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, 0.5 million prepaid and 0.1 million reseller and other connections Operates in 23 states Employs approximately 6,100 employees Headquartered in Chicago, Illinois 6,421 cell sites including 4,044 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 2017, U.S. Cellular continues to execute on its strategies to protect its current customer base, grow revenues by attracting new customers through economical offerings and identifying new revenue opportunities, and drive improvements in its overall cost structure.  Strategic efforts include:

• U.S. Cellular continues to devote efforts to enhance its network capabilities.  During the second quarter of 2017, U.S. Cellular commercially deployed VoLTE technology for the first time in one key market and will continue to build out VoLTE services over the next few years.  The next commercial launch is expected to occur in several additional operating markets in early 2018.  VoLTE technology allows customers to utilize a 4G LTE network for both voice and data services, and offers enhanced services such as high definition voice, video calling and simultaneous voice and data sessions.  In addition, the deployment of VoLTE technology expands U.S. Cellular’s ability to offer roaming services to other carriers. 
• U.S. Cellular continues to enhance its spectrum position and monetize non-strategic assets by participating in auctions and entering into agreements with third parties.  In April 2017, the FCC announced by way of public notice that U.S. Cellular was the winning bidder for 188 licenses for an aggregate purchase price of $329 million in the forward auction of 600 MHz spectrum licenses, referred to as Auction 1002.  U.S. Cellular made an upfront payment of $143 million to the FCC in June 2016 and paid the remaining balance of $186 million and was granted these licenses during the second quarter of 2017.  In addition, U.S. Cellular closed on certain license exchange agreements in the six months ended June 30, 2017, and received $15 million of cash and recognized gains of $19 million.  See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements 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 connected machine-to-machine solutions and software applications 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

The following is a list of definitions of certain industry terms that are used throughout this document:

• 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.
• Auctions 1000, 1001, and 1002 – Auction 1000 is an FCC auction of 600 MHz spectrum licenses that started in 2016 and continued into 2017 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.
• EBITDA – refers to earnings before interest, taxes, depreciation, amortization and accretion and is used in the non-GAAP metric Adjusted EBITDA throughout this document. 
• 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 agreements with device manufacturers and software developers which 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.
• OIBDA – refers to operating income before depreciation, amortization and accretion and is used in the non-GAAP metric Adjusted OIBDA throughout this document. 
• 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.
• 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 2017	YTD 2016
	Postpaid Connections
		Gross Additions:		320,000	412,000
			Handsets	218,000	249,000
			Connected Devices	102,000	163,000
		Net Additions (Losses):		(4,000)	81,000
			Handsets	(9,000)	(17,000)
			Connected Devices	5,000	98,000
		Churn:		1.21%	1.24%
			Handsets	0.99%	1.14%
			Connected Devices	2.45%	1.92%
		Connections – end of period		4,478,000	4,490,000
	Prepaid connections – end of period			484,000	413,000
	Retail connections – end of period			4,962,000	4,903,000
The decrease in postpaid net additions for the six months ended June 30, 2017, when compared to the same period last year, was a result of lower handsets and tablet gross additions, partially offset by a decline in postpaid handsets churn due to improvements in both voluntary and involuntary churn.

 

 

 

Postpaid Revenue

		Three Months Ended							Six Months Ended
		June 30,							June 30,
		2017			2016			2017			2016
Average Revenue Per User (ARPU)		$	44.60		$	47.37		$	45.00		$	47.76
Average Billings Per User (ABPU)1		$	55.19		$	56.09		$	55.49		$	56.08
Average Revenue Per Account (ARPA)		$	119.73		$	124.91		$	120.46		$	125.13
Average Billings Per Account (ABPA)1		$	148.15		$	147.90		$	148.54		$	146.95
1	Postpaid ABPU and Postpaid ABPA are non-GAAP financial measures.  Refer to Supplemental Information Relating to Non-GAAP Financial Measures within this MD&A for a reconciliation of these measures.

 

Postpaid ARPU and Postpaid ARPA decreased for the three and six months ended June 30, 2017, due primarily to industry-wide price competition resulting in overall price reductions on plan offerings.

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 certain 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, 2017, due to increased adoption of equipment installment plans by postpaid customers.  Postpaid ABPU decreased for the three and six months ended June 30, 2017, as the increase in equipment installment plan billings was more than offset by the decline in Postpaid ARPU discussed above.  Postpaid ABPA, however, increased slightly for the three months ended June 30, 2017, and to a greater extent for the six months ended June 30, 2017, as the increase in equipment installment plan billings more than offset the decline in Postpaid ARPA discussed above.  U.S. Cellular expects the penetration of equipment installment plans to continue to increase over time due to the fact that, effective in September 2016, all equipment sales to retail customers are made under installment plans. 

 

 

 

Financial Overview

					Three Months Ended								Six Months Ended
					June 30,								June 30,
											2017 vs.							2017 vs.
					2017			2016			2016		2017			2016			2016
(Dollars in millions)
Retail service					$	647		$	680		(5)%		$	1,304		$	1,361		(4)%
Inbound roaming						31			38		(18)%			58			74		(22)%
Other1						62			56		9%			124			110		13%
	Service revenues1					740			774		(4)%			1,486			1,545		(4)%
Equipment sales						223			218		2%			413			417		(1)%
	Total operating revenues1					963			992		(3)%			1,899			1,962		(3)%
System operations (excluding Depreciation, amortization and accretion reported below)						189			193		(2)%			364			376		(3)%
Cost of equipment sold						260			262		(1)%			488			518		(6)%
Selling, general and administrative						351			357		(2)%			691			719		(4)%
Depreciation, amortization and accretion						155			154		-			307			307		-
(Gain) loss on asset disposals, net						5			5		6%			9			10		(12)%
(Gain) loss on license sales and exchanges, net						(2)			(9)		81%			(19)			(9)		>(100)%
	Total operating expenses					958			962		(1)%			1,840			1,921		(4)%
Operating income¹					$	5		$	30		(82)%		$	59		$	41		45%
Net income					$	12		$	27		(57)%		$	40		$	37		8%
Adjusted OIBDA (Non-GAAP)1,2					$	163		$	180		(9)%		$	356		$	349		2%
Adjusted EBITDA (Non-GAAP)2					$	198		$	218		(9)%		$	426		$	424		1%
Capital expenditures					$	84		$	93		(9)%		$	145		$	172		(16)%
1	Equipment installment plan interest income is reflected as a component of Service revenues consistent with an accounting policy change effective January 1, 2017.  All prior period numbers have been recast to conform to this accounting change.  See Note 1 — Basis of Presentation in the Notes to Consolidated Financial Statements for additional details.
2	Refer to Supplemental Information Relating to Non-GAAP Financial Measures within this MD&A for a reconciliation of this measure.

 

 

 

 

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 Service – Primarily amounts received from the Federal USF, imputed interest recognized on equipment installment plan contracts 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

On January 1, 2017, U.S. Cellular elected to change the classification of interest income on equipment installment plan contracts from Interest and dividend income to Service revenues in the Consolidated Statement of Operations.  All prior period numbers have been recast to conform to this accounting change.  See Note 1 — Basis of Presentation in the Notes to Consolidated Financial Statements for additional details. 

Service revenues decreased for the three and six months ended June 30, 2017, as a result of (i) a decrease in retail service revenues primarily driven by industry-wide price competition resulting in overall price reductions on plan offerings; and (ii) a decrease in inbound roaming revenues primarily driven by lower roaming rates.  Such reductions were partially offset by an increase in imputed interest income due to an increase in the total number of active equipment installment plans.

 

Federal USF revenue remained flat at $23 million and $46 million for the three and six months ended June 30, 2017, respectively, when compared to the same periods last year.  See the Regulatory Matters section in this MD&A for a description of the FCC’s Reform Order (Reform Order) and its expected impacts on U.S. Cellular’s current Federal USF support.

Equipment sales revenues increased for the three months ended June 30, 2017, when compared to the same period last year, due to a mix shift from connected devices to smartphones and an increase in the proportion of new device sales made under equipment installment plans versus subsidy plans.  These impacts were partially offset by a reduction in guarantee liability amortization for equipment installment contracts as a result of changes in plan offerings and a reduction in device activation fees.

 

Equipment sales revenues decreased for the six months ended June 30, 2017, when compared to the same period last year, as a result of an overall reduction in the number of devices sold, along with the related impact on accessories revenues, as well as reductions in device activation fees and guarantee liability amortization for equipment installment contracts as a result of changes in plan offerings.  These impacts were partially offset by an increase in the proportion of new device sales made under equipment installment plans and, to a lesser extent, a mix shift from connected devices to smartphones.

 

 

System operations expenses

System operations expenses decreased for the six months ended June 30, 2017, when compared to the same period last year, as a result of (i) a decrease in roaming expenses driven primarily by lower rates for both data and voice traffic, partially offset by increased data roaming usage; and (ii) a decrease in customer usage expenses primarily driven by decreased circuit costs.

Cost of equipment sold

The decrease in Cost of equipment sold for the six months ended June 30, 2017, when compared to the same period last year, was mainly due to a reduction in the number of devices sold, partially offset by a shift in sales from connected devices to higher cost smartphones.  Cost of equipment sold included $200 million and $174 million related to equipment installment plan sales for the three months ended June 30, 2017 and 2016, respectively, and $368 million and $334 million for the six months ended June 30, 2017 and 2016, respectively.  Loss on equipment, defined as Equipment sales revenues less Cost of equipment sold, was $37 million and $44 million for the three months ended June 30, 2017 and 2016, respectively, and $75 million and $101 million for the six months ended June 30, 2017 and 2016, respectively.

Selling, general and administrative expenses

Selling, general and administrative expenses decreased for the six months ended June 30, 2017, due to lower advertising expenses, lower agent commission expenses driven by fewer activations and renewals, lower phone program expenses and the aggregate impact of modest reductions in numerous other general and administrative categories.

(Gain) loss on license sales and exchanges, net

Net gains in 2017 and 2016 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								Six Months Ended
					June 30,								June 30,
											2017 vs.								2017 vs.
					2017			2016			2016		2017			2016			2016
(Dollars in millions)
Operating income¹					$	5		$	30		(82)%		$	59		$	41		45%
Equity in earnings of unconsolidated entities						33			37		(9)%			66			72		(8)%
Interest and dividend income1						2			2		29%			5			3		38%
Interest expense						(28)			(28)		(1)%			(56)			(56)		(1)%
Other, net						–			(1)		(56)%			(1)			–		(23)%
Total investment and other income1						7			10		(32)%			14			19		(27)%
Income before income taxes						12			40		(70)%			73			60		22%
Income tax expense						–			13		(97)%			33			23		43%
Net income						12			27		(57)%			40			37		8%
Less: Net income attributable to noncontrolling   interests, net of tax						–			–		>100%			2			1		>100%
Net income attributable to U.S. Cellular   shareholders					$	12		$	27		(58)%		$	38		$	36		5%
1	Equipment installment plan interest income is reflected as a component of Service revenues consistent with an accounting policy change effective January 1, 2017.  All prior period numbers have been recast to conform to this accounting change.  See Note 1 — Basis of Presentation in the Notes to Consolidated Financial Statements for additional details.

 

 

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 $17 million and $20 million to Equity in earnings of unconsolidated entities for the three months ended June 2017 and 2016, respectively, and $33 million and $40 million for the six months ended June 2017 and 2016, respectively.  See Note 7 — Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information.

Income tax expense

The effective tax rate on Income before income taxes for the three and six months ended June 30, 2017, was 2.7% and 45.6%, respectively, and for the three and six months ended June 30, 2016, was 31.8% and 38.9%, respectively.  The effective rate for the three months ended June 30, 2017, is not meaningful, due primarily to the relatively low pretax income for the quarter combined with adjustments to the estimated annual tax rate, resulting in a distortive impact on the tax rate for the quarter.  Due to difficulty in reliably projecting an annual tax rate, U.S. Cellular calculated income taxes for the six months ended June 30, 2017, based on an estimated year-to-date tax rate. 

 

The lower effective tax rate for the six months ended June 30, 2016, resulted from a decrease in unrecognized tax benefits due to the expiration of statutes of limitation in certain states in the prior year.

 

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, certain 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.  See Market Risk for additional information regarding maturities of long-term debt.

Although U.S. Cellular currently has a significant cash balance, in certain recent periods, U.S. Cellular has incurred negative free cash flow (non-GAAP metric 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 2017.  However, 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. 

U.S. Cellular may require substantial additional capital for, among other uses, funding day-to-day operating needs including 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.  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 is exploring a potential securitized borrowing using its equipment installment plan receivables, which may occur later in 2017.  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, the LA Partnership discontinues or reduces distributions compared to historical levels, or Federal USF and/or other regulatory support payments decline.  In addition, although sales of assets or businesses by U.S. Cellular have been an important source of liquidity in prior periods, U.S. Cellular does not expect a similar level of such sales in the future.    

U.S. Cellular’s credit rating has been sub-investment grade since 2014.  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, including spectrum purchases and capital expenditures.  This credit facility matures in June 2021.

U.S. Cellular’s unused capacity under its revolving credit facility was $298 million as of June 30, 2017.  U.S. Cellular believes it was in compliance with all of the financial covenants and requirements set forth in its revolving credit facility as of that date.

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

Long-term debt payments due for the remainder of 2017 and the next four years represent less than 4% of U.S. Cellular’s total long-term debt obligation as of June 30, 2017.

Capital Expenditures

Capital expenditures (i.e., additions to property, plant and equipment and system development expenditures), which include the effects of accruals and capitalized interest, in 2017 and 2016 were as follows:

 

U.S. Cellular plans to finance its capital expenditures program for 2017 using primarily Cash flows from operating activities, existing cash balances, 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 (subject to all applicable regulations) 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 July 2016, the FCC announced U.S. Cellular as a qualified bidder in the FCC’s forward auction of 600 MHz spectrum licenses, referred to as Auction 1002.  In April 2017, the FCC announced by way of public notice that U.S. Cellular was the winning bidder for 188 licenses for an aggregate purchase price of $329 million.  Prior to commencement of the forward auction, U.S. Cellular made an upfront payment to the FCC of $143 million in June 2016.  U.S. Cellular paid the remaining $186 million to the FCC and was granted the licenses during the second quarter of 2017.

In February 2016, U.S. Cellular entered into an agreement with a third party to exchange certain 700 MHz licenses for certain AWS and PCS licenses and $28 million of cash.  This license exchange was accomplished in two closings.  The first closing occurred in the second quarter of 2016, at which time U.S. Cellular received $13 million of cash and recorded a gain of $9 million.  The second closing occurred in the first quarter of 2017, at which time U.S. Cellular received $15 million of cash and recorded a gain of $17 million. 

 

Variable Interest Entities

U.S. Cellular consolidates certain “variable interest entities” as defined under GAAP. See Note 8 — 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 additional capital contributions and/or advances to these variable interest entities in future periods in order to fund their operations.

During the first quarter of 2017, U.S. Cellular formed USCC EIP LLC, a special purpose entity (SPE), to facilitate a potential securitized borrowing using its equipment installment plan receivables in the future.  During the six months ended June 30, 2017, net equipment installment plan receivables totaling $883 million were transferred to the newly formed SPE from affiliated entities.  On a consolidated basis, the transfer of receivables into this SPE did not have a material impact to the financial condition of U.S. Cellular. 

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 2017 and 2016 were as follows:

		Six Months Ended
		June 30,
		2017			2016
Number of shares			–			46,861
Average cost per share		$	–		$	34.77
Dollar amount (in millions)		$	–		$	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, 2016 and June 30, 2017, 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, 2016.

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, 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 spectrum 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, 2017 and 2016.

2017 Commentary

U.S. Cellular’s Cash and cash equivalents decreased $114 million in 2017.  Net cash provided by operating activities was $220 million in 2017 due to net income of $40 million plus non-cash items of $266 million and distributions received from unconsolidated entities of $65 million, including $30 million in distributions from the LA Partnership.  This was partially offset by changes in working capital items which decreased net cash by $151 million.  The decrease resulting from changes in working capital items was due in part to a $107 million 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 decrease was also a result of a $53 million decrease in accounts payable. 

The net cash provided by operating activities was offset by Cash flows used for investing activities of $327 million.  Cash paid in 2017 for additions to property, plant and equipment totaled $155 million.  Cash paid for acquisitions and licenses was $189 million which included the remaining $186 million due to the FCC for licenses U.S. Cellular won in Auction 1002.  This was 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.

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 received 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. 

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.

 

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 2017 are as follows:

Licenses

Licenses increased $340 million due primarily to an aggregate winning bid of $329 million in FCC Auction 1002.  These licenses were granted by the FCC in the second quarter of 2017.  See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for more information about this transaction.

Other assets and deferred charges

Other assets and deferred charges decreased $86 million due primarily to the $143 million deposit paid to the FCC in June 2016 for participation in Auction 1002, being applied to total amounts due for the licenses won in said auction in the second quarter of 2017.  This was partially offset by a $59 million increase in the long-term portion of unbilled equipment installment plan receivables, net, due to the offering of longer term equipment installment plan contracts and the overall increase in the number of such contracts outstanding.  See Note 3 — Equipment Installment Plans and Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to these balances.

Accounts payable — Trade

Accounts payable — Trade decreased $59 million due primarily to reduction of expenses in 2017 as well as payment timing differences.

Accrued taxes

Accrued taxes increased $40 million due primarily to the excess of current income tax expense over federal estimated payments made during the six months ended June 30, 2017.

Accrued compensation

Accrued compensation decreased $27 million due primarily to employee bonus payments in March 2017.

 

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
• Adjusted OIBDA
• Free cash flow
• Postpaid ABPU

• Postpaid ABPA

Following are explanations of each of these measures.

Adjusted EBITDA and Adjusted OIBDA

Adjusted EBITDA is defined as net income adjusted for the items set forth in the reconciliation below.  Adjusted OIBDA is defined as net income adjusted for the items set forth in the reconciliation below.  Adjusted EBITDA and Adjusted OIBDA are not measures of financial performance under GAAP and should not be considered as alternatives to Net income or Cash flows from operating activities, 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 Adjusted OIBDA as measurements of profitability and, therefore, reconciliations to Net income are deemed appropriate.  Management believes Adjusted EBITDA and Adjusted OIBDA 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, and gains and losses, while Adjusted OIBDA 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 Adjusted OIBDA to the corresponding GAAP measure, Net income.

 

			Three Months Ended						Six Months Ended
			June 30,						June 30,
			2017			2016			2017			2016
(Dollars in millions)
Net income (GAAP)			$	12		$	27		$	40		$	37
Add back:
	Income tax expense			–			13			33			23
	Interest expense			28			28			56			56
	Depreciation, amortization and accretion			155			154			307			307
EBITDA (Non-GAAP)				195			222			436			423
Add back or deduct:
	(Gain) loss on license sales and exchanges, net			(2)			(9)			(19)			(9)
	(Gain) loss on asset disposals, net			5			5			9			10
Adjusted EBITDA (Non-GAAP)				198			218			426			424
Deduct:
	Equity in earnings of unconsolidated entities			33			37			66			72
	Interest and dividend income1			2			2			5			3
	Other, net			–			(1)			(1)			–
Adjusted OIBDA (Non-GAAP)1				163			180			356			349
Deduct:
	Depreciation, amortization and accretion			155			154			307			307
	(Gain) loss on license sales and exchanges, net			(2)			(9)			(19)			(9)
	(Gain) loss on asset disposals, net			5			5			9			10
Operating income (GAAP)¹			$	5		$	30		$	59		$	41
1		Equipment installment plan interest income is reflected as a component of Service revenues consistent with the accounting policy change effective January 1, 2017.  All prior period numbers have been recast to conform to this accounting change.  See Note 1 — Basis of Presentation in the Notes to Consolidated Financial Statements for additional details.

 

 

Free Cash Flow

The following table presents Free cash flow.  Management uses Free cash flow as a liquidity measure and it is defined as Cash flows from operating activities less Cash paid for additions to property, plant and equipment.  Free cash flow is a non-GAAP financial measure which U.S. Cellular believes may be useful to investors and other users of its financial information in evaluating liquidity, specifically, the amount of net cash generated by business operations after deducting Cash paid for additions to property, plant and equipment. 

		Six Months Ended June 30,
		2017			2016
(Dollars in millions)
Cash flows from operating activities (GAAP)		$	220		$	261
Less: Cash paid for additions to property, plant and equipment			155			177
	Free cash flow (Non-GAAP)	$	65		$	84

 

 

Postpaid ABPU and Postpaid ABPA

U.S. Cellular presents Postpaid ABPU and Postpaid ABPA to reflect the revenue shift from Service revenues to Equipment sales resulting from the increased adoption of equipment installment plans.  Postpaid ABPU and Postpaid ABPA, as previously defined, are non-GAAP financial measures which U.S. Cellular believes are useful to investors and other users of its financial information in showing trends in both service and equipment sales revenues received from customers. 

			Three Months Ended June 30,						Six Months Ended June 30,
			2017			2016			2017			2016
(Dollars and connection counts in millions)
Calculation of Postpaid ARPU
Postpaid service revenues			$	597		$	636		$	1,205		$	1,275
Average number of postpaid connections				4.47			4.48			4.46			4.45
Number of months in period				3			3			6			6
	Postpaid ARPU (GAAP metric)		$	44.60		$	47.37		$	45.00		$	47.76
Calculation of Postpaid ABPU
Postpaid service revenues			$	597		$	636		$	1,205		$	1,275
Equipment installment plan billings				142			118			281			223
	Total billings to postpaid connections		$	739		$	754		$	1,486		$	1,498
Average number of postpaid connections				4.47			4.48			4.46			4.45
Number of months in period				3			3			6			6
	Postpaid ABPU (Non-GAAP metric)		$	55.19		$	56.09		$	55.49		$	56.08
Calculation of Postpaid ARPA
Postpaid service revenues			$	597		$	636		$	1,205		$	1,275
Average number of postpaid accounts				1.66			1.70			1.67			1.70
Number of months in period				3			3			6			6
	Postpaid ARPA (GAAP metric)		$	119.73		$	124.91		$	120.46		$	125.13
Calculation of Postpaid ABPA
Postpaid service revenues			$	597		$	636		$	1,205		$	1,275
Equipment installment plan billings				142			118			281			223
	Total billings to postpaid accounts		$	739		$	754		$	1,486		$	1,498
Average number of postpaid accounts				1.66			1.70			1.67			1.70
Number of months in period				3			3			6			6
	Postpaid ABPA (Non-GAAP metric)		$	148.15		$	147.90		$	148.54		$	146.95