FINANCIAL RESOURCES AND LIQUIDITY The Company operates a capital- and marketing-intensive business. In recent years, the Company has generated operating cash flow and received cash proceeds from divestitures to fund its network construction costs and operating expenses. The Company anticipates further increases in wireless units in service, revenues, operating cash flow and fixed asset additions in the future. Operating cash flow may fluctuate from quarter to quarter depending on the seasonality of each of these growth factors. Cash flows from operating activities provided $463.6 million in 2002 and $356.2 million in 2001. Income from operations excluding all noncash items increased $63.5 million to $428.9 million in the first nine months of 2002. Changes in assets and liabilities from operations provided $34.7 million in 2002 and required $9.2 million in 2001, reflecting primarily timing differences in the payment of accounts payable and the receipt of accounts receivable. Income taxes and interest paid totaled $59.8 million in 2002 and $84.9 million in 2001. Cash flows from investing activities required $828.2 million in 2002 and $510.1 million in 2001. Cash required for property, plant and equipment and system development expenditures totaled $449.0 million in 2002 and $377.7 million in 2001. These expenditures were financed primarily with internally generated cash. These expenditures primarily represent the construction of 263 and 256 cell sites in 2002 and 2001, respectively, as well as other plant additions. These plant additions included the migration to a single digital equipment platform, the addition of digital radio channels to accommodate increased usage and costs related to the development of the Company’s billing and office systems. Other plant additions included significant amounts related to the replacement of retired assets and the changeout of analog equipment for digital equipment. Acquisitions, excluding cash received and bonds issued to the sellers of Chicago 20MHz, required $451.5 million in 2002 and $134.6 million in 2001. Cash distributions from wireless entities in which the Company has an interest provided $25.0 million in 2002 and $10.6 million in 2001. In 2002, the Company was refunded $47.6 million of its deposit with the FCC related to the January 2001 FCC spectrum auction. -16-
Cash flows from financing activities provided $374.2 million in 2002 and $39.4 million in 2001. In 2002, the Company received $159.9 million from the VOD contracts and received $105.0 million from TDS through the Intercompany Note. The Company repaid $306.4 million in 2002 and $22.5 million in 2001 under the 1997 Revolving Credit Facility. Borrowings under the 1997 Revolving Credit Facility totaled $422.4 million in 2002, primarily to fund the Chicago 20MHz acquisition, and $118.5 million in 2001. In 2001, the Company paid $30.1 million in cash, recorded $612,000 of accounts payable for payments made in October 2001 and issued 550,000 USM Common Shares to satisfy the conversion of $113.5 million face value ($49.4 million carrying value) of LYONs by the holders. In 2001, the Company paid $25.8 million for the repurchase of 322,600 of its Common Shares. The cash paid includes $11.0 million paid in 2001 for repurchases executed in December 2000, and excludes $1.0 million of accounts payable recorded for payments made in October 2001. Acquisitions and Divestitures Acquisitions The Company assesses its wireless holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. The Company also reviews attractive opportunities for the acquisition of additional wireless spectrum. Acquisition of Chicago 20MHz On August 7, 2002, the Company completed the acquisition of Chicago 20MHz, representing 13.2 million pops, for approximately $607 million, subject to certain working capital and other adjustments. The Company financed the purchase using its 1997 Revolving Credit Facility, the $175 million 9% Series A Notes and the $105 million Intercompany Note with TDS. Net of cash acquired in the transaction and bonds issued to the sellers of Chicago 20MHz, the Company used cash totaling $430.4 million for the acquisition of Chicago 20MHz. See “Liquidity and Capital Resources – Financing of Chicago 20MHz Acquisition.” The Chicago MTA is the fourth largest MTA in the United States. The markets that comprise the Chicago MTA are adjacent to the Iowa, Illinois, Wisconsin and Indiana markets of the Company’s Midwest cluster, which is its largest market cluster. Of the total Chicago MTA population of 13.2 million, approximately 81% was not previously covered by the Company’s licenses. There is a strong community of interest between the Company’s existing markets and the Chicago 20MHz markets. The Chicago MTA is the single largest roaming destination of the Company’s current customers. Chicago 20MHz owns licenses covering the 18 Basic Trading Areas (“BTAs”) that comprise the Chicago MTA. The Chicago MTA includes, among others, the Chicago, Bloomington-Normal, Champaign-Urbana, Decatur-Effingham, Peoria, Rockford and Springfield BTAs in Illinois, the South Bend and Fort Wayne BTAs in Indiana and the Benton Harbor BTA in Michigan. The Chicago 20MHz network currently covers approximately 73% of the population in the licensed area. Chicago 20MHz utilizes Code Division Multiple Access (“CDMA”) technology in a network which serves the Chicago MTA with over 500 cell sites. Chicago 20MHz currently serves approximately 305,000 customers, representing a penetration rate of approximately 2.3% based on 2001 Claritas population estimates for the licensed area of Chicago 20MHz. Chicago 20MHz utilizes both direct and indirect distribution channels, with direct distribution provided through 34 stores and kiosks, and indirect distribution through approximately 600 authorized agents. In addition, Chicago 20MHz has approximately 720 replenishment locations for its prepaid customers. The Company launched its “U.S. Cellular” brand in the Chicago 20MHz licensed area in the fourth quarter of 2002. -17-
At September 30, 2002, Chicago 20MHz had approximately 500 employees, none of whom are represented by labor unions. Chicago 20MHz competes in the Chicago MTA directly against larger and more established wireless service providers, as the Company does in many of its other markets. The other wireless carriers competing in all or part of the Chicago MTA include Cingular, Verizon Wireless, AT&T Wireless, Sprint PCS, Nextel and T-Mobile. These competitors provide wireless services on a substantially national basis. As a result, they have customer bases substantially greater than Chicago 20MHz, which is only a local competitor, and also greater than the Company, which is a regional competitor, and have financial resources that are substantially greater than Chicago 20MHz and the Company. For the twelve months ended December 31, 2001, Chicago 20MHz had net revenues of $232 million, operating loss of $26 million and a net loss of $27 million. For the portion of the third quarter subsequent to the acquisition, Chicago 20MHz contributed $26.4 million of service revenue, with average monthly service revenue per customer of $46.83, $1.8 million of equipment sales revenue and $5.3 million of operating loss to the Company’s operating results. Subsequent to the acquisition, Chicago 20MHz lost 15,000 net customers and ended the quarter with 305,000 customers. Other Acquisitions Additionally, in the first nine months of 2002, the Company, through joint ventures, acquired majority interests in 10 megahertz (“MHz”) licenses in three PCS markets. The interests the Company acquired are 100% owned by the joint ventures, and the Company is considered to have the controlling financial interest in these joint ventures for financial reporting purposes. The Company also acquired the remaining minority interests in three other PCS markets in which it previously owned an interest, resulting in 100% ownership in those markets. The aggregate amount paid by the Company to acquire the interests in these transactions, which represented 1.3 million pops, was $20.8 million. In the first nine months of 2001, the Company completed the acquisition of majority interests in 17 wireless licenses, representing 5.1 million pops, for $136.9 million. Divestitures In 2002 and 2001, the Company had no material divestitures of wireless interests.Pending Transactions The Company is a limited partner in a joint venture that was a successful bidder for 17 licenses in 13 markets in the January 2001 FCC spectrum auction (“Auction 35”). The cost for the 17 licenses totaled $283.9 million. Legally, the general partner controls the joint venture; however, the Company has included the joint venture in its consolidated financial statements because the Company is considered to have controlling financial interest for financial reporting purposes under GAAP. In 2001, the joint venture acquired five of such licenses in four markets for a total of $4.1 million and had deposits with the FCC totaling $56.1 million for the remaining licenses. In May 2002, the FCC refunded 85% of the deposits, or $47.6 million, and retained the remaining $8.5 million of deposits pending the outcome of the proceedings discussed below. The remaining deposits are classified as a current asset at September 30, 2002. -18-
On September 12, 2002, the FCC issued a public notice (“WT Docket 02-276”) seeking comment on whether it should consider refunding the remainder of the deposits as well as permit the winning bidders in Auction 35 to dismiss some or all of their applications. The FCC also sought comment on whether winning bidders who elected to “opt out” of certain applications should be barred from participating in any subsequent reauction with respect to those licenses. The pleading cycle in WT Docket 02-276 ended on October 21, 2002 and the FCC has indicated its intention of issuing an order soon thereafter. Subject to the final outcome of the proceedings discussed below, or the earlier decision of the FCC in WT Docket 02-276 and the election by the joint venture to opt out of all of its applications, the joint venture’s portion of the funding for the acquisition of the remaining licenses could range from zero up to an aggregate of an additional $271.3 million. At this time, the joint venture has made no decision as to whether it will exercise any opt-out rights, even if the FCC were to grant such rights. In addition, the Company has agreed to loan the general partner up to $20 million that could be used by the general partner to fund its investment in the licenses. With respect to the remaining 12 licenses in nine markets, such licenses had been reauctioned by the FCC after defaults by winning bidders in a prior auction and were made subject by the FCC to the final outcome of certain legal proceedings initiated by the prior winning bidders. Following the reauction, one of the prior winning bidders obtained a court ruling that the FCC’s actions were illegal. In response to a request of the U.S. Department of Justice and the FCC, the U.S. Supreme Court agreed to review this court ruling and oral arguments were heard on October 8, 2002. In the event the prior winning bidder is successful in this litigation, the joint venture would receive a refund of its remaining deposit of $8.5 million made to the FCC for such 12 licenses. The joint venture’s financial requirements would then be limited to the five licenses in four markets that it acquired in 2001. If the FCC is successful in this litigation or the matter is otherwise resolved in a manner that will permit the joint venture to acquire the remaining licenses, the joint venture could be required to pay to the FCC the balance of the auction price for such licenses. The joint venture could then have significant financial requirements to build out such markets. The exact nature of the Company’s financial commitment going forward will be determined as the joint venture evaluates its alternatives as a result of any Order issued in WT Docket 02-276 and develops its long-term business and financing plans. Liquidity and Capital Resources Anticipated capital expenditures requirements for 2002 primarily reflect the Company’s plans for construction, system expansion, the execution of its plans to migrate to a single digital equipment platform and the buildout of its Chicago 20MHz licensed area. The Company’s construction and system expansion budget for 2002 is $720 million to $740 million, of which $449 million of expenditures have been incurred as of September 30, 2002. These expenditures primarily address the following needs: - Expand and enhance the Company’s coverage in its service areas, particularly in the Chicago 20MHz service area.
- Provide additional capacity to accommodate increased network usage by current customers.
- Addition of digital service capabilities to its systems, including the initial steps toward migration to a single digital equipment platform, Code Division Multiple Access (“CDMA”), from a mixture of CDMA and another digital technology, Time Division Multiple Access (“TDMA”).
- Satisfy certain regulatory requirements for specific services such as enhanced 911 and wireless number portability.
- Enhance the Company's billing and office systems.
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The Company expects its conversion to CDMA to be completed during 2004, at an approximate cost of $400 million to $450 million spread over three years. The estimated capital expenditures in 2002 include $130 million to $145 million related to this conversion. Approximately $50 million of the conversion expenditures were moved into 2002 from 2003 to enable the Company to migrate some service areas to the new platform sooner and minimize the Company’s investment in infrastructure and handsets related to the old platform. Customers in the areas converted to CDMA in 2002 will be able to use the Company’s Chicago 20MHz network instead of roaming on third-party networks, potentially reducing system operations expense. The Company has contracted with an infrastructure vendor to provide a substantial portion of the equipment related to the conversion. The Company has no current plans to repurchase its common shares. However, as market conditions warrant, the Company may continue the repurchase of its common shares, on the open market or at negotiated prices in private transactions. The Company’s repurchase program is intended to create value for the shareholders. The repurchases of common shares will be funded by internal cash flow, supplemented by short-term borrowings and other sources. The Company’s Board of Directors has authorized management to opportunistically repurchase LYONs in private transactions. The Company may also purchase a limited amount of LYONs in open-market transactions from time to time. The Company’s LYONs are convertible, at the option of their holders, at any time prior to maturity, redemption or purchase, into USM Common Shares at a conversion rate of 9.475 USM Common Shares per LYON. Upon conversion, the Company has the option to deliver to holders either USM Common Shares or cash equal to the market value of the USM Common Shares into which the LYONs are convertible. The Company may redeem the LYONs for cash at the issue price plus accrued original issue discount through the date of redemption. The Company is generating substantial cash from its operations and anticipates financing all of the remaining 2002 obligations listed above with internally generated cash and with borrowings under the Company’s 1997 Revolving Credit Facility and its recently obtained five-year credit facility, which provides up to $325 million in financing (the “2002 Revolving Credit Facility”), as the timing of such expenditures warrants. The Company had $38.6 million of cash and cash equivalents at September 30, 2002. At September 30, 2002, $120 million of the $500 million under the Company’s 1997 Revolving Credit Facility and the entire $325 million of the 2002 Revolving Credit Facility were unused and remained available to meet any short-term borrowing requirements. The 1997 Revolving Credit Facility expires in August 2004 and provides for borrowings with interest at LIBOR plus a margin percentage based on the Company’s credit rating, which was 19.5 basis points as of September 30, 2002. The 2002 Revolving Credit Facility expires in June 2007 and permits revolving loans on terms and conditions substantially similar to the Company’s 1997 Revolving Credit Facility. The terms of the 2002 Revolving Credit Facility provide for borrowings with interest at LIBOR plus a margin percentage based on the Company’s credit rating, which was 55 basis points (for a rate of 2.36% as of September 30, 2002). The continued availability of these revolving lines of credit requires the Company to comply with certain negative and affirmative covenants, maintain certain financial ratios and to represent certain matters at the time of each borrowing. At September 30, 2002, the Company was in compliance with all covenants and other requirements set forth in the revolving credit facilities. The Company’s interest costs related to both lines of credit would increase if its credit rating goes down, which would increase its cost of financing, but such lines of credit would not cease to be available solely as a result of a decline in its credit rating. -20-
The Company has on file with the SEC a shelf registration statement on Form S-3 for the issuance from time to time of up to $500 million of senior debt securities. In November 2002, the Company sold $115 million of 8.75% Senior Notes due 2032 (the “8.75% Senior Notes”) under this registration statement, as more fully discussed below. See also “Financing of Chicago 20MHz Acquisition and Upgrade.” The Company holds investments in publicly traded companies valued at $131.8 million as of September 30, 2002. These assets are classified for financial reporting purposes as available-for-sale securities. In May 2002, the Company entered into the VOD contracts. The Company received $159.9 million related to the VOD contracts, which expire in five years and may be settled in cash or delivery of the underlying securities. See “Market Risk” for further information on the VOD contracts. Management continues to believe there exists a seasonality in both service revenues and operating expenses, which may cause cash flows from operations to vary from quarter to quarter. However, these fluctuations are not considered to be large enough to cause the Company to look beyond its short-term financing sources to meet its cash needs during the remainder of 2002 or during 2003. Subject to the discussion under “Financing of Chicago 20 MHz Acquisition and Upgrade” below, management believes that the Company’s cash flows from operations and sources of external financing, including the above-referenced 1997 and 2002 Revolving Credit Facilities, provide substantial financial flexibility for the Company to meet both its short- and long-term needs. The Company also may have access to public and private capital markets to help meet its long-term financing needs. The Company anticipates issuing debt and equity securities only when capital requirements (including acquisitions), financial market conditions and other factors warrant. However, the availability of financial resources is dependent on economic events, business developments, technological changes, financial conditions or other factors, some of which may not be in the Company’s control. If at any time financing is not available on terms acceptable to the Company, it might be required to reduce its business development and capital expenditure plans, which could have a materially adverse effect on its business and financial condition. The Company does not believe that any circumstances that could materially adversely affect its liquidity or its capital resources are currently reasonably likely to occur, but it cannot provide assurances that such circumstances will not occur or that they will not occur rapidly. Economic downturns, changes in financial markets or other factors could rapidly change the availability of the Company’s liquidity and capital resources. Uncertainty of access to capital for telecommunications companies, further deterioration in the capital markets, other changes in market conditions or other factors could limit or restrict the availability of financing on terms and prices acceptable to the Company, which could require the Company to reduce its construction, development and acquisition programs. At September 30, 2002, the Company is in compliance with all covenants and other requirements set forth in long-term debt indentures. The Company does not have any rating downgrade triggers that would accelerate the maturity dates of its debt. However, a downgrade in the Company’s credit rating could adversely affect its ability to renew existing, or obtain access to new, credit facilities in the future. Financing of Chicago 20MHz Acquisition and UpgradeThe Chicago 20MHz acquisition price of approximately $607 million was financed using $327 million from the Company’s 1997 Revolving Credit Facility, $175 million from the 9% Series A Notes and the $105 million Intercompany Note with TDS. -21-
The 9% Series A Notes were issued to PrimeCo in a private placement as part of the payment of the purchase price for Chicago 20MHz. Interest is payable quarterly. The notes are callable by the Company after five years at the principal amount plus accrued but unpaid interest. In connection with the purchase of Chicago 20MHz from PrimeCo, the Company entered into an agreement pursuant to which it provided PrimeCo and transferees of PrimeCo rights to have such notes registered with the SEC for resale. The Company filed the registration statement on August 29, 2002. This registration statement will be amended due to the purchase of a portion of the 9% Series A Notes, as described in the following paragraph. In November 2002, the Company sold $115 million of 8.75% Senior Notes. Interest is payable quarterly. The notes are callable by the Company, at the principal amount plus accrued and unpaid interest, at any time on and after November 7, 2007. The net proceeds of the 8.75% Senior Notes are being used to repurchase a portion of the 9% Series A Notes that were issued to PrimeCo. The Company issued the 8.75% Senior Notes under the $500 million shelf registration statement on Form S-3 filed in May 2002. The Company has also granted the underwriters of the offering an option to purchase up to an additional $17.25 million of 8.75% Senior Notes, exercisable through November 30, 2002. The underwriters have exercised the option to acquire an additional $15 million of such notes. The $105 million loan from TDS bears interest at an annual rate of 8.1%, payable quarterly, and becomes due in August 2008, with no penalty for prepayment. This loan is subordinated to the 2002 Revolving Credit Facility. Subsequent to its acquisition of Chicago 20MHz, the Company began reevaluating its capital spending plans for the remainder of 2002. The Company expects to incur approximately $90 million in capital expenditures during the first 12 months following the Chicago 20MHz acquisition, to improve coverage in the Chicago 20MHz network, including an upgrade of the current CDMA system to 1XRTT, and to enhance its marketing distribution in the Chicago market, including opening new retail and agent locations. The Company expects to invest approximately $50 million of the $90 million during 2002. RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 143 “Accounting for Asset Retirement Obligations” was issued in September 2001, and will become effective for the Company beginning January 1, 2003. SFAS No. 143 requires entities to record the fair value of a liability for legal obligations associated with an asset retirement in the period in which the obligation is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Throughout the useful life of the asset, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the asset’s useful life. The Company is currently reviewing the requirements of this new standard and has not yet determined the impact, if any, on the Company’s financial position or results of operations. SFAS No. 145 “Rescission of SFAS No. 4, 44, and 64 and Technical Corrections” was issued in April 2002. The Company elected to adopt SFAS No. 145 early, in the second quarter of 2002, and as a result no longer reports gains and losses from extinguishment of debt as an extraordinary item. Prior year after-tax losses related to LYONs debt retirements of $1.8 million and $6.9 million, respectively, for the three and nine months ended September 30, 2001, previously reported as extraordinary items, have been reclassified to Other Income (Expense), Net in the Company’s statement of operations to conform with SFAS No. 145. SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” was issued in June 2002 and will become effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred and states that an entity’s commitment to an exit plan, by itself, does not create a present obligation that meets the definition of a liability. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. The Company will apply this new standard on exit or disposal activities, if any, initiated after December 31, 2002. -22-
MARKET RISKThe Company is subject to market rate risks due to fluctuations in interest rates and market prices of marketable equity securities. The Company currently has both fixed-rate and variable-rate long-term debt instruments, with original maturities ranging from five to 30 years. Accordingly, fluctuations in interest rates can lead to significant fluctuations in the fair value of such instruments. As of September 30, 2002, the Company has not entered into financial derivatives to reduce its exposure to interest rate risks. The Company maintains a portfolio of available for sale marketable equity securities, which resulted from acquisitions and the sale of non-strategic investments. The market value of these investments aggregated $131.8 million at September 30, 2002 (VOD ADRs $131.5 million and RCCC shares $0.3 million) and $272.4 million at December 31, 2001. The Company has entered into the VOD contracts in order to hedge the market price risk with respect to the VOD ADRs. See Note 11 – Derivative Contracts for a description of the VOD contracts. The risk management objective of the VOD contracts is to establish a collar around the value of the marketable equity securities to protect the value of the marketable securities from downside risk while maintaining a share of the upside potential. The downside risk is hedged at or above the accounting cost basis, thereby eliminating the other than temporary risk on the VOD ADRs. The unhedged downside risk on the RCCC shares is not material. The following analysis presents the hypothetical change in the fair value of the Company’s marketable equity securities and derivative instruments at September 30, 2002, assuming the same hypothetical price fluctuations of plus and minus 10%, 20% and 30%. |
