UNITED STATES CELLULAR CORP - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[x]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

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 001-09712

 

 

UNITED STATES CELLULAR CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware

62-1147325

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)

8410 West Bryn Mawr, Chicago, Illinois 60631

(Address of principal executive offices) (Zip code)

Registrant’s telephone number, including area code: (773) 399-8900

Yes

No

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.

[x]

[ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

[x]

[ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

[ ]

Accelerated filer

[x]

Non-accelerated filer

[ ]

Smaller reporting company

[ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

[ ]

[x]

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 June 30, 2016

Common Shares, $1 par value

51,801,561 Shares

Series A Common Shares, $1 par value

33,005,877 Shares

 

 

 

United States Cellular Corporation
Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 30, 2016
Index		Page No.
	Management Discussion and Analysis of Financial Condition and Results of Operations	1
	Executive Overview	1
	Terms used by U.S. Cellular	4
	Operational Overview	5
	Financial Overview	8
	Liquidity and Capital Resources	12
	Consolidated Cash Flow Analysis	14
	Consolidated Balance Sheet Analysis	15
	Supplemental Information Relating to Non-GAAP Financial Measures	16
	Application of Critical Accounting Policies and Estimates	18
	Recent Accounting Pronouncements	18
	Regulatory Matters	19
	Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement	20
	Risk Factors	22
	Quantitative and Qualitative Disclosures About Market Risk	22
	Financial Statements (Unaudited)	23
	Consolidated Statement of Operations	23
	Consolidated Statement of Cash Flows	24
	Consolidated Balance Sheet	25
	Consolidated Statement of Changes in Equity	27
	Notes to Consolidated Financial Statements	29
	Controls and Procedures	37
	Legal Proceedings	37
	Unregistered Sales of Equity Securities and Use of Proceeds	37
	Other Information	38
	Exhibits	39
	Form 10-Q Cross Reference Index	40
	Signatures	41

United States Cellular Corporation Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Overview

The following discussion and analysis should be read in conjunction with United States Cellular Corporation’s (“U.S. Cellular”) interim consolidated financial statements and notes included within, and with the description of U.S. Cellular’s business, its audited consolidated financial statements and Management's Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations included in U.S. Cellular’s Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2015.  Analysis of U.S. Cellular’s financial results compares the three and six months ended June 30, 2016 to the three and six months ended June 30, 2015.  Calculated amounts and percentages are based on the underlying actual numbers rather than the numbers rounded to millions as presented.

This report contains statements that are not based on historical facts, including the words “believes,” “anticipates,” “intends,” “expects” and similar words.  These statements constitute and represent “forward looking statements” as this term is defined in the Private Securities Litigation Reform Act of 1995.  Such forward looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, events or developments to be significantly different from any future results, events or developments expressed or implied by such forward looking statements. See Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement for additional information.

U.S. Cellular uses certain “non-GAAP financial measures” throughout the MD&A.  A discussion of the reason U.S. Cellular determines these metrics to be useful and a reconciliation of these measures to their most directly comparable measures determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) are included in the Supplemental Information Relating to Non-GAAP Financial Measures section within the MD&A of this Form 10-Q Report.

General

U.S. Cellular owns, operates, and invests in wireless markets throughout the United States. U.S. Cellular is an 83%-owned subsidiary of Telephone and Data Systems, Inc. (“TDS”).  U.S. Cellular’s strategy is to attract and retain wireless customers through a value proposition comprised of a high-quality network, outstanding customer service, and competitive devices, plans, and pricing, all provided with a local focus.

OPERATIONS

Serves customers with approximately 5.0 million connections including 4.5 million postpaid, 0.4 million prepaid and 0.1 million reseller and other connections Operates in 23 states Employs approximately 6,400 employees Headquartered in Chicago, Illinois 6,324 cell sites including 3,988 owned towers in service

 

 

U.S. Cellular Mission and Strategy

U.S. Cellular’s mission is to provide exceptional wireless communication services which enhance consumers’ lives, increase the competitiveness of local businesses, and improve the efficiency of government operations in the mid-sized and rural markets served.

In 2016, U.S. Cellular will continue to execute on its strategies to grow revenues by increasing its customer base, driving smartphone adoption and ongoing data usage monetization.  Strategic efforts include:

• U.S. Cellular deployed 4G LTE as a result of U.S. Cellular’s strategic initiative to enhance its network.  4G LTE reaches 99% of postpaid connections and 98% of cell sites.  The adoption of data-centric smartphones and connected devices is driving significant growth in data traffic.  At the end of the second quarter of 2016, 76% of postpaid connections had 4G capable devices, with the LTE network handling 89% of data traffic.  U.S. Cellular continues to devote efforts to enhance its network capabilities with the deployment of VoLTE technology and plans a multi-year roll out beginning with one market in 2017. VoLTE, when deployed commercially, will enable customers to utilize the LTE network for both voice and data services, and will enable enhanced services such as high definition voice, video calling and simultaneous voice and data sessions.  The deployment of VoLTE also will expand U.S. Cellular’s ability to offer roaming services to additional carriers.
• U.S. Cellular continued to enhance its spectrum position and monetize non-strategic assets by entering into multiple agreements with third parties.  Certain of these agreements involve the purchase of licenses for cash, while others involve the exchange of licenses in non-operating markets for other licenses in operating markets and cash.  The first closing of one of the exchange agreements occurred in June 2016 at which time U.S. Cellular received $13 million of cash and recognized a gain of $9 million. The remaining license purchase and exchange transactions are expected to close in the second half of 2016, at which point U.S. Cellular expects to recognize additional gains.  See Note 5 — Acquisitions, Divestitures and Exchanges for additional information related to these transactions.
• U.S. Cellular is focused on expanding its solutions available to business and government customers, including a growing suite of machine-to-machine solutions across various categories.  U.S. Cellular will continue to enhance its advanced wireless services and connected solutions for consumer, business and government customers.

Terms Used by U.S. Cellular

All defined terms in this MD&A are used as defined in the Notes to Consolidated Financial Statements, and additional terms are defined below:

• 4G LTE – fourth generation Long-Term Evolution which is a wireless broadband technology.
• Account – represents an individual or business financially responsible for one or multiple associated connections. An account may include a variety of types of connections such as handsets and connected devices.
• Auction 97 – An FCC auction of AWS-3 spectrum licenses that ended in January 2015.
• Auction 1002 – Auction 1002 is part of Auction 1000.  Auction 1000 is an FCC auction of 600 MHz spectrum licenses being held in 2016 involving: (1) a “reverse auction” in which broadcast television licensees submit bids to voluntarily relinquish spectrum usage rights in exchange for payments (referred to as Auction 1001); (2) a “repacking” of the broadcast television bands in order to free up certain broadcast spectrum for other uses; and (3) a “forward auction” of licenses for spectrum cleared through this process to be used for wireless communications (referred to as Auction 1002).
• Churn Rate – represents the percentage of the connections that disconnect service each month.  These rates represent the average monthly churn rate for each respective period.
• Connections - individual lines of service associated with each device activated by a customer.  This includes smartphones, feature phones, tablets, modems, and machine-to-machine devices.
• FCC – Federal Communications Commission.
• Gross Additions – represents the total number of new connections added during the period, without regard to connections that were terminated during that period.
• Machine-to-Machine or M2M – technology that involves the transmission of data between networked devices, as well as the performance of actions by devices without human intervention.  U.S. Cellular sells and supports M2M solutions to customers, provides connectivity for M2M solutions via the U.S. Cellular network, and has partnerships with device manufacturers and software developers who offer M2M solutions.
• Net Additions – represents the total number of new connections added during the period, net of connections that were terminated during that period.
• Postpaid Average Billings per Account (“Postpaid ABPA”) – non-GAAP metric is calculated by dividing total postpaid service revenues plus equipment installment plan billings by the average number of postpaid accounts and by the number of months in the period.
• Postpaid Average Billings per User (“Postpaid ABPU”) – non-GAAP metric is calculated by dividing total postpaid service revenues plus equipment installment plan billings by the average number of postpaid connections and by the number of months in the period.
• Postpaid Average Revenue per Account (“Postpaid ARPA”) – metric is calculated by dividing total postpaid service revenues by the average number of postpaid accounts and by the number of months in the period.
• Postpaid Average Revenue per User (“Postpaid ARPU”) – metric is calculated by dividing total postpaid service revenues by the average number of postpaid connections and by the number of months in the period. 
• Retail Connections – the sum of postpaid connections and prepaid connections.
• Smartphone Penetration – is calculated by dividing postpaid smartphone connections by postpaid handset connections.
• Universal Service Fund (“USF”) – A system of telecommunications collected fees and support payments managed by the FCC intended to promote universal access to telecommunications services in the United States.
• VoLTE – Voice over Long-Term Evolution is a technology specification that defines the standards and procedures for delivering voice communications and related services over 4G LTE networks.

 

Operational Overview

					YTD 2015	YTD 2016
		Postpaid Connections
			Gross Additions		391,000	412,000
			Net Additions		26,000	81,000
			Churn		1.41%	1.24%
				Handsets	1.32%	1.14%
				Connected Devices	2.38%	1.92%
			Connections – end of period		4,324,000	4,490,000
		Retail Connections – end of period			4,692,000	4,903,000
U.S. Cellular believes the increase in net additions in 2016 is a result of competitive services and products priced to offer the best value to customers and expanded equipment installment plan offerings.  Postpaid churn continued to decline due to enhancements in the customer experience, targeted retention programs and improvement in the overall credit mix of gross additions.

 

 

Smartphones represented 92% and 86% of total postpaid handset sales for the six months ended June 30, 2016 and 2015, respectively.  As a result, smartphone penetration increased to 77% of the postpaid handset base as of June 30, 2016, up from 69% a year ago.  Smartphone customers generally use more data than feature phone customers, thereby driving growth in service revenues. Continued growth in customer usage related to data services and products may result in increased operating expenses and the need for additional investment in spectrum, network capacity and network enhancements.

 

*Postpaid ABPU and ABPA are non-GAAP financial measures.  Refer to Supplemental Information Relating to Non-GAAP Financial Measures within this MD&A for a reconciliation of this measure.

 

Postpaid ARPU and Postpaid ARPA decreased for the three and six months ended June 30, 2016 due to industry-wide price competition, together with discounts on shared data plans provided to customers on equipment installment plans and those providing their own device at the time of activation or renewal.  Postpaid ARPU also decreased due to net additions of connected devices, which on a per unit basis contribute less revenue than handsets.  These factors were partially offset by the impacts of continued adoption of smartphones and the related increase in service revenues from data usage.

Equipment installment plans increase equipment sales revenue as customers pay for their wireless devices in installments at a total device price that is generally higher than the device price offered to customers in conjunction with alternative plans that are subject to a service contract.  Equipment installment plans also have the impact of reducing service revenues as many equipment installment plans provide for reduced monthly access charges.  In order to show the trends in total service and equipment revenues received, U.S. Cellular has presented Postpaid ABPU and Postpaid ABPA, which are calculated as Postpaid ARPU and Postpaid ARPA plus average monthly equipment installment plan billings per connection and account, respectively.

Equipment installment plan billings increased for the three and six months ended June 30, 2016 due to increased adoption of equipment installment plans by postpaid customers.  Postpaid ABPU decreased in 2016 as the increase in equipment installment plan billings was more than offset by the Postpaid ARPU drivers discussed above. Postpaid ABPA, however, increased in 2016 due to the increase in equipment installment plan billings and an increase in device connections per account, partially offset by the Postpaid ARPU and Postpaid ARPA drivers discussed above.

Financial Overview

									Three Months Ended June 30,																Six Months Ended June 30,
																					2016 vs.														2016 vs.
									2016						2015						2015				2016						2015						2015
(Dollars in millions)
Retail service									$		680				$		734				(8)%				$		1,361				$		1,482				(8)%
Inbound roaming											38						49				(23)%						74						89				(17)%
Other											44						41				10%						86						82				5%
	Service revenues										762						824				(8)%						1,521						1,653				(8)%
Equipment sales											218						152				44%						417						288				45%
	Total operating revenues										980						976				-						1,938						1,941				-
System operations (excluding Depreciation, amortization and accretion reported below)											193						196				(2)%						376						387				(3)%
Cost of equipment sold											262						254				3%						518						492				5%
Selling, general and administrative											357						364				(1)%						719						731				(2)%
											812						814				-						1,613						1,610				-
	Operating cash flow*										168						162				3%						325						331				(2)%
Depreciation, amortization and accretion											154						151				2%						307						298				3%
(Gain) loss on asset disposals, net											5						5				(12)%						10						10				2%
(Gain) loss on sale of business and other exit costs, net											–						(2)				N/M						–						(113)				100%
(Gain) loss on license sales and exchanges											(9)						–				>(100)%						(9)						(123)				93%
	Total operating expenses										962						968				(1)%						1,921						1,682				14%
Operating income (loss)									$		18				$		8				>100%				$		17				$		259				(93)%
Net Income									$		27				$		20				37%				$		37				$		185				(80)%
Adjusted EBITDA*									$		218				$		207				5%				$		424				$		418				2%
Capital expenditures									$		93				$		134				(31)%				$		172				$		200				(14)%
*		Represents a non-GAAP financial measure.  Refer to Supplemental Information Relating to Non-GAAP Financial Measures within this MD&A for a reconciliation of this measure.
N/M - Percentage change not meaningful

 

 

 

Service revenues consist of: Retail Service - Charges for access, airtime, roaming, recovery of regulatory costs and value added services, including data services and products Inbound Roaming - Charges to other wireless carriers whose customers use U.S. Cellular’s wireless systems when roaming Other – Primarily amounts received from the Federal USF and tower rental revenues   Equipment revenues consist of: Sales of wireless devices and related accessories to new and existing customers, agents, and third-party distributors

 

Key components of changes in the statement of operations line items were as follows:

Total operating revenues

Service revenues decreased for the three and six months ended June 30, 2016 as a result of (i) a decrease in retail service revenues driven by industry-wide price competition, including discounts on shared data plans provided to customers on equipment installment plans and those providing their own device at the time of activation or renewal; and (ii) reductions in inbound roaming revenues driven by lower roaming rates.  Such reductions were partially offset by an increase in the average connections base and continued adoption of shared data plans.

 

Federal USF revenue was $23 million and $46 million for the three and six months ended June 30, 2016, respectively, which remained flat when compared to the same periods last year. Pursuant to the FCC's Reform Order (“Reform Order”), U.S. Cellular’s Federal USF support was to be phased down at the rate of 20% per year beginning July 1, 2012. The Phase II Mobility Fund was not operational as of July 2014 and, therefore, as provided by the Reform Order, the phase down was suspended at 60% of the baseline amount. U.S. Cellular will continue to receive USF support at the 60% level until the FCC takes further action. At this time, U.S. Cellular cannot predict the changes that the FCC might make to the USF high cost support program and, accordingly, cannot predict whether such changes will have a material adverse effect on U.S. Cellular’s business, financial condition or results of operations. 

 

Equipment sales revenues increased for the three and six months ended June 30, 2016 due primarily to an increase in average revenue per device sold from sales under equipment installment plans and an increase in the number of devices sold. Equipment installment plan sales contributed $162 million and $69 million during the three months ended June 30, 2016 and 2015, respectively, and $309 million and $137 million for the six months ended June 30, 2016 and 2015, respectively.  Equipment installment plans represented 69% of the total postpaid devices sold to end users for the three and six months ended June 30, 2016 and 44% and 43% for the three and six months ended June 30, 2015, respectively.  Equipment installment plan connections represented 37% and 20% of total postpaid connections as of June 30, 2016 and 2015, respectively.

 

System operations expenses

System operations expenses remained relatively flat for the three months ended June 30, 2016 when compared to the three months ended June 30, 2015.

System operations expenses decreased 3% to $376 million for the six months ended June 30, 2016 when compared to the six months ended June 30, 2015.  The primary drivers were as follows:

Expenses incurred when U.S. Cellular’s customers used other carriers’ networks while roaming decreased $12 million or 12% to $90 million driven primarily by lower rates for both data and voice traffic, partially offset by increased data roaming usage.

 

Customer usage expenses decreased $10 million or 10% to $88 million driven by a decrease in circuit costs from the migration to LTE and lower fees for platform and content providers.

The aforementioned drivers were partially offset by maintenance, utility and cell site expenses, which increased $11 million or 6% to $197 million reflecting higher support costs for the expanded 4G LTE network, increased cell site rent, the completion of certain tower maintenance and repair projects, and other maintenance activities.

 

U.S. Cellular expects system operations expenses to increase in the future to support the continued growth in cell sites and other network facilities as it continues to add capacity, enhance quality and deploy new technologies as well as to support increases in total customer data usage.  However, these increases are expected to be offset to some extent by cost savings generated by shifting data traffic to the 4G LTE network from the 3G network.

Cost of equipment sold

Cost of equipment sold increased primarily as a result of a 6% and 7% increase in devices sold for the three and six months ended June 30, 2016, respectively.  Cost of equipment sold included $174 million and $105 million related to equipment installment plan sales for the three months ended June 30, 2016 and 2015, respectively, and $334 million and $191 million for the six months ended June 30, 2016 and 2015, respectively.  Loss on equipment, defined as Equipment sales revenues less Cost of equipment sold, was $44 million and $102 million for the three months ended June 30, 2016 and 2015, respectively, and $101 million and $204 million for the six months ended June 30, 2016 and 2015, respectively.

Selling, general and administrative expenses

Selling, general and administrative expenses remained relatively flat for the three and six months ended June 30, 2016 when compared to the same periods last year.

Depreciation, amortization, and accretion expenses

The increase in Depreciation, amortization, and accretion expenses for the three and six months ended June 30, 2016 is mainly driven by the increase in amortization expense related to billing system upgrades.

(Gain) loss on sale of business and other exit costs, net

The net gain for the six months ended June 30, 2015 was due primarily to a $108 million gain recognized on sale of towers and certain related contracts, assets and liabilities.

(Gain) loss on license sales and exchanges, net

The net gains in 2016 and 2015 were due to gains recognized on license exchange transactions with third parties.

See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.  

Components of Other Income (Expense)
					Three Months Ended June 30,								Six Months Ended June 30,
											2016 vs.								2016 vs.
					2016			2015			2015		2016			2015			2015
(Dollars in millions)
Operating income					$	18		$	8		>100%		$	17		$	259		(93)%
Equity in earnings of unconsolidated entities						37			36		4%			72			70		3%
Interest and dividend income						14			9		52%			27			17		63%
Interest expense						(28)			(20)		(40)%			(56)			(40)		(40)%
Other, net						(1)			–		10%			–			–		28%
Total investment and other income						22			25		(9)%			43			47		(8)%
Income before income taxes						40			33		21%			60			306		(80)%
Income tax expense						13			13		(3)%			23			121		(81)%
Net income						27			20		37%			37			185		(80)%
Less: Net income attributable to noncontrolling   interests, net of tax						–			1		>(100)%			1			6		(92)%
Net income attributable to U.S. Cellular   shareholders					$	27		$	19		42%		$	36		$	179		(80)%

 

 

Equity in earnings of unconsolidated entities

Equity in earnings of unconsolidated entities represents U.S. Cellular’s share of net income from entities in which it has a noncontrolling interest and that are accounted for by the equity method. U.S. Cellular’s investment in the Los Angeles SMSA Limited Partnership (“LA Partnership”) contributed $20 million and $19 million to Equity in earnings of unconsolidated entities for the three months ended June 30, 2016 and 2015, respectively, and $40 million and $39 million for the six months ended June 2016 and 2015, respectively.

See Note 7 — Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information.

Interest and dividend income

Interest and dividend income increased due to imputed interest income recognized on equipment installment plans of $12 million and $8 million during the three months ended June 30, 2016 and 2015, respectively, and $24 million and $15 million during the six months ended June 30, 2016 and 2015, respectively.  

See Note 3 — Equipment Installment Plans in the Notes to Consolidated Financial Statements for additional information.  

Interest expense

The increase in Interest expense for the three and six months ended June 30, 2016 is primarily driven by U.S. Cellular’s issuance of $300 million of 7.25% Senior Notes due 2064 in November 2015 and borrowing of $225 million on its senior term loan facility that was drawn in July 2015.

Income tax expense

U.S. Cellular’s effective tax rate on Income before income taxes for the three and six months ended June 30, 2016 was 31.8% and 38.9%, respectively, and for the three and six months ended June 30, 2015 was 39.6% and 39.5%, respectively.   The lower effective tax rate for the three and six months ended June 30, 2016 resulted from a decrease in unrecognized tax benefits resulting from the expiration of statutes of limitation during the period in certain states.

Net income attributable to noncontrolling interests, net of tax

The decrease for the three and six months ended June 30, 2016 is due primarily to lower income from certain partnerships in 2016.

Liquidity and Capital Resources

Sources of Liquidity

U.S. Cellular operates a capital-intensive business.  Historically, U.S. Cellular has used internally-generated funds and also has obtained substantial funds from external sources for general corporate purposes.  In the past, U.S. Cellular’s existing cash and investment balances, funds available under its revolving credit facility, funds from other financing sources, including a term loan and other long-term debt, and cash flows from operating, investing and financing activities, including sales of assets or businesses, provided sufficient liquidity and financial flexibility for U.S. Cellular to meet its normal day-to-day operating needs and debt service requirements, to finance the build-out and enhancement of markets and to fund acquisitions, primarily of spectrum licenses.  There is no assurance that this will be the case in the future.  It may be necessary from time-to-time to increase the size of the existing revolving credit facility, to put in place a new credit facility, or to obtain other forms of financing in order to fund potential expenditures.  U.S. Cellular’s liquidity would be adversely affected if, among other things, U.S. Cellular is unable to obtain short or long-term financing on acceptable terms, U.S. Cellular makes significant spectrum license purchases in FCC auctions or from other parties, the LA Partnership discontinues or reduces distributions compared to historical levels, or Federal USF and/or other regulatory support payments continue to decline.  In addition, although sales of assets or businesses by U.S. Cellular have been an important source of liquidity in recent periods, U.S. Cellular does not expect a similar level of such sales in the future, which will reduce a source of liquidity.  In recent years, U.S. Cellular’s credit rating has declined to sub-investment grade.   

U.S. Cellular believes that existing cash and investment balances, funds available under its revolving credit facility, and expected cash flows from operating and investing activities provide liquidity for U.S. Cellular to meet its normal day-to-day operating needs and debt service requirements for the coming year.  Although U.S. Cellular currently has a significant cash balance, in certain recent periods, U.S. Cellular has incurred negative free cash flow (defined as Cash flows from operating activities less Cash paid for additions to property, plant and equipment) and this will continue in the future if operating results do not improve or capital expenditures are not reduced.  U.S. Cellular currently expects to have negative free cash flow in 2016 due to anticipated growth in equipment installment plan receivables combined with significant capital expenditures.  U.S. Cellular may require substantial additional capital for, among other uses, funding day-to-day operating needs, working capital, acquisitions of providers of wireless telecommunications services, spectrum license or system acquisitions, system development and network capacity expansion, debt service requirements, the repurchase of shares, the payment of dividends, or making additional investments.  There can be no assurance that sufficient funds will continue to be available to U.S. Cellular or its subsidiaries on terms or at prices acceptable to U.S. Cellular.  Insufficient cash flows from operating activities, changes in its credit ratings, defaults of the terms of debt or credit agreements, uncertainty of access to capital, deterioration in the capital markets, reduced regulatory capital at banks which in turn limits their ability to borrow and lend, other changes in the performance of U.S. Cellular or in market conditions or other factors could limit or restrict the availability of financing on terms and prices acceptable to U.S. Cellular, which could require U.S. Cellular to reduce its acquisition, capital expenditure and business development programs, reduce the acquisition of spectrum licenses, and/or reduce or cease share repurchases and/or the payment of dividends.   U.S. Cellular cannot provide assurance that circumstances that could have a material adverse effect on its liquidity or capital resources will not occur.  Any of the foregoing would have an adverse impact on U.S. Cellular’s businesses, financial condition or results of operations. 

Cash and Cash Equivalents

Cash and cash equivalents include cash and money market investments. The primary objective of U.S. Cellular’s Cash and cash equivalents is for use in its operations and acquisition, capital expenditure and business development programs.

 

Financing

U.S. Cellular has a revolving credit facility available for general corporate purposes.  In June 2016, U.S. Cellular entered into a new $300 million revolving credit agreement with certain lenders and other parties.  As a result of the new agreement, U.S. Cellular’s revolving credit agreement due to expire in December 2017 was terminated.  Amounts under the new revolving credit facility may be borrowed, repaid and reborrowed from time-to-time until maturity in June 2021.  Certain U.S. Cellular wholly-owned subsidiaries have jointly and severally unconditionally guaranteed the payment and performance of the obligations of U.S. Cellular under the revolving credit agreement.  As of June 30, 2016, there were no outstanding borrowings under the revolving credit facility, except for letters of credit, and U.S. Cellular’s unused capacity under its revolving credit facility was $283 million.  The continued availability of the new revolving credit facility requires U.S. Cellular to comply with certain negative and affirmative covenants, maintain certain financial ratios and provide representations on certain matters at the time of each borrowing.  See Note 8 — Debt in the Notes to Consolidated Financial Statements for additional information.

In June 2016, U.S. Cellular also amended and restated its senior term loan credit facility.  Certain modifications were made to the financial covenants and subsidiary guarantees were added in order to align with the new revolving credit agreement.  There were no significant changes to the maturity date or other key terms of the agreement. 

U.S. Cellular believes it was in compliance with all of the financial covenants and requirements set forth in its revolving credit facility and the senior term loan credit facility as of June 30, 2016.

U.S. Cellular has in place an effective shelf registration statement on Form S-3 to issue senior or subordinated debt securities.

The proceeds from any of the aforementioned financing facilities are available for general corporate purposes, including spectrum purchases and capital expenditures.

The long-term debt payments due for the remainder of 2016 and the next four years represent less than 4% of U.S. Cellular’s total long-term debt obligation measured as of June 30, 2016.

Capital Expenditures

Capital expenditures (i.e., additions to property, plant and equipment and system development expenditures), which include accruals and capitalized interest, in 2016 and 2015 were as follows:

 

U.S. Cellular plans to finance its capital expenditures program for 2016 using primarily Cash flows from operating activities and, as necessary, existing cash balances and borrowings under its revolving credit agreement and/or other long-term debt.

Acquisitions, Divestitures and Exchanges

U.S. Cellular may be engaged from time-to-time in negotiations relating to the acquisition, divestiture or exchange of companies, properties or wireless spectrum.  In general, U.S. Cellular may not disclose such transactions until there is a definitive agreement.  U.S. Cellular assesses its existing wireless interests on an ongoing basis with a goal of improving the competitiveness of its operations and maximizing its long-term return on capital.  As part of this strategy, U.S. Cellular reviews attractive opportunities to acquire additional wireless operating markets and wireless spectrum, including pursuant to FCC auctions.  U.S. Cellular also may seek to divest outright or include in exchanges for other wireless interests those interests that are not strategic to its long-term success.

In March 2016, the FCC released a list of applicants that successfully completed applications for the forward auction of 600 MHz spectrum licenses, referred to as Auction 1002, which included U.S. Cellular.  In July 2016, the FCC released a list of applicants that qualified to bid in Auction 1002, which again included U.S. Cellular.  Forward auction bidding is scheduled to begin in August 2016.  See “Regulatory Matters — FCC Auction 1002.”  Prior to becoming a qualified bidder, U.S. Cellular was required to make an upfront payment, the size of which establishes its initial bidding eligibility.  In June 2016, U.S. Cellular made an upfront payment to the FCC of $143 million to establish its initial bidding eligibility.  If U.S. Cellular is a winning bidder in the auction, it may be required to make additional payments to the FCC that may be substantial.  In such event, U.S. Cellular plans to finance such payments from its existing cash balances, borrowings under its revolving credit agreement and/or additional long-term debt.  Further, if U.S. Cellular is not the winning bidder of any licenses, or is the winning bidder of licenses with an aggregate bid price that is less than the upfront payment, all or a portion of the upfront payment will be refunded to U.S. Cellular.

In 2015 and in 2016, U.S. Cellular entered into multiple spectrum license purchase agreements.  The aggregate purchase price for these spectrum licenses is $56 million, of which $46 million closed in the six months ended June 30, 2016.  In 2016, U.S. Cellular also entered into multiple agreements with third parties to transfer FCC licenses in non-operating markets and receive FCC licenses in operating markets.  The agreements provide for the transfer of certain AWS and PCS spectrum licenses and approximately $29 million, net, in cash to U.S. Cellular, in exchange for U.S. Cellular transferring certain AWS, PCS and 700 MHz spectrum licenses to the third parties.  The first closing of one of the exchange agreements occurred in June 2016 at which time U.S. Cellular received $13 million of cash.  The remaining license purchase and exchange transactions are expected to close in the second half of 2016.  See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to these transactions.

Variable Interest Entities

U.S. Cellular consolidates certain entities as “variable interest entities” under GAAP. See Note 9 — Variable Interest Entities in the Notes to Consolidated Financial Statements for additional information related to these variable interest entities. U.S. Cellular may elect to make capital contributions and/or advances to variable interest entities in order to fund their operations.

Common Share Repurchase Program

U.S. Cellular has repurchased and expects to continue to repurchase its Common Shares, subject to its repurchase program. Share repurchases made under this program in 2016 and 2015 were as follows:

		Six Months Ended
		June 30,
		2016			2015
Number of shares			46,861			66,209
Average cost per share		$	34.77		$	34.77
Dollar Amount (in millions)		$	2		$	2

 

For additional information related to the current repurchase authorization, see Unregistered Sales of Equity Securities and Use of Proceeds.

Contractual and Other Obligations

There were no material changes outside the ordinary course of business between December 31, 2015 and June 30, 2016 to the Contractual and Other Obligations disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in U.S. Cellular’s Form 10-K for the year ended December 31, 2015.

Off-Balance Sheet Arrangements

U.S. Cellular had no transactions, agreements or other contractual arrangements with unconsolidated entities involving “off-balance sheet arrangements,” as defined by SEC rules, that had or are reasonably likely to have a material current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Consolidated Cash Flow Analysis

U.S. Cellular operates a capital- and marketing-intensive business.  U.S. Cellular makes substantial investments to acquire wireless licenses and properties and to construct and upgrade wireless telecommunications networks and facilities as a basis for creating long-term value for shareholders.  In recent years, rapid changes in technology and new opportunities have required substantial investments in potentially revenue‑enhancing and cost-reducing upgrades to U.S. Cellular’s networks.  U.S. Cellular utilizes cash on hand, cash from operating activities, cash proceeds from divestitures and dispositions of investments, short-term credit facilities and long-term debt financing to fund its acquisitions (including licenses), construction costs, operating expenses and share repurchases.  Cash flows may fluctuate from quarter-to-quarter and year-to-year due to seasonality, the timing of acquisitions and divestitures, capital expenditures and other factors.  The following discussion summarizes U.S. Cellular's cash flow activities for the six months ended June 30, 2016 and 2015.

2016 Commentary

U.S. Cellular’s Cash and cash equivalents decreased $94 million in 2016.  Net cash provided by operating activities was $261 million in 2016 due to net income of $37 million plus non-cash items of $298 million and distributions from unconsolidated entities of $30 million.  This was partially offset by changes in working capital items which decreased net cash by $104 million.  U.S. Cellular received a federal tax refund of $28 million related to an overpayment of the 2015 expected tax liability, which resulted from the enactment of federal bonus depreciation in December 2015.  This was offset by a use of cash of $94 million due to an increase in equipment installment plan receivables, which are expected to continue to increase and further require the use of working capital in the near term.

The net cash provided by operating activities was offset by Cash flows used for investing activities of $350 million.  Cash paid in 2016 for additions to property, plant and equipment totaled $177 million.  In June 2016, U.S. Cellular made a deposit of $143 million to the FCC for its participation in Auction 1002.  Cash paid for acquisitions and licenses in 2016 was $46 million partially offset by Cash received from divestitures and exchanges of $17 million.  See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to these transactions.

2015 Commentary

Cash flows from operating activities were $423 million in 2015, contributing to a net increase in Cash and cash equivalents of $150 million for the period.  Changes in working capital items provided net cash of $161 million.  As a result of increased focus by U.S. Cellular to sell through inventory of wireless devices on hand in 2015, inventory levels decreased.  During 2015, U.S. Cellular received federal income tax refunds of $66 million related to an overpayment of the 2014 expected tax liability and the carryback of its 2014 net operating loss to the 2012 and 2013 tax years.  These refunds resulted from the enactment of federal bonus depreciation in December 2014.  In addition, income taxes incurred on the sale of towers and on the license exchange in 2015 were not payable until periods after June 30, 2015, resulting in increased income tax payable amounts included in Accrued taxes.

Cash flows used for investing activities were $256 million in 2015.  Cash paid for additions to property, plant and equipment totaled $259 million in 2015.  During 2015, a $278 million payment was made by Advantage Spectrum L.P. to the FCC for licenses for which it was the provisional winning bidder in Auction 97.  Cash received from divestitures and exchanges in 2015 included $117 million related to licenses and $141 million related to the sale of 359 towers and certain related contracts, assets and liabilities.

Other Information

U.S. Cellular did not receive any cash distribution in 2015 and in the six months ended June 30, 2016 from the LA Partnership.  In July 2016, U.S. Cellular received a cash distribution of $10 million.

Consolidated Balance Sheet Analysis

The following discussion addresses certain captions in the consolidated balance sheet and changes therein.  This discussion is intended to highlight the significant changes and is not intended to fully reconcile the changes.  Changes in financial condition during 2016 are as follows:

Other current assets

Other current assets decreased $33 million due primarily to the receipt of a federal income tax refund of $28 million in March 2016.

Assets held for sale

Assets held for sale increased $23 million due to reclassification of Licenses to this account as a result of exchanges with third parties.  The license exchange agreements are expected to close in the second half of 2016.  See Note 5 — Acquisitions, Divestitures and Exchanges for additional information.

Other assets and deferred charges

Other assets and deferred charges increased $170 million due primarily to an upfront payment of $143 million to the FCC to establish U.S. Cellular’s initial bidding eligibility for its participation in Auction 1002.  See Note 5 — Acquisitions, Divestitures and Exchanges for additional information.

 

Supplemental Information Relating to Non-GAAP Financial Measures

U.S. Cellular sometimes uses information derived from consolidated financial information but not presented in its financial statements prepared in accordance with U.S. GAAP to evaluate the performance of its business.  Certain of these measures are considered “non-GAAP financial measures” under U.S. Securities and Exchange Commission Rules.  Specifically, U.S. Cellular has referred to the following measures in this Form 10-Q Report:

• EBITDA
• Adjusted EBITDA
• Operating cash flow
• Free cash flow
• Adjusted free cash flow
• Postpaid ABPU

• Postpaid ABPA

Below is a reconciliation of each of these measures.

Adjusted EBITDA and Operating Cash Flow

Adjusted EBITDA (earnings before interest, taxes, depreciation, amortization and accretion) is defined as net income adjusted for the items set forth in the reconciliation.  Operating cash flow is defined as net income adjusted for the items set forth in the reconciliation.  Adjusted EBITDA and Operating cash flow are not measures of financial performance under GAAP and should not be considered as alternatives to Net income, as indicators of cash flows or as measures of liquidity.  U.S. Cellular does not intend to imply that any such items set forth in the reconciliation below are non-recurring, infrequent or unusual; such items may occur in the future.

Management uses Adjusted EBITDA and Operating cash flow as measurements of profitability, and therefore reconciliations to Net income are deemed most appropriate.  Management believes Adjusted EBITDA and Operating cash flow are useful measures of U.S. Cellular’s operating results before significant recurring non-cash charges, gains and losses, and other items as presented below as they provide additional relevant and useful information to investors and other users of U.S. Cellular’s financial data in evaluating the effectiveness of its operations and underlying business trends in a manner that is consistent with management’s evaluation of business performance.  Adjusted EBITDA shows adjusted earnings before interest, taxes, depreciation, amortization and accretion, while Operating cash flow reduces this measure further to exclude Equity in earnings of unconsolidated entities and Interest and dividend income in order to more effectively show the performance of operating activities excluding investment activities.  The following table reconciles Adjusted EBITDA and Operating cash flow to the corresponding GAAP measure, Net income.

			Three Months Ended June 30,						Six Months Ended June 30,
			2016			2015			2016			2015
(Dollars in millions)
Net income (GAAP)			$	27		$	20		$	37		$	185
Add back:
	Income tax expense			13			13			23			121
	Interest expense			28			20			56			40
	Depreciation, amortization and accretion			154			151			307			298
EBITDA (Non-GAAP)				222			204			423			644
Add back or deduct:
	(Gain) loss on sale of business and other exit costs, net			–			(2)			–			(113)
	(Gain) loss on license sales and exchanges, net			(9)			–			(9)			(123)
	(Gain) loss on asset disposals, net			5			5			10			10
Adjusted EBITDA (Non-GAAP)				218			207			424			418
Deduct:
	Equity in earnings of unconsolidated entities			37			36			72			70
	Interest and dividend income			14			9			27			17
	Other, net			(1)			–			–			–
Operating cash flow (Non-GAAP)				168			162			325			331
Deduct:
	Depreciation, amortization and accretion			154			151			307			298
	(Gain) loss on sale of business and other exit costs, net			–			(2)			–			(113)
	(Gain) loss on license sales and exchanges, net			(9)			–			(9)			(123)
	(Gain) loss on asset disposals, net			5			5			10			10
Operating income (GAAP)			$	18		$	8		$	17		$	259