AD

Business Context and Reporting Period

Company: United States Cellular Corporation (U.S. Cellular), an 80.7%-owned subsidiary of Telephone and Data Systems, Inc. (TDS).

Reporting Period: Quarterly Report (Form 10-Q) for the period ended June 30, 2007.

Business Overview: U.S. Cellular owns, operates, and invests in wireless markets across the United States. As of June 30, 2007, the company served approximately 6 million customers across six market areas in 26 states. The company's strategy focuses on acquiring and developing controlling interests in wireless licenses to build contiguous operating markets while exiting non-strategic areas.

Key Financial Metrics (Six Months Ended June 30, 2007)

Operating Margins: Operating income margin (as a percent of service revenues) improved to 13.1% in the first six months of 2007, compared to 9.5% in the same period of 2006.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 13% year-over-year, driven by a 6% growth in the average customer base and a 7% increase in average monthly service revenue per customer ($49.60 vs. $46.38). Data product and service revenues surged 74% to $163.0 million.
• Profitability Surge: Net income increased 148% to $222.0 million. This significant increase was primarily attributable to higher operating income and a one-time pre-tax gain of $131.7 million recognized from the settlement of forward contracts and the sale of remaining Vodafone Group Plc American Depositary Receipts (ADRs).
• Customer Base: Total customers increased 5% to 6.01 million. Net retail customer additions were 217,000 for the six-month period.
• Liquidity: Cash and cash equivalents grew significantly from $32.9 million at year-end 2006 to $146.1 million at June 30, 2007. The company paid off all outstanding balances under its revolving credit facility during the second quarter.
• Capital Expenditures: Additions to property, plant, and equipment totaled $246.8 million, reflecting continued network expansion and cell site construction.

Guidance, Outlook, and Risks

Full-Year 2007 Estimates (Updated August 7, 2007):

• Service Revenues: Approximately $3.6 billion.
• Operating Income: $395 million to $445 million.
• Net Retail Customer Additions: 375,000 to 425,000.
• Capital Expenditures: Estimated range of $600 million to $615 million.

Management Commentary: Management anticipates continued pressure on operating income and margins in the coming years due to customer acquisition costs, competition, and the costs of developing new products and network enhancements. However, the company expects to continue improving customer satisfaction and network quality.

Risks and Contingencies:

• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of June 30, 2007, due to material weaknesses in accounting personnel expertise, income tax accounting, and property, plant, and equipment accounting. These weaknesses led to prior restatements of financial statements.
• Credit Ratings: Standard & Poor's lowered the company's credit rating to BB+ in April 2007 (from BBB-), though it was removed from "Credit Watch" in June. A downgrade could increase borrowing costs or limit access to capital.
• Regulatory and Legal: The company is subject to FCC regulations and various legal proceedings. It is also under examination by the IRS and state taxing authorities for years 2002-2005.
• Unconsolidated Entities: The company has significant investments in entities like Barat Wireless and Carroll Wireless, which are in the process of developing long-term financing plans.

Key Facts for Investor Verification

• One-Time Gain Impact: Verify the sustainability of earnings by excluding the $131.7 million pre-tax gain from the Vodafone ADR settlement, which significantly inflated Net Income and EPS for the period.
• Internal Control Remediation: Monitor the progress of remediation efforts for the identified material weaknesses in internal controls over financial reporting, which pose a risk to future financial statement accuracy.
• Share Repurchase Program: Note that the company utilized its "Additional Authorization" for 500,000 shares in an Accelerated Share Repurchase (ASR) in April 2007. The final cost basis of these shares is subject to adjustment based on the average market price over the program term.
• License Impairment: The company recorded a $2.1 million impairment charge on licenses in 2007 related to units of accounting where operations have not yet begun. Investors should monitor future impairment risks for unlaunched markets.
• Related Party Transactions: Review the $58.7 million in billings from parent company TDS for the six-month period, which are included in selling, general, and administrative expenses.