RESULTS OF OPERATIONS

Nine Months Ended 9/30/02 Compared to Nine Months Ended 9/30/01

Following is a table of summarized operating data for the Company's consolidated operations.

Investment and other income decreased $284.9 million in 2002, primarily due to the $278.9 million in losses recorded on the writedown of investments in 2002. Net income and diluted earnings per share decreased $173.9 million and $1.99, respectively, in 2002. A summary of the after-tax effects of the losses on investments, license and goodwill amortization and losses on the retirement of debt on net income and diluted earnings per share in both 2002 and 2001 is shown below.

The Company has been transitioning the operations of Chicago 20MHz from PrimeCo to U.S. Cellular since the acquisition date in August 2002, and is reorganizing its operations to increase efficiency. The Company launched its “U.S. Cellular” brand in the Chicago 20MHz licensed area in the fourth quarter of 2002. In conjunction with this brand launch, the Company plans to incur additional costs for advertising and customer care in 2002 and 2003. Additionally, the Company plans to invest approximately $90 million in capital expenditures during the first year following the Chicago 20MHz acquisition. These capital investments will improve coverage in the Chicago 20MHz network, including an upgrade of the current CDMA system to 1XRTT, and will enhance the Company’s marketing distribution in the Chicago market.

Operating Revenues

The operating revenues of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating revenues. Following is a summary of operating revenues for the nine months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001.

Monthly local retail minutes of use per customer averaged 274 in 2002 and 208 in 2001. The increase in monthly local retail minutes of use was driven by the Company’s focus on designing incentive programs and rate plans to stimulate overall usage. This increase was partially offset by a decrease in average revenue per minute of use in 2002. Management anticipates that the Company’s average revenue per minute of use will continue to decline in the future, reflecting increased competition and continued penetration of the consumer market.

Inbound roaming revenue decreased $18.3 million, or 9%, in 2002. The decline in inbound roaming revenue resulted from the decrease in revenue per roaming minute of use on the Company’s systems, partially offset by an increase in roaming minutes used. The increase in inbound roaming minutes of use was primarily driven by the overall growth in the number of customers throughout the wireless industry. The decline in revenue per minute of use is primarily due to the general downward trend in negotiated rates.

Management anticipates that the rate of growth in inbound roaming minutes of use will be reduced due to two factors:

• newer customers may roam less than existing customers, reflecting further penetration of the consumer market; and
• as wireless operators expand service in the Company’s markets, the Company’s roaming partners could switch their business to these operators.

Management also anticipates that average inbound roaming revenue per minute of use will continue to decline, reflecting the continued general downward trend in negotiated rates.

Long-distance and other revenue increased $3.8 million, or 3%, in 2002 as the volume of long-distance calls billed by the Company increased, primarily from inbound roamers using the Company’s systems to make long-distance calls. This effect was partially offset both by price reductions primarily related to long-distance charges on roaming minutes of use as well as the Company’s increasing use of pricing plans which include long-distance calling at no additional charge. Monthly long-distance and other revenue per customer averaged $3.59 in 2002 and $3.78 in 2001.

Equipment sales revenues increased $26.7 million, or 52%, in 2002. The increase in equipment sales revenues reflects a change in the Company’s method of distributing handsets to its agent channel. Beginning in the second quarter of 2002, the Company began selling handsets to its agents at a price approximately equal to the Company’s cost. Previously, the Company’s agents purchased handsets from third parties. Selling handsets to agents enables the Company to provide better control over handset quality, set roaming preferences and pass along quantity discounts. These handset sales to agents increased equipment sales revenue by approximately $31 million during 2002. This impact was partially offset by the recognition of previously deferred revenues which increased revenue by $5.2 million in 2001. Management anticipates that the Company will continue to sell handsets to agents in the future.

Operating Expenses

The operating expenses of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating expenses. Following is a summary of operating expenses for the nine months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001.

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Marketing and selling expenses increased $43.5 million, or 20%, in 2002. Marketing and selling expenses primarily consist of salaries, commissions and expenses of field sales and retail personnel and offices; agent expenses; corporate marketing, merchandise management and telesales department salaries and expenses; advertising; and public relations expenses. The increase in 2002 was primarily due to the following factors:

• enhancements made to the Company’s merchandise management and telesales processes and the development of data services strategies, which resulted in an $18.6 million increase in 2002;
• a $9.7 million increase in commissions and related payments to Company personnel and third-party agents; and
• a $7.2 million increase in advertising costs, primarily related to certain pricing promotions implemented in the second quarter of 2002.

Also, during the second half of 2001, the Company changed certain agent compensation plans to reduce the base commission payment and include future residual payments to agents. Such residual payments recognize the agent’s role in providing ongoing customer support, promote agent loyalty and encourage agent sales to customers who are more likely to have greater usage and remain customers for a longer period of time. As a greater percentage of the Company’s customer base becomes activated by agents receiving residual payments, it is possible that the Company’s aggregate residual payments to agents may grow by a larger percentage than the growth in the Company’s gross customer activations.

Cost of equipment sold increased $21.1 million, or 22%, in 2002. The increase is primarily due to the approximately $29 million in handset costs related to the sale of handsets to agents beginning in the second quarter of 2002. Excluding these costs, cost of equipment sold decreased by approximately $8 million, or 7%, in 2002, reflecting reduced per unit handset prices and a 2% decline in gross customer activations.

Marketing cost per gross customer activation (“CPGA”), which includes marketing and selling expenses and equipment subsidies, increased 17% to $363 in 2002 (excluding the effect of Chicago 20MHz) from $311 in 2001. The following summarizes the components of CPGA:

The Company anticipates that customer retention expenses will increase in the future as it changes to a single digital technology platform and certain customers will require new handsets.

Monthly general and administrative expenses per customer increased 2% to $11.22 in 2002 from $11.00 in 2001. General and administrative expenses represented 24% of service revenues both in 2002 and 2001.

Depreciation expense increased $49.1 million, or 28%, in 2002. The increases reflect rising average fixed asset balances, which increased 21% in 2002. Increased fixed asset balances in 2002 resulted from the following factors:

• the addition of new cell sites built to improve coverage and capacity in the Company’s markets;
• the addition of digital radio channels to the Company’s network to accommodate increased usage;
• upgrades to provide digital service in more of the Company’s service areas;
• the commencement of the migration of the Company’s network to a single digital equipment platform; and
• investments in the Company’s billing and office systems.

See “Financial Resources and Liquidity – Liquidity and Capital Resources” for further discussion of the Company’s capital expenditures.

In addition, depreciation expense increased $15.0 million in 2002 to reflect the writeoff of certain analog radio equipment based on fixed asset inventory reviews performed in 2002.

Amortization of intangibles decreased $25.6 million, or 54%, in 2002. In accordance with SFAS No. 142, effective January 1, 2002, the Company no longer amortizes previously recorded goodwill and intangible assets with indefinite lives. These assets will be subject to periodic impairment tests. No impairment charge was required to be recorded upon the completion of the initial impairment review. In the first nine months of 2001, amortization of these intangibles totaled $27.1 million.

Operating Income

Operating income totaled $243.6 million in 2002, a decrease of $1.2 million, or less than 1%, from 2001. The operating income margins (as a percent of service revenues) were 16.0% in 2002 and 17.9% in 2001. Excluding the effect of SFAS No. 142 on amortization of intangibles, operating income would have decreased $28.3 million, or 10%, in 2002. Excluding amortization of intangibles related to licenses and goodwill, 2001’s operating income margin would have been 19.9%. Excluding the operations of Chicago 20MHz, 2002’s operating income would have been $248.9 million and the operating income margin would have been 16.6%.

The decline in operating income and operating income margin in 2002 reflects the following:

• increased marketing and selling expenses, primarily driven by increased costs related to improvements in the Company’s telesales and merchandise management processes, commissions and agent-related expenses and advertising expenses; and
• increased depreciation expense, driven by an increase in average fixed assets and a writeoff of analog radio equipment.

These were partially offset by the following factors:

• increased service revenues, driven by growth in the number of customers served by the Company's systems; and
• a decrease in amortization of intangibles due to the implementation of SFAS No. 142.

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Long-distance and other revenue increased $1.9 million, or 5%, in 2002 as the volume of long-distance calls billed by the Company increased, primarily from inbound roamers using the Company’s systems to make long-distance calls. This effect was partially offset both by price reductions primarily related to long-distance charges on roaming minutes of use as well as the Company’s increasing use of pricing plans which include long-distance calling at no additional charge. Monthly long-distance and other revenue per customer averaged $3.95 in 2002 and $4.08 in 2001.

Equipment sales revenue increased $12.8 million, or 59%, in 2002, primarily due to the change in the Company’s method of distributing handsets to its agent channel. These handset sales to agents increased equipment sales revenue by approximately $23 million during 2002. Excluding the sales of handsets to agents in 2002, equipment sales revenues would have decreased approximately $10 million. The decrease was primarily due to the reduction in per unit prices for handsets in 2002 and the recognition of previously deferred revenues which increased revenue by $5.2 million in 2001, partially offset by the effect of a 7% increase in gross customer activations.

The operating expenses of Chicago 20MHz for the period from the acquisition date through September 30, 2002 are included in the Company’s consolidated operating expenses. Following is a summary of operating expenses for the three months ended September 30, 2002 excluding the effect of Chicago 20MHz, and the resulting variances from the same period of 2001.

Marketing cost per gross customer activation (“CPGA”), which includes marketing and selling expenses and equipment subsidies, increased 19% to $340 in 2002 (excluding the effect of Chicago 20MHz) from $285 in 2001. The following summarizes the components of CPGA:

Cash flows from financing activities provided $374.2 million in 2002 and $39.4 million in 2001. In 2002, the Company received $159.9 million from the VOD contracts and received $105.0 million from TDS through the Intercompany Note. The Company repaid $306.4 million in 2002 and $22.5 million in 2001 under the 1997 Revolving Credit Facility. Borrowings under the 1997 Revolving Credit Facility totaled $422.4 million in 2002, primarily to fund the Chicago 20MHz acquisition, and $118.5 million in 2001. In 2001, the Company paid $30.1 million in cash, recorded $612,000 of accounts payable for payments made in October 2001 and issued 550,000 USM Common Shares to satisfy the conversion of $113.5 million face value ($49.4 million carrying value) of LYONs by the holders. In 2001, the Company paid $25.8 million for the repurchase of 322,600 of its Common Shares. The cash paid includes $11.0 million paid in 2001 for repurchases executed in December 2000, and excludes $1.0 million of accounts payable recorded for payments made in October 2001.

Acquisitions and Divestitures

Acquisitions

The Company assesses its wireless holdings on an ongoing basis in order to maximize the benefits derived from clustering its markets. The Company also reviews attractive opportunities for the acquisition of additional wireless spectrum.

Acquisition of Chicago 20MHz

On August 7, 2002, the Company completed the acquisition of Chicago 20MHz, representing 13.2 million pops, for approximately $607 million, subject to certain working capital and other adjustments. The Company financed the purchase using its 1997 Revolving Credit Facility, the $175 million 9% Series A Notes and the $105 million Intercompany Note with TDS. Net of cash acquired in the transaction and bonds issued to the sellers of Chicago 20MHz, the Company used cash totaling $430.4 million for the acquisition of Chicago 20MHz. See “Liquidity and Capital Resources – Financing of Chicago 20MHz Acquisition.”

The Chicago MTA is the fourth largest MTA in the United States. The markets that comprise the Chicago MTA are adjacent to the Iowa, Illinois, Wisconsin and Indiana markets of the Company’s Midwest cluster, which is its largest market cluster. Of the total Chicago MTA population of 13.2 million, approximately 81% was not previously covered by the Company’s licenses. There is a strong community of interest between the Company’s existing markets and the Chicago 20MHz markets. The Chicago MTA is the single largest roaming destination of the Company’s current customers.

Chicago 20MHz owns licenses covering the 18 Basic Trading Areas (“BTAs”) that comprise the Chicago MTA. The Chicago MTA includes, among others, the Chicago, Bloomington-Normal, Champaign-Urbana, Decatur-Effingham, Peoria, Rockford and Springfield BTAs in Illinois, the South Bend and Fort Wayne BTAs in Indiana and the Benton Harbor BTA in Michigan. The Chicago 20MHz network currently covers approximately 73% of the population in the licensed area.

Chicago 20MHz utilizes Code Division Multiple Access (“CDMA”) technology in a network which serves the Chicago MTA with over 500 cell sites. Chicago 20MHz currently serves approximately 305,000 customers, representing a penetration rate of approximately 2.3% based on 2001 Claritas population estimates for the licensed area of Chicago 20MHz.

Chicago 20MHz utilizes both direct and indirect distribution channels, with direct distribution provided through 34 stores and kiosks, and indirect distribution through approximately 600 authorized agents. In addition, Chicago 20MHz has approximately 720 replenishment locations for its prepaid customers. The Company launched its “U.S. Cellular” brand in the Chicago 20MHz licensed area in the fourth quarter of 2002.

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Critical Accounting Estimates

Management believes the following critical accounting estimates reflect its more significant judgments and estimates used in the preparation of its consolidated financial statements.

Valuation of Notes Receivable

The Company holds notes receivable aggregating $45.8 million from Kington Management Corporation (“Kington”) that are due in June 2005. These notes relate to the purchase by Kington of two of the Company’s minority interests in 2000. The value of these notes is directly related to the future fair market value of the related interests. An independent third party valuation of one of the wireless minority interests sold to Kington and a recent transaction involving an unrelated party holding an interest in the same market as the other wireless minority interest sold to Kington indicated a lower market value for these wireless minority interests, and therefore a lower value of the notes. Management concluded that the notes receivable were impaired and established a valuation allowance against the notes. A loss of $34.2 million was charged to the statement of operations in the third quarter of 2002 and was included in the caption (Loss) on Wireless and Other Investments. Following this writedown, the carrying value of such notes receivable at September 30, 2002 is $11.6 million. If or when the market values for the related wireless interests will recover is unclear. There may continue to be substantial variability in the future market values of these interests and risk of further decline in the value of the notes. Management will continue to review the valuation on a periodic basis.

Marketable Equity Securities

The Company holds a substantial amount of marketable securities that are publicly traded and can have volatile share prices. These investments are classified as available-for-sale and are stated at fair value based on quoted market prices. The reported value of the marketable securities is adjusted to market value each period with the unrealized gain or loss in value of the securities reported as Other Comprehensive Income, net of income taxes, which is included in the common shareholders’ equity section of the balance sheet.

The market values of marketable securities may fall below the accounting cost basis of such securities. GAAP requires management to determine whether a decline in fair value below the accounting cost basis is other than temporary. If management determined that the decline in value of the Company’s marketable securities was other than temporary, the unrealized loss included in Other Comprehensive Income would be recognized and recorded as a loss in the statement of operations.

Factors that management reviews in determining an other than temporary decline include the following:

• whether there has been a significant change in the financial condition, operational structure or near-term prospects of the issuer;
• how long and how much the value of the security has been below historical cost; and
• whether the Company has the intent and ability to retain its investment in the issuer’s securities to allow the market value to return to historical cost levels.

The Company is in the same industry classification as the issuers of its marketable securities, enhancing the Company’s ability to evaluate the effects of any changes in industry-specific factors which may affect the determination of whether a decline in market values of its marketable securities is other than temporary.

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The valuation allowance relates to state net operating loss carryforwards that are expected to expire before they can be utilized.

The Company is included in a consolidated federal income tax return with other members of the TDS consolidated group. TDS and the Company are parties to the TDS Tax Agreement. The TDS Tax Agreement provides that the Company 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. The Company and its subsidiaries calculate their income and credits as if they comprised a separate affiliated group. Under the TDS Tax Agreement, the Company remits its applicable income tax payments to TDS.

The Internal Revenue Service has completed audits of tax years through 1996. The Company expects to pay $33.6 million, including interest, to TDS in the fourth quarter of 2002 related to the Company’s share of tax liabilities from the most recent audit. The $33.6 million liability was included in Accrued Taxes on the September 30, 2002 balance sheet and was provided for in the income tax provisions in prior periods.

Initial Adoption of Accounting Policies

During 2002, the Company began utilizing derivative financial instruments to reduce market risks due to fluctuations in market prices of marketable equity securities. Prior to 2002, the Company had no significant derivative financial instruments. The Company does not hold or issue derivative financial instruments for trading purposes. The Company recognizes all derivatives as either assets or liabilities in the statement of financial condition and measures those instruments at fair value. Changes in fair value of those instruments will be reported in earnings or other comprehensive income depending on the use of the derivative and whether it qualifies for hedge accounting. The accounting for gains and losses associated with changes in the fair value of the derivative and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of the hedged item or cash flows of the asset or liability hedged. Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” (as amended) establishes the accounting and reporting standards for derivative instruments and hedging activities.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

In August 2002, the Company entered into a loan agreement with TDS under which it borrowed $105 million, which was used for the Chicago 20MHz purchase. The loan bears interest at an annual rate of 8.1%, payable quarterly, and becomes due in August 2008, with prepayments optional. The loan is subordinated to the 2002 Revolving Credit Facility. The Company’s Board of Directors, including independent directors, approved the terms of this loan and determined that such terms were fair to the Company and all of its shareholders.

The Company is billed for all services it receives from TDS, pursuant to the terms of various agreements between the Company and TDS. The majority of these billings are included in the Company’s general and administrative expenses. Some of these agreements were established at a time prior to the Company’s initial public offering when TDS owned more than 90% of the Company’s outstanding capital stock and may not reflect terms that would be obtainable from an unrelated third party through arms-length negotiations. The principal arrangements that affect the Company’s operations are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, which is incorporated by reference herein. Management believes the method TDS uses to allocate common expenses is reasonable and that all expenses and costs applicable to the Company are reflected in the Company’s financial statements on a basis which is representative of what they would have been if the Company operated on a stand-alone basis.

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