UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                    to

 

Commission File Number 1-9712

UNITED STATES CELLULAR CORPORATION

(Exact name of registrant as specified in its charter)

 

8410 West Bryn Mawr, Suite 700, Chicago, Illinois  60631

(Address of principal executive offices)  (Zip Code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    x      No    o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

 

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

Yes    o      No    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, 2007
Common Shares, $1 par value			54,750,763 Shares
Series A Common Shares, $1 par value			33,005,877 Shares

 

UNITED STATES CELLULAR CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED JUNE 30, 2007

INDEX

 

				Page No.
Part I.	Financial Information
	Item 1.	Financial Statements (Unaudited)
		Consolidated Statements of Operations Three and Six Months Ended June 30, 2007 and 2006		3
		Consolidated Statements of Cash Flows Six Months Ended June 30, 2007 and 2006		4
		Consolidated Balance Sheets June 30, 2007 and December 31, 2006		5
		Notes to Consolidated Financial Statements		7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
		Six Months Ended June 30, 2007 and 2006		24
		Three Months Ended June 30, 2007 and 2006		32
		Recent Accounting Pronouncements		38
		Financial Resources		38
		Liquidity and Capital Resources		40
		Application of Critical Accounting Policies and Estimates		45
		Certain Relationships and Related Transactions		46
		Safe Harbor Cautionary Statement		47
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		50
	Item 4.	Controls and Procedures		52
Part II.	Other Information
	Item 1.	Legal Proceedings		55
	Item 1A.	Risk Factors		55
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		55
	Item 4.	Submission of Matters to a Vote of Security-Holders		57
	Item 5.	Other Information		57
	Item 6.	Exhibits		58
Signatures

 

PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

UNAUDITED

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
		(Dollars in thousands, except per share amounts)
OPERATING REVENUES
Service		$	906,218		$	791,705		$	1,766,801		$	1,560,927
Equipment sales		65,428			54,432			139,519			121,586
Total Operating Revenues		971,646			846,137			1,906,320			1,682,513
OPERATING EXPENSES
System operations (excluding Depreciation, amortization and accretion shown separately below)		176,409			150,555			343,693			303,873
Cost of equipment sold		151,015			133,416			305,694			276,732
Selling, general and administrative (including charges from affiliates of $30.9 million and $25.3 million for the three months ended June 30, 2007 and 2006, respectively, and $58.7 million and $49.6 million for the six months ended June 30, 2007 and 2006, respectively)		371,894			342,769			726,825			670,473
Depreciation, amortization and accretion		148,856			140,486			298,113			282,511
Total Operating Expenses		848,174			767,226			1,674,325			1,533,589
OPERATING INCOME		123,472			78,911			231,995			148,924
INVESTMENT AND OTHER INCOME (EXPENSE)
Equity in earnings of unconsolidated entities		22,980			21,957			46,078			41,440
Interest and dividend income		2,653			9,807			5,203			10,395
Fair value adjustment of derivative instruments		(17,849		)	(922		)	(5,388		)	3,893
Gain on sale of investments		131,686			—			131,686			—
Interest expense		(21,325		)	(23,007		)	(45,009		)	(46,215		)
Other, net		91			(140		)	(494		)	62
Total Investment and Other Income (Expense)		118,236			7,695			132,076			9,575
INCOME BEFORE INCOME TAXES AND MINORITY INTEREST		241,708			86,606			364,071			158,499
Income tax expense		91,500			33,683			135,388			62,393
INCOME BEFORE MINORITY INTEREST		150,208			52,923			228,683			96,106
Minority share of income		(2,637		)	(2,859		)	(6,711		)	(6,596		)
NET INCOME		$	147,571		$	50,064		$	221,972		$	89,510
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING (000s)		87,590			87,281			87,735			87,247
BASIC EARNINGS PER SHARE		$	1.68		$	0.57		$	2.53		$	1.03
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING (000s)		88,410			88,083			88,615			87,994
DILUTED EARNINGS PER SHARE		$	1.67		$	0.57		$	2.50		$	1.02

 

The accompanying notes are an integral part of these consolidated financial statements.

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UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

 

		Six Months Ended June 30,
		2007			2006
		(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	221,972		$	89,510
Add (deduct) adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		298,113			282,511
Bad debts expense		23,870			23,089
Stock-based compensation expense		8,177			10,457
Deferred income taxes, net		5,002			(978		)
Equity in earnings of unconsolidated entities		(46,078		)	(41,440		)
Distributions from unconsolidated entities		43,169			37,176
Minority share of income		6,711			6,596
Unrealized fair value adjustment for derivative instruments		5,388			(3,893		)
Gain on sale of assets		(5,000		)	—
Gain on sale of investments		(131,686		)	—
Noncash interest expense		890			890
Changes in assets and liabilities from operations:
Change in accounts receivable		(30,103		)	(51,819		)
Change in inventory		(770		)	10,770
Change in accounts payable		(7,311		)	(33,462		)
Change in customer deposits and deferred revenues		17,606			2,978
Change in accrued taxes		50,739			6,416
Change in accrued interest		(742		)	749
Change in other assets and liabilities		(23,803		)	(19,326		)
		436,144			320,224
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment		(246,790		)	(268,607		)
Proceeds from sale of investments		4,301			—
Cash received from divestitures		4,277			—
Cash paid for acquisitions		(18,283		)	(18,546		)
Other investing activities		(156		)	(3,083		)
		(256,651		)	(290,236		)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of notes payable		25,000			195,000
Repayment of notes payable		(60,000		)	(225,000		)
Common shares reissued		13,516			3,856
Common shares repurchased		(49,057		)	—
Capital (distributions) to minority partners		(5,461		)	(11,220		)
Excess tax benefit from exercise of stock awards		9,679			342
		(66,323		)	(37,022		)
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS		113,170			(7,034		)
CASH AND CASH EQUIVALENTS
Beginning of period		32,912			29,003
End of period		$	146,082		$	21,969

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

UNAUDITED

 

		June 30,  2007			December 31, 2006
		(Dollars in thousands)
CURRENT ASSETS
Cash and cash equivalents		$	146,082		$	32,912
Accounts receivable
Customers, less allowance of $9,864 and $12,027, respectively		321,668			305,475
Roaming		36,745			30,396
Other, less allowance of $356 and $989, respectively		51,358			71,567
Marketable equity securities		—			249,039
Inventory		118,072			117,189
Prepaid expenses		46,277			34,955
Deferred tax asset		9,082			—
Other current assets		10,734			13,385
		740,018			854,918
INVESTMENTS
Licenses		1,500,092			1,494,327
Goodwill		491,316			485,452
Customer lists, net of accumulated amortization of $74,486 and $68,110, respectively		21,381			26,196
Marketable equity securities		16,248			4,873
Investments in unconsolidated entities		155,514			150,325
Notes and interest receivable — long-term		4,482			4,541
		2,189,033			2,165,714
PROPERTY, PLANT AND EQUIPMENT
In service and under construction		5,313,726			5,120,994
Less accumulated depreciation		2,715,722			2,492,146
		2,598,004			2,628,848
OTHER ASSETS AND DEFERRED CHARGES		30,356			31,136
TOTAL ASSETS		$	5,557,411		$	5,680,616

 

The accompanying notes are an integral part of these consolidated financial statements.

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UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS’ EQUITY

UNAUDITED

 

		June 30,  2007			December 31, 2006
		(Dollars in thousands)
CURRENT LIABILITIES
Notes payable		$	—		$	35,000
Prepaid forward contracts		—			159,856
Accounts payable
Affiliated		10,038			13,568
Trade		237,522			241,303
Customer deposits and deferred revenues		141,116			123,344
Accrued taxes		70,492			26,913
Derivative liability		—			88,840
Deferred income tax liability		—			26,326
Accrued compensation		38,635			47,842
Other current liabilities		90,632			93,718
		588,435			856,710
DEFERRED LIABILITIES AND CREDITS
Net deferred income tax liability		582,343			601,535
Asset retirement obligation		136,643			127,639
Other deferred liabilities and credits		76,997			62,914
		795,983			792,088
LONG-TERM DEBT
Long-term debt		1,002,066			1,001,839
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST		39,518			36,700
COMMON SHAREHOLDERS’ EQUITY
Common Shares, par value $1 per share; authorized 140,000,000 shares; issued 55,045,685 shares		55,046			55,046
Series A Common Shares, par value $1 per share; authorized 50,000,000 shares; issued and outstanding 33,005,877 shares		33,006			33,006
Additional paid-in capital		1,313,041			1,290,829
Treasury Shares, at cost, 294,922 and 329,934 Common Shares, respectively		(21,609		)	(14,462		)
Accumulated other comprehensive income		10,082			80,382
Retained earnings		1,741,843			1,548,478
		3,131,409			2,993,279
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	5,557,411		$	5,680,616

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6

UNITED STATES CELLULAR CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.               Basis of Presentation

The accounting policies of United States Cellular Corporation (“U.S. Cellular”) conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”). The consolidated financial statements include the accounts of U.S. Cellular, its majority-owned subsidiaries since acquisition, general partnerships in which U.S. Cellular has a majority partnership interest and any entity in which U.S. Cellular has a variable interest that requires U.S. Cellular to recognize a majority of the entity’s expected gains or losses. All material intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the 2007 presentation.

The consolidated financial statements included herein have been prepared by U.S. Cellular, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. However, U.S. Cellular believes that the disclosures included herein are adequate to make the information presented not misleading.  It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in U.S. Cellular’s Annual Report on Form 10-K for the year ended December 31, 2006 (“Form 10-K”).

The accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring items unless otherwise disclosed) necessary to present fairly the financial position as of June 30, 2007 and December 31, 2006, the results of operations for the three and six months ended June 30, 2007 and 2006, and the cash flows for the six months ended June 30, 2007 and 2006.  The results of operations for the three and six months ended June 30, 2007 are not necessarily indicative of the results to be expected for the full year.

2.               Summary of Significant Accounting Policies

Pension Plan

U.S. Cellular participates in a qualified noncontributory defined contribution pension plan sponsored by Telephone and Data Systems, Inc. (“TDS”), U.S. Cellular’s parent organization.  The plan provides pension benefits for the employees of U.S. Cellular and its subsidiaries.  Under this plan, pension benefits and costs are calculated separately for each participant and are funded currently.  Pension costs were $2.0 million and $4.1 million for the three and six months ended June 30, 2007, respectively, and $2.5 million and $4.3 million for the three and six months ended June 30, 2006, respectively.

Amounts Collected from Customers and Remitted to Governmental Authorities

U.S. Cellular records amounts collected from customers and remitted to governmental authorities net within a tax liability account if the tax is assessed upon the customer and U.S. Cellular merely acts as an agent in collecting the tax on behalf of the imposing governmental authority.  If the tax is assessed upon U.S. Cellular, then amounts collected from customers as recovery of the tax are recorded in revenues and amounts remitted to governmental authorities are recorded in expenses. The amounts recorded gross in revenues that are billed to customers and remitted to governmental authorities totaled $33.5 million and $60.9 million for the three and six months ended June 30, 2007, respectively, and $20.3 million and $39.3 million for the three and six months ended June 30, 2006, respectively.

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Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”). This Statement defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in U.S. GAAP and expands disclosure related to the use of fair value measures in financial statements. SFAS 157 does not expand the use of fair value measures in financial statements, but standardizes its definition and guidance in U.S. GAAP. The Statement emphasizes that fair value is a market-based measurement and not an entity-specific measurement, based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS 157 establishes a fair value hierarchy, from observable market data as the highest level to fair value based on an entity’s own fair value assumptions as the lowest level. The Statement is effective for U.S. Cellular’s 2008 financial statements. U.S. Cellular is currently reviewing the requirements of SFAS 157 and has not determined the impact, if any, on its financial position or results of operations.

In September 2006, FASB ratified Emerging Issues Task Force Issue No. 06-1, Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider (“EITF 06-1”). This guidance requires the application of EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer (“EITF 01-9”), when consideration is given to a reseller or manufacturer for benefit to the service provider’s end customer. EITF 01-9 requires the consideration given be recorded as a liability at the time of the sale of the equipment and also provides guidance for the classification of the expense. EITF 06-1 is effective for U.S. Cellular’s 2008 financial statements. U.S. Cellular is currently reviewing the requirements of EITF 06-1 and has not yet determined the impact, if any, on its financial position or results of operations.

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115 (“SFAS 159”), was issued in February 2007.  SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates.  Unrealized gains and losses on items for which the fair value option has been elected shall be reported in earnings at each subsequent reporting date.  SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.  SFAS 159 is effective for U.S. Cellular’s 2008 financial statements. U.S. Cellular is currently reviewing the requirements of SFAS 159 and has not yet determined the impact, if any, on its financial position or results of operations.

3.               Acquisitions, Divestitures and Exchanges

U.S. Cellular assesses its existing wireless interests on an ongoing basis with a goal of improving competitiveness of its operations and maximizing its long-term return on investment. As part of this strategy, U.S. Cellular reviews attractive opportunities to acquire additional operating markets and wireless spectrum.  In addition, U.S. Cellular may seek to divest outright or include in exchanges for other wireless interests those markets and wireless interests that are not strategic to its long-term success.

In the first six months of 2007, U.S. Cellular received $4.3 million from an escrow that was set up in the fourth quarter of 2006 in conjunction with the sale of Midwest Wireless Communications to ALLTEL Corporation. U.S. Cellular had owned an interest in Midwest Wireless Communications prior to the purchase by ALLTEL.

On February 1, 2007, U.S. Cellular purchased 100% of the membership interests of Iowa 15 Wireless, LLC (“Iowa 15”) and obtained the 25 megahertz Federal Communications Commission (“FCC”) cellular license to provide wireless service in Iowa Rural Service Area (“RSA”) 15 for approximately $18.2 million in cash. This acquisition increased investments in licenses, goodwill and customer lists by $7.9 million, $5.9 million and $1.6 million, respectively.  Goodwill of $5.9 million is deductible for income tax purposes.

U.S. Cellular is a limited partner in Barat Wireless, L.P. (“Barat Wireless”), an entity which participated in the auction of wireless spectrum designated by the FCC as Auction 66. Barat Wireless was qualified to receive a 25% discount available to “very small businesses” which were defined as having annual gross revenues of less than $15 million. At the conclusion of the auction on September 18, 2006, Barat Wireless was the high bidder with respect to 17 licenses and had bid $127.1 million, net of its discount. On April 30, 2007, the FCC granted Barat Wireless’ applications with respect to the 17 licenses for which it was the winning bidder.

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Barat Wireless is in the process of developing its long-term business and financing plans. As of June 30, 2007, U.S. Cellular had made capital contributions and advances to Barat Wireless and/or its general partner of $127.2 million. Barat Wireless used the funding to pay the FCC an initial deposit of $79.9 million on July 14, 2006 to allow it to participate in Auction 66. On October 18, 2006, Barat Wireless paid the balance due at the conclusion of the auction for the licenses with respect to which Barat Wireless was the high bidder; such amount totaled $47.1 million. For financial statement purposes, U.S. Cellular consolidates Barat Wireless and Barat Wireless, Inc., the general partner of Barat Wireless, pursuant to the guidelines of FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, (“FIN 46(R)”), as U.S. Cellular anticipates benefiting from or absorbing a majority of Barat Wireless’ expected gains or losses. Pending finalization of Barat Wireless’ permanent financing plan, and upon request by Barat Wireless, U.S. Cellular may agree to make additional capital contributions and advances to Barat Wireless and/or its general partner.

In April 2006, U.S. Cellular purchased the remaining ownership interest in a Tennessee wireless market, in which it had previously owned a 16.7% interest, for approximately $18.8 million in cash. This acquisition increased investments in licenses, goodwill and customer lists by $5.5 million, $4.0 million and $2.0 million, respectively. The $4.0 million of goodwill is not deductible for income tax purposes.

U.S. Cellular is a limited partner in Carroll Wireless, an entity which participated in the auction of wireless spectrum designated by the FCC as Auction 58. Carroll Wireless was qualified to bid on “closed licenses”-spectrum that was available only to companies included under the FCC definition of “entrepreneurs,” which are small businesses that have a limited amount of assets and revenues.  In addition, Carroll Wireless bid on “open licenses” that were not subject to restriction.  With respect to these licenses, however, Carroll Wireless was qualified to receive a 25% discount available to “very small businesses” which were defined as having average annual gross revenues of less than $15 million. Carroll Wireless was a successful bidder for 17 license areas in Auction 58, which ended on February 15, 2005. The aggregate amount paid to the FCC for the 17 licenses was $129.9 million, net of the discounts to which Carroll Wireless was entitled. These 17 license areas cover portions of 12 states and are in markets which are either adjacent to or overlap current U.S. Cellular licensed areas.

On January 6, 2006, the FCC granted Carroll Wireless’ applications with respect to 16 of the 17 licenses for which it had been the successful bidder and dismissed one application, relating to Walla Walla, Washington. Following the completion of Auction 58, the FCC determined that a portion of the Walla Walla license was already licensed to another party and should not have been included in Auction 58. Accordingly, in 2006, Carroll Wireless received a full refund of the $228,000 previously paid to the FCC with respect to the Walla Walla license.

Carroll Wireless is in the process of developing its long-term business and financing plans. As of June 30, 2007, U.S. Cellular had made capital contributions and advances to Carroll Wireless and/or its general partner of approximately $129.9 million; $129.7 million of this amount is included in Licenses in the Consolidated Balance Sheets. For financial statement purposes, U.S. Cellular consolidates Carroll Wireless and Carroll PCS, Inc., the general partner of Carroll Wireless, pursuant to the guidelines of FIN 46(R), as U.S. Cellular anticipates benefiting from or absorbing a majority of Carroll Wireless’ expected gains or losses. Pending finalization of Carroll Wireless’ permanent financing plan, and upon request by Carroll Wireless, U.S. Cellular may make additional capital contributions and advances to Carroll Wireless and/or its general partner. In November 2005, U.S. Cellular approved additional funding of $1.4 million of which $0.1 million was provided to Carroll Wireless through June 30, 2007.

4.               Fair Value Adjustments of Derivative Instruments

Fair value adjustments of derivative instruments resulted in losses of $17.8 million and $5.4 million in the three and six months ended June 30, 2007, respectively, and a loss of $0.9 million and a gain of $3.9 million in the three and six months ended June 30, 2006, respectively.  Fair value adjustments of derivative instruments for the period reflect the change in the fair value of the bifurcated embedded collars within the forward contracts related to the Vodafone marketable equity securities not designated as a hedge. See Note 9 — Marketable Equity Securities and Forward Contracts and Note 12 — Long-Term Debt and Forward Contracts for additional information related to the forward contracts.

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The accounting for the embedded collars as derivative instruments not designated as a hedge resulted in increased volatility in the results of operations, as fluctuations in the market price of the underlying Vodafone marketable equity securities resulted in changes in the fair value of the embedded collars being recorded in the Consolidated Statements of Operations.

5.               Income Taxes

The overall effective tax rate on income before income taxes and minority interest for the three and six months ended June 30, 2007 was 37.9% and 37.2%, respectively, and 38.9% and 39.4% for the three and six months ended June 30, 2006, respectively. The effective tax rate for the 2007 period is lower than 2006 primarily due to lower state income tax expense.

Effective January 1, 2007, U.S. Cellular adopted Financial Accounting Standards Board Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. In accordance with FIN 48, U.S. Cellular recognized a cumulative-effect adjustment of $1.3 million, increasing its liability for unrecognized tax benefits, interest, and penalties and reducing the January 1, 2007 balance of Retained earnings.

At January 1, 2007, U.S. Cellular had $25.8 million in unrecognized tax benefits, which, if recognized, would reduce income tax expense by $19.3 million ($12.6 million, net of the federal benefit from state income taxes). Included in the balance of unrecognized tax benefits at January 1, 2007, is an immaterial amount related to tax positions for which it is possible that the total amounts could change during the next twelve months. At June 30, 2007 U.S. Cellular had $28.9 million in unrecognized tax benefits, which, if recognized, would reduce income tax expense by $14.5 million, net of the federal benefit from state income taxes.

U.S. Cellular recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. This amount totaled $0.8 million and $2.2 million for the three and six months ended June 30, 2007, respectively. Accrued interest and penalties were $6.2 million and $8.4 million as of January 1, 2007 and June 30, 2007, respectively.

U.S. Cellular is included in a consolidated federal income tax return with other members of the TDS consolidated group. TDS and U.S. Cellular are parties to a Tax Allocation Agreement which provides that U.S. Cellular and its subsidiaries be included with the TDS affiliated group in a consolidated federal income tax return and in state income or franchise tax returns in certain situations. For financial statement purposes, U.S. Cellular and its subsidiaries calculate their income, income taxes and credits as if they comprised a separate affiliated group. Under the Tax Allocation Agreement, U.S. Cellular remits its applicable income tax payments to TDS. U.S. Cellular had a tax payable balance with TDS of $24.6 million as of June 30, 2007 and $3.7 million as of December 31, 2006.

U.S. Cellular and its subsidiaries file federal and various state income tax returns. With few exceptions, U.S. Cellular is no longer subject to Federal, state and local income tax examinations by tax authorities for years prior to 2002.  TDS’s consolidated federal income tax returns for the years 2002 - 2005, which include U.S. Cellular, are currently under examination by the Internal Revenue Service.  U.S. Cellular and its subsidiaries are also under examination by various state taxing authorities.

6.               Earnings per Share

Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using net income and weighted average common shares adjusted to include the effect of potentially dilutive securities.

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The net income amounts used in computing earnings per share and the effects on the weighted average number of common shares and earnings per share of potentially dilutive securities are as follows:

 

		Three Months Ended  June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
		(Dollars and shares in thousands, except earnings per share)
Net income		$	147,571		$	50,064		$	221,972		$	89,510
Weighted average number of common shares used in basic earnings per share		87,590			87,281			87,735			87,247
Effect of stock options (1)		573			681			634			631
Effects of Restricted Stock Units		133			121			132			116
Dilutive effect assuming shares delivered upon settlement of Accelerated Share Repurchase (2)		114			—			114			—
Weighted average number of common shares used in diluted earnings per share		88,410			88,083			88,615			87,994
Basic Earnings per Share		$	1.68		$	0.57		$	2.53		$	1.03
Diluted Earnings per Share		$	1.67		$	0.57		$	2.50		$	1.02

(1)          Stock options convertible into 3,700 and 3,700 Common Shares in the three and six months ended June 30, 2007, respectively, and 144,244 and 712,909 Common Shares in the three and six months ended June 30, 2006, respectively, were not included in computing Diluted Earnings per Share because their effects were antidilutive.

(2)          See Note 15 - Common Share Repurchase Program below for a discussion of U.S. Cellular’s purchase of 670,000 of its Common Shares from an investment banking firm in a private transaction pursuant to an accelerated share repurchase (“ASR”) agreement.

7.               Licenses and Goodwill

U.S. Cellular has substantial amounts of licenses and goodwill as a result of the acquisition of wireless markets. The changes in licenses and goodwill for the six months ended June 30, 2007 and 2006 were as follows:

		June 30, 2007			June 30, 2006
		(Dollars in thousands)
Licenses
Balance, beginning of period		$	1,494,327		$	1,362,263
Acquisitions		7,901			5,534
Impairment		(2,136		)	—
Other adjustments		—			(228		)
Balance, end of period		$	1,500,092		$	1,367,569

 

		June 30,  2007			June 30, 2006
		(Dollars in thousands)
Goodwill
Balance, beginning of period		$	485,452		$	481,235
Acquisitions		5,864			3,990
Other adjustments		—			318
Balance, end of period		$	491,316		$	485,543

 

See Note 3 — Acquisitions, Divestitures and Exchanges below for additional information related to transactions which affected licenses and goodwill.

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Licenses and goodwill must be reviewed for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. U.S. Cellular performs the annual impairment review on licenses and goodwill during the second quarter of its fiscal year. Accordingly, the annual impairment tests for licenses and goodwill for 2007 and 2006 were performed in the second quarter of 2007 and 2006. Such impairment tests indicated that there was an impairment of licenses totaling $2.1 million in 2007; the loss is included in Depreciation, amortization and accretion on the Consolidated Statements of Operations. There was no impairment of licences in 2006, and no impairment of goodwill in either 2007 or 2006.

U.S. Cellular’s license impairments in 2007 were related to two of its six units of accounting in which operations have not yet begun. The carrying values of licenses associated with these six units of accounting are tested separately from those associated with U.S. Cellular’s operating licenses. Fair values for such units of accounting were determined by reference to values established by auctions and other market transactions involving licenses comparable to those included in each specific unit of accounting.

8.               Customer Lists

Customer lists, which are intangible assets resulting from acquisitions of wireless markets, are amortized based on average customer retention periods using the double declining balance method in the first year, switching to straight-line over the remaining estimated life. The changes in the customer lists for the six months ended June 30, 2007 and 2006 were as follows:

		June 30,  2007			June 30, 2006
		(Dollars in thousands)
Customer Lists
Balance, beginning of period		$	26,196		$	47,649
Acquisitions		1,560			2,056
Amortization		(6,375		)	(11,707		)
Balance, end of period		$	21,381		$	37,998

 

Amortization expense for the remainder of 2007 and for the years 2008-2012 is expected to be $4.0 million, $7.5 million, $5.6 million, $3.9 million, $0.3 million and $0.1 million, respectively.

9.               Marketable Equity Securities and Forward Contracts

U.S. Cellular holds marketable equity securities that are publicly traded and can have volatile movements in share prices.  U.S. Cellular does not make direct investments in publicly traded companies and all of these interests were acquired as a result of sales, trades or reorganizations of other assets.

Information regarding U.S. Cellular’s marketable equity securities is summarized below.

		June 30,  2007			December 31, 2006
		(Dollars in thousands)
Marketable Equity Securities — Current Assets
Vodafone Group Plc
0 and 8,964,698 American Depositary Receipts, respectively		$	—		$	249,039
Marketable Equity Securities — Investments
Rural Cellular Corporation
370,882 Common Shares		16,248			4,873
Total aggregate fair value		16,248			253,912
Accounting cost basis		334			131,512
Gross unrealized holding gains		15,914			122,400
Deferred income tax liability		(5,832		)	(44,855		)
Net unrealized holding gains		10,082			77,545
Derivative instruments, net of tax		—			2,837
Accumulated other comprehensive income		$	10,082		$	80,382

 

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The investment in Vodafone Group Plc (“Vodafone”) resulted from certain dispositions of non-strategic wireless investments to, or settlements with, AirTouch Communications, Inc. (“AirTouch”), in exchange for stock of AirTouch, which was then acquired by Vodafone whereby U.S. Cellular received American Depositary Receipts (“ADRs”) representing Vodafone stock.

U.S. Cellular entered into a number of forward contracts related to the Vodafone ADRs that it held.  The economic hedge risk management objective of the forward contracts was to hedge the value of the securities from losses due to decreases in the market prices of the securities while retaining a share of gains from increases in the market prices of such securities.  The downside risk was hedged at or above the accounting cost basis of the securities.

The forward contracts related to the Vodafone ADRs matured in May 2007. U.S. Cellular delivered Vodafone ADRs in settlement of the forward contracts and disposed of all remaining Vodafone ADRs in connection therewith.  As a result, U.S. Cellular no longer owns any Vodafone ADRs and no longer has any liability or other obligations under the related forward contracts.  U.S. Cellular recorded a pre-tax gain of $131.7 million on the settlement of the forward contracts and the disposition of the remaining Vodafone ADRs.

See Note 12 — Long-term Debt and Forward Contracts for additional information related to U.S. Cellular’s forward contracts.

10.         Unconsolidated Entities

Investments in unconsolidated entities consist of amounts invested in wireless entities in which U.S. Cellular holds a minority interest.  These investments are accounted for using either the equity or cost method.

U.S. Cellular’s significant investments in unconsolidated entities include the following:

(1)          In addition, U.S. Cellular owns a 49% interest in an entity which owned an interest of approximately 2.9% in Midwest Wireless Holdings, L.L.C., the parent company of Midwest Wireless Communications, L.L.C. The entity’s investment in Midwest Wireless Holdings L.L.C. was disposed of in the fourth quarter of 2006.

Based primarily on data furnished to U.S. Cellular by third parties, the following summarizes the combined results of operations of U.S. Cellular’s equity method investments:

		Three Months Ended  June 30,						Six Months Ended June 30,
		2007			2006			2007			2006
		(Dollars in thousands)
Results of Operations
Revenues		$	1,104,000		$	1,019,000		$	2,196,000		$	2,006,000
Operating expenses		733,000			698,000			1,460,000			1,381,000
Operating income		371,000			321,000			736,000			625,000
Other income (expense), net		7,000			15,000			14,000			23,000
Net Income		$	378,000		$	336,000		$	750,000		$	648,000

 

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11.         Revolving Credit Facility

U.S. Cellular has a $700 million revolving credit facility available for general corporate purposes.  At June 30, 2007, there were no outstanding notes payable and letters of credit were $0.2 million leaving $699.8 million available for use. Borrowings under the revolving credit facility bear interest at the London InterBank Offered Rate (“LIBOR”) plus a contractual spread based on U.S. Cellular’s credit rating.  At June 30, 2007, the contractual spread was 75 basis points.  U.S. Cellular may select borrowing periods of either seven days or one, two, three or six months (the one-month LIBOR was 5.32% at June 30, 2007). If U.S. Cellular provides less than two days’ notice of intent to borrow, interest on borrowings is the prime rate less 50 basis points (the prime rate was 8.25% at June 30, 2007).  This credit facility expires in December 2009.

U.S. Cellular’s interest cost on its revolving credit facility would increase if its current credit rating from Moody’s Investor Service (“Moody’s”) was lowered. However, the credit facility would not cease to be available or accelerate solely as a result of a decline in U.S. Cellular’s credit rating. A downgrade in U.S. Cellular’s credit rating could adversely affect its ability to renew existing, or obtain access to new, credit facilities in the future. U.S. Cellular’s credit ratings are as follows:

 

On February 13, 2007, Standard & Poor’s lowered its credit rating on U.S. Cellular to BBB- from BBB. The ratings remained on credit watch with negative implications. On April 23, 2007, Standard & Poor’s lowered its credit rating on U.S. Cellular to BB+ from BBB-. The ratings remained on credit watch with negative implications. On June 21, 2007, Standard & Poor’s affirmed the BB+ rating, and removed the Company from Credit Watch.  The outlook is developing.

The maturity date of U.S. Cellular’s revolving credit facility would accelerate in the event of a change in control.

The continued availability of the revolving credit facility requires U.S. Cellular to comply with certain negative and affirmative covenants, maintain certain financial ratios and make representations regarding certain matters at the time of each borrowing. On November 6, 2006, U.S. Cellular announced that it would restate certain financial statements which caused U.S. Cellular to be late with certain SEC filings. The restatements and late filings resulted in defaults under the revolving credit facility.  However, U.S. Cellular was not in violation of any covenants that require U.S. Cellular to maintain certain financial ratios and U.S. Cellular did not fail to make any scheduled payments.  U.S. Cellular received waivers from the lenders associated with the revolving credit facility, under which the lenders agreed to waive any defaults that may have occurred as a result of the restatements and late filings.  U.S. Cellular believes it was in compliance as of June 30, 2007 with all covenants and the requirements set forth in its revolving credit facility.

12.         Long-Term Debt and Forward Contracts

There were no significant changes in long-term debt during the six months ended June 30, 2007.

U.S. Cellular’s long-term debt does not contain any provisions resulting in acceleration of the maturities of outstanding debt in the event of a change in U.S. Cellular’s credit rating.  However, U.S. Cellular’s ability to obtain long-term debt financing in the future could be adversely affected by a downgrade in its credit rating. U.S. Cellular believes it was in compliance as of June 30, 2007 with all covenants and other requirements set forth in its long-term debt indenture.

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Forward Contracts

A subsidiary of U.S. Cellular had outstanding prepaid forward contracts with counterparties in connection with its 8,964,698 Vodafone Group Plc ADRs. The $159.9 million principal amount of the forward contracts was accounted for as a loan. The prepaid forward contracts contained embedded collars that were bifurcated and received separate accounting treatment in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS “133”). The Vodafone securities were pledged as collateral for the forward contracts.

The economic hedge risk management objective of the forward contracts was to hedge the value of the Vodafone securities from losses due to decreases in the market prices of the securities (“downside limit”) while retaining a share of gains from increases in the market prices of such securities (“upside potential”). The downside limit was hedged at or above the accounting cost basis of the securities.

Under the terms of the forward contracts, a subsidiary of U.S. Cellular owned the contracted shares and received dividends paid on such contracted shares. The forward contracts, at U.S. Cellular’s option, could have been settled in shares of the security or in cash, pursuant to formulas that “collared” the price of the shares. The collars effectively reduced U.S. Cellular’s downside limit and upside potential on the contracted shares. The collars were typically contractually adjusted for any changes in dividends on the underlying shares. If the dividend increased, the collar’s upside potential was typically reduced. If the dividend decreased, the collar’s upside potential was typically increased.

The forward contracts related to the Vodafone ADRs matured in May 2007. U.S. Cellular settled the forward contracts by delivery of Vodafone ADRs pursuant to the formula and then disposed of all remaining Vodafone ADRs.  U.S. Cellular recognized a pre-tax gain of $131.7 million at the time of delivery and sale of the shares. Since shares were delivered in the settlement of the forward contract, U.S. Cellular incurred a current tax liability in the amount of $35.5 million at the time of delivery and sale of the shares. As a result, U.S. Cellular no longer owns any Vodafone ADRs and no longer has any liability or other obligations under the related forward contracts.  See Note 9 — Marketable Equity Securities and Forward Contracts for additional information related to settlement of the forward contracts and disposal of the remaining Vodafone ADRs.

U.S. Cellular was required to comply with certain covenants under the forward contracts.  On November 6, 2006, U.S. Cellular announced that it would restate certain financial statements which caused U.S. Cellular to be late in certain SEC filings. The restatements and late filings resulted in defaults under certain forward contracts.  However, U.S. Cellular was not in violation of any covenants that require U.S. Cellular to maintain certain financial ratios and U.S. Cellular did not fail to make any scheduled payments. U.S. Cellular received waivers from the counterparty associated with such forward contracts, under which the counterparty agreed to waive any defaults that may have occurred as a result of the restatements and late filings.

13.         Commitments and Contingencies

Indemnity Agreements

U.S. Cellular enters into agreements in the normal course of business that provide for indemnification of counterparties. These agreements include certain asset sales and financings with other parties. The terms of the indemnification vary by agreement. The events or circumstances that would require U.S. Cellular to perform under these indemnities are transaction specific; however, these agreements may require U.S. Cellular to indemnify the counterparty for costs and losses incurred from litigation or claims arising from the underlying transaction. U.S. Cellular is unable to estimate the maximum potential liability for these types of indemnifications as the amounts are dependent on the outcome of future events, the nature and likelihood of which cannot be determined at this time. Historically, U.S. Cellular has not made any significant indemnification payments under such agreements.

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Legal Proceedings

U.S. Cellular is involved in a number of legal proceedings before the FCC and various state and federal courts. In accordance with SFAS No. 5, Accounting for Contingencies, if U.S. Cellular believes that a loss arising from such legal proceedings is probable and can be reasonably estimated, an amount is accrued in the financial statements for the estimated loss.  If only a range of loss can be determined, the best estimate within that range is accrued; if none of the estimates within that range is better than another, the low end of the range is accrued.  The assessment of the expected outcomes of legal proceedings is a highly subjective process that requires judgments about future events.  The legal proceedings are reviewed at least quarterly to determine the adequacy of accruals and related financial statement disclosures. The ultimate outcomes of legal proceedings could differ materially from amounts accrued in the financial statements.

14.         Minority Interest in Subsidiaries

Under SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, certain minority interests in consolidated entities with finite lives may meet the standard’s definition of a mandatorily redeemable financial instrument and thus require reclassification as liabilities and remeasurement at the estimated amount of cash that would be due and payable to settle such minority interests under the applicable entity’s organization agreement, assuming an orderly liquidation of the finite-lived entity, net of estimated liquidation costs (the “settlement value”).  U.S. Cellular’s consolidated financial statements include certain minority interests that meet the standard’s definition of mandatorily redeemable financial instruments.  These mandatorily redeemable minority interests represent interests held by third parties in consolidated partnerships and limited liability companies (“L.L.C.s”), where the terms of the underlying partnership or L.L.C. agreement provide for a defined termination date at which time the assets of the subsidiary are to be sold, the liabilities are to be extinguished and the remaining net proceeds are to be distributed to the minority interest holders and U.S. Cellular in accordance with the respective partnership and L.L.C. agreements.  The termination dates of U.S. Cellular’s mandatorily redeemable minority interests range from 2042 to 2105.

The settlement value of U.S. Cellular’s mandatorily redeemable minority interests was estimated to be $225.1 million at June 30, 2007. This represents the estimated amount of cash that would be due and payable to settle minority interests assuming an orderly liquidation of the finite-lived consolidated partnerships and L.L.C.s on June 30, 2007, net of estimated liquidation costs. This amount is being disclosed pursuant to the requirements of FASB Staff Position (“FSP”) No. FAS 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests. U.S. Cellular has no current plans or intentions to liquidate any of the related partnerships or L.L.C.s prior to their scheduled termination dates. The corresponding carrying value of the minority interests in finite-lived consolidated partnerships and L.L.C.s at June 30, 2007 was $40.8 million and is included in the Consolidated Balance Sheet caption Minority Interest. The excess of the aggregate settlement value over the aggregate carrying value of the mandatorily redeemable minority interests of $184.3 million is primarily due to the unrecognized appreciation of the minority interest holders’ share of the underlying net assets in the consolidated partnerships and L.L.C.s. Neither the minority interest holders’ share, nor U.S. Cellular’s share, of the appreciation of the underlying net assets of these subsidiaries is reflected in the consolidated financial statements under U.S. GAAP. The estimate of settlement value was based on certain factors and assumptions which are subjective in nature. A change in those factors and assumptions could result in a materially larger or smaller settlement amount.

15.         Common Share Repurchase Program

The Board of Directors of U.S. Cellular has authorized the repurchase of up to 1% of the outstanding U.S. Cellular Common Shares held by non-affiliates on a quarterly basis, primarily for use in employee benefit plans (the “Limited Authorization”).  This authorization does not have an expiration date.

On March 6, 2007, in addition to U.S. Cellular’s existing Limited Authorization discussed above, the Board of Directors of U.S. Cellular authorized the repurchase of up to 500,000 Common Shares of U.S. Cellular (the “Additional Authorization”) from time to time through open market purchases, block transactions, private transactions or other methods.  This authorization was scheduled to expire on March 6, 2010.  However, as discussed below, because this authorization was fully utilized, no further purchases are available under this authorization.

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On April 4, 2007, U.S. Cellular entered into an agreement to purchase 670,000 of its Common Shares from an investment banking firm in a private transaction in connection with an accelerated share repurchase (“ASR”). This amount represents 170,000 shares under the Limited Authorization and 500,000 shares under the Additional Authorization, both as described above.  Including a per share discount and commission payable to the investment bank, the shares were repurchased for approximately $49.1 million or $73.22 per share. The repurchased shares are being held as treasury shares.

In addition, on July 10, 2007, U.S. Cellular entered into another ASR to purchase 168,000 of its Common Shares from an investment banking firm in a private transaction under the Limited Authorization. Including a commission payable to the investment bank, the shares were repurchased for approximately $16.1 million or $96.10 per share. The repurchased shares are being held as treasury shares.

In connection with each ASR, the investment bank will purchase an equivalent number of shares in the open market over time. Each program must be completed within two years of the trade date of the respective ASR. At the end of the program, U.S. Cellular will receive or pay a price adjustment based on the average price of shares acquired by the investment bank pursuant to the ASR during the purchase period, less a negotiated discount. Generally, the purchase price adjustment can be settled, at U.S. Cellular’s option, in cash or in U.S. Cellular Common Shares. The subsequent purchase price adjustment will change the cost basis of the U.S. Cellular treasury shares.

As of June 30, 2007, the investment bank had purchased 87,700 shares at an average price of $75.26 per share under the April 4, 2007 ASR. The purchase price adjustment totals approximately $0.2 million owed by U.S. Cellular to the investment bank as of June 30, 2007 based on the difference between the price paid by U.S. Cellular of $73.22 per share in connection with the ASR, and the average price paid by the investment bank of $75.26 per share. U.S. Cellular could elect to settle the amount owed by issuing approximately 2,000 U.S. Cellular Common Shares to the investment bank.  U.S. Cellular would owe the investment bank an additional $10.1 million or approximately 111,700 U.S. Cellular Common Shares if the investment bank repurchased the remaining 582,300 shares at the June 30, 2007 closing market price of $90.60.  The amount owed would increase or decrease by $582,300 for each $1 increase or decrease in the stock price. Any amount owed will be settled at the conclusion of the program.

No U.S. Cellular Common Shares were repurchased in the first six months of 2006.

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16.         Accumulated Other Comprehensive Income

The cumulative balances of unrealized gains and losses on marketable equity securities and derivative instruments and related income tax effects included in Accumulated other comprehensive income are as follows:

		Six Months Ended June 30,
		2007			2006
		(Dollars in thousands)
Marketable Equity Securities
Balance, beginning of period		$	77,545		$	41,287
Add (deduct):
Unrealized gains (losses) on marketable equity securities		20,721			(3,084		)
Income tax (expense) benefit		(7,595		)	1,132
Net change in unrealized gains (losses) on marketable equity securities		13,126			(1,952		)
Recognized gain on sale of marketable equity securities		(127,207		)	—
Income tax expense		46,618			—
Net recognized gain on marketable equity securities		(80,589		)	—
Net change in marketable equity securities		(67,463		)	(1,952		)
Balance, end of period		$	10,082		$	39,335
Derivative Instruments
Balance, beginning of period		$	2,837		$	2,835
Add (deduct):
Recognized gain on settlement of derivative instruments		(4,479		)	—
Income tax expense		1,642			—
Net recognized gain on settlement of derivatives instruments		(2,837		)	—
Net change in derivative instruments		(2,837		)	—
Balance, end of period		$	—		$	2,835
Accumulated Other Comprehensive Income
Balance, beginning of period		$	80,382		$	44,122
Net change in marketable equity securities		(67,463		)	(1,952		)
Net change in derivative instruments		(2,837		)	—
Net change in unrealized gains included in comprehensive income		(70,300		)	(1,952		)
Balance, end of period		$	10,082		$	42,170

 

		Six Months Ended June 30,
		2007			2006
		(Dollars in thousands)
Comprehensive Income
Net Income		$	221,972		$	89,510
Net change in unrealized and realized gains (losses) on marketable equity securities and derivative instruments		(70,300		)	(1,952		)
		$	151,672		$	87,558

 

17.         Stock-Based Compensation

Stock-Based Compensation Plans

Effective January 1, 2006, U.S. Cellular adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), using the modified prospective transition method.   Upon adoption of SFAS 123(R), U.S. Cellular elected to continue to value its share-based payment transactions using a Black-Scholes valuation model, which was previously used by U.S. Cellular for purposes of preparing the pro forma disclosures under SFAS 123.

U.S. Cellular has established the following stock-based compensation plans: a long-term incentive plan, an employee stock purchase plan, and a non-employee director compensation plan.

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Under the U.S. Cellular 2005 Long-Term Incentive Plan, U.S. Cellular may grant fixed and performance-based incentive and non-qualified stock options, restricted stock, restricted stock units, and deferred compensation stock unit awards to key employees. At June 30, 2007, the only types of awards outstanding are fixed non-qualified stock option awards, restricted stock unit awards, and deferred compensation stock unit awards.

At June 30, 2007, U.S. Cellular had reserved 4,188,000 Common Shares for equity awards granted and to be granted under the long-term incentive plan, and also had reserved 104,000 Common Shares for issuance to employees under an employee stock purchase plan. The maximum number of U.S. Cellular Common Shares that may be issued to employees under all stock-based compensation plans in effect at June 30, 2007 was 4,292,000 shares. U.S. Cellular currently utilizes treasury stock to satisfy stock option exercises, issuances under its employee stock purchase plan, restricted stock unit awards and deferred compensation stock unit awards.

Long-Term Incentive Plan — Stock Options— Non-qualified stock options granted to key employees are exercisable over a specified period not in excess of ten years. Stock options generally vest over periods up to four years from the date of grant. Stock options outstanding at June 30, 2007 expire between 2007 and 2017. U.S. Cellular granted 470,000 and 551,000 stock options during the six months ended June 30, 2007 and 2006, respectively. U.S. Cellular used the assumptions shown in the table below in valuing options granted in 2007.

 

A summary of U.S. Cellular stock options outstanding and exercisable as of June 30, 2007 and changes during the six months ended June 30, 2007 is presented below.

		Number of  Options		Weighted Average Exercise Prices			Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at December 31, 2006		2,571,000		$	44.07		7.2		$	119,651,000
(1,430,000 exercisable)				42.15			6.4		69,288,000
Granted		470,000		73.92					7,834,000
Exercised		1,084,000		41.44					39,136,000
Forfeited		64,000		54.08					2,342,000
Expired		10,000		37.83					509,000
Outstanding at June 30, 2007		1,883,000		52.71			7.9		71,359,000
(851,000 exercisable)				$	42.10		6.7		$	41,257,000

 

The aggregate intrinsic value represents the total pretax intrinsic value (the difference between U.S. Cellular’s closing stock price on the last trading day of the period and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. This amount will change in future periods based on the market price of U.S. Cellular’s stock.

Long-Term Incentive Plan — Restricted Stock Units—U.S. Cellular grants restricted stock unit awards, which generally vest after three years, to key employees.  U.S. Cellular estimates the fair value of restricted stock units based on the closing market price of U.S. Cellular shares on the date of grant. U.S. Cellular granted 137,000 and 128,000 restricted stock units during the six months ended June 30, 2007 and 2006, respectively.

 

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A summary of U.S. Cellular nonvested restricted stock units at June 30, 2007 and changes during the six months then ended is presented in the tables that follow:

Liability Classified Awards

 

Equity Classified Awards

 

Long-Term Incentive Plan — Deferred Compensation Stock Units—Certain U.S. Cellular employees may elect to defer receipt of all or a portion of their annual bonuses and to receive a company matching contribution on the amount deferred. All bonus compensation that is deferred by employees electing to participate is immediately vested and is deemed to be invested in U.S. Cellular Common Share stock units. The matching contributions also are deemed to be invested in U.S. Cellular Common Share stock units, with the number of such units determined based on the dollar amount of the matching contribution and the closing market price of U.S. Cellular Common Shares on the date of the match.

A summary of U.S. Cellular nonvested deferred compensation stock units at June 30, 2007 and changes during the six months then ended is presented in the table below:

 

Employee Stock Purchase Plan—Under the 2003 Employee Stock Purchase Plan, eligible employees of U.S. Cellular and its subsidiaries may purchase a limited number of U.S. Cellular Common Shares on a quarterly basis. The per share cost to each participant is 85% of the market value of the Common Shares as of the issuance date. U.S. Cellular employees are also eligible to participate in the TDS employee stock purchase plan. The per share costs in the TDS plan are the same as those for the U.S. Cellular plan.  U.S. Cellular issued 2,300 during the six months ended June 30, 2007. No shares were issued during the six months ended June 30, 2006.

Non-Employee Director Compensation Plan— Under the Non-Employee Director Compensation Plan, U.S. Cellular has reserved 3,100 Common Shares of U.S. Cellular for issuance as compensation to members of the board of directors who are not employees of U.S. Cellular or TDS. U.S. Cellular issued 663 shares during the six months ended June 30, 2007 and 40 shares during the six months ended June 30, 2006.

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During the three and six months ended June 30, 2007 and 2006, U.S. Cellular recognized stock-based compensation costs of $5.2 million and $8.2 million and $3.1 million and $10.5 million, respectively. At June 30, 2007, unrecognized compensation cost for all U.S. Cellular stock-based compensation awards was $20.1 million. The unrecognized compensation cost for stock-based compensation awards at June 30, 2007 is expected to be recognized over a weighted average period of one year.

18.         Gain on Sale of Assets

In December 2006, U.S. Cellular entered into an agreement to sell $226.0 million face amount of accounts receivable previously written off for $5.9 million.  The agreement transferred all rights, title, and interest in the account balances, along with the right to collect all amounts due, to the buyer.  The sale was subject to a 180-day period in which the buyer may request a refund for unenforceable accounts.  The transaction was recognized as a sale during the fourth quarter of 2006 in accordance with the provisions of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with the gain deferred until expiration of the recourse period.  During the second quarter 2007, U.S. Cellular recognized a gain of $5.0 million, net of refunds for unenforceable accounts. The gain is included in Selling, general and administrative expense on the Consolidated Statements of Operations. All expenses related to the transaction were recognized in the period incurred.

19.         Supplemental Cash Flow Disclosures — Non-Cash Financing Activities; Gain on Sale of Marketable Equity Securities

During the second quarter of 2007, U.S. Cellular delivered 8,815,475 Vodafone ADRs with a fair market value of $254.1 million to settle the $159.9 million principal amount of prepaid forward contracts and $94.2 million of related derivative liability.

Upon settlement of the prepaid forward contracts and related derivative liability, U.S. Cellular disposed of its remaining 149,223 Vodafone ADRs.  U.S. Cellular recorded a gain of $131.7 million in the second quarter of 2007 on the settlement of the prepaid forward contracts and the related derivative liability and the disposition of remaining Vodafone ADRs.

See Note 9 — Marketable Equity Securities and Forward Contracts and Note 12 Long-Term Debt and Forward Contracts for additional information related to the Vodafone ADRs and prepaid forward contracts.

20.         Subsequent Events

On July 10, 2007, pursuant to its Limited Authorization, U.S. Cellular entered into an agreement to purchase 168,000 of its Common Shares, from an investment banking firm in a private transaction in connection with an ASR. See Note 15 - Common Share Repurchase Program for additional information.

U.S. Cellular owns 370,882 shares of Rural Cellular Corporation (“RCCC”).  On July 30, 2007, RCCC announced that Verizon Wireless has agreed to purchase the outstanding shares of RCCC for $45 per share in cash.  The acquisition is expected to close in the first half of 2008.  If the transaction closes, U.S. Cellular will receive approximately $16.7 million in cash, recognize a $16.4 million pre-tax gain and cease to own any interest in RCCC.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with U.S. Cellular’s interim consolidated financial statements included in Item 1 above, and with its audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in its Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2006.

OVERVIEW

United States Cellular Corporation (“U.S. Cellular”) owns, operates and invests in wireless markets throughout the United States. U.S. Cellular is an 80.7%-owned subsidiary of Telephone and Data Systems, Inc. (“TDS”) as of June 30, 2007.

U.S. Cellular differentiates itself from its competitors through a customer satisfaction strategy, reflecting a customer service focus, a high-quality wireless network and broad product distribution. U.S. Cellular’s business development strategy is to acquire, develop and operate controlling interests in wireless licenses in areas adjacent to or in proximity to its other wireless licenses, thereby building contiguous operating market areas.  U.S. Cellular’s operating strategy is to strengthen the geographic areas where it can continue to build long-term operating synergies and to exit those areas where it does not have opportunities to build such synergies.

U.S. Cellular offers wireless telephone service to approximately 6 million customers covering six market areas in 26 states as of June 30, 2007. U.S. Cellular is a limited partner in Barat Wireless, L.P. (“Barat Wireless”), an entity which participated in the auction of wireless spectrum designated by the FCC as Auction 66. During the second quarter of 2007, Barat Wireless was awarded the 17 licenses for which it was the successful bidder in Auction 66. U.S. Cellular owned, or had the right to acquire pursuant to certain agreements, interests in 253 wireless markets at June 30, 2007.

Results of Operations

The following is a summary of certain selected information contained in the comprehensive Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows. The overview does not contain all of the information that may be important. You should carefully read the entire Management’s Discussion and Analysis of Financial Condition and Results of Operations and not rely solely on the overview.

Operating highlights in the first six months of 2007 included the following:

·            Total customers increased 5% year-over-year to 6,010,000 and average monthly service revenue per customer increased 7% to $49.60;

·            The retail postpay churn rate per month was 1.3%. The total postpay churn rate per month, including reseller customers was 1.7%;

·            Cash flows from operating activities were $436.1 million. During the second quarter of 2007, U.S. Cellular paid off all outstanding balances under its revolving credit facility and, at June 30, 2007, had cash and cash equivalents totaling $146.1 million; and

·            Additions to property, plant and equipment totaled $246.8 million, including expenditures to construct cell sites, increase capacity in existing cell sites and switches, outfit new and remodel existing retail stores and continue the development and enhancements of U.S. Cellular’s office systems. Total cell sites in service increased 10% year-over-year to 6,140.

Service Revenues increased $205.9 million, or 13%, to $1,766.8 million in the six months ended June 30, 2007 from $1,560.9 million in 2006.  Revenues from data products and services increased 74% to $163.0 million in the six months ended June 30, 2007 from $93.7 million in 2006 as customers continue to increase usage of U.S. Cellular’s easyedgeSM products and offerings such as Short Messaging Service (SMS) and BlackBerry® handsets and service.

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Operating Income increased $83.1 million, or 56%, to $232.0 million in the six months ended June 30, 2007 from $148.9 million in 2006. The increase in Operating Income reflected both higher operating revenues and a higher operating income margin (as a percent of service revenues), which was 13.1% in the six months ended June 30, 2007 compared to 9.5% in 2006.  During the second quarter of 2007, U.S. Cellular recognized a gain on sale of assets of $5.0 million related to an agreement entered into during December 2006 to sell accounts receivable amounts written off during previous years.

Although operating income margin improved in 2007 on a year-over-year basis, U.S. Cellular anticipates that there will be continued pressure on its operating income and operating income margin in the next few years related to the following factors:

·                  costs of customer acquisition and retention;

·                  effects of competition;

·                  providing service in recently launched areas;

·                  potential increases in prepaid and reseller customers as a percentage of U.S. Cellular’s customer base;

·                  costs of developing and introducing new products and services; and

·                  continued enhancements to its wireless networks.

Investment and Other Income (Expense) totaled $132.1 million in the six months ended June 30, 2007 and $9.6 million in the same period of 2006. During the second quarter of 2007, U.S. Cellular elected to settle prepaid forward contracts related to Vodafone ADRs by delivering Vodafone ADRs and to sell the remaining Vodafone ADRs. In connection with the delivery and sale of the ADRs, U.S. Cellular recognized a pre-tax gain of $131.7 million.

Net Income in the first six months ended June 30, 2007 increased 148% to $222.0 million compared to $89.5 million in 2006. Basic Earnings per Share was $2.53 in 2007, which was $1.50 higher than last year and Diluted Earnings per Share was $2.50, which was $1.48 higher than last year. The increases in Net Income and Earnings per Share in 2007 compared to 2006 were attributable primarily to higher Operating Income and the gain recognized on the delivery and disposition of the Vodafone ADRs as discussed above.

During 2007, U.S. Cellular will continue to face challenges resulting from competition in the wireless industry and changes in the regulatory environment, including the effects of potential changes to the rules governing universal service. In addressing these challenges, U.S. Cellular will continue to focus on improving customer satisfaction, enhancing the quality of its networks and expanding its product and service offerings.

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RESULTS OF OPERATIONS

Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006.

Following is a table of summarized operating data for U.S. Cellular’s consolidated operations.

		2007			2006
As of June 30, (1a)
Total market population (2)		81,581,000			55,543,000
Customers (3)		6,010,000			5,704,000
Market penetration (4)		7.4		%	10.3		%
Total full-time equivalent employees		7,516			7,458
Cell sites in service		6,140			5,583
For the Six Months Ended June 30, (1b)
Net customer additions (5)		189,000			199,000
Net retail customer additions (5)		217,000			172,000
Average monthly service revenue per customer (6)		$	49.60		$	46.38
Retail postpay churn rate per month (7)		1.3		%	1.5		%
Total postpay churn rate per month (7)		1.7		%	1.5		%
Sales and marketing cost per gross customer addition (8)		$	451		$	453

(1a)          Amounts in 2007 include information related to all markets included in U.S. Cellular’s consolidated operations as of June 30, 2007.  Such markets include: (i) the market acquired during February 2007 from February 1 through June 30, 2007; and (ii) the markets related to the 17 licenses granted to Barat Wireless by the FCC in April 2007 which are incremental to U.S. Cellular’s currently owned or acquirable markets from April 30, 2007 through June 30, 2007. Amounts in 2006 include information related to all markets included in U.S. Cellular’s consolidated operations as of June 30, 2006. Such markets include: (i) the 11 markets granted to Carroll Wireless by the FCC in January 2006 for the period January 6 through June 30, 2006; and (ii) the additional market interest acquired during April 2006 for the period April 1, 2006 through June 30, 2006.

(1b)         Amounts in 2007 include results from all markets included in U.S. Cellular’s consolidated operations for the period January 1, 2007 through June 30, 2007.  The market acquired in February 2007 is included for the period February 1, 2007 through June 30, 2007.  Amounts in 2006 include results from all markets included in U.S. Cellular’s consolidated operations for the period January 1, 2006 through June 30, 2006. The 11 markets granted to Carroll Wireless by the FCC in January 2006 are included for the period January 6 through June 30, 2006. The additional market interest acquired during April 2006 is included for the period April 1, 2006 through June 30, 2006.

(2)                Represents 100% of the population of the markets in which U.S. Cellular had a controlling financial interest for financial reporting purposes as of June 30 of each respective year.

(3)                U.S. Cellular’s customer base consists of the following types of customers:

 

* Pursuant to its agreement with the third party, U.S. Cellular is compensated by the third party on a postpay basis; as a result, all customers U.S. Cellular has acquired through this agreement are considered to be postpay customers.

(4)                Calculated using 2006 and 2005 Claritas population estimates for 2007 and 2006, respectively. “Total market population” is used only for the purposes of calculating market penetration, which is calculated by dividing customers by the total market population, including unbuilt licenses (without duplication of population in overlapping markets).

(5)                “Net customer additions” represents the number of net customers added to U.S. Cellular’s overall customer base through all of its marketing distribution channels, excluding any customers transferred through acquisitions, divestitures or exchanges. “Net retail customer additions” represents the number of net customers added to U.S. Cellular’s customer base, excluding net reseller customers added to its reseller customer base, through its marketing distribution channels, excluding any customers transferred through acquisitions, divestitures or exchanges. See “Operating Income” below for information related to U.S. Cellular’s estimate of net retail customer additions for the full year 2007.

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(6)                Management uses this measurement to assess the amount of service revenue that U.S. Cellular generates each month on a per customer basis. Variances in this measurement are monitored and compared to variances in expenses on a per customer basis. Average monthly service revenue per customer is calculated as follows:

 

*  “Average customers during period” is calculated by adding the number of total customers, including reseller customers, at the beginning of the first month of the period and at the end of each month in the period and dividing by the number of months in the period plus one. Acquired and divested customers are included in the calculation on a prorated basis for the amount of time U.S. Cellular included such customers during each period.

(7)               Postpay churn rate per month represents the percentage of the postpay customer base that disconnects service each month. Total postpay churn rate includes both retail postpay customers and reseller customers.  Retail postpay churn rate includes only retail postpay customers. Effective for 2007, consistent with a change in U.S. Cellular's operating practices with its reseller, U.S. Cellular reports reseller customer disconnects as postpay disconnects in the period in which the reseller customers are disconnected by the reseller.  Previously, only those reseller customer numbers that were disconnected from U.S. Cellular's network were counted in the number of postpay disconnects; this previous practice reflected the fact that reseller customers could disconnect service without the associated account numbers being disconnected from U.S. Cellular's network if the reseller elected to reuse the customer telephone numbers. 

 

Total reseller disconnects totaled 161,000 for the six months ended June 30, 2007.  On a comparable basis, total reseller disconnects for the six months ended June 30, 2006 were estimated to be 210,000, versus the previously reported total of 42,000.  The total postpay churn rate per month for the six months ended June 30, 2007 was 1.7%.  On a comparable basis, the total postpay churn rate per month for the six months ended June 30, 2006 was estimated to be 2.0%, versus the previously reported figure of 1.5%. 

 

(8)               Sales and marketing cost per gross customer addition for 2007 and for 2006 is not comparable as a result of the change in operating practices with its reseller. For a discussion of the components of this calculation and the change in U.S. Cellular’s operating practices with its resellers, see “Operating expenses – Selling, general and administrative expenses”, below.  Excluding the impact of reseller gross customer additions, sales and marketing cost per gross customer addition in 2007 was $531 compared to $497 in 2006.

Operating Revenues increased $223.8 million, or 13%, to $1,906.3 million in 2007 from $1,682.5 million in 2006.

		Six Months Ended June 30,
		2007			2006
		(Dollars in thousands)
Retail service		$	1,543,050		$	1,375,335
Inbound roaming		89,352			74,089
Long-distance and other service revenues		134,399			111,503
Service Revenues		1,766,801			1,560,927
Equipment sales		139,519			121,586
		$	1,906,320		$	1,682,513

 

Service revenues increased $205.9 million, or 13%, to $1,766.8 million in 2007 from $1,560.9 million in 2006. Service revenues primarily consist of: (i) charges for access, airtime, roaming, recovery of regulatory costs and value-added services, including data products and services, provided to U.S. Cellular’s retail customers and to end users through third party resellers (“retail service”); (ii) charges to other wireless carriers whose customers use U.S. Cellular’s wireless systems when roaming (“inbound roaming”); (iii) charges for long-distance calls made on U.S. Cellular’s systems; and (iv) amounts received from the Federal Universal Service Fund (“USF”).  The increase in service revenues in 2007 was primarily due to the following factors:

·                  a 6% growth in the average customer base; and

·                  a 7% increase in monthly service revenue per customer, which averaged $49.60 in the first six months of 2007 and $46.38 in the first six months of 2006.

See footnote 6 to the table of summarized operating data in “Results of Operations” above for the calculation of average monthly service revenue per customer.

 

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