 |
| UNITED STATES CELLULAR CORPORATION |
| 3RD QUARTER REPORT ON FORM 10-Q |
| INDEX |
| Page No. |
| Part I. Financial Information |
| Management's Discussion and Analysis of Results of |
| Operations and Financial Condition |
| Results of Operations |
| Nine Months Ended September 30, 2002 and 2001 | 4-13 |
| Three Months Ended September 30, 2002 and 2001 | 13-16 |
| Financial Resources and Liquidity | 16-22 |
| Application of Critical Accounting Policies | 23-27 |
| Certain Relationships and Related Transactions | 27-28 |
| Safe Harbor Cautionary Statement | 28-29 |
| Consolidated Statements of Operations - |
| Three Months and Nine Months Ended September 30, 2002 and 2001 | 30 |
| Consolidated Statements of Cash Flows - |
| Nine Months Ended September 30, 2002 and 2001 | 31 |
| Consolidated Balance Sheets - |
| September 30, 2002 and December 31, 2001 | 32-33 |
| Notes to Consolidated Financial Statements | 34-44 |
| Item 4. Controls and Procedures | 45 |
| Part II. Other Information | 46 |
| Signatures | 47 |
| |
Nine Months Ended or At
September 30,
----------------------
2002 2001
---------- ----------
Total market population (in thousands) (1) 36,568 25,670
Customers 3,943,000 3,379,000
Market penetration - cellular and PCS markets 10.78% 13.16%
Market penetration - cellular markets only 13.68% 13.16%
Markets in operation - cellular and PCS markets 149 142
Markets in operation - cellular markets only 143 142
Total employees 5,900 5,150
Cell sites in service 3,750 2,804
Average monthly service revenue per customer $ 47.02 $ 46.66
Postpay churn rate per month - total 1.9% 1.7%
Postpay churn rate per month - cellular markets only 1.8% 1.7%
Marketing cost per gross customer addition $ 365 $ 311
(1) Represents 100% of the population of the licensed areas in which the Company
has a controlling financial interest for financial reporting purposes.
Calculated using Claritas population estimates for 2001 and 2000, respectively.
"Total market population" is used only for the purposes of calculating market
penetration and is not related to "pops", as previously defined.
|
The Company’s operating income in the first nine months of 2002, which includes 100% of the revenues and expenses of its consolidated markets plus its corporate office operations, declined less than 1% from 2001. The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 effective January 1, 2002, and ceased the amortization of license costs and goodwill on that date. The Company determined that no impairment charge was required upon the completion of the initial impairment review required under SFAS No. 142. The aggregate effect of ceasing amortization increased operating income by $27.1 million, or 11%, in 2002. Excluding the effect of SFAS No. 142, operating income would have decreased $28.3 million, or 10%, in 2002. Growth in the Company’s customer base and revenues and a reduction in amortization of intangibles were offset by increases in marketing and selling expense, cost of equipment sold and depreciation that were larger than the growth in operating revenues. Operating revenues, driven by a 17% increase in customers served, rose $187.6 million, or 13%, in 2002. Operating cash flow (operating income plus depreciation and amortization of intangibles) increased $29.2 million, or 6%, in 2002. Operating cash flow does not represent cash flows from operations as defined by accounting principles generally accepted in the United States of America (“GAAP”). The Company believes that this is a useful measure of its performance but it should not be construed as an alternative to measures of performance determined under GAAP. -4- Investment and other income decreased $284.9 million in 2002, primarily due to the $278.9 million in losses recorded on the writedown of investments in 2002. Net income and diluted earnings per share decreased $173.9 million and $1.99, respectively, in 2002. A summary of the after-tax effects of the losses on investments, license and goodwill amortization and losses on the retirement of debt on net income and diluted earnings per share in both 2002 and 2001 is shown below. |
Nine Months Ended
September 30,
-----------------------
2002 2001
---------- ----------
(Dollars in thousands,
except per share amounts)
Net Income (Loss) from:
Operations $ 134,340 $ 167,253
(Loss) on investments (167,386) --
License and goodwill amortization -- (19,435)
(Loss) on retirement of debt -- (6,934)
---------- ----------
Net income (loss) as reported $ (33,046) $ 140,884
========== ==========
Diluted Earnings (Loss) Per Share from:
Operations $ 1.55 $ 1.91
(Loss) on investments (1.93) --
License and goodwill amortization -- (.22)
(Loss) on retirement of debt -- (.08)
---------- ----------
Diluted earnings (loss) per share as reported $ (.38) $ 1.61
========== ==========
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On August 7, 2002, the Company completed the acquisition of all of the equity interests in Chicago 20MHz, LLC (“Chicago 20MHz”), including the assets and certain liabilities of Chicago 20MHz, from PrimeCo Wireless Communications LLC (“PrimeCo”). The purchase price was approximately $607 million, subject to working capital and other adjustments. Chicago 20MHz operated the PrimeCo wireless system in the Chicago Major Trading Area (“MTA”). Chicago 20MHz is the holder of certain FCC licenses, including a 20 megahertz PCS license in the Chicago MTA (excluding Kenosha County, Wisconsin) covering a total population of 13.2 million. The Company’s consolidated financial statements include the assets and liabilities of Chicago 20MHz and the results of operations since August 7, 2002. The Chicago 20MHz results of operations included in the Company’s consolidated financial statements were as follows: |
Operating Revenues (thousands)
Retail service $ 25,333.8
Inbound roaming 115.2
Long-distance and other 965.0
----------
Service Revenues 26,414.0
Equipment sales 1,818.2
----------
Total Operating Revenues $ 28,232.2
----------
Operating Expenses
System operations $ 5,382.9
Marketing and selling 6,863.6
Cost of equipment sold 3,782.4
General and administrative 10,586.1
Depreciation 4,818.2
Amortization of intangibles 2,144.5
----------
Total Operating Expenses $ 33,577.7
----------
Operating (Loss) $ (5,345.5)
==========
|
-5- The Company has been transitioning the operations of Chicago 20MHz from PrimeCo to U.S. Cellular since the acquisition date in August 2002, and is reorganizing its operations to increase efficiency. The Company launched its “U.S. Cellular” brand in the Chicago 20MHz licensed area in the fourth quarter of 2002. In conjunction with this brand launch, the Company plans to incur additional costs for advertising and customer care in 2002 and 2003. Additionally, the Company plans to invest approximately $90 million in capital expenditures during the first year following the Chicago 20MHz acquisition. These capital investments will improve coverage in the Chicago 20MHz network, including an upgrade of the current CDMA system to 1XRTT, and will enhance the Company’s marketing distribution in the Chicago market. Operating Revenues The operating revenues of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating revenues. Following is a summary of operating revenues for the nine months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001. |
Nine Months Ended September 30,
--------------------------------------------------
2002
2002 As Reported
---------------------- Less Chicago
As Reported 20MHz
As Less Chicago % Change
Reported 20MHz 2001 from 2001
---------- ---------- ---------- -------------
(Dollars in millions)
OPERATING REVENUES
Retail service $ 1,217.4 $ 1,192.1 $ 1,044.9 + 14%
Inbound roaming 190.9 190.8 209.1 - 9%
Long-distance and other 115.2 114.2 110.4 + 3%
---------- ---------- ---------- -------------
Total Service Revenues 1,523.5 1,497.1 1,364.4 + 10%
Equipment sales 80.2 78.4 51.7 + 52%
---------- ---------- ---------- -------------
Total Operating Revenues 1,603.7 1,575.5 1,416.1 + 11%
---------- ---------- ---------- -------------
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The following discussion of operating revenues is presented excluding the effect of Chicago 20MHz on 2002 results. The resulting variances from prior year are therefore related only to the Company’s operations that were included in consolidated results in both 2001 and 2002. Operating revenues increased $159.4 million, or 11%, in 2002. Service revenues primarily consist of: (i) charges for access, airtime and value-added services provided to the Company’s retail customers (“retail service”); (ii) charges to other wireless carriers whose customers use the Company’s wireless systems when roaming (“inbound roaming”); and (iii) charges for long-distance calls made on the Company’s systems. Service revenues increased $132.7 million, or 10%, in 2002. The increase was primarily due to the growing number of retail customers. Monthly service revenue per customer averaged $47.03 in 2002 and $46.66 in 2001. Retail service revenue increased $147.2 million, or 14%, in 2002. Growth in the Company’s customer base and an increase in average monthly retail service revenue per customer were the primary reasons for the increase in retail service revenue. The number of customers increased 8% to 3,638,000 at September 30, 2002. Average monthly retail service revenue per customer increased 5% to $37.45 in 2002. Management anticipates that overall growth in the Company’s customer base will continue at a slower pace in the future, primarily as a result of an increase in the number of competitors in its markets and continued penetration of the consumer market. -6- Monthly local retail minutes of use per customer averaged 274 in 2002 and 208 in 2001. The increase in monthly local retail minutes of use was driven by the Company’s focus on designing incentive programs and rate plans to stimulate overall usage. This increase was partially offset by a decrease in average revenue per minute of use in 2002. Management anticipates that the Company’s average revenue per minute of use will continue to decline in the future, reflecting increased competition and continued penetration of the consumer market. Inbound roaming revenue decreased $18.3 million, or 9%, in 2002. The decline in inbound roaming revenue resulted from the decrease in revenue per roaming minute of use on the Company’s systems, partially offset by an increase in roaming minutes used. The increase in inbound roaming minutes of use was primarily driven by the overall growth in the number of customers throughout the wireless industry. The decline in revenue per minute of use is primarily due to the general downward trend in negotiated rates. Management anticipates that the rate of growth in inbound roaming minutes of use will be reduced due to two factors:
Management also anticipates that average inbound roaming revenue per minute of use will continue to decline, reflecting the continued general downward trend in negotiated rates. Long-distance and other revenue increased $3.8 million, or 3%, in 2002 as the volume of long-distance calls billed by the Company increased, primarily from inbound roamers using the Company’s systems to make long-distance calls. This effect was partially offset both by price reductions primarily related to long-distance charges on roaming minutes of use as well as the Company’s increasing use of pricing plans which include long-distance calling at no additional charge. Monthly long-distance and other revenue per customer averaged $3.59 in 2002 and $3.78 in 2001. Equipment sales revenues increased $26.7 million, or 52%, in 2002. The increase in equipment sales revenues reflects a change in the Company’s method of distributing handsets to its agent channel. Beginning in the second quarter of 2002, the Company began selling handsets to its agents at a price approximately equal to the Company’s cost. Previously, the Company’s agents purchased handsets from third parties. Selling handsets to agents enables the Company to provide better control over handset quality, set roaming preferences and pass along quantity discounts. These handset sales to agents increased equipment sales revenue by approximately $31 million during 2002. This impact was partially offset by the recognition of previously deferred revenues which increased revenue by $5.2 million in 2001. Management anticipates that the Company will continue to sell handsets to agents in the future. Operating Expenses The operating expenses of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating expenses. Following is a summary of operating expenses for the nine months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001. -7- |
Nine Months Ended September 30,
--------------------------------------------------
2002
2002 As Reported
---------------------- Less Chicago
As Reported 20MHz
As Less Chicago % Change
Reported 20MHz 2001 from 2001
---------- ---------- ---------- -------------
(Dollars in millions)
OPERATING EXPENSES
System operations $ 362.4 $ 357.0 $ 320.6 + 11%
Marketing and selling 264.0 257.2 213.7 + 20%
Cost of equipment sold 118.6 114.8 93.7 + 22%
General and administrative 363.1 352.5 321.7 + 10%
Depreciation 228.3 223.5 174.4 + 28%
Amortization of intangibles 23.7 21.6 47.2 - 54%
---------- ---------- ---------- -------------
Total Operating Expenses 1,360.1 1,326.6 1,171.3 + 13%
---------- ---------- ---------- -------------
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The following discussion of operating expenses is presented excluding the effect of Chicago 20MHz on 2002 results. The resulting variances from prior year are therefore related only to the Company’s operations that were included in consolidated results in both 2001 and 2002. Operating expenses increased $155.3 million, or 13%, in 2002. System operations expenses increased $36.4 million, or 11%, in 2002. System operations expenses include charges from other telecommunications service providers for the Company’s customers’ use of their facilities, costs related to local interconnection to the landline network, long-distance charges and outbound roaming expenses. The increase in system operations expenses in 2002 was due to the following factors:
The ongoing reduction both in the per-minute cost of usage on the Company’s systems and in negotiated roaming rates partially offset the above factors. As a result of the above factors, the components of system operations expenses were affected as follows:
In total, management expects system operations expenses to increase over the next few years, driven by increases in the number of cell sites within the Company’s systems and increases in minutes of use, both on the Company’s systems and by the Company’s customers on other systems when roaming, partially offset by decreases in the per-minute cost of usage both on the Company’s systems and in negotiated roaming rates. Management anticipates that the integration of Chicago 20MHz into its operations will result in an increase in minutes of use by the Company’s customers on its systems and a corresponding decrease in minutes of use by its customers on other systems. Such a shift in minutes of use should reduce the Company’s per-minute cost of usage in the future. -8- Marketing and selling expenses increased $43.5 million, or 20%, in 2002. Marketing and selling expenses primarily consist of salaries, commissions and expenses of field sales and retail personnel and offices; agent expenses; corporate marketing, merchandise management and telesales department salaries and expenses; advertising; and public relations expenses. The increase in 2002 was primarily due to the following factors:
Also, during the second half of 2001, the Company changed certain agent compensation plans to reduce the base commission payment and include future residual payments to agents. Such residual payments recognize the agent’s role in providing ongoing customer support, promote agent loyalty and encourage agent sales to customers who are more likely to have greater usage and remain customers for a longer period of time. As a greater percentage of the Company’s customer base becomes activated by agents receiving residual payments, it is possible that the Company’s aggregate residual payments to agents may grow by a larger percentage than the growth in the Company’s gross customer activations. Cost of equipment sold increased $21.1 million, or 22%, in 2002. The increase is primarily due to the approximately $29 million in handset costs related to the sale of handsets to agents beginning in the second quarter of 2002. Excluding these costs, cost of equipment sold decreased by approximately $8 million, or 7%, in 2002, reflecting reduced per unit handset prices and a 2% decline in gross customer activations. Marketing cost per gross customer activation (“CPGA”), which includes marketing and selling expenses and equipment subsidies, increased 17% to $363 in 2002 (excluding the effect of Chicago 20MHz) from $311 in 2001. The following summarizes the components of CPGA: |
Nine Months Ended
September 30,
---------------------------
2002 2001
------------ ------------
Cost Components (Millions):
Marketing and selling $ 257.2 $ 213.7
Cost of equipment sold 114.8 93.7
Less equipment sales revenues (78.4) (51.7)
------------ ------------
Total marketing costs $ 293.6 $ 255.7
------------ ------------
Gross Customer Activations (Thousands) 809.0 823.0
------------ ------------
Cost per Gross Customer Activation $ 363 $ 311
============ ============
Three Months Ended September 30,
--------------------------------------------------
2002
2002 As Reported
---------------------- Less Chicago
As Reported 20MHz
As Less Chicago % Change
Reported 20MHz 2001 from 2001
---------- ---------- ---------- -------------
(Dollars in millions)
OPERATING REVENUES
Retail service $ 443.3 $ 418.0 $ 360.7 + 16%
Inbound roaming 74.2 74.1 77.8 - 5%
Long-distance and other 43.7 42.7 40.8 + 5%
---------- ---------- ---------- -------------
Total Service Revenues 561.2 534.8 479.3 + 12%
Equipment sales 36.4 34.5 21.7 + 59%
---------- ---------- ---------- -------------
Total Operating Revenues 597.6 569.3 501.0 + 14%
---------- ---------- ---------- -------------
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The following discussion of operating revenues is presented excluding the effect of Chicago 20MHz on 2002 results. The resulting variances from prior year are therefore related only to the Company’s operations that were included in consolidated results in both 2001 and 2002. Operating revenues totaled $569.3 million in the third quarter of 2002, an increase of $68.3 million, or 14%, from 2001. Average monthly service revenue per customer increased to $49.44 in the third quarter of 2002 compared to $47.92 in the same period of 2001. The increase was primarily due to the increase in average retail service revenue per customer, to $38.64 from $36.06. Retail service revenues increased $57.3 million, or 16%, in 2002 primarily due to the increased number of customers served. Average monthly local retail minutes of use per customer totaled 304 in the third quarter of 2002 compared to 230 in 2001. The increase in monthly local retail minutes of use was driven by the Company’s focus on designing incentive programs and rate plans to stimulate overall usage. Inbound roaming revenue decreased $3.7 million, or 5%, in 2002 as the increase in inbound roaming minutes of use was more than offset by a decrease in the average inbound roaming revenue per minute of use. -13- Long-distance and other revenue increased $1.9 million, or 5%, in 2002 as the volume of long-distance calls billed by the Company increased, primarily from inbound roamers using the Company’s systems to make long-distance calls. This effect was partially offset both by price reductions primarily related to long-distance charges on roaming minutes of use as well as the Company’s increasing use of pricing plans which include long-distance calling at no additional charge. Monthly long-distance and other revenue per customer averaged $3.95 in 2002 and $4.08 in 2001. Equipment sales revenue increased $12.8 million, or 59%, in 2002, primarily due to the change in the Company’s method of distributing handsets to its agent channel. These handset sales to agents increased equipment sales revenue by approximately $23 million during 2002. Excluding the sales of handsets to agents in 2002, equipment sales revenues would have decreased approximately $10 million. The decrease was primarily due to the reduction in per unit prices for handsets in 2002 and the recognition of previously deferred revenues which increased revenue by $5.2 million in 2001, partially offset by the effect of a 7% increase in gross customer activations. The operating expenses of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating expenses. Following is a summary of operating expenses for the three months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001. |
Three Months Ended September 30,
--------------------------------------------------
2002
2002 As Reported
---------------------- Less Chicago
As Reported 20MHz
As Less Chicago % Change
Reported 20MHz 2001 from 2001
---------- ---------- ---------- -------------
(Dollars in millions)
OPERATING EXPENSES
System operations $ 136.4 $ 131.0 $ 119.2 + 10%
Marketing and selling 100.9 94.0 74.4 + 26%
Cost of equipment sold 51.6 47.8 31.7 + 51%
General and administrative 141.1 130.6 105.8 + 23%
Depreciation 93.4 88.5 61.5 + 44%
Amortization of intangibles 9.5 7.4 15.8 - 53%
---------- ---------- ---------- -------------
Total Operating Expenses 532.9 499.3 408.4 + 22%
---------- ---------- ---------- -------------
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The following discussion of operating expenses is presented excluding the effect of Chicago 20MHz on 2002 results. The resulting variances from prior year are therefore related only to the Company’s operations that were included in consolidated results in both 2001 and 2002. Operating expenses totaled $499.3 million in the third quarter of 2002, an increase of $90.9 million, or 22%, from 2001. System operations expenses increased $11.8 million, or 10%, in 2002 as a result of increases in minutes of use and costs associated with maintaining 16% more average cell sites than in 2001. These factors were partially offset by decreases in cost per minute for outbound roaming transactions. Marketing and selling expenses increased $19.6 million, or 26%, in 2002. The increase was primarily due to a 7% increase in gross customer activations, increased costs related to improvements made to the Company’s telesales and merchandise management processes, commissions and agent-related costs and additional advertising costs related to certain pricing promotions. Cost of equipment sold increased $16.1 million, or 51%, in 2002. The increase is primarily due to the approximately $21 million in handset costs related to the sale of handsets to agents in the third quarter of 2002. Excluding the sales of handsets to agents in 2002, cost of equipment sold would have decreased approximately $5 million. This decrease was due to the reduction in per unit cost per handset in 2002, partially offset by the effect of a 7% increase in gross customer activations, to 316,000 in 2002 from 296,000 in 2001. -14- Marketing cost per gross customer activation (“CPGA”), which includes marketing and selling expenses and equipment subsidies, increased 19% to $340 in 2002 (excluding the effect of Chicago 20MHz) from $285 in 2001. The following summarizes the components of CPGA: |
Three Months Ended
September 30,
---------------------------
2002 2001
------------ ------------
Cost Components (Millions):
Marketing and selling $ 94.0 $ 74.4
Cost of equipment sold 47.8 31.7
Less equipment sales revenues (34.5) (21.7)
------------ ------------
Total marketing costs $ 107.3 $ 84.4
------------ ------------
Gross Customer Activations (Thousands) 316.0 296.0
------------ ------------
Cost per Gross Customer Activation $ 340 $ 285
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General and administrative expenses increased $24.8 million, or 23%, in 2002. The increase was primarily driven by a $7.6 million increase in bad debt expense, related to the downturn in the economy over the past 15 months, by a $9.6 million increase in customer retention costs and also by an increase in the expenses required to serve the growing customer base. Depreciation expense increased $27.0 million, or 44%, in 2002, reflecting a 19% increase in average fixed asset balances. In addition, depreciation expense increased $15.0 million in 2002 to reflect the writeoff of certain analog radio equipment. Operating income decreased $28.0 million, or 30%, to $64.7 million in 2002; operating income margins (as a percent of service revenues) totaled 11.5% in 2002 and 19.3% in 2001. Excluding the effect of SFAS No. 142 on amortization of intangibles, operating income would have decreased $37.1 million, or 36%, in 2002. Excluding amortization of intangibles related to licenses and goodwill, 2001‘s operating income margin would have been 21.2%. Excluding the operations of Chicago 20MHz, 2002‘s operating income would have been $70.0 million and the operating income margin would have been 13.1%. The decrease in operating income was primarily driven by increases in marketing and selling expense, cost of equipment sold, general and administrative expense and depreciation expense which were all greater than the increase in operating revenues. Investment and other income (loss) totaled a loss of $33.7 million in 2002 and income of $5.4 million in 2001. Loss on wireless and other investments totaled $34.2 million in 2002, as the Company recorded a writedown related to certain notes receivable. Investment income decreased $1.3 million, or 9%, in 2002, as the aggregate net income from the markets managed by others that are accounted for by the equity method decreased in the third quarter of 2002. Interest expense increased $4.6 million, or 54%, in 2002, primarily due to the interest expense related to the debt incurred to finance the PrimeCo acquisition. Income tax expense totaled $16.3 million in 2002 and $42.9 million in 2001. Excluding $12.4 million of income tax benefit in 2002 related to the writedown of certain notes receivable, the Company’s effective tax rate was 44% both in 2002 and 2001. Net income totaled $12.2 million in 2002 and $53.1 million in 2001. Diluted earnings (loss) per share totaled $.14 in 2002 and $.60 in 2001. Excluding the after-tax effects of the writedown of notes receivable, net income and diluted earnings per share totaled $34.0 million and $.39, respectively, in 2002. A summary of the after-tax effects of the losses on investments, license and goodwill amortization and losses on the retirement of debt on net income and diluted earnings per share in both 2002 and 2001 is shown below. -15- |
Three Months Ended
September 30,
---------------------------
2002 2001
------------ ------------
(Dollars in thousands,
except per share amounts)
Net Income (Loss) from:
Operations $ 33,963 $ 61,653
(Loss) on writedown of notes receivable (21,799) --
License and goodwill amortization -- (6,758)
(Loss) on retirement of debt -- (1,768)
------------ ------------
Net income (loss) as reported $ 12,164 $ 53,127
============ ============
Diluted Earnings Per Share from:
Operations $ .39 $ .69
(Loss) on writedown of notes receivable (.25) --
License and goodwill amortization -- (.07)
(Loss) on retirement of debt -- (.02)
------------ ------------
Diluted earnings per share as reported $ .14 $ .60
============ ============
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FINANCIAL RESOURCES AND LIQUIDITY The Company operates a capital- and marketing-intensive business. In recent years, the Company has generated operating cash flow and received cash proceeds from divestitures to fund its network construction costs and operating expenses. The Company anticipates further increases in wireless units in service, revenues, operating cash flow and fixed asset additions in the future. Operating cash flow may fluctuate from quarter to quarter depending on the seasonality of each of these growth factors. Cash flows from operating activities provided $463.6 million in 2002 and $356.2 million in 2001. Income from operations excluding all noncash items increased $63.5 million to $428.9 million in the first nine months of 2002. Changes in assets and liabilities from operations provided $34.7 million in 2002 and required $9.2 million in 2001, reflecting primarily timing differences in the payment of accounts payable and the receipt of accounts receivable. Income taxes and interest paid totaled $59.8 million in 2002 and $84.9 million in 2001. Cash flows from investing activities required $828.2 million in 2002 and $510.1 million in 2001. Cash required for property, plant and equipment and system development expenditures totaled $449.0 million in 2002 and $377.7 million in 2001. These expenditures were financed primarily with internally generated cash. These expenditures primarily represent the construction of 263 and 256 cell sites in 2002 and 2001, respectively, as well as other plant additions. These plant additions included the migration to a single digital equipment platform, the addition of digital radio channels to accommodate increased usage and costs related to the development of the Company’s billing and office systems. Other plant additions included significant amounts related to the replacement of retired assets and the changeout of analog equipment for digital equipment. Acquisitions, excluding cash received and bonds issued to the sellers of Chicago 20MHz, required $451.5 million in 2002 and $134.6 million in 2001. Cash distributions from wireless entities in which the Company has an interest provided $25.0 million in 2002 and $10.6 million in 2001. In 2002, the Company was refunded $47.6 million of its deposit with the FCC related to the January 2001 FCC spectrum auction. -16- Cash flows from financing activities provided $374.2 million in 2002 and $39.4 million in 2001. In 2002, the Company received $159.9 million from the VOD contracts and received $105.0 million from TDS through the Intercompany Note. The Company repaid $306.4 million in 2002 and $22.5 million in 2001 under the 1997 Revolving Credit Facility. Borrowings under the 1997 Revolving Credit Facility totaled $422.4 million in 2002, primarily to fund the Chicago 20MHz acquisition, and $118.5 million in 2001. In 2001, the Company paid $30.1 million in cash, recorded $612,000 of accounts payable for payments made in October 2001 and issued 550,000 USM Common Shares to satisfy the conversion of $113.5 million face value ($49.4 million carrying value) of LYONs by the holders. In 2001, the Company paid $25.8 million for the repurchase of 322,600 of its Common Shares. The cash paid includes $11.0 million paid in 2001 for repurchases executed in December 2000, and excludes $1.0 million of accounts payable recorded for payments made in October 2001. Acquisitions and Divestitures Acquisitions The Company assesses its wireless holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. The Company also reviews attractive opportunities for the acquisition of additional wireless spectrum. Acquisition of Chicago 20MHz On August 7, 2002, the Company completed the acquisition of Chicago 20MHz, representing 13.2 million pops, for approximately $607 million, subject to certain working capital and other adjustments. The Company financed the purchase using its 1997 Revolving Credit Facility, the $175 million 9% Series A Notes and the $105 million Intercompany Note with TDS. Net of cash acquired in the transaction and bonds issued to the sellers of Chicago 20MHz, the Company used cash totaling $430.4 million for the acquisition of Chicago 20MHz. See “Liquidity and Capital Resources – Financing of Chicago 20MHz Acquisition.” The Chicago MTA is the fourth largest MTA in the United States. The markets that comprise the Chicago MTA are adjacent to the Iowa, Illinois, Wisconsin and Indiana markets of the Company’s Midwest cluster, which is its largest market cluster. Of the total Chicago MTA population of 13.2 million, approximately 81% was not previously covered by the Company’s licenses. There is a strong community of interest between the Company’s existing markets and the Chicago 20MHz markets. The Chicago MTA is the single largest roaming destination of the Company’s current customers. Chicago 20MHz owns licenses covering the 18 Basic Trading Areas (“BTAs”) that comprise the Chicago MTA. The Chicago MTA includes, among others, the Chicago, Bloomington-Normal, Champaign-Urbana, Decatur-Effingham, Peoria, Rockford and Springfield BTAs in Illinois, the South Bend and Fort Wayne BTAs in Indiana and the Benton Harbor BTA in Michigan. The Chicago 20MHz network currently covers approximately 73% of the population in the licensed area. Chicago 20MHz utilizes Code Division Multiple Access (“CDMA”) technology in a network which serves the Chicago MTA with over 500 cell sites. Chicago 20MHz currently serves approximately 305,000 customers, representing a penetration rate of approximately 2.3% based on 2001 Claritas population estimates for the licensed area of Chicago 20MHz. Chicago 20MHz utilizes both direct and indirect distribution channels, with direct distribution provided through 34 stores and kiosks, and indirect distribution through approximately 600 authorized agents. In addition, Chicago 20MHz has approximately 720 replenishment locations for its prepaid customers. The Company launched its “U.S. Cellular” brand in the Chicago 20MHz licensed area in the fourth quarter of 2002. -17- At September 30, 2002, Chicago 20MHz had approximately 500 employees, none of whom are represented by labor unions. Chicago 20MHz competes in the Chicago MTA directly against larger and more established wireless service providers, as the Company does in many of its other markets. The other wireless carriers competing in all or part of the Chicago MTA include Cingular, Verizon Wireless, AT&T Wireless, Sprint PCS, Nextel and T-Mobile. These competitors provide wireless services on a substantially national basis. As a result, they have customer bases substantially greater than Chicago 20MHz, which is only a local competitor, and also greater than the Company, which is a regional competitor, and have financial resources that are substantially greater than Chicago 20MHz and the Company. For the twelve months ended December 31, 2001, Chicago 20MHz had net revenues of $232 million, operating loss of $26 million and a net loss of $27 million. For the portion of the third quarter subsequent to the acquisition, Chicago 20MHz contributed $26.4 million of service revenue, with average monthly service revenue per customer of $46.83, $1.8 million of equipment sales revenue and $5.3 million of operating loss to the Company’s operating results. Subsequent to the acquisition, Chicago 20MHz lost 15,000 net customers and ended the quarter with 305,000 customers. Other Acquisitions Additionally, in the first nine months of 2002, the Company, through joint ventures, acquired majority interests in 10 megahertz (“MHz”) licenses in three PCS markets. The interests the Company acquired are 100% owned by the joint ventures, and the Company is considered to have the controlling financial interest in these joint ventures for financial reporting purposes. The Company also acquired the remaining minority interests in three other PCS markets in which it previously owned an interest, resulting in 100% ownership in those markets. The aggregate amount paid by the Company to acquire the interests in these transactions, which represented 1.3 million pops, was $20.8 million. In the first nine months of 2001, the Company completed the acquisition of majority interests in 17 wireless licenses, representing 5.1 million pops, for $136.9 million. Divestitures In 2002 and 2001, the Company had no material divestitures of wireless interests.Pending Transactions The Company is a limited partner in a joint venture that was a successful bidder for 17 licenses in 13 markets in the January 2001 FCC spectrum auction (“Auction 35”). The cost for the 17 licenses totaled $283.9 million. Legally, the general partner controls the joint venture; however, the Company has included the joint venture in its consolidated financial statements because the Company is considered to have controlling financial interest for financial reporting purposes under GAAP. In 2001, the joint venture acquired five of such licenses in four markets for a total of $4.1 million and had deposits with the FCC totaling $56.1 million for the remaining licenses. In May 2002, the FCC refunded 85% of the deposits, or $47.6 million, and retained the remaining $8.5 million of deposits pending the outcome of the proceedings discussed below. The remaining deposits are classified as a current asset at September 30, 2002. -18- On September 12, 2002, the FCC issued a public notice (“WT Docket 02-276”) seeking comment on whether it should consider refunding the remainder of the deposits as well as permit the winning bidders in Auction 35 to dismiss some or all of their applications. The FCC also sought comment on whether winning bidders who elected to “opt out” of certain applications should be barred from participating in any subsequent reauction with respect to those licenses. The pleading cycle in WT Docket 02-276 ended on October 21, 2002 and the FCC has indicated its intention of issuing an order soon thereafter. Subject to the final outcome of the proceedings discussed below, or the earlier decision of the FCC in WT Docket 02-276 and the election by the joint venture to opt out of all of its applications, the joint venture’s portion of the funding for the acquisition of the remaining licenses could range from zero up to an aggregate of an additional $271.3 million. At this time, the joint venture has made no decision as to whether it will exercise any opt-out rights, even if the FCC were to grant such rights. In addition, the Company has agreed to loan the general partner up to $20 million that could be used by the general partner to fund its investment in the licenses. With respect to the remaining 12 licenses in nine markets, such licenses had been reauctioned by the FCC after defaults by winning bidders in a prior auction and were made subject by the FCC to the final outcome of certain legal proceedings initiated by the prior winning bidders. Following the reauction, one of the prior winning bidders obtained a court ruling that the FCC’s actions were illegal. In response to a request of the U.S. Department of Justice and the FCC, the U.S. Supreme Court agreed to review this court ruling and oral arguments were heard on October 8, 2002. In the event the prior winning bidder is successful in this litigation, the joint venture would receive a refund of its remaining deposit of $8.5 million made to the FCC for such 12 licenses. The joint venture’s financial requirements would then be limited to the five licenses in four markets that it acquired in 2001. If the FCC is successful in this litigation or the matter is otherwise resolved in a manner that will permit the joint venture to acquire the remaining licenses, the joint venture could be required to pay to the FCC the balance of the auction price for such licenses. The joint venture could then have significant financial requirements to build out such markets. The exact nature of the Company’s financial commitment going forward will be determined as the joint venture evaluates its alternatives as a result of any Order issued in WT Docket 02-276 and develops its long-term business and financing plans. Liquidity and Capital Resources Anticipated capital expenditures requirements for 2002 primarily reflect the Company’s plans for construction, system expansion, the execution of its plans to migrate to a single digital equipment platform and the buildout of its Chicago 20MHz licensed area. The Company’s construction and system expansion budget for 2002 is $720 million to $740 million, of which $449 million of expenditures have been incurred as of September 30, 2002. These expenditures primarily address the following needs:
-19- The Company expects its conversion to CDMA to be completed during 2004, at an approximate cost of $400 million to $450 million spread over three years. The estimated capital expenditures in 2002 include $130 million to $145 million related to this conversion. Approximately $50 million of the conversion expenditures were moved into 2002 from 2003 to enable the Company to migrate some service areas to the new platform sooner and minimize the Company’s investment in infrastructure and handsets related to the old platform. Customers in the areas converted to CDMA in 2002 will be able to use the Company’s Chicago 20MHz network instead of roaming on third-party networks, potentially reducing system operations expense. The Company has contracted with an infrastructure vendor to provide a substantial portion of the equipment related to the conversion. The Company has no current plans to repurchase its common shares. However, as market conditions warrant, the Company may continue the repurchase of its common shares, on the open market or at negotiated prices in private transactions. The Company’s repurchase program is intended to create value for the shareholders. The repurchases of common shares will be funded by internal cash flow, supplemented by short-term borrowings and other sources. The Company’s Board of Directors has authorized management to opportunistically repurchase LYONs in private transactions. The Company may also purchase a limited amount of LYONs in open-market transactions from time to time. The Company’s LYONs are convertible, at the option of their holders, at any time prior to maturity, redemption or purchase, into USM Common Shares at a conversion rate of 9.475 USM Common Shares per LYON. Upon conversion, the Company has the option to deliver to holders either USM Common Shares or cash equal to the market value of the USM Common Shares into which the LYONs are convertible. The Company may redeem the LYONs for cash at the issue price plus accrued original issue discount through the date of redemption. The Company is generating substantial cash from its operations and anticipates financing all of the remaining 2002 obligations listed above with internally generated cash and with borrowings under the Company’s 1997 Revolving Credit Facility and its recently obtained five-year credit facility, which provides up to $325 million in financing (the “2002 Revolving Credit Facility”), as the timing of such expenditures warrants. The Company had $38.6 million of cash and cash equivalents at September 30, 2002. At September 30, 2002, $120 million of the $500 million under the Company’s 1997 Revolving Credit Facility and the entire $325 million of the 2002 Revolving Credit Facility were unused and remained available to meet any short-term borrowing requirements. The 1997 Revolving Credit Facility expires in August 2004 and provides for borrowings with interest at LIBOR plus a margin percentage based on the Company’s credit rating, which was 19.5 basis points as of September 30, 2002. The 2002 Revolving Credit Facility expires in June 2007 and permits revolving loans on terms and conditions substantially similar to the Company’s 1997 Revolving Credit Facility. The terms of the 2002 Revolving Credit Facility provide for borrowings with interest at LIBOR plus a margin percentage based on the Company’s credit rating, which was 55 basis points (for a rate of 2.36% as of September 30, 2002). The continued availability of these revolving lines of credit requires the Company to comply with certain negative and affirmative covenants, maintain certain financial ratios and to represent certain matters at the time of each borrowing. At September 30, 2002, the Company was in compliance with all covenants and other requirements set forth in the revolving credit facilities. The Company’s interest costs related to both lines of credit would increase if its credit rating goes down, which would increase its cost of financing, but such lines of credit would not cease to be available solely as a result of a decline in its credit rating. -20- The Company has on file with the SEC a shelf registration statement on Form S-3 for the issuance from time to time of up to $500 million of senior debt securities. In November 2002, the Company sold $115 million of 8.75% Senior Notes due 2032 (the “8.75% Senior Notes”) under this registration statement, as more fully discussed below. See also “Financing of Chicago 20MHz Acquisition and Upgrade.” The Company holds investments in publicly traded companies valued at $131.8 million as of September 30, 2002. These assets are classified for financial reporting purposes as available-for-sale securities. In May 2002, the Company entered into the VOD contracts. The Company received $159.9 million related to the VOD contracts, which expire in five years and may be settled in cash or delivery of the underlying securities. See “Market Risk” for further information on the VOD contracts. Management continues to believe there exists a seasonality in both service revenues and operating expenses, which may cause cash flows from operations to vary from quarter to quarter. However, these fluctuations are not considered to be large enough to cause the Company to look beyond its short-term financing sources to meet its cash needs during the remainder of 2002 or during 2003. Subject to the discussion under “Financing of Chicago 20 MHz Acquisition and Upgrade” below, management believes that the Company’s cash flows from operations and sources of external financing, including the above-referenced 1997 and 2002 Revolving Credit Facilities, provide substantial financial flexibility for the Company to meet both its short- and long-term needs. The Company also may have access to public and private capital markets to help meet its long-term financing needs. The Company anticipates issuing debt and equity securities only when capital requirements (including acquisitions), financial market conditions and other factors warrant. However, the availability of financial resources is dependent on economic events, business developments, technological changes, financial conditions or other factors, some of which may not be in the Company’s control. If at any time financing is not available on terms acceptable to the Company, it might be required to reduce its business development and capital expenditure plans, which could have a materially adverse effect on its business and financial condition. The Company does not believe that any circumstances that could materially adversely affect its liquidity or its capital resources are currently reasonably likely to occur, but it cannot provide assurances that such circumstances will not occur or that they will not occur rapidly. Economic downturns, changes in financial markets or other factors could rapidly change the availability of the Company’s liquidity and capital resources. Uncertainty of access to capital for telecommunications companies, further deterioration in the capital markets, other changes in market conditions or other factors could limit or restrict the availability of financing on terms and prices acceptable to the Company, which could require the Company to reduce its construction, development and acquisition programs. At September 30, 2002, the Company is in compliance with all covenants and other requirements set forth in long-term debt indentures. The Company does not have any rating downgrade triggers that would accelerate the maturity dates of its debt. However, a downgrade in the Company’s credit rating could adversely affect its ability to renew existing, or obtain access to new, credit facilities in the future. Financing of Chicago 20MHz Acquisition and UpgradeThe Chicago 20MHz acquisition price of approximately $607 million was financed using $327 million from the Company’s 1997 Revolving Credit Facility, $175 million from the 9% Series A Notes and the $105 million Intercompany Note with TDS. -21- The 9% Series A Notes were issued to PrimeCo in a private placement as part of the payment of the purchase price for Chicago 20MHz. Interest is payable quarterly. The notes are callable by the Company after five years at the principal amount plus accrued but unpaid interest. In connection with the purchase of Chicago 20MHz from PrimeCo, the Company entered into an agreement pursuant to which it provided PrimeCo and transferees of PrimeCo rights to have such notes registered with the SEC for resale. The Company filed the registration statement on August 29, 2002. This registration statement will be amended due to the purchase of a portion of the 9% Series A Notes, as described in the following paragraph. In November 2002, the Company sold $115 million of 8.75% Senior Notes. Interest is payable quarterly. The notes are callable by the Company, at the principal amount plus accrued and unpaid interest, at any time on and after November 7, 2007. The net proceeds of the 8.75% Senior Notes are being used to repurchase a portion of the 9% Series A Notes that were issued to PrimeCo. The Company issued the 8.75% Senior Notes under the $500 million shelf registration statement on Form S-3 filed in May 2002. The Company has also granted the underwriters of the offering an option to purchase up to an additional $17.25 million of 8.75% Senior Notes, exercisable through November 30, 2002. The underwriters have exercised the option to acquire an additional $15 million of such notes. The $105 million loan from TDS bears interest at an annual rate of 8.1%, payable quarterly, and becomes due in August 2008, with no penalty for prepayment. This loan is subordinated to the 2002 Revolving Credit Facility. Subsequent to its acquisition of Chicago 20MHz, the Company began reevaluating its capital spending plans for the remainder of 2002. The Company expects to incur approximately $90 million in capital expenditures during the first 12 months following the Chicago 20MHz acquisition, to improve coverage in the Chicago 20MHz network, including an upgrade of the current CDMA system to 1XRTT, and to enhance its marketing distribution in the Chicago market, including opening new retail and agent locations. The Company expects to invest approximately $50 million of the $90 million during 2002. RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 143 “Accounting for Asset Retirement Obligations” was issued in September 2001, and will become effective for the Company beginning January 1, 2003. SFAS No. 143 requires entities to record the fair value of a liability for legal obligations associated with an asset retirement in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Throughout the useful life of the asset, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the asset’s useful life. The Company is currently reviewing the requirements of this new standard and has not yet determined the impact, if any, on the Company’s financial position or results of operations. SFAS No. 145 “Rescission of SFAS No. 4, 44, and 64 and Technical Corrections” was issued in April 2002. The Company elected to adopt SFAS No. 145 early, in the second quarter of 2002, and as a result no longer reports gains and losses from extinguishment of debt as an extraordinary item. Prior year after-tax losses related to LYONs debt retirements of $1.8 million and $6.9 million, respectively, for the three and nine months ended September 30, 2001, previously reported as extraordinary items, have been reclassified to Other Income (Expense), Net in the Company’s statement of operations to conform with SFAS No. 145. SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” was issued in June 2002 and will become effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity’s commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. The Company will apply this new standard on exit or disposal activities, if any, initiated after December 31, 2002. -22- The Company is subject to market rate risks due to fluctuations in interest rates and market prices of marketable equity securities. The Company currently has both fixed-rate and variable-rate long-term debt instruments, with original maturities ranging from five to 30 years. Accordingly, fluctuations in interest rates can lead to significant fluctuations in the fair value of such instruments. As of September 30, 2002, the Company has not entered into financial derivatives to reduce its exposure to interest rate risks. The Company maintains a portfolio of available for sale marketable equity securities, which resulted from acquisitions and the sale of non-strategic investments. The market value of these investments aggregated $131.8 million at September 30, 2002 (VOD ADRs $131.5 million and RCCC shares $0.3 million) and $272.4 million at December 31, 2001. The Company has entered into the VOD contracts in order to hedge the market price risk with respect to the VOD ADRs. See Note 11 – Derivative Contracts for a description of the VOD contracts. The risk management objective of the VOD contracts is to establish a collar around the value of the marketable equity securities to protect the value of the marketable securities from downside risk while maintaining a share of the upside potential. The downside risk is hedged at or above the accounting cost basis, thereby eliminating the other than temporary risk on the VOD ADRs. The unhedged downside risk on the RCCC shares is not material. The following analysis presents the hypothetical change in the fair value of the Company’s marketable equity securities and derivative instruments at September 30, 2002, assuming the same hypothetical price fluctuations of plus and minus 10%, 20% and 30%. |
Valuation of investments September Valuation of investments
($ in thousands) assuming indicated decrease 30, 2002 assuming indicated increase
- ----------------
-30% -20% -10% Fair Value +10% +20% +30%
---- ---- ---- ---------- ---- ---- ----
Marketable Equity
Securities $92,237 $105,414 $118,590 $131,767 $144,944 $158,120 $171,297
Derivative
Instruments (1) $61,821 $51,043 $40,211 $35,961 $18,302 $7,206 $(3,989)
(1) Represents change in the fair value of the derivative instrument assuming
the indicated increase or decrease in the underlying securities.
|
APPLICATION OF CRITICAL ACCOUNTING POLICIES The Company prepares its consolidated financial statements in accordance with GAAP. The Company’s significant accounting policies are discussed in detail in Note 1 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various other assumptions and information that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from estimates under different assumptions or conditions. -23- Critical Accounting Estimates Management believes the following critical accounting estimates reflect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Valuation of Notes Receivable The Company holds notes receivable aggregating $45.8 million from Kington Management Corporation (“Kington”) that are due in June 2005. These notes relate to the purchase by Kington of two of the Company’s minority interests in 2000. The value of these notes is directly related to the future fair market value of the related interests. An independent third party valuation of one of the wireless minority interests sold to Kington and a recent transaction involving an unrelated party holding an interest in the same market as the other wireless minority interest sold to Kington indicated a lower market value for these wireless minority interests, and therefore a lower value of the notes. Management concluded that the notes receivable were impaired and established a valuation allowance against the notes. A loss of $34.2 million was charged to the statement of operations in the third quarter of 2002 and was included in the caption (Loss) on Wireless and Other Investments. Following this writedown, the carrying value of such notes receivable at September 30, 2002 is $11.6 million. If or when the market values for the related wireless interests will recover is unclear. There may continue to be substantial variability in the future market values of these interests and risk of further decline in the value of the notes. Management will continue to review the valuation on a periodic basis. Marketable Equity Securities The Company holds a substantial amount of marketable securities that are publicly traded and can have volatile share prices. These investments are classified as available-for-sale and are stated at fair value based on quoted market prices. The reported value of the marketable securities is adjusted to market value each period with the unrealized gain or loss in value of the securities reported as Other Comprehensive Income, net of income taxes, which is included in the common shareholders’ equity section of the balance sheet. The market values of marketable securities may fall below the accounting cost basis of such securities. GAAP requires management to determine whether a decline in fair value below the accounting cost basis is other than temporary. If management determined that the decline in value of the Company’s marketable securities was other than temporary, the unrealized loss included in Other Comprehensive Income would be recognized and recorded as a loss in the statement of operations. Factors that management reviews in determining an other than temporary decline include the following:
The Company is in the same industry classification as the issuers of its marketable securities, enhancing the Company’s ability to evaluate the effects of any changes in industry-specific factors which may affect the determination of whether a decline in market values of its marketable securities is other than temporary. -24- In June 2002, based on a review of such factors, management determined that the decline in value of its investment in marketable securities relative to their respective accounting cost basis was other than temporary and charged an aggregate $244.7 million loss to the statement of operations ($145.6 net of tax) and reduced the accounting cost basis of such marketable equity securities by a respective amount. As of September 30, 2002, the aggregate market value of the marketable equity securities totaled $131.8 million, the aggregate cost basis was $160.4 million and the unrealized loss included in accumulated other comprehensive income was $17.0 million (net of tax of $11.6 million). The downside risk is hedged at or above the accounting cost basis, thereby eliminating the other than temporary risk on the VOD ADRs. The unhedged downside risk on the RCCC shares is not material. Investment in Licenses and GoodwillAs of September 30, 2002, the Company reported $1,040.8 million of investment in licenses, net of accumulated amortization and $629.5 million of goodwill, net of accumulated amortization, as a result of acquisitions of interests in wireless licenses and businesses. The Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets” on January 1, 2002. In connection with SFAS No. 142, the Company has assessed its recorded balances of investment in licenses and goodwill for potential impairment. The Company completed its initial impairment assessments in the first quarter of 2002 and no impairment charge was necessary. After these initial impairment reviews, investments in licenses and goodwill must be reviewed for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. There can be no assurance that, upon review at a later date, material impairment charges will not be required. The intangible asset impairment test consists of comparing the fair value of the intangible asset to the carrying amount of the intangible asset. If the carrying amount exceeds the fair value, an impairment loss is recognized for the difference. The goodwill impairment test is a two-step process. The first step compares the fair value of the reporting unit to its carrying value. If the carrying amount exceeds the fair value, the second step of the test is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value, an impairment loss is recognized for that difference. The fair value of an intangible asset and reporting unit goodwill is the amount at which that asset or reporting unit could be bought or sold in a current transaction between willing parties. Therefore, quoted market prices in active markets are the best evidence of fair value and should be used when available. If quoted market prices are not available, the estimate of fair value shall be based on the best information available, including prices for similar assets and the use of other valuation techniques. Other valuation techniques include present value analysis, multiples of earnings or revenue or a similar performance measure. The use of these techniques involve management estimating future cash flows, selecting the appropriate discount rate, and estimating other factors and inputs, and generally result in a range of values. There can be no assurance that these estimates incorporate all known and unknown risks, uncertainties and other factors necessary to arrive at an estimated fair value. Allocation of Chicago 20MHz Purchase Price In connection with the purchase of Chicago 20MHz, the Company allocated the total acquisition costs to all tangible and intangible assets acquired and all liabilities assumed, with the excess purchase price over the fair value of net assets acquired recorded to goodwill. An independent appraiser provided a preliminary valuation of Chicago 20MHz’s assets. The following table summarizes the estimated fair values of the Chicago 20MHz assets acquired and liabilities assumed at the date of acquisition. -25- |
August 7, 2002
----------------------------------------
(Dollars in
millions)
Current assets $ 31.6
Property, plant and equipment 239.3
Other assets 0.1
Customer list 43.4
Licenses 163.5
Goodwill 150.0
--------
Total assets acquired $ 627.9
--------
Current liabilities (19.0)
Noncurrent liabilities (1.6)
--------
Total liabilities acquired $ (20.6)
--------
Purchase price $ 607.3
========
|
The Company expects that the allocation will require revisions as it obtains additional information relating to the valuation and finalizes the working capital and other adjustments. The Company is not currently aware of any matter that would require a material adjustment to the purchase price. Income Taxes The preparation of the consolidated financial statements requires the Company to calculate its provision for income taxes. This process involves estimating the actual current tax expense together with assessing temporary differences resulting from differing treatment of items, such as depreciation expense, for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheet. The Company must then assess the likelihood that deferred tax assets will be recovered from future taxable income, and, to the extent management believes that recovery is not likely, a valuation allowance must be established. Management’s judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against deferred tax assets. The temporary differences that gave rise to the noncurrent deferred tax assets and liabilities as of September 30, 2002 are as follows: |
September 30, 2002
------------------
(dollars in
millions)
------------------
Deferred Tax Asset
State net operating loss carryforwards $ 10.9
Notes receivable valuation 12.4
Other 8.1
------------------
31.4
Less valuation allowance (8.5)
------------------
Total Deferred Tax Asset 22.9
------------------
Deferred Tax Liability
Marketable equity securities 51.0
Property, plant and equipment 163.1
Licenses 138.4
Other 64.4
------------------
Total Deferred Tax Liability 416.9
------------------
Net Deferred Income Tax Liability $ 394.0
==================
| UNITED STATES CELLULAR
CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Unaudited |
| Three Months Ended | Nine Months Ended | |||||||||||
| September 30, | September 30, | |||||||||||
| 2002 | 2001 | 2002 | 2001 | |||||||||
| (Dollars in thousands, except per share amounts) | ||||||||||||
| OPERATING REVENUES | ||||||||||||
| Service | $ | 561,240 | $ | 479,318 | $ | 1,523,506 | $ | 1,364,439 | ||||
| Equipment sales | 36,331 | 21,706 | 80,195 | 51,643 | ||||||||
| | | | | |||||||||
| Total Operating Revenues | 597,571 | 501,024 | 1,603,701 | 1,416,082 | ||||||||
| | | | | |||||||||
| OPERATING EXPENSES | ||||||||||||
| System operations | 136,367 | 119,160 | 362,426 | 320,596 | ||||||||
| Marketing and selling | 100,877 | 74,363 | 264,032 | 213,667 | ||||||||
| Cost of equipment sold | 51,595 | 31,721 | 118,550 | 93,737 | ||||||||
| General and administrative | 141,161 | 105,817 | 363,066 | 321,663 | ||||||||
| Depreciation | 93,355 | 61,520 | 228,289 | 174,437 | ||||||||
| Amortization of intangibles | 9,521 | 15,766 | 23,748 | 47,196 | ||||||||
| | | | | |||||||||
| Total Operating Expenses | 532,876 | 408,347 | 1,360,111 | 1,171,296 | ||||||||
| | | | | |||||||||
| OPERATING INCOME | 64,695 | 92,677 | 243,590 | 244,786 | ||||||||
| | | | | |||||||||
| INVESTMENT AND OTHER INCOME | ||||||||||||
| Investment income | 12,963 | 14,294 | 30,711 | 31,289 | ||||||||
| Amortization of licenses related to investments | — | (178 | ) | — | (532 | ) | ||||||
| Interest income | 729 | 1,697 | 3,142 | 9,513 | ||||||||
| Other income (expense), net | 156 | (1,708 | ) | 1,782 | (3,419 | ) | ||||||
| Interest (expense) | (13,306 | ) | (8,668 | ) | (30,993 | ) | (26,191 | ) | ||||
| (Loss) on wireless and other investments | (34,210 | ) | — | (278,909 | ) | — | ||||||
| | | | | |||||||||
| Total Investment and Other Income | (33,668 | ) | 5,437 | (274,267 | ) | 10,660 | ||||||
| | | | | |||||||||
| INCOME (LOSS) BEFORE INCOME TAXES | ||||||||||||
| AND MINORITY INTEREST | 31,027 | 98,114 | (30,677 | ) | 255,446 | |||||||
| Income tax expense (benefit) | 16,269 | 42,950 | (3,879 | ) | 107,376 | |||||||
| | | | | |||||||||
| INCOME (LOSS) BEFORE | ||||||||||||
| BEFORE MINORITY INTEREST | 14,758 | 55,164 | (26,798 | ) | 148,070 | |||||||
| Minority share of income | (2,594 | ) | (2,037 | ) | (6,248 | ) | (7,186 | ) | ||||
| | | | | |||||||||
| NET INCOME (LOSS) | $ | 12,164 | $ | 53,127 | $ | (33,046 | ) | $ | 140,884 | |||
| | | | | |||||||||
| BASIC WEIGHTED AVERAGE COMMON | ||||||||||||
| AND SERIES A COMMON SHARES (000s) | 86,095 | 86,394 | 86,077 | 86,231 | ||||||||
| BASIC EARNINGS PER COMMON AND | ||||||||||||
| SERIES A COMMON SHARES | $ | 0.14 | $ | 0.61 | $ | (0.38 | ) | $ | 1.63 | |||
| | | | | |||||||||
| DILUTED EARNINGS PER COMMON AND | ||||||||||||
| SERIES A COMMON SHARES | $ | 0.14 | $ | 0.60 | $ | (0.38 | ) | $ | 1.61 | |||
| | | | | |||||||||
| The accompanying notes to consolidated financial statements are an integral part of these statements. |
| -30- |
|
UNITED STATES CELLULAR
CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASHFLOWS Unaudited |
| Nine Months Ended September 30, | ||||||
| 2002 | 2001 | |||||
| (Dollars in thousands) | ||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||
| Net income (loss) | $ | (33,046 | ) | $ | 140,884 | |
| Add (Deduct) adjustments to reconcile net income | ||||||
| (loss) to net cash provided by operating activities | ||||||
| Depreciation and amortization | 252,037 | 221,633 | ||||
| Deferred income tax provision | (53,094 | ) | 15,316 | |||
| Investment income | (30,711 | ) | (31,289 | ) | ||
| Minority share of income | 6,248 | 7,186 | ||||
| Loss on wireless and other investments | 278,909 | — | ||||
| Other noncash expense | 8,583 | 11,649 | ||||
| Change in assets and liabilities from operations | ||||||
| Change in accounts receivable | (19,919 | ) | (42,925 | ) | ||
| Change in inventory | 16,463 | 23,680 | ||||
| Change in accounts payable | 4,079 | (29,012 | ) | |||
| Change in accrued interest | (3,501 | ) | (3,526 | ) | ||
| Change in accrued taxes | 21,464 | 35,207 | ||||
| Change in customer deposits and deferred revenues | 15,325 | (2,689 | ) | |||
| Change in other assets and liabilities | 811 | 10,097 | ||||
| | | |||||
| 463,648 | 356,211 | |||||
| | | |||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||
| Additions to property, plant and equipment | (421,959 | ) | (368,849 | ) | ||
| System development costs | (27,071 | ) | (8,872 | ) | ||
| Refund of deposit from FCC | 47,566 | — | ||||
| Acquisitions, excluding cash acquired | (451,487 | ) | (134,580 | ) | ||
| Distributions from unconsolidated entities | 24,975 | 10,577 | ||||
| Other investing activities | (201 | ) | (8,386 | ) | ||
| | | |||||
| (828,177 | ) | (510,110 | ) | |||
| | | |||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||
| Proceeds from contracts payable | 159,856 | — | ||||
| Affiliated long term debt borrowings | 105,000 | — | ||||
| Borrowings from 1997 Revolving Credit Facility | 422,444 | 118,500 | ||||
| Repayment of 1997 Revolving Credit Facility | (306,444 | ) | (22,500 | ) | ||
| Repurchase and conversion of LYONs | (70 | ) | (30,149 | ) | ||
| Repurchase of common shares | — | (25,795 | ) | |||
| Proceeds from Common Shares issued | 822 | 3,626 | ||||
| Capital distributions to minority partners | (4,631 | ) | (4,285 | ) | ||
| Other financing activities | (2,793 | ) | — | |||
| | | |||||
| 374,184 | 39,397 | |||||
| | | |||||
| NET INCREASE (DECREASE) IN CASH | 9,655 | (114,502 | ) | |||
| AND CASH EQUIVALENTS | ||||||
| Beginning of period | 28,941 | 124,281 | ||||
| | | |||||
| End of period | $ | 38,596 | $ | 9,779 | ||
| | | |||||
| The accompanying notes to consolidated financial statements are an integral part of these statements. |
| -31- |
|
UNITED STATES CELLULAR
CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS |
| (Unaudited) September 30, 2002 |
December 31, 2001 | |||||
| (Dollars in thousands) | ||||||
| CURRENT ASSETS | ||||||
| Cash and cash equivalents | ||||||
| General funds | $ | 27,401 | $ | 28,941 | ||
| Affiliated cash equivalents | 11,195 | — | ||||
| | | |||||
| 38,596 | 28,941 | |||||
| Accounts Receivable | ||||||
| Customers, net of allowance | 198,044 | 149,920 | ||||
| Roaming | 67,294 | 78,572 | ||||
| Other | 22,680 | 18,883 | ||||
| Inventory | 41,419 | 55,996 | ||||
| Prepaid expenses | 14,922 | 9,442 | ||||
| Deposit receivable from Federal | ||||||
| Communications Commission | 8,494 | 56,060 | ||||
| Other current assets | 5,980 | 6,141 | ||||
| | | |||||
| 397,429 | 403,955 | |||||
| | | |||||
| INVESTMENTS | ||||||
| Licenses, net of accumulated amortization | 1,040,840 | 858,791 | ||||
| Goodwill, net of accumulated amortization | 629,541 | 473,975 | ||||
| Customer list, net of accumulated amortization | 42,090 | — | ||||
| Marketable equity securities | 131,767 | 272,390 | ||||
| Other Investments | ||||||
| Investment in unconsolidated entities, | ||||||
| net of accumulated amortization | 162,211 | 159,454 | ||||
| Notes and interest receivable - long-term | 18,887 | 49,220 | ||||
| | | |||||
| 2,025,336 | 1,813,830 | |||||
| | | |||||
| PROPERTY, PLANT AND EQUIPMENT | ||||||
| In service and under construction | 2,802,207 | 2,253,016 | ||||
| Less accumulated depreciation | 976,028 | 833,675 | ||||
| | | |||||
| 1,826,179 | 1,419,341 | |||||
| | | |||||
| OTHER ASSETS AND DEFERRED CHARGES | ||||||
| System development costs, | ||||||
| net of accumulated amortization | 142,080 | 108,464 | ||||
| Derivative Asset | 35,961 | — | ||||
| Other, net of accumulated amortization | 17,308 | 13,567 | ||||
| | | |||||
| 195,349 | 122,031 | |||||
| | | |||||
| Total Assets | $ | 4,444,293 | $ | 3,759,157 | ||
| | | |||||
| The accompanying notes to consolidated financial statements are an integral part of these statements. |
| -32- |
|
UNITED STATES CELLULAR
CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS’ EQUITY |
| (Unaudited) September 30, 2002 |
December 31, 2001 | |||||
| (Dollars in thousands) | ||||||
| CURRENT LIABILITIES | ||||||
| 1997 Revolving Credit Facility | $ | 380,000 | $ | 264,000 | ||
| Accounts payable | ||||||
| Affiliates | 2,634 | 4,018 | ||||
| Other | 208,495 | 192,742 | ||||
| Customer deposits and deferred revenues | 79,349 | 58,000 | ||||
| Accrued interest | 4,356 | 7,857 | ||||
| Accrued taxes | 30,374 | 8,362 | ||||
| Accrued compensation | 24,444 | 22,185 | ||||
| Other current liabilities | 19,883 | 19,974 | ||||
| | | |||||
| 749,535 | 577,138 | |||||
| | | |||||
| LONG-TERM DEBT | ||||||
| 6% zero coupon convertible debentures | 146,434 | 140,156 | ||||
| 7.25% unsecured notes | 250,000 | 250,000 | ||||
| 9% Series A notes | 175,000 | — | ||||
| Long-term debt - affiliates | 105,000 | — | ||||
| Contracts payable | 159,856 | — | ||||
| Other | 13,000 | 13,000 | ||||
| | | |||||
| 849,290 | 403,156 | |||||
| | | |||||
| DEFERRED LIABILITIES AND CREDITS | ||||||
| Net deferred income tax liability | 394,013 | 388,296 | ||||
| Other | 11,157 | 8,466 | ||||
| | | |||||
| 405,170 | 396,762 | |||||
| | | |||||
| MINORITY INTEREST | 50,499 | 46,432 | ||||
| | | |||||
| COMMON SHAREHOLDERS' EQUITY | ||||||
| Common Shares, par value $1 per share | 55,046 | 55,046 | ||||
| Series A Common Shares, par value $1 per share | 33,006 | 33,006 | ||||
| Additional paid-in capital | 1,307,842 | 1,307,584 | ||||
| Treasury Shares, at cost (1,950,108 and 2,001,560 shares) | (118,476 | ) | (122,010 | ) | ||
| Accumulated other comprehensive income (loss) | 4,385 | (78,997 | ) | |||
| Retained earnings | 1,107,996 | 1,141,040 | ||||
| | | |||||
| 2,389,799 | 2,335,669 | |||||
| | | |||||
| Total Liabilities and Shareholders' Equity | $ | 4,444,293 | $ | 3,759,157 | ||
| | | |||||
| The accompanying notes to consolidated financial statements are an integral part of these statements. |
| -33- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| 1. | Basis of Presentation |
| The
consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are adequate to
make the information presented not misleading. It is suggested that these
consolidated financial statements are read in conjunction with the consolidated
financial statements and the notes thereto included in the Company’s latest
annual report on Form 10-K. |
|
| The
accompanying unaudited consolidated financial statements contain all adjustments
(consisting of only normal recurring items, except as otherwise noted) necessary
to present fairly the financial position as of September 30, 2002 and December
31, 2001, and the results of operations and cash flows for the nine months ended
September 30, 2002 and 2001. The results of operations for the nine months ended
September 30, 2002 and 2001, are not necessarily indicative of the results to be
expected for the full year. |
|
| Certain
amounts reported in prior years have been reclassified to conform to current
period presentation. These reclassifications had no impact on previously
reported operating revenue, net income and shareholders’ equity. |
|
| 2. | Significant Accounting Policy - Derivative Instruments |
| The
Company utilizes derivative financial instruments to reduce marketable equity
security market value risks. The Company does not hold or issue derivative
financial instruments for trading purposes. The Company recognizes all
derivatives as either assets or liabilities in the statement of financial
condition and measures those instruments at fair value. Changes in fair value of
those instruments will be reported in earnings or other comprehensive income
depending on the use of the derivative and whether it qualifies for hedge
accounting. The accounting for gains and losses associated with changes in the
fair value of the derivative and the effect on the consolidated financial
statements will depend on its hedge designations and whether the hedge is
anticipated to be effective in achieving offsetting changes in the fair value of
the hedged item or cash flows of the asset hedged. |
|
| 3. | Recent Accounting Pronouncements |
| Statement
of Financial Accounting Standards No. 143 (“SFAS No. 143”)
“Accounting for Asset Retirement Obligations” was issued in June 2001,
and will become effective for the Company beginning January 1, 2003. SFAS No.
143 requires entities to record the fair value of a liability for legal
obligations associated with an asset retirement in the period in which the
obligation is incurred. When the liability is initially recorded, the entity
capitalizes the cost by increasing the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. The Company is currently reviewing the requirements of this new standard
and has not yet determined the impact, if any, on the Company’s financial
position or results of operations. |
| -34- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| SFAS
No. 145 “Rescission of SFAS No. 4, 44, and 64 and Technical
Corrections” was issued in April 2002. The Company elected to adopt SFAS
No. 145 early, in the second quarter of 2002, and as a result no longer reports
gains and losses from extinguishment of debt as an extraordinary item. Prior
year after-tax losses related to LYONs debt retirements of $1.8 million and $6.9
million, respectively, for the three and nine months ended September 30, 2001,
previously reported as extraordinary items, have been reclassified to Other
Income (Expense), Net in the Company’s statement of operations to conform
with SFAS No. 145. |
|
| SFAS
No. 146 “Accounting for Costs Associated with Exit or Disposal
Activities” was issued in June 2002 and will become effective for exit or
disposal activities initiated after December 31, 2002. SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred and states that an entity’s
commitment to an exit plan, by itself, does not create a present obligation that
meets the definition of a liability. SFAS No. 146 also establishes that fair
value is the objective for initial measurement of the liability. The Company
will apply this new standard on exit or disposal activities, if any, initiated
after December 31, 2002. |
|
| 4. | Earnings (Loss) Per Share |
| Net
Income (Loss) used in computing Earnings per Common Share and the weighted
average number of Common and Series A Common Shares of dilutive potential common
stock are as follows: |
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2002 2001 2002 2001
-------- -------- -------- --------
(Dollars in thousands,
except per share amounts)
Net Income (Loss) Available to Common
used in Basic Earnings per Share $ 12,164 $ 53,127 $(33,046) $140,884
======== ======== ======== ========
Weighted average number of Common Shares
used in Basic Earnings per Share (000's) 86,095 86,394 86,077 86,231
======== ======== ======== ========
Basic Earnings per Share $ 0.14 $ 0.61 $ (0.38) $ 1.63
======== ======== ======== ========
| -35- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
(Dollars in thousands,
except per share amounts)
Net Income (Loss) used in Basic Earnings per Share $ 12,164 $ 53,127 $(33,046) $140,884
Interest expense eliminated as a result of
the pro forma conversion of Convertible
Debentures, net of tax -- 1,328 -- 4,340
-------- -------- -------- --------
Net Income (Loss) Available to Common used in
Diluted Earnings per Share $ 12,164 $ 54,455 $(33,046) $145,224
======== ======== ======== ========
Weighted average number of Common
Shares used in Basic Earnings per Share (000's) 86,095 86,394 86,077 86,231
Effect of Dilutive Securities:
Stock Options and Stock Appreciation Rights 211 209 -- 241
Conversion of Convertible Debentures -- 3,604 -- 3,604
-------- -------- -------- --------
Weighted Average Number of Common Shares
used in Diluted Earnings per Share 86,306 90,207 86,077 90,076
======== ======== ======== ========
Diluted Earnings Per Share $ 0.14 $ 0.60 $ (0.38) $ 1.61
======== ======== ======== ========
| 5. | Supplemental Cash Flow Information |
| The following summarizes certain noncash transactions and interest and income taxes paid. |
Nine Months Ended
September 30,
------------------------
2002 2001
------- -------
(Dollars in thousands)
Interest paid $26,697 $21,761
Income taxes paid 33,068 63,104
Noncash interest expense $ 6,995 $ 7,933
| 6. | Other Comprehensive Income (Loss) |
| The
Company’s Comprehensive Income (Loss) includes Net Income, Unrealized
(Losses) from Marketable Equity Securities that are classified as
“available-for-sale” and Unrealized Gains on Derivative Instruments.
The following tables summarize the Company’s Comprehensive Income (Loss): |
| -36- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
Nine Months Ended
September 30,
-----------------------
2002 2001
---------- ----------
(Dollars in thousands)
Accumulated Other Comprehensive Income (Loss)
Balance, beginning of period $ (78,997) $ (16,296)
---------- ----------
Add (Deduct):
Unrealized (losses) gains on
marketable equity securities (140,623) (143,899)
Unrealized gain on derivative instruments 35,961 --
Income tax effect 42,457 58,349
---------- ----------
Net unrealized (losses) (62,205) (85,550)
---------- ----------
Deduct (Add):
Recognized (loss) (244,699) --
Income tax effect 99,112 --
---------- ----------
(145,587) --
---------- ----------
Net change in unrealized (losses) gains
included in Comprehensive Income (Loss) 83,382 (85,550)
---------- ----------
Balance, end of period $ 4,385 $ (101,846)
========== ==========
Nine Months Ended
September 30,
------------------------
2002 2001
---------- ----------
(Dollars in thousands)
Accumulated Unrealized Gain on Derivative Instruments
Balance, beginning of period $ -- $ --
Add (Deduct):
Unrealized gain on derivative instruments 35,961 --
---------- ----------
Balance, end of period $ 35,961 --
========== ==========
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(Dollars in thousands)
Comprehensive Income (Loss)
Net Income (Loss) $ 12,164 $ 53,127 $ (33,406) $ 140,884
Net change in unrealized gains
(losses) on marketable equity
securities and derivative
instruments 6,244 (7,434) 83,382 (85,550)
--------- --------- --------- ---------
$ 18,408 $ 45,693 $ 49,976 $ 55,334
========= ========= ========= =========
| 7. | Marketable Equity Securities |
| Marketable
equity securities include the Company’s investments in equity securities,
primarily Vodafone AirTouch plc American Depository Receipts (“VOD
ADRs”) and Rural Cellular Corporation (“RCCC”) common shares.
These securities are classified as available-for-sale and stated at fair market
value. |
| -37- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| In
May 2002, the Company entered into contracts with third parties relating to its
investment in 10.2 million VOD ADRs. See Note 11 – Derivative Contracts. |
|
| Information regarding the
Company's marketable equity securities is summarized below. |
September 30, December 31,
2002 2001
------------ ------------
(Dollars in thousands)
Available-for-sale Marketable Equity Securities
Aggregate Fair Value $ 131,767 $ 272,390
Accounting Cost Basis* 160,362 405,061
------------ ------------
Gross Holding (Losses) (28,595) (132,671)
Tax Effect (11,583) (53,674)
------------ ------------
Holding (Losses), net of tax $ (17,012) $ (78,997)
============ ============
* The accounting cost basis of the marketable equity securities was reduced,
recognizing the other than temporary loss of $244,699 in the first nine months
of 2002.
| 8. | (Loss) on Wireless
and Other Investments |
| In
June 2002, management determined that the decline in value of its investments in
VOD and RCCC relative to their respective accounting cost basis was
other than temporary and charged an aggregate $244.7 million loss to the
statement of operations ($145.6 net of tax) and reduced the accounting cost
basis of such marketable equity securities by a respective amount. |
|
| Notes
receivable – long-term primarily consists of loans to Kington Management
Corporation (“Kington”) that are due in June 2005. These notes relate
to the purchase by Kington of certain of the Company’s minority interests
in 2000. As of June 30, 2002, the principal amount of these notes aggregated
$45.8 million. An independent third party valuation of one of the wireless
minority interests sold and a recent transaction involving the same market as
the other wireless minority interest sold indicated a lower market value for
these wireless minority interests, and therefore a lower value of the notes.
Management concluded that the notes receivable were impaired and established a
valuation allowance against the notes. A loss of $34.2 million was charged to
the statement of operations and was included in the caption (Loss) on Wireless
and Other Investments. Following this action, the carrying value of such notes
receivable at September 30, 2002 is $11.6 million. |
|
| 9. | Investment in Goodwill |
| The
Company has substantial amounts of goodwill as a result of the acquisition of
wireless licenses and markets. Included in the Company’s goodwill are costs
related to various acquisitions structured to be tax-free. No deferred taxes
have been provided on this goodwill. The Company adopted Statement of Financial
Accounting Standards (“SFAS”) No. 142 “Goodwill and Other
Intangible Assets” on January 1, 2002, and no longer amortizes licenses and
goodwill. Prior periods have been revised to conform to current period
presentation. Pursuant to SFAS No. 142, the Company assessed its recorded
balances of investments in licenses and goodwill for potential impairment in the
first quarter of 2002. No impairment charge was required as of January 1, 2002.
The changes in the carrying amount of goodwill for the three and nine months
ended September 30, 2002 and 2001, were as follows. |
| -38- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(Dollars in thousands)
Balance, beginning of period $ 473,975 $ 480,914 $ 473,975 $ 400,967
Net additions 155,566 662 155,566 86,871
Amortization -- (3,753) -- (10,015)
--------- --------- --------- ---------
Balance, end of period $ 629,541 $ 477,823 $ 629,541 $ 477,823
========= ========= ========= =========
|
Investments
in unconsolidated entities, accounted for under the equity method, also included
goodwill of $24.6 million at September 30, 2002 and December 31, 2001. |
|
|
Net
income (loss) and income (loss) adjusted to exclude license and goodwill
amortization expense, net of tax, recorded in the three and nine months ended
September 30, 2002 and 2001 is summarized below. |
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2002 2001 2002 2001
-------- -------- -------- --------
(Dollars in thousands,
except for share amounts)
Net Income (Loss) $ 12,164 $ 53,127 $(33,046) $140,884
Amortization adjustment net
to tax and minority interest
effect of:
License Costs -- 6,842 -- 22,227
Goodwill -- 4,781 -- 12,998
Equity method goodwill -- 227 -- 692
-------- -------- -------- --------
Adjusted Income (Loss) $ 12,164 $ 64,977 $(33,046) $176,801
======== ======== ======== ========
Basic earnings per share:
Net Income (Loss) $ 0.14 $ 0.61 $ (0.38) $ 1.63
Amortization of license costs -- 0.08 -- 0.26
Amortization of goodwill -- 0.06 -- 0.16
-------- -------- -------- --------
Adjusted Net Income (Loss) $ 0.14 $ 0.75 $ (0.38) $ 2.05
======== ======== ======== ========
Diluted earnings per share:
Net Income (Loss) $ 0.14 $ 0.60 $ (0.38) $ 1.61
Amortization of license costs -- 0.07 -- 0.25
Amortization of goodwill -- 0.05 -- 0.15
-------- -------- -------- --------
Adjusted Net Income (Loss) $ 0.14 $ 0.72 $ (0.38) $ 2.01
======== ======== ======== ========
| 10. | Treasury Shares
|
| In
2000, the Company authorized the repurchase of up to 4.2 million of its Common
Shares through three separate 1.4 million share programs. The Company may use
repurchased shares to fund acquisitions and for other corporate purposes.
|
|
| As
of September 30, 2002, the Company had repurchased 4,139,000 Common Shares under
these and other authorized programs. No shares were repurchased in the first
nine months of 2002.
|
| -39- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| 11. | Derivative Contracts
|
| The
Company maintains a portfolio of available-for-sale marketable equity
securities. The market value of these investments aggregated $131.8 million at
September 30, 2002. During 2002, the Company entered into variable prepaid
forward contracts in connection with its VOD ADRs (the “VOD
contracts”) which are $131.4 million (99.7%) of the Company’s
marketable equity securities portfolio.
|
|
| The
risk management objective of the VOD contracts is to hedge the value of the
marketable equity securities, protecting the value of the marketable securities
from losses due to decreases in the market prices of the marketable securities
(“downside risk”) while retaining a share of gains from increases in
the market prices of such marketable securities. The downside risk is hedged at
or above the accounting cost basis, thereby eliminating the other than temporary
risk on the VOD ADRs. The unhedged downside risk on the RCCC shares is not
material. The VOD contracts also enable the Company to receive cash for the
value of the marketable equity securities at the beginning of the contracts and
defer the payment of income taxes to the end of the contracts. Upon expiration,
the VOD contracts may be settled in stock or cash at the Company’s option.
If shares are delivered in the settlement of the VOD contracts, the Company will
have a current tax liability at the time of delivery for the difference between
the tax basis of the marketable equity securities and the maturity value of the
contracts. If the Company elects to settle in cash, it will be required to pay
an amount in cash equal to fair market value of the number of shares determined
pursuant to various formulae.
|
|
| During
2002, the Company monetized 10,245,370 (or 100%) of the VOD ADRs it owned
through the VOD contracts and received a net amount of $159.9 million in cash.
Under the terms of the VOD contracts, the Company will continue to own such VOD
ADRs and will receive dividends paid by VOD on such ADRs. The VOD contracts
mature in May 2007.
|
|
| Currently,
the formulae effectively limit the Company’s downside risk to an average of
$15.60 per share and its upside potential to an average of $23.29 per share. The
upside limits of the collars will be adjusted to take into account any changes
in dividends on the VOD ADRs. As a result of an increase in dividends on the VOD
ADRs, the aggregate upside limit declined from $23.68 in the second quarter of
2002 to $23.29 in the third quarter of 2002. The principal amount of the VOD
contracts at maturity is $159.9 million, with quarterly interest payments at
LIBOR plus 0.5% (for a rate of 2.29% based on the LIBOR rate at September 30,
2002). The principal amount of the VOD contracts is accounted for as long-term
debt. The collar portion of the VOD contracts is accounted for as a cash flow
hedge. As of September 30, 2002, the Company had long-term debt of $159.9
million and a derivative asset of $36.0 million relating to the VOD contracts.
|
|
| The
prepaid forward contracts for the forecasted transactions and hedged items are
designated as cash flow hedges and recorded as assets or liabilities on the
balance sheet at their fair value. The fair value of the derivative instruments
is determined using the Black-Scholes model.
|
| -40- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| As
cash flow hedges, the changes in the contracts’ fair values are recognized
in accumulated other comprehensive income until they are recognized in earnings
when the contracts are settled. If the delivery of the contracted shares does
not occur, or it becomes probable that it will not occur, the gain or loss on
the related cash flow hedge is recognized in earnings at that time. No
components of the contracts are excluded in the measurement of hedge
effectiveness for cash flow hedges. The critical terms of the variable prepaid
forward contracts are the same as the underlying forecasted transactions;
therefore, changes in the fair value of the variable prepaid forward contracts
are anticipated to be effective in offsetting changes in the expected cash flows
from the forecasted transactions. No gains or losses related to ineffectiveness
of cash flow hedges were recognized in earnings for the nine months ended
September 30, 2002.
|
|
| At
September 30, 2002, the Company had recorded $36.0 million of derivative assets
because the VOD share price at that date was below the floor for all the VOD
contracts. The derivative assets are reported in the Company’s balance
sheet in Other Assets and Deferred Charges at September 30, 2002.
|
|
| 12. | 2002 Revolving Credit Facility
|
| The
Company has a revolving credit facility to provide up to $325 million in
financing (the “2002 Revolving Credit Facility”). The 2002 Revolving
Credit Facility, which expires in June 2007, permits revolving loans on terms
and conditions substantially similar to the Company’s 1997 Revolving Credit
Facility. The terms of the 2002 Revolving Credit Facility provide for borrowings
with interest at LIBOR plus a margin percentage based on the Company’s
credit rating. Based on its current credit rating, the margin percentage is 55
basis points (for a rate of 2.36% as of September 30, 2002). The continued
availability of this revolving line of credit requires the Company to comply
with certain negative and affirmative covenants, maintain certain financial
ratios and to represent certain matters at the time of each borrowing.
|
|
| 13. | Long-term Debt
|
| The
Company issued $175 million of 9% Series A Notes due 2032 (the “9% Series A
Notes”) to PrimeCo Wireless Communications LLC (“PrimeCo”) in a
private placement as part of the payment of the purchase price for Chicago
20MHz. Interest is payable quarterly. The 9% Series A Notes are callable by the
Company after five years at the principal amount plus accrued but unpaid
interest. In connection with the purchase of Chicago 20MHz from PrimeCo, the
Company entered into an agreement pursuant to which the Company provided PrimeCo
and transferees of PrimeCo rights to have such notes registered with the SEC for
resale. The Company filed the registration statement on August 29, 2002.
|
|
| The
Company borrowed $105 million from TDS under an intercompany note agreement (the
“Intercompany Note”). The Intercompany Note bears interest at an
annual rate of 8.1%, payable quarterly. The Intercompany Note becomes due in
2008 with no penalty for prepayment. The Intercompany Note is subordinated to
the 2002 Revolving Credit Facility.
|
|
| During 2002, the Company
entered into the VOD contracts in connection with 99.7% of the Company’s
marketable securities portfolio and received $159.9 million in cash. The
principal amount of the VOD contracts is accounted for as long-term debt. The
VOD contracts mature from May to July 2007 and, at the Company’s option,
may be settled in VOD shares or in cash. The VOD contracts require quarterly
interest payments at LIBOR plus 50 basis points (for a rate of 2.29% based on
the LIBOR rate at September 30, 2002). See Note 11 – Derivative Contracts.
|
| -41- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| 14. | Acquisitions
|
| Cash
expenditures for acquisitions aggregated $451.5 million for the nine months
ended September 30, 2002.
|
|
| On
August 7, 2002, the Company completed the acquisition of all of the equity
interests in Chicago 20MHz, LLC (“Chicago 20MHz”), including
the assets and certain liabilities of Chicago 20MHz, from PrimeCo Wireless
Communications LLC (“PrimeCo”). Chicago 20MHz operates the PrimeCo
wireless system in the Chicago Major Trading Area (“MTA”). Chicago
20MHz is the holder of certain FCC licenses, including a 20 megahertz PCS
license in the Chicago MTA (excluding Kenosha County, Wisconsin) covering a
total population of 13.2 million. This transaction strengthens the
Company’s Midwest Region, which is its largest operating region. The
Chicago area is the commercial hub of the Midwest, with positive demographics.
|
|
| The
purchase price was approximately $607 million, subject to certain working
capital and other adjustments. The Company financed the purchase using $327
million from its revolving lines of credit, $175 million in 30-year notes issued
to PrimeCo and a $105 million loan from TDS. The Company has included the
Chicago 20MHz results of operations subsequent to the purchase date in its
statement of operations.
|
|
| The
following table summarizes the estimated fair values of the Chicago 20MHz assets
acquired and liabilities assumed at the date of acquisition.
|
August 7,
2002
---------
(Dollars in
thousands)
Current assets $ 31,675
Property, plant and equipment 239,262
Other Assets 80
Customer list 43,400
Licenses 163,500
Goodwill 149,989
---------
Total assets acquired $ 627,906
---------
Current liabilities (19,063)
Non-current liabilities (1,593)
---------
Total liabilities assumed $ (20,656)
---------
Purchase price $ 607,250
Notes issued to PrimeCo (175,000)
Capitalized transaction costs 1,750
Chicago 20MHz cash at date of acquisition (3,581)
---------
Cash required, excluding cash at date of acquisition $ 430,419
=========
| -42- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| An
independent appraiser completed a preliminary valuation of Chicago 20MHz’s
assets. The tangible fixed assets were valued at $239.3 million. The PCS license
was valued at $163.5 million. This license has an indefinite life and is not
being amortized. The customer list was assigned a value of $43.4 million. This
intangible is being amortized based on a 30-month average customer retention
period using the declining balance method. Amortization expense was $1.3 million
for the three- and nine-month periods ending September 30, 2002, and is expected
to be $4.5 million for the remainder of 2002. Amortization expense for the years
2003 – 2007 is expected to be $15.0 million, $9.1 million, $5.5 million,
$3.2 million and $1.9 million, respectively. Goodwill was assigned a value of
$150.0 million and is not being amortized for financial reporting purposes.
Goodwill is deductible for tax purposes and will be amortized over 15 years.
|
|
| In
addition, the Company acquired majority interests in 10MHz licenses in three PCS
markets during the first nine months of 2002. In the first nine months of 2001,
the Company completed the acquisition of majority interests in 17 wireless
licenses. In conjunction with these acquisitions, the following assets were
acquired and liabilities assumed.
|
Nine Months Ended
September 30,
-----------------------
2002 2001
---------- ----------
(Dollars in thousands)
Property, plant and equipment, net $ -- $ 2,570
Wireless licenses 18,010 132,010
Goodwill 3,827 --
Minority interest (769) --
---------- ----------
Decrease in cash due to acquisitions $ 21,068 $ 134,580
========== ==========
| Assuming
acquisitions accounted for as purchases during the period January 1, 2001 to
September 30, 2002, had taken place on January 1, 2001, pro forma results of
operations would have been as follows:
|
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
Service Revenues $ 576,839 $ 531,138 $ 1,632,692 $ 1,520,144
Equipment Sales 37,305 29,067 87,012 73,726
Interest Expense (including cost to
finance acquisitions) 15,897 14,648 45,546 44,332
Net Income (Loss) 6,281 36,708 (69,944) 91,601
Earnings per Common and Series A Common
Share-Basic 0.07 0.43 (0.81) 1.06
----------- ----------- ----------- -----------
Earnings per Common and Series A Common
Share-Diluted 0.07 0.42 (0.81) 1.06
=========== =========== =========== ===========
| -43- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| 15. | Income Taxes
|
| Net
Income (Loss) includes losses on wireless and other investments in the three and
nine month periods ended September 30, 2002. The following table provides a
summary of the effective tax rates used in each of the periods to compute income
tax expense (benefit) on net income excluding losses on wireless and other
investments; losses on wireless and other investments; and net income (loss).
|
Three Months Ended Nine Months Ended
September 30, September 30,
---------------- ----------------
2002 2001 2002 2001
------ ------ ------ ------
Effective Tax Rate Used for:
Operations excluding losses on
wireless and other investments 44.0% 43.8% 43.4% 42.0%
Losses on wireless and other
investments (36.3%) -- (40.0%) --
Net income (loss) 52.4% 43.8% (12.6%) 42.0%
| 16. |
Subsequent Event |
|
In
November 2002, the Company issued $115 million of 8.75% Senior Notes due 2032
(the “8.75% Senior Notes”). Interest is payable quarterly. The 8.75%
Senior Notes are callable by the Company, at the principal amount plus accrued
and unpaid interest, at any time on and after November 7, 2007. The net proceeds
of the offering are being used to repurchase a portion of the Company’s 9%
Series A Notes. The Company has also granted the underwriters of the offering an
option to purchase up to an additional $17.25 million of 8.75% Senior Notes,
exercisable until November 30, 2002. The underwriters have exercised the option
to acquire an additional $15 million of such notes. |
| -44- |
| UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES |
| (a) | Exhibits: |
| Exhibit 10.1 - Guaranty,
dated as of May 14, 2002, by U.S. Cellular in favor of Citibank N.A.
| |
| Exhibit
10.2 - Guarantee, dated as of May 10, 2002, by U.S. Cellular in favor of Credit
Suisse First Boston International.
| |
| Exhibit
10.3 - Guaranty, dated as of May 15, 2002, by U.S. Cellular in favor of Wachovia
Bank, National Association.
| |
| Exhibit
10.4 - Guaranty, dated as of May 15, 2002, by U.S. Cellular in favor of Toronto
Dominion (New York), Inc.
| |
| Exhibit
11 - Statement regarding computation of per share earnings is included herein as
Note 4 to the financial statements.
| |
| Exhibit 12 -
Statement regarding computation of ratios.
| |
| Exhibit
99.1 – Chief Executive Officer certification pursuant to Section 1350 of
Chapter 63 of Title 18 of the United States Code. | |
| Exhibit
99.2 – Chief Financial Officer certification pursuant to Section 1350 of
Chapter 63 of Title 18 of the United States Code. | |
| (b) | Reports on Form 8-K filed during the quarter ended September 30, 2002:
|
| The Company filed a Current Report on Form 8-K, dated July 16, 2002, for the purpose of filing a news release. The news release, dated July 16, 2002, announced the Company’s financial results for the quarter ended June 30, 2002. |
| -46- |
| SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. |
| UNITED STATES CELLULAR CORPORATION |
| (Registrant) |
| Date November 13, 2002 | /s/ John E. Rooney |
| John E. Rooney President (Chief Executive Officer) |
| Date November 13, 2002 | /s/ Kenneth R. Meyers |
| Kenneth R. Meyers Executive Vice President-Finance and Treasurer (Chief Financial Officer and Principal Accounting Officer) |
| Signature page for the U.S. Cellular 2002 Third Quarter Form 10-Q |
|
-47- |
| Certification of Chief Executive Officer |
| I, John E. Rooney, certify that: | ||
| 1. | I have reviewed this quarterly report of Form 10-Q of
United States Cellular Corporation; | |
| 2. | Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report; | |
| 3. | Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report; | |
| 4. | The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: | |
| a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; | |
| b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and | |
| c) | presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date; | |
| 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): | |
| a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and | |
| b) | any fraud, whether or not material, that involves management or other employees
who have a significant role in the registrant’s internal controls; and | |
| 6. | The registrant’s other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. | |
| Date: November 13, 2002 | ||
| /s/ John E. Rooney John E. Rooney President and Chief Executive Officer |
|
|
| Certification of Chief Financial Officer |
| I, Kenneth R. Meyers, certify that: | ||
| 1. | I have reviewed this quarterly report of Form 10-Q of
United States Cellular Corporation; | |
| 2. | Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report; | |
| 3. | Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report; | |
| 4. | The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: | |
| a) | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; | |
| b) | evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and | |
| c) | presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date; | |
| 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): | |
| a) | all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and | |
| b) | any fraud, whether or not material, that involves management or other employees
who have a significant role in the registrant’s internal controls; and | |
| 6. | The registrant’s other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. | |
| Date: November 13, 2002 | ||
| /s/ Kenneth R. Meyers Kenneth R. Meyers Executive Vice President-Finance and Treasurer (Chief Financial Officer) |
|
|