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Business Context and Reporting Period

Company: United States Cellular Corporation (USM), an 81.1%-owned subsidiary of Telephone and Data Systems, Inc. (TDS).

Reporting Period: First quarter ended March 31, 1998.

Operations: USM owns, operates, and invests in cellular markets across the U.S. As of March 31, 1998, it held interests in 182 markets (25.5 million population equivalents), consolidating 134 majority-owned markets (22.8 million pops) and accounting for 40 minority interests via the equity method.

Key Financial Metrics

Key Operational Stats: Customers grew 56% to 1.817 million. Market penetration reached 7.56%. Average monthly revenue per customer declined 17% to $44.66 due to pricing pressures and the acquisition of lower-yield markets.

Material Changes vs. Prior Period

• Non-Recurring Gains: Net income surged primarily due to a $180.0 million pre-tax gain on the sale of minority interests in ten cellular markets. Excluding these gains, net income was $19.5 million (EPS $0.22), a modest increase from the prior year.
• Revenue Drivers: Local retail revenue increased 41% driven by a 56% growth in the customer base. However, average revenue per minute declined due to competitive pricing and the integration of markets acquired from BellSouth.
• Expense Growth: Operating expenses rose 32% to $212.0 million. Depreciation increased 67% due to higher fixed asset balances and a reduction in asset useful lives. Marketing expenses rose 32% to support customer acquisition.
• Roaming Impact: Inbound roaming revenue increased only 2% because transactions between previously acquired BellSouth markets and existing USM markets are now treated as intercompany transfers and eliminated in consolidation.

Guidance, Outlook, and Risks

• Outlook: Management expects service revenues to continue growing but anticipates a continued decline in average monthly revenue per customer due to industry-wide pricing trends and deeper consumer market penetration. Expenses are expected to rise due to customer growth and cell site expansion.
• Capital Requirements: The 1998 construction and system expansion budget is approximately $330 million. Anticipated capital spending for the remainder of 1998 is $261 million, plus $58 million for pending acquisitions.
• Liquidity: The company has $62.7 million in cash and a $500 million Revolving Credit Facility (with $500 million remaining available). Financing needs are expected to be met through operating cash flow, divestiture proceeds, and short-term borrowings.
• Risks and Contingencies:
  • Competition: Personal Communications Services (PCS) operators are deploying in USM markets, potentially increasing competitive pressure.
  • M&A Activity: Pending agreements exist to acquire minority interests in six markets ($57.6 million) and divest a minority interest in one market.
  • Parent Company Merger: TDS has made an offer to acquire all non-owned USM shares via a merger for TDS tracking stock. A special committee is reviewing the offer, but significant reservations exist, and no agreement is currently in place.

Investor Verification Checklist

• Quality of Earnings: Verify the sustainability of earnings by excluding the $110.2 million after-tax gain on asset sales; core operating EPS was $0.22.
• Revenue Per User Trend: Monitor the 17% decline in average monthly revenue per customer ($44.66) to assess the impact of pricing wars and market mix changes.
• Capital Expenditure Execution: Confirm the ability to fund the $330 million 1998 capex budget without diluting equity or over-leveraging, given the reliance on operating cash flow and divestitures.
• Merger Status: Track the progress of the potential merger with parent company TDS, as the current offer is under review with no assurance of completion.
• Debt Structure: Review the terms of the $250 million 7.25% unsecured notes (due 2007) and the $500 million revolving credit facility (LIBOR + 26.5 bps).