System operations expenses

System operations expenses decreased for the three and nine months ended September 30, 2017, when compared to the same periods last year, as a result of (i) a decrease in roaming expenses driven primarily by lower roaming rates, 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 three and nine months ended September 30, 2017, when compared to the same periods last year, was mainly due to a reduction in the number of devices sold as well as a decrease in the average cost of smartphones, partially offset by a mix shift from feature phones and connected devices to higher cost smartphones.  Loss on equipment, defined as Equipment sales revenues less Cost of equipment sold, was $35 million and $41 million for the three months ended September 30, 2017 and 2016, respectively, and $110 million and $144 million for the nine months ended September 30, 2017 and 2016, respectively.

Selling, general and administrative expenses

Selling expenses for the three and nine months ended September 30, 2017, decreased by $8 million and $24 million, respectively, mainly due to lower advertising expenses, including a decrease in sponsorship expenses related to the termination of a naming rights agreement during the third quarter of 2016; increases in commissions expenses were partially offsetting.  General and administrative expenses for the three and nine months ended September 30, 2017, decreased $11 million and $25 million, respectively, mainly due to lower bad debts and phone program expenses together with reductions in numerous other general and administrative categories. 

Loss on impairment of goodwill

During the third quarter of 2017, U.S. Cellular recorded a $370 million loss on impairment related to goodwill.  See Note 6 — Intangible Assets in the Notes to Consolidated Financial Statements for additional information.  

(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								Nine Months Ended
					September 30,								September 30,
											2017 vs.								2017 vs.
					2017			2016			2016		2017			2016			2016
(Dollars in millions)
Operating income (loss)¹					$	(360)		$	22		>(100)%		$	(301)		$	63		>(100)%
Equity in earnings of unconsolidated entities						35			38		(7)%			101			110		(8)%
Interest and dividend income1						2			1		68%			6			4		45%
Interest expense						(28)			(28)		(2)%			(85)			(84)		(1)%
Other, net						–			–		29%			1			–		(9)%
Total investment and other income1						9			11		(21)%			23			30		(25)%
Income (loss) before income taxes						(351)			33		>(100)%			(278)			93		>(100)%
Income tax expense (benefit)						(53)			15		>(100)%			(19)			39		>(100)%
Net income (loss)						(298)			18		>(100)%			(259)			54		>(100)%
Less: Net income (loss) attributable to    noncontrolling interests, net of tax						1			1		(9)%			2			1		>100%
Net income (loss) attributable to U.S. Cellular   shareholders					$	(299)		$	17		>(100)%		$	(261)		$	53		>(100)%
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 to Equity in earnings of unconsolidated entities for both the three months ended September 30, 2017 and 2016, and $50 million and $57 million for the nine months ended September 30, 2017 and 2016, respectively.  See Note 7 — Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information.

Income tax expense

U.S. Cellular’s effective tax rate on Income (loss) before income taxes for the three and nine months ended September 30, 2017, was not meaningful due primarily to the recognition of a loss on impairment of goodwill and for the three and nine months ended September 30, 2016, was 46.0% and 41.4%, respectively. Due to difficulty in reliably projecting an annual tax rate, U.S. Cellular calculated income taxes for the nine months ended September 30, 2017, based on an estimated year-to-date tax rate.

 

A reconciliation of U.S. Cellular’s income tax expense (benefit) computed at the statutory rate to the reported income tax expense (benefit) and effective tax rate is as follows:

			Nine Months Ended
			September 30,
			2017				2016
			Amount	Rate			Amount	Rate
(Dollars in millions)
Pretax income (loss)		$	(278)	N/A		$	93	N/A
Statutory federal income tax expense (benefit) and rate			(97)	35.0 %			33	35.0%
Goodwill impairment1			76	(27.3)%			–	0.0%
Other differences, net			2	(0.7)%			6	6.4%
Total tax expense (benefit) and rate		$	(19)	7.0 %		$	39	41.4%
1	Goodwill impairment reflects an adjustment to increase federal and state income tax expense by $76 million related to a portion of the goodwill impairment U.S. Cellular recorded which is nondeductible for tax purposes.  See Note 6 - Intangible Assets for a detailed discussion regarding the goodwill impairment.

 

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 in 2018.  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.

 

 

Short-term investments

At September 30, 2017, U.S. Cellular held $50 million of Short-term investments which consisted of U.S. Treasury Bills with original maturities of six months.  For these investments, U.S. Cellular’s objective is to earn a higher rate of return on funds that are not anticipated to be required to meet liquidity needs in the immediate future while maintaining low investment risk.  See Note 2 – Fair Value Measurements in the Notes to Consolidated Financial Statements for additional details on short-term investments.

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 September 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 September 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 and existing cash balances.

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 nine months ended September 30, 2017, net equipment installment plan receivables totaling $1,093 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:

		Nine Months Ended
		September 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 September 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 nine months ended September 30, 2017 and 2016.

2017 Commentary

U.S. Cellular’s Cash and cash equivalents decreased $88 million in 2017.  Net cash provided by operating activities was $394 million and was offset by Cash flows used for investing activities of $472 million and Cash flows used for financing activities of $10 million.

Net cash provided by operating activities consisted of net income adjusted for non-cash items of $477 million, distributions received from unconsolidated entities of $85 million, including $30 million in distributions from the LA Partnership, and changes in working capital items which decreased net cash by $168 million.  The non-cash items included a $370 million loss on impairment of goodwill.  The decrease resulting from changes in working capital items was due in part to a $164 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.  

Cash flows used for investing activities were $472 million.  Cash paid in 2017 for additions to property, plant and equipment totaled $252 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.  Cash paid for investments was $50 million which included the purchase of short-term Treasury bills.  This was partially offset by Cash received from divestitures and exchanges of $19 million.  See Note 5 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to these transactions.

Cash flows used for financing activities were $10 million, primarily for scheduled repayments of debt.

2016 Commentary

U.S. Cellular’s Cash and cash equivalents decreased $41 million in 2016.  Net cash provided by operating activities was $415 million in 2016 due to net income of $54 million plus non-cash items of $450 million and distributions received from unconsolidated entities of $55 million including a $10 million distribution from the LA Partnership.  This was partially offset by changes in working capital items which decreased cash by $144 million.  The decrease in working capital items was due primarily to a $160 million increase in equipment installment plan receivables. This was partially offset by a federal tax refund of $28 million related to an overpayment of the 2015 tax liability, which resulted from the enactment of federal bonus depreciation in December 2015. 

The net cash provided by operating activities was offset by Cash flows used for investing activities of $449 million.  Cash paid in 2016 for additions to property, plant and equipment totaled $280 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 $20 million.

Cash flows used for financing activities were $7 million, reflecting ordinary activity such as scheduled repayments of debt.

 

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:

Cash and cash equivalents

Cash and cash equivalents decreased $88 million due primarily to the purchase of $50 million in short-term investments.  See the Consolidated Cash Flow analysis above for a discussion of cash and cash equivalents.

Short-term investments

Short-term investments increased $50 million due to the purchase of short-term investments, which consisted of U.S. Treasury Bills with original maturities of six months.  See Note 2 – Fair Value Measurements in the Notes to Consolidated Financial Statements for additional details on short-term investments.

Inventory, net

Inventory, net decreased $36 million due primarily to overall improvements in inventory planning and procurement practices.

Licenses

Licenses increased $339 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.

Goodwill

Goodwill decreased $370 million due to the impairment loss recorded in the third quarter of 2017.  See Note 6 — Intangible Assets in the Notes to Consolidated Financial Statements for additional information.

Accounts payable — Trade

Accounts payable — Trade decreased $50 million due primarily to reduction of expenses in 2017 as well as payment timing differences.

Accrued taxes

Accrued taxes increased $26 million due primarily to the excess of current income tax expense over federal estimated payments made during the nine months ended September 30, 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
• Goodwill impairment, net of tax

 

Following are explanations of each of these measures.

Adjusted EBITDA and Adjusted OIBDA

Adjusted EBITDA is defined as net income (loss) adjusted for the items set forth in the reconciliation below.  Adjusted OIBDA is defined as net income (loss) 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 (loss) 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 (loss) 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 (loss).

 

			Three Months Ended						Nine Months Ended
			September 30,						September 30,
			2017			2016			2017			2016
(Dollars in millions)
Net income (loss) (GAAP)			$	(298)		$	18		$	(259)		$	54
Add back:
	Income tax expense (benefit)			(53)			15			(19)			39
	Interest expense			28			28			85			84
	Depreciation, amortization and accretion			153			155			460			462
EBITDA (Non-GAAP)				(170)			216			267			639
Add back or deduct:
	Loss on impairment of goodwill			370			–			370			–
	(Gain) loss on sale of business and other exit costs, net			(1)			–			(1)			–
	(Gain) loss on license sales and exchanges, net			–			(7)			(19)			(16)
	(Gain) loss on asset disposals, net			5			7			14			16
Adjusted EBITDA (Non-GAAP)				204			216			631			639
Deduct:
	Equity in earnings of unconsolidated entities			35			38			101			110
	Interest and dividend income1			2			1			6			4
	Other, net			–			–			1			–
Adjusted OIBDA (Non-GAAP)1				167			177			523			525
Deduct:
	Depreciation, amortization and accretion			153			155			460			462
	Loss on impairment of goodwill			370			–			370			–
	(Gain) loss on sale of business and other exit costs, net			(1)			–			(1)			–
	(Gain) loss on license sales and exchanges, net			–			(7)			(19)			(16)
	(Gain) loss on asset disposals, net			5			7			14			16
Operating income (loss) (GAAP)¹			$	(360)		$	22		$	(301)		$	63
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.