-based compensation. This reduced reported net income by $1.8 million and diluted EPS by $0.02 compared to the previous APB 25 method.
• Customer Metrics: Net customer additions were 151,000 in Q1 2006 compared to 182,000 in Q1 2005. Market penetration decreased to 10.21% from 11.50%.

Guidance, Outlook, and Risks

2006 Full-Year Estimates (Updated July 28, 2006):

• Service Revenues: Approximately $3.2 billion.
• Operating Income: $250 million to $300 million.
• Net Retail Customer Additions: 370,000 to 400,000.
• Capital Expenditures: Estimated between $580 million and $610 million.

Management Commentary: Management expects operating income and margins to improve slightly over the next few years due to revenue growth from new customers and data services, offset by costs related to customer acquisition, competition, and network enhancements.

Risks and Contingencies:

• Internal Controls: The company disclosed that its disclosure controls and procedures were not effective as of March 31, 2006, due to material weaknesses in accounting personnel, income tax accounting, and lease recording. These weaknesses led to prior restatements of financial statements.
• Regulatory and Legal: The company is subject to an IRS audit of TDS consolidated tax returns (2002-2004). It also filed a petition to deny an FCC license transfer related to the ALLTEL acquisition of Midwest Wireless Holdings, pending which U.S. Cellular expects to receive approximately $114 million in cash.
• Debt Covenants: Late filings of SEC reports in 2005 resulted in technical defaults under the revolving credit facility and forward contracts, though waivers were obtained. Credit ratings are under review for possible downgrade (Moody's Baa3, S&P A-).
• Investments: The company holds significant marketable equity securities (primarily Vodafone ADRs) hedged by forward contracts. A subsequent share consolidation and special distribution by Vodafone occurred in July 2006.

Investor Verification Checklist

• Internal Control Remediation: Verify the progress of remediation plans for material weaknesses in internal controls over financial reporting, specifically regarding tax accounting and lease recording.
• Regulatory Filings: Confirm the status of the pending FCC petition regarding the Midwest Wireless Holdings transaction and the outcome of the IRS audit.
• Capital Expenditures: Monitor actual capital spending against the $580-$610 million guidance to ensure network build-out plans are on track.
• Customer Growth: Track net retail customer additions against the 370,000-400,000 full-year estimate, noting the slowdown in Q1 additions.
• Debt and Liquidity: Review credit rating actions by Moody's, S&P, and Fitch, and monitor the utilization of the $700 million revolving credit facility.