- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 ------------------------------------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- ----------------------- Commission File Number 1-9712 - -------------------------------------------------------------------------------- UNITED STATES CELLULAR CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 62-1147325 ------------------------------ ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 8410 West Bryn Mawr, Suite 700, Chicago, Illinois 60631 ------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (773) 399-8900 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at April 30, 1999 --------------------------------- ----------------------------- Common Shares, $1 par value 54,452,675 Shares Series A Common Shares, $1 par value 33,005,877 Shares - --------------------------------------------------------------------------------
UNITED STATES CELLULAR CORPORATION ---------------------------------- 1ST 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 2-14 Consolidated Statements of Operations - Three Months Ended March 31, 1999 and 1998 15 Consolidated Statements of Cash Flows - Three Months Ended March 31, 1999 and 1998 16 Consolidated Balance Sheets - March 31, 1999 and December 31, 1998 17-18 Notes to Consolidated Financial Statements 19-21 Part II. Other Information 22 Signatures 23
PART I. FINANCIAL INFORMATION ----------------------------- UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES --------------------------------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS - --------------------- Three Months Ended 3/31/99 Compared to Three Months Ended 3/31/98 - ----------------------------------------------------------------- United States Cellular Corporation (the "Company" - AMEX symbol: USM) owns, operates and invests in cellular markets throughout the United States. USM is an 80.9%-owned subsidiary of Telephone and Data Systems, Inc. ("TDS"). USM owned either majority or minority cellular interests in 182 markets at March 31, 1999, representing 26,512,000 population equivalents ("pops"). USM included the operations of 138 majority-owned and managed cellular markets, representing 23.7 million pops, in consolidated operations ("consolidated markets") as of March 31, 1999. Minority interests in 38 markets, representing 2.5 million pops, were accounted for using the equity method and were included in investment income at that date. All other interests were accounted for using the cost method. Following is a table of summarized operating data for USM's consolidated operations. <TABLE> <CAPTION> Three Months Ended or At March 31, -------------------------- 1998 1997 ---------- ----------- <S> <C> <C> Total market population (in thousands) (1) 24,683 24,034 Customers 2,270,000 1,817,000 Market penetration 9.20% 7.56% Markets in operation 138 134 Total employees 4,800 4,600 Cell sites in service 2,106 1,786 Average monthly revenue per customer $ 47.18 $ 44.66 Churn rate per month 2.1% 1.7% Marketing cost per gross customer addition $ 319 $ 313 </TABLE> (1) Calculated using 1998 Claritas population estimates for each year. The growth in the Company's operating income in the first three months of 1999, which includes 100% of the revenues and expenses of its consolidated markets plus its corporate office operations, primarily reflects improvements in the Company's overall operations compared to the first three months of 1998. The improvements resulted from growth in the Company's customer base and revenues coupled with continuing economies of scale. Operating revenues, driven by a 25% increase in customers served, rose $80.8 million, or 33%, in 1999. Cash operating expenses rose $55.2 million, or 33%, in 1999. Operating cash flow (operating income plus depreciation and amortization expense) increased $25.6 million, or 33%, in 1999. Depreciation and amortization expense -2-
increased $6.6 million, or 15%, in 1999. Operating income increased $19.0 million, or 57%, in 1999. Investment and other income decreased $185.3 million to $5.9 million in 1999, due primarily to a decrease of $180.0 million in gains on the sales of cellular interests in 1999, plus a $6.2 million, or 48%, reduction in investment income. Gains on sales of cellular interests in 1998 primarily resulted from the sale of certain minority interests to AirTouch Communications, Inc. ("AirTouch"); there were no such sales in 1999. Investment income declined due both to a decrease in 1999 in the aggregate results of markets managed by others in which the Company owned investment interests in both periods, and also related to the sale of minority interests to AirTouch in 1998, which had generated investment income until their disposition. Net income totaled $27.8 million in 1999, a decrease of $101.9 million, or 79%, from 1998. Diluted earnings per share totaled $0.32 in 1999, a decrease of $1.17, or 79%, from 1998. Net income in 1998 was significantly affected by gains on the sales of cellular interests. A summary of the after-tax effects of gains on net income and diluted earnings per share in each period is shown below. <TABLE> <CAPTION> Three Months Ended March 31, ------------------------ 1999 1998 ---- ---- (Dollars in thousands, except per share amounts) <S> <C> <C> Net income before after-tax effects of gains $ 27,826 $ 19,513 Add: After-tax effects of gains -- 110,239 ----------- ---------- Net income as reported $ 27,826 $ 129,752 =========== ========== Earnings per share before after-tax effects of gains $ 0.32 $ 0.22 Add: After-tax effects of gains -- 1.27 ----------- ---------- Diluted earnings per share $ 0.32 $ 1.49 =========== ========== </TABLE> Operating Revenues - ------------------ Operating revenues totaled $326.0 million in 1999, up $80.8 million, or 33%, over 1998. Service revenues primarily consist of: (i) charges for access, airtime and value-added services provided to the Company's local retail customers who use the local systems operated by the Company ("local retail"); (ii) charges to customers of other systems who use the Company's cellular systems when roaming ("inbound roaming"); and (iii) charges for long-distance calls made on the Company's systems. Service revenues totaled $315.2 million in 1999, up $78.9 million, or 33%, over 1998. The increase was primarily due to the growing number of local retail customers and also due to the increase in inbound roaming minutes of use on the Company's systems. Average monthly service revenue per customer increased 6% to $47.18 in 1999 from $44.66 in 1998. The increases in average monthly service revenue per customer resulted from increases in minutes of use on the Company's systems from both local retail customers and inbound roamers. This effect was partially offset by the continued decline -3-
in average revenue per minute of use from both local retail customers and inbound roamers. Monthly local retail minutes of use per customer increased to 101 in 1999 from 95 in 1998, resulting from the Company's focus on adding value to its services for its customers in order to stimulate overall usage. Also, total inbound roaming minutes used on the Company's systems increased 72% in 1999. This increase was largely affected by the introduction of certain "one rate" programs by other wireless companies in the second half of 1998. Wireless customers who sign up for these programs are given price incentives to roam in other markets, including the Company's markets, thus driving an increase in the Company's inbound roaming minutes. Management anticipates that the increase in minutes of use will be slower in the second half of 1999 as the effect of "one rate" programs becomes present in both periods of comparison. Competitive pressures and the Company's increasing use of pricing and other incentive programs to stimulate overall usage resulted in decreases in average local retail revenue per minute of use during 1999. The Company's average inbound roaming revenue per minute of use also decreased during 1999, in line with the ongoing trend toward reduced per minute prices for roaming negotiated between the Company and other wireless operators. Management anticipates that the Company's average revenue per minute of use for both local retail and inbound roaming revenues will continue to decline in the future, reflecting the continued effect of the previously mentioned factors. Local retail revenue increased $43.4 million, or 26%, in 1999. Growth in the Company's customer base was the primary reason for the increase in local retail revenue. The number of customers increased 25% to 2,270,000 at March 31, 1999 from 1,817,000 at March 31, 1998. Management anticipates that overall growth in the Company's customer base will be slower in the future, primarily as a result of an increase in the number of competitors in its markets. Average monthly local retail revenue per customer declined 1% to $31.96 in 1999 from $32.14 in 1998. Monthly local retail minutes of use per customer was 101 in 1999 and 95 in 1998. Average revenue per minute of use decreased as a result of the pricing and other incentive programs stated previously, totaling $.32 in 1999 compared to $.34 in 1998. The increase in monthly local retail minutes of use was driven by the Company's focus on adding value to its services for local retail customers through incentive programs and rate plans which are designed to stimulate overall usage. The decrease in average monthly local retail revenue per minute primarily reflects the increasing level of competition for wireless services. Inbound roaming revenue increased $24.8 million, or 54%, in 1999. The growth in inbound roaming revenue in 1999 was affected by an increase in roaming minutes used on the Company's systems and a decrease in revenue per minute. The number of minutes used by customers from other wireless systems when roaming in the Company's service areas increased by 72% in 1999. The increase in minutes of use was significantly affected by certain "one rate" programs offered by other wireless companies beginning in the second half of 1998. Average inbound roaming revenue per minute decreased 14% to $.59 in 1999 from $.69 in 1998, due to the downward trend in negotiated rates. Monthly inbound -4-
roaming revenue per Company customer averaged $10.62 in 1999 and $8.73 in 1998. The increase in monthly inbound roaming revenue per Company customer is attributable to a larger increase in inbound roaming revenue than in the Company's customer base. Long-distance revenue increased $10.9 million, or 57%, in 1999 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. Monthly long-distance revenue per customer averaged $4.49 in 1999 and $3.60 in 1998. Equipment sales revenues increased $2.0 million, or 22%, in 1999. The increase in equipment sales revenues reflects the 16% increase in the number of gross customer activations, to 229,000 in 1999 from 198,000 in 1998, plus an increase in the volume of accessories sold. Most of the gross customer activations were produced by the Company's direct and retail distribution channels; activations from these channels usually generate sales of cellular telephone units. The increases in the volume of accessories sold in both years reflect an increased emphasis on the sale of accessories at retail prices in the Company's retail locations. Operating Expenses - ------------------ Operating expenses totaled $273.9 million in 1999, up $61.9 million, or 29%, over 1998. System operations expenses increased $21.7 million, or 59%, in 1999 as a result of increases in customer usage expenses and costs associated with serving the Company's increased number of customers and the growing number of cell sites within the Company's systems. In total, system operations costs are expected to continue to increase as the number of customers using and the number of cell sites within the Company's systems grows. Customer usage expenses represent charges from other telecommunications service providers for the Company's customers' use of their facilities as well as for the Company's inbound roaming traffic on these facilities. Also included are costs related to local interconnection to the landline network, toll charges and expenses incurred by the Company when its customers use systems other than their local systems ("outbound roaming"). These expenses are offset somewhat by amounts the Company bills to its customers for outbound roaming. Customer usage expenses increased $19.0 million, or 84%, in 1999. The increase in 1999 is primarily due to the 164% increase in net outbound roaming expense, which has resulted from the Company offering its customers increasingly larger service footprints in which their calls are billed at local rates. In an increasing number of cases, these service areas include other operators' service areas. The Company pays roaming rates to the other carriers for calls the Company's customers make in these areas, while charging those customers a local rate which is usually lower than the roaming rate. Also contributing to the increase in customer usage expenses in 1999 was a 19% rise in costs related to the increase in minutes used on the Company's systems, partially offset by a 5% reduction in costs related to fraudulent use of the Company's customers' cellular -5-
telephone numbers. Customer usage expenses represented 13% of service revenues in 1999 and 10% in 1998. Maintenance, utility and cell site expenses increased $2.8 million, or 20%, in 1999. The increase primarily reflects an increase in the number of cell sites in the Company's systems, to 2,106 in 1999 from 1,786 in 1998. Marketing and selling expenses increased $8.3 million, or 17%, in 1999. Marketing and selling expenses primarily consist of salaries, commissions and expenses of field sales and retail personnel and offices; agent expenses; corporate marketing department salaries and expenses; local advertising; and public relations expenses. The increase was primarily due to the 16% rise in the number of gross customer activations. Marketing cost per gross customer activation, which includes marketing and selling expenses and losses on equipment sales, increased 2% to $319 in 1999 from $313 in 1998. The increase in cost per gross customer activation was primarily driven by additional advertising expenses incurred to promote the Company's brand and to distinguish the Company's service offerings from those of its competitors. Also contributing was an increase in losses on equipment sales in 1999, primarily driven by the sale of more digital phone units, which on average generate greater equipment losses than the sale of analog phone units. Cost of equipment sold increased $4.7 million, or 23%, in 1999. The increase reflects the growth in unit sales related to the 16% increase in gross customer activations as well as the impact of selling more higher cost digital phone units in 1999. Also contributing to the increase was a greater volume of sales of accessories. General and administrative expenses increased $20.5 million, or 35%, in 1999. These expenses include the costs of operating the Company's local business offices and its corporate expenses other than the corporate engineering and marketing departments. The increase includes the effects of increases in expenses required to serve the growing customer base in existing markets and an expansion of both local administrative office and corporate staff, necessitated by growth in the Company's business. Also, the Company incurred additional start-up costs in 1999 related to its six Communications Centers, which were created to centralize certain customer service functions; incurred costs, which were no longer capitalizable beginning in January 1999, related to its conversion to a new billing system; and incurred additional costs by providing digital phone units to customers who migrated from analog to digital rate plans. Employee-related expenses increased $7.0 million, or 25%, in 1999, primarily due to increases in the number of customer service and administrative employees. Monthly general and administrative expenses per customer increased 7% to $11.90 in 1999 from $11.16 in 1998. General and administrative expenses represented 25% of service revenues in both 1999 and 1998. Operating cash flow increased $25.6 million, or 33%, to $104.0 million in 1999. The improvement was primarily due to substantial growth in customers and service revenues and the effects of continued operational efficiencies on cash operating expenses. Operating cash flow margins (as a percent of service revenues) were 33.0% in 1999 and 33.2% in 1998. -6-
Depreciation expense increased $5.7 million, or 16%, in 1999. The increase reflects rising average fixed asset balances, which increased 16% in 1999. Increased fixed asset balances in 1999 resulted from the addition of new cell sites built to improve coverage and capacity in the Company's markets and from upgrades to provide digital service in more of the Company's service areas. Amortization of intangibles increased $952,000, or 10%, in 1999. The increase in 1999 primarily reflects a 9% increase in investment in licenses, related to acquisitions completed during the last half of 1998. Operating Income - ---------------- Operating income totaled $52.1 million in 1999, a 57% increase over 1998. The operating income margin was 16.5% in 1999 and 14.0% in 1998. The improvements in operating income and operating income margins in 1999 reflect increased revenues resulting from growth in the number of customers served by the Company's systems and the effect of continued operational efficiencies on total operating expenses. The Company expects service revenues to continue to grow during the remainder of 1999; however, management anticipates that average monthly revenue per customer will decrease for the full year of 1999 compared to 1998, despite the increase in the first quarter comparison, as local retail and inbound roaming revenue per minute of use decline and as the Company further penetrates the consumer market. Additionally, the Company expects expenses to increase during the remainder of 1999 as it incurs costs associated with both customer growth and fixed assets added. Although service revenues increased 33% and average monthly revenue per customer increased 6% in the first quarter of 1999, management does not expect these trends to continue throughout 1999 for the reasons stated previously. Management continues to believe there exists a seasonality in both service revenues, which tend to increase more slowly in the first and fourth quarters, and operating expenses, which tend to be higher in the fourth quarter due to increased marketing activities and customer growth, which may cause operating income to vary from quarter to quarter. Additionally, competitors licensed to provide personal communications services ("PCS") have initiated service in certain of the Company's markets over the past three years. The Company expects PCS operators to continue deployment of PCS in portions of all of the Company's clusters throughout 1999. The Company has increased its advertising, particularly brand advertising, since 1997 to promote its brand and distinguish the Company's service from other wireless communications providers. The Company's management continues to monitor other wireless communications providers' strategies to determine how additional competition is affecting the Company's results. While the effects of additional wireless competition have slowed customer growth in certain of the Company's markets, the overall effect on the Company's total customer growth to date has not been material. However, management anticipates that customer growth will be lower in the future, primarily as a result of the increase in the number of competitors in its markets. Investment and Other Income - --------------------------- -7-
Investment and other income totaled $5.9 million in 1999 and $191.2 million in 1998. There were no gains recorded in the first quarter of 1999. Gains totaling $180.0 million were recorded in 1998 from sales of the Company's investment interests in ten markets, and also related to amounts received from TDS pursuant to an agreement between the Company and TDS. Investment income was $6.6 million in 1999 compared to $12.8 million in 1998, a 48% decrease. Investment income primarily represents the Company's share of net income from the markets managed by others that are accounted for by the equity method. The aggregate income from the markets in which the Company had interests in both 1998 and 1999 decreased significantly in 1999, reducing investment income. Investment income in 1999 was also negatively impacted by the divestitures of certain minority interests to AirTouch in the first half of 1998. See "Financial Resources and Liquidity - Acquisitions and Divestitures" for further discussion of these transactions. Interest and Income Taxes - ------------------------- Interest expense totaled $9.2 million in 1999 compared to $10.1 million in 1998. Interest expense in 1999 is primarily related to Liquid Yield Option Notes ("LYONs") ($4.3 million); the Company's 7.25% Notes (the "Notes") ($4.6 million); and the Company's revolving credit facility with a series of banks ("Revolving Credit Facility") ($199,000). Interest expense in 1998 was primarily related to LYONs ($4.1 million), the Company's 7.25% Notes ($4.6 million) and borrowings under the Revolving Credit Facility ($566,000). The Company's $250 million principal amount of 7.25% Notes, issued under a shelf registration statement, were priced to yield 7.33% to maturity. The Notes are unsecured and become due in August 2007. Interest on the Notes is payable semi-annually on February 15 and August 15 of each year. The LYONs are zero coupon convertible debentures which accrete interest at 6% annually, but do not require current cash payments of interest. All accreted interest is added to the outstanding principal balance on June 15 and December 15 of each year. The Revolving Credit Facility is a seven-year facility which was established in 1997. Borrowings under this facility accrue interest at the London InterBank Offered Rate ("LIBOR") plus 26.5 basis points (for a rate of 5.2% at March 31, 1999). Interest and principal are due the last day of the borrowing period, as selected by the borrower, of either seven days or one, two, three or six months; any borrowings made under the facility are short-term in nature and automatically renew until they are repaid. The Company pays facility and administrative fees totaling $710,000 per year in addition to interest on any borrowings; these fees are recorded as interest expense. Any borrowings outstanding in August 2004, the termination date of the Revolving Credit Facility, are due and payable at that time along with any accrued interest. The Company borrowed and repaid amounts totaling $47 million during the first quarter of 1998; no borrowings were made during the first quarter of 1999. Income tax expense was $21.0 million in 1999 and $84.5 million in 1998. In 1998, $69.8 million of income tax expense related to the gains on sales of cellular interests. The -8-
effective tax rates were 43% in 1999 and 39% in 1998. The increase in 1999's effective tax rate is primarily related to the nature of the gains on sales of cellular interests in 1998, which have varying tax rates. The 1999 effective tax rate approximates the normalized tax rate from operations. TDS and the Company are parties to a Tax Allocation Agreement, pursuant to which the Company is included in a consolidated federal income tax return with other members of the TDS consolidated group. For financial reporting purposes, the Company computes federal income taxes as if it were filing a separate return as its own affiliated group and was not included in the TDS group. Net Income - ---------- Net income totaled $27.8 million in 1999 and $129.8 million in 1998. Diluted earnings per share was $.32 in 1999 and $1.49 in 1998. Net income and earnings per share in 1998 included significant after-tax gains on the sales of cellular interests, representing $110.2 million and $1.27 per share. Excluding the after-tax effect of these gains, net income would have been $19.5 million, or $.22 per share, in 1998. 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 most of its construction costs and substantially all of its operating expenses. The Company anticipates further increases in cellular units in service, revenues, operating cash flow and cell sites as it continues its growth strategy. 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 $98.4 million in 1999 and $48.3 million in 1998. Operating cash flow provided $104.0 million in 1999 and $78.4 million in 1998. Cash flows from other operating activities (investment and other income, interest expense, income taxes, changes in working capital and changes in other assets and liabilities) required $5.6 million in 1999 and $30.1 million in 1998. Income taxes and interest paid totaled $13.7 million in 1999 and $37.8 million in 1998. Cash flows from financing activities provided $891,000 in 1999 and $93,000 in 1998. There were no material financing transactions in either period. Cash flows from investing activities required $85.0 million in 1999 and provided $460,000 in 1998. Cash required for property, plant and equipment and system development expenditures totaled $84.7 million in 1999 and $69.1 million in 1998. In 1999 and 1998, these expenditures were financed primarily with internally generated cash. These expenditures primarily represent the construction of 41 and 38 cell sites in 1999 and 1998, respectively, plus other plant additions and costs related to the development of the Company's office systems. In both periods, other plant additions included significant amounts related to the replacement of retired assets and the changeout of analog radio -9-
equipment for digital radio equipment. Acquisitions required $8.1 million in 1999 and $48.9 million in 1998. The Company received net cash proceeds totaling $118.9 million in 1998 related to sales of cellular interests. Cash distributions from cellular entities in which the Company has an interest provided $5.8 million in 1999 and $4.5 million in 1998. Anticipated capital requirements for 1999 primarily reflect the Company's construction and system expansion program. The Company's construction and system expansion budget for 1999 is approximately $300 million, to expand and enhance the Company's coverage in its service areas, including the addition of digital service capabilities to its systems, and to enhance the Company's office systems. Acquisitions and Divestitures - ----------------------------- The Company assesses its cellular holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. As the Company's clusters have grown, the Company's focus has shifted toward exchanges and divestitures of managed and investment interests along with the outright purchases of controlling interests which helped build the Company's clusters since its inception. Over the past few years, the Company has completed exchanges of controlling interests in its less strategic markets for controlling interests in markets which better complement its clusters. The Company has also completed outright sales of other less strategic markets, and has purchased controlling interests in markets which enhance its clusters. The proceeds from any sales have been used to further the Company's growth. In the first three months of both 1999 and 1998, there were no completed acquisitions or divestitures of majority interests. In the first three months of 1999, the Company acquired minority interests in several markets, representing 81,000 pops, for a total of $8.5 million in cash. In the first three months of 1998, the Company acquired minority interests in several markets, representing 225,000 pops, for a total of $42.0 million in cash, most of which was borrowed under the Company's Revolving Credit Facility. In the first quarter of 1998, the Company divested minority interests in ten markets, representing approximately 872,000 pops. In exchange, the Company received approximately 3.9 million shares of AirTouch stock and cash and receivables totaling $120.4 million. Approximately $28.7 million, consisting of cash and receivables, was received pursuant to a contract right termination agreement entered into between the Company and TDS. This agreement was related to two interests which were sold directly by TDS to AirTouch and which were to be acquired by the Company as part of a June 1996 agreement between the Company and TDS. The contract right termination agreement enabled the Company to receive cash equal to the value of the gain the Company would have realized had it purchased the interests from TDS and sold them to AirTouch under terms similar to those in the agreement between TDS and AirTouch. As of March 31, 1999, the Company had an agreement pending to divest a majority interest in one market, representing 264,000 pops, for $39.4 million in cash. The Company will not record a gain or loss on the sale transaction. The Company completed this transaction in April 1999. -10-
Liquidity - --------- The Company anticipates that the aggregate resources required for the remainder of 1999 will include approximately $215 million for capital spending. The Company is generating substantial cash from its operations and anticipates financing its capital spending for 1999 primarily with internally generated cash, proceeds from the sales of cellular interests and short-term borrowings. The Company had $66 million of cash and cash equivalents at March 31, 1999 and received approximately $39 million from the divestiture completed in April 1999. Additionally, the entire balance of $500 million under the Company's Revolving Credit Facility is unused and remains available to meet any short-term borrowing requirements. Management believes that the Company's operating cash flows and sources of external financing, including the above-referenced Revolving Credit Facility, provide substantial financial flexibility for the Company to meet both its short- and long-term needs. The Company also currently has 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. Market Risk - ----------- The Company is subject to market rate risks due to fluctuations in interest rates and equity markets. All of the Company's current debt is in the form of long-term fixed-rate notes with original maturities ranging from seven to 20 years. Accordingly, fluctuations in interest rates can lead to fluctuations in the fair value of such instruments. The Company has not entered into financial derivatives to reduce its exposure to interest rate risks. There have been no material changes to the Company's outstanding debt instruments since December 31, 1998. 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, principally AirTouch common shares, amounted to $400.9 million at March 31, 1999. A hypothetical 10% decrease in the share prices of these investments would result in a $40.1 million decline in the market value of the investments. Year 2000 Issue - --------------- The Year 2000 issue exists because many computer systems and applications abbreviate dates using only two digits rather than four digits, e.g., "98" rather than "1998". Unless corrected, this shortcut may cause problems when the century date "2000" occurs. On that date, some computer operating systems and applications and embedded technology may recognize the date as January 1, 1900 instead of January 1, 2000. If the Company fails to correct any critical Year 2000 processing problems prior to January 1, 2000, the affected systems may either cease to function or produce erroneous data, which could have material adverse operational and financial consequences. -11-
The Company's management has established a project team to address Year 2000 issues. The Company's plan to address the Year 2000 Issue consists of five general phases: (i) Awareness, (ii) Assessment, (iii) Renovation, (iv) Validation and (v) Implementation. The awareness phase consisted of establishing a Year 2000 project team, that reports periodically to the Company's Audit Committee, and developing an overall strategy. TDS management has established a Year 2000 Program Office at the corporate level to coordinate activities of the Year 2000 project team, to monitor the current status of individual projects, to report periodically to the TDS Audit Committee and to promote the exchange of information between all TDS business units to share knowledge and solution techniques. Management has made the Year 2000 Issue a top priority. The Year 2000 effort covers the network and supporting infrastructure for the provision of cellular services; the operational and financial information technology ("IT") systems and applications, including computer systems that support key business functions such as billing, finance, customer service, procurement and supply; and a review of the Year 2000 compliance efforts of the Company's critical vendors. The assessment phase included the identification of core business areas and processes, analysis of systems and hardware supporting the core business areas and the prioritization of renovation or replacement of the systems and hardware that are not Year 2000 compliant. Included in the assessment phase is an analysis of risk management factors such as contingency plans and legal matters. Except for the contingency plans as discussed herein, the assessment phase was completed in the first quarter of 1999. The Year 2000 project team has identified those mission critical hardware, systems and applications that are not Year 2000 compliant. These noncompliant critical hardware, systems and applications have undergone renovation or are currently in the renovation phase. The renovation phase consists of the remediation or replacement of mission critical systems, applications and hardware. The renovation of these mission critical hardware, systems and applications is on schedule and should be substantially completed in the third quarter of 1999. The mission critical hardware, systems and applications that have been renovated are undergoing Year 2000 validation testing. The validation phase includes testing, verifying and validating the renovated or replaced platforms, applications, databases and utilities. The validation phase consists of independent verification testing of mission critical systems, applications and hardware as well as network and system component upgrades received from suppliers. In addition, selected Year 2000 upgrades are slated to undergo testing in a controlled environment that replicates the current environment and is equipped to simulate the turn of the century and leap year dates. The Cellular Telecommunications Industry Association ("CTIA") has formed a working group to coordinate efforts of various carriers and manufacturers to assist in inter-network Year 2000 testing. Validation of mission critical hardware, systems and applications is scheduled to be completed in the third quarter of 1999. -12-
The implementation phase involves migrating the converted, renovated and validated mission critical systems, applications and hardware into production. This phase is expected to be completed during the fourth quarter of 1999. Management cannot provide assurance that its plan to achieve Year 2000 compliance will be successful as it is subject to various risks and uncertainties. The Company's current schedule is subject to change depending on developments that may arise through unforeseen circumstances in the renovation, validation and implementation phases of the Company's compliance efforts. The Company, like most other telecommunications operators, is highly dependent on the telecommunications network vendors to provide compliant hardware, systems and applications and on other third parties, including vendors, other telecommunications service providers, government agencies and financial institutions, to deliver reliable services. The Company is dependent on the development of compliant hardware, systems and applications and upgrades by experts, both internal and external, and the availability of critical resources with the requisite skill sets. The Company's ability to meet its target dates is dependent upon the timely provision of necessary upgrades and modifications by its suppliers and internal resources. In addition, the Company cannot guarantee that third parties on whom it depends for essential services (such as electric utilities and other interconnected telecommunications operators) will convert their critical systems and processes in a timely manner. Failure or delay by any of these parties could significantly disrupt the Company's business, including the provision of cellular service to customers, billing and collection processes and other areas of the business, and cause a material adverse effect on the Company's results of operations, financial position and cash flow. The Company has contacted critical vendors requesting information about their Year 2000 readiness. The responses are being reviewed and used in developing the Company's overall contingency plans. The Company's Year 2000 worst case scenario may involve interruption of telecommunications services and data processing service and/or interruption of customer billing, operating and other information systems. As part of its Year 2000 initiative, the Company is evaluating these worst case scenarios and is in the process of developing contingency and business plans tailored for adverse Year 2000-related occurrences. The contingency and business continuity plans are expected to assess the potential for business disruption in various scenarios, and to provide key operational backup, recovery and restorational alternatives. The Company's contingency plan initiatives will include the following: reviewing, assessing and updating existing business recovery plans; identifying teams who will be on call during the millennium change to monitor the network, critical systems, operations centers and business processes to react immediately to facilitate repairs; re-prioritization of mission critical work processes and associated resources; developing alternate processes to support critical customer functions in the event information systems or mechanized processes experience Year 2000 disruptions; establishing replacement/repair parallel paths to provide for repair and readiness of existing systems and components that are scheduled for replacement by the Year 2000, in the event the replacement schedules are not met; developing alternate plans for critical suppliers of products and services that fail to meet Year 2000 compliance commitment schedules; and developing data retention and recovery procedures to be in place for customer and critical business data to provide -13-
pre-millennium backups with on-site as well as off-site data copies. The Company anticipates having these contingency plans in place early in the fourth quarter of 1999. The Company estimates that the total direct costs related to the Year 2000 project will be approximately $3 million to $5 million. Through March 31, 1999, the total direct costs associated with the Year 2000 Issue were approximately $1.5 million. In recent years, the Company has made capital expenditures, primarily related to the ongoing upgrade of its network to provide digital capabilities as well as certain financial and customer information systems, which are by design thought to be Year 2000 compliant. These expenditures are not considered to be directly related to the Year 2000 project because they are in conjunction with the Company's overall operating strategies to add digital capabilities for competitive purposes and to improve financial systems and customer service. However, these upgrades and financial systems will be tested for Year 2000 compliance. The timing of the Company's expenditures may vary and is not necessarily indicative of readiness efforts or progress to date. Though Year 2000 project costs will directly impact the reported level of future net income, the Company intends to manage its total cost structure, including deferral of non-critical projects, in an effort to mitigate the impact of Year 2000 project costs. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 SAFE HARBOR CAUTIONARY STATEMENT This Management's Discussion and Analysis of Results of Operations and Financial Condition and other sections of this Quarterly Report on Form 10-Q contain "forward-looking" statements as defined in the Private Securities Litigation Reform Act of 1995, that are based on current expectations, estimates and projections. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are forward-looking statements. These statements contain potential risks and uncertainties; therefore, actual results may differ materially. The Company undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Important factors that may affect these projections or expectations include, but are not limited to: changes in the overall economy; changes in competition in markets in which the Company operates; advances in telecommunications technology; changes in the telecommunications regulatory environment; pending and future litigation; availability of future financing; start-up of PCS operations; unanticipated changes in growth in cellular customers, penetration rates, churn rates and the mix of products and services offered in the Company's markets; and unanticipated problems with the Year 2000 Issue. Readers should evaluate any statements in light of these important factors. -14-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES --------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- Unaudited --------- <TABLE> <CAPTION> Three Months Ended March 31, ------------------ 1999 1998 ------ ------ (Dollars in thousands, except per share amounts) <S> <C> <C> OPERATING REVENUES Service $ 315,194 $ 236,344 Equipment sales 10,791 8,813 --------- --------- Total Operating Revenues 325,985 245,157 --------- --------- OPERATING EXPENSES System operations 58,691 36,943 Marketing and selling 58,305 50,001 Cost of equipment sold 25,441 20,748 General and administrative 79,519 59,043 Depreciation 41,616 35,920 Amortization of intangibles 10,299 9,347 --------- --------- Total Operating Expenses 273,871 212,002 --------- --------- OPERATING INCOME 52,114 33,155 --------- --------- INVESTMENT AND OTHER INCOME Investment income 6,618 12,788 Amortization of licenses related to investments (307) (333) Interest income 1,199 1,660 Other (expense), net (108) (1,727) Minority share of income (1,483) (1,182) Gain on sale of cellular and other investments -- 179,992 --------- --------- Total Investment and Other Income 5,919 191,198 --------- --------- INCOME BEFORE INTEREST AND INCOME TAXES 58,033 224,353 Interest expense 9,216 10,128 --------- --------- INCOME BEFORE INCOME TAXES 48,817 214,225 Income tax expense 20,991 84,473 --------- --------- NET INCOME $ 27,826 $ 129,752 ========= ========= WEIGHTED AVERAGE COMMON AND SERIES A COMMON SHARES (000s) 87,390 87,239 BASIC EARNINGS PER COMMON AND SERIES A COMMON SHARE $ .32 $ 1.49 ========= ========= DILUTED EARNINGS PER COMMON AND SERIES A COMMON SHARE $ .32 $ 1.49 ========= ========= </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. -15-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES --------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- Unaudited --------- <TABLE> <CAPTION> Three Months Ended March 31, ------------------ 1999 1998 ------ ----- (Dollars in thousands) <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 27,826 $ 129,752 Add (Deduct) adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 51,915 45,267 Deferred income tax provision 5,518 54,289 Investment income (6,618) (12,788) Minority share of income 1,483 1,182 Gain on sale of cellular and other investments -- (179,992) Other noncash expense 5,035 5,824 Change in accounts receivable 10,715 2,621 Change in accounts payable (10,393) 3,461 Change in accrued interest (4,700) (4,168) Change in accrued taxes 14,752 3,431 Change in customer deposits and deferred revenue 213 1,350 Change in other assets and liabilities 2,684 (1,916) --------- --------- 98,430 48,313 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Common Shares issued 2,244 1,050 Capital (distributions) to minority partners (1,353) (957) --------- --------- 891 93 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Additions to property, plant and equipment (76,161) (56,479) System development costs (8,527) (12,614) Investments in and advances to minority interests in cellular entities 1,633 (5,430) Distributions from minority interests in cellular entities 5,775 4,454 Proceeds from sale of cellular and other investments -- 118,892 Acquisitions, excluding cash acquired (8,131) (48,900) Other investing activities 150 306 Change in temporary investments and marketable non-equitable securities 222 232 --------- --------- (85,039) 461 --------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 14,282 48,867 CASH AND CASH EQUIVALENTS- Beginning of period 51,975 13,851 --------- --------- End of period $ 66,257 $ 62,718 ========= ========= </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. -16-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES --------------------------------------------------- CONSOLIDATED BALANCE SHEETS --------------------------- ASSETS ------ <TABLE> <CAPTION> (Unaudited) March 31, December 31, 1999 1998 ------------ ------------- (Dollars in thousands) <S> <C> <C> CURRENT ASSETS Cash and cash equivalents General funds $ 13,400 $ 15,576 Affiliated cash equivalents 52,857 36,399 ---------- ---------- 66,257 51,975 Temporary investments 184 284 Accounts Receivable Customers 81,058 99,931 Roaming 54,905 46,634 Affiliates 57 26 Other 13,766 13,671 Inventory 11,965 16,673 Prepaid expenses 11,963 10,506 Other current assets 3,231 3,105 ---------- ---------- 243,386 242,805 ---------- ---------- INVESTMENTS Licenses, net of accumulated amortization 1,198,340 1,200,653 Minority interests in cellular entities 136,439 140,286 Notes and interest receivable 11,433 11,530 Marketable equity securities 400,898 296,860 Marketable non-equity securities 214 336 ---------- ---------- 1,747,324 1,649,665 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT In service and under construction 1,466,732 1,400,597 Less accumulated depreciation 422,906 389,754 ---------- ---------- 1,043,826 1,010,843 ---------- ---------- DEFERRED CHARGES System development costs, net of accumulated amortization 134,825 127,742 Other, net of accumulated amortization 13,291 16,581 ---------- ---------- 148,116 144,323 ---------- ---------- Total Assets $3,182,652 $3,047,636 ========== ========== </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. -17-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES --------------------------------------------------- CONSOLIDATED BALANCE SHEETS --------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ <TABLE> <CAPTION> (Unaudited) March 31, December 31, 1999 1998 ----------- ------------ (Dollars in thousands) <S> <C> <C> CURRENT LIABILITIES Accounts payable Affiliates $ 11,623 $ 11,508 Other 157,230 172,568 Customer deposits and deferred revenues 27,788 27,575 Accrued interest 2,369 7,069 Accrued taxes 28,680 13,928 Accrued compensation 11,147 13,263 Other current liabilities 13,773 12,362 ---------- ---------- 252,610 258,273 ---------- ---------- LONG-TERM DEBT 6% zero coupon convertible debentures 285,693 281,487 7.25% unsecured notes 250,000 250,000 ---------- ---------- 535,693 531,487 ---------- ---------- DEFERRED LIABILITIES AND CREDITS Net deferred income tax liability 304,737 258,123 Other 6,613 5,914 ---------- ---------- 311,350 264,037 ---------- ---------- MINORITY INTEREST 41,100 43,609 ---------- ---------- COMMON SHAREHOLDERS' EQUITY Common Shares, par value $1 per share 54,449 54,365 Series A Common Shares, par value $1 per share 33,006 33,006 Additional paid-in capital 1,322,056 1,319,895 Accumulated other comprehensive income 131,062 69,465 Retained earnings 501,326 473,499 ---------- ---------- 2,041,899 1,950,230 ---------- ---------- Total Liabilities and Shareholders' Equity $3,182,652 $3,047,636 ========== ========== </TABLE> The accompanying notes to consolidated financial statements are an integral part of these statements. -18-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. 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 be 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) necessary to present fairly the financial position as of March 31, 1999 and December 31, 1998, and the results of operations and cash flows for the three months ended March 31, 1999 and 1998. The results of operations for the three months ended March 31, 1999 and 1998, are not necessarily indicative of the results to be expected for the full year. 2. The amounts used in computing Earnings per Common Share and the effect on income and the weighted average number of Common Series A Common Shares of dilutive potential common stock are as follows: <TABLE> <CAPTION> Three Months Ended March 31, ------------------ 1999 1998 ----- ------ (Dollars and Common Shares in thousands) <S> <C> <C> Net Income used in Earnings Per Share-Basic and Diluted $ 27,826 $129,752 ======== ======== Basic Weighted average number of Common Shares used in Earnings Per Share 87,390 87,239 Effect of Dilutive Securities: Stock Options and Stock Appreciation Rights 107 39 -------- -------- Diluted Weighted Average Number of Common Shares used in Earnings Per Share 87,497 87,278 ======== ======== </TABLE> -19-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. Supplemental Cash Flow Information The Company acquired certain cellular licenses and interests during the first three months of 1999 and 1998. In conjunction with these acquisitions, the following assets were acquired, liabilities assumed and Common Shares issued. <TABLE> <CAPTION> Three Months Ended March 31, ------------------ 1999 1998 ---- ---- (Dollars in thousands) <S> <C> <C> Cellular licenses $ 5,464 $34,080 Other investments -- 7,000 Minority interest 2,667 7,820 ------- ------- Decrease in cash due to acquisitions $ 8,131 $48,900 ======= ======= </TABLE> The following summarizes certain noncash transactions, and interest and income taxes paid. <TABLE> <CAPTION> Three Months Ended March 31, -------------------- 1999 1998 ---- ---- (Dollars in thousands) <S> <C> <C> Interest paid $ 9,332 $ 9,091 Income taxes paid 4,376 28,751 Noncash interest expense 4,416 4,987 </TABLE> 4. Gain on sale of cellular and other investments in 1998 primarily reflects gains recorded on the sale of the Company's minority interests in ten markets and on cash received from TDS pursuant to an agreement between the Company and TDS. 5. Other Comprehensive Income The Company's Comprehensive Income includes Net Income and Unrealized Gains from Marketable Equity Securities that are classified as "available-for-sale". The following table summarizes the Company's Comprehensive Income. -20-
UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS <TABLE> <CAPTION> Three Months Ended March 31, ------------------- 1999 1998 ---- ---- (Dollars in thousands) <S> <C> <C> Accumulated Other Comprehensive Income Balance, beginning of period $ 69,465 $ -- Other Comprehensive Income - Unrealized gains on securities 102,665 19,554 Income Tax effect (41,068) (6,844) --------- --------- Net unrealized gains included in Comprehensive Income 61,597 12,710 --------- --------- Balance, end of period $ 131,062 $ 12,710 ========= ========= Comprehensive Income Net Income $ 27,826 $ 129,752 Net unrealized gains on securities 61,597 12,710 --------- --------- $ 89,423 $ 142,462 ========= ========= </TABLE> 6. Marketable Equity Securities Marketable equity securities include the Company's investments in equity securities, primarily AirTouch Communications, Inc. ("AirTouch") common shares. These securities are classified as available-for-sale and stated at fair market value. Information regarding the Company's marketable equity securities is summarized below. <TABLE> <CAPTION> March 31, December 31, 1999 1998 ---------- ----------- (Dollars in thousands) <S> <C> <C> Available-for-sale Equity Securities Aggregate Fair Value $ 400,898 $ 296,860 Original Cost 182,461 181,087 --------- --------- Gross Unrealized Holding Gains 218,437 115,773 Tax Effect (87,375) (46,308) --------- --------- Net Unrealized Holding Gains, net of tax $ 131,062 $ 69,465 ========= ========= </TABLE> -21-
PART II. OTHER INFORMATION -------------------------- Item 6. Exhibits and Reports on Form 8-K. (a) Exhibit 11 - Statement regarding computation of per share earnings is included herein as footnote 2 to the financial statements. (b) Exhibit 12 - Statement regarding computation of ratios. (c) Exhibit 27 - Financial Data Schedule. (d) No reports on Form 8-K were filed during the quarter ended March 31, 1999. -22-
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) /s/ H.Donald Nelson Date May 14, 1999 --------------------------------------------- ------------ H. Donald Nelson President (Chief Executive Officer) /s/ Kenneth R. Meyers Date May 14, 1999 --------------------------------------------- ------------ Kenneth R. Meyers Executive Vice President-Finance and Treasurer (Chief Financial Officer) /s/ John T. Quille Date May 14, 1999 --------------------------------------------- ------------ John T. Quille Vice President and Controller (Principal Accounting Officer) -23-