Telephone and Data Systems, Inc.
Q1 2008 Earnings Call Transcript

Published: 7 May 2008

[Operator:]

Good morning. My name is Michael and I will be your conference operator today. At this time I would like to welcome everyone to the First Quarter Operating Results Conference Call for Telephone & Data Systems and U.S. Cellular. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. [Operator Instructions]. Thank you. I will now turn the call over to Mr. Mark Steinkrauss.

[Mark A. Steinkrauss:]

Hi, thank you Michael. Good morning everybody and thanks for joining us as we wind down the earnings release season. With me today are Ken Meyers, Executive VP and CFO at TDS; Steve Campbell, Executive VP of Finance, CFO, and Treasurer at U.S. Cellular; Bill Megan, Executive VP, Finance and CFO at TDS Telecom; and also joining us are Jack Rooney, CEO of U.S. Cellular and Jay Ellison, Executive VP and Chief Operating Officer. A replay of the teleconference will be available today at 1 PM Chicago time, will run through midnight Thursday, May 8th. The replay number is 800-642-1687, conference ID 45884257. For international callers the number is 706-645-9291 same pass code. The call is being simultaneously webcast on the Investor Relations sections of both the TDS and U.S. Cellular websites. The webcast will be available for the next two weeks after which it will be available in the conference call archive. Please recall that archived calls are not updated. Some information during this call and subsequent Q&A period contains statements about expected future events and financial results that are forward-looking and subject to risk and uncertainties. Please review the Safe Harbor paragraph in our releases and the more extended version on our websites as well as in our filings with the SEC. Shortly after we released our earnings results earlier this morning and before this call, TDS and U.S. Cellular filed 8-K. The 8-K include both press releases we issued this morning and some additional information and I encourage you to take a look at these. Both press releases have been posted to the TDS internet homepage and the U.S. Cellular have posted their release to their website as well. You will also find posted on our website additional information and reconciliation of non-GAAP financial measures that maybe used by management when discussing the operating data during today's teleconference as well as some of the company's guidance for 2008. Two of the reconciliations offer net income and diluted earnings per share. The reconciliation provides net income, EPS, less the effect of gains and losses on investments and financial investments. All of this information is included on a separate page entitled Guidance and Reconciliation to make it easier to find. The information can also be accessed on the conference call page of the Investor Relations sections of both websites. Please note that the comparisons made by the speakers today in their prepared remarks are first quarter year-to-year compares unless otherwise indicated. We have added a consolidated statement of cash flow to the press release to allow you to access some key information more quickly and we will continue to provide this information going forward. We will be presenting at the following investment conferences all within the next month or so. Next week, May 13th, at the Baird Growth Stock Conference in Chicago; May 14th, at the Morgan Stanley 13th Annual Communications Conference in Washington DC.; May 28th, Lehman Brothers World-Wide Wireless and Wireline Conference in New York City; June 9th, the Deutsche Bank Annual Meeting and Telecommunications Conference in New York City; and June 10th, the Credit Suisse Convergence Conference in Dana Point, California. We'll also be meeting with the investors in Toronto and Montreal on June 26th and 27th. If you would like to meet with any of us at these events, please let me know and we will work with the host to arrange a meeting time. So, with that I am going to turn the call over Ken Meyers.

[Kenneth R. Meyers:]

Good morning and thank you for joining us today. I have a few comments to make before turning the call over to Steve and Bill, who'll cover the operating results of their respected businesses. Then we will all take questions at the end of the prepared remarks. I am pleased to report first quarter results for TDS with operating revenues and operating income each up 8%. Quickly we cover our year-over-year non-operating comparisons of the income statement. First, interest and dividend income is down about $6.5 million due to lower rates and interest bearing cash investments. We made a decision in the fall of 2007, to move our cash investments into treasuries knowing that while we are giving up some yields, it will ensure that our cash was safe. Interest expense is down over $16 million principally due to the settlement of a number of variable prepaid forward contracts since last year. This quarter we delivered a substantial majority of the 30 million Deutsche Telekom shares in settlement of the forward contracts which matured during the quarter and sold the remaining shares. In the quarter TDS adopted statement of the accounting... Financial Accounting Standards 159. By adopting SFAS 159 for both the Deutsche Telekom stock and the related covers, gains and losses on both these items are expected to largely offset each other which should reduce large income statement swings that resulted from the application of FAS 133, as a fair value adjustment of derivative instruments. The impact on the balance sheet from the adoption of SFAS 159 this quarter was to reclassify approximately $500 million of unrecognized gains out of accumulated other comprehensive income and into beginning retained earnings. As noted in our release, under TDS's current stock repurchase authorization, to date the company has bought back 3.1 million special common shares for total consideration of $172 million. As of the end of the quarter, there is $78.2 million remaining under that authorization. U.S. Cellular continues to purchase shares under it's deminimus program purchasing a 150,000 shares in the first quarter. Also during the quarter, the FCCC auction spectrum is a 700 megahertz ban on this auction 73. U.S. Cellular participated in the auction indirectly towards interest in King Street Wireless L.P. King Street Wireless was a provisional winning bidder of 152 licenses for an aggregate bid of $300.5 million net of the designated entry discount, which was recorded as licenses on U.S. Cellular's balance sheet as of March 31. U.S. Cellular made a contribution in the first quarter to King Street of about $97 million, in April made an additional contribution of $203 million. U.S. Cellular financed these amongst with cash on hand and through its revolving credit agreement. As you know, we remediated two of three material weakness at year-end. We continue to make progress on our final material weakness, income tax accounting. We are working towards remediation of that on or before the filings of this year's 10-K. For the year we expect the effective tax rate for both companies to be approximately 40%. Finally we have ended the quarter with a very strong balance sheet of $1.2 billion in cash, all of which is invested in treasuries, which is all of the credit facilities that are unused, to leave a lot of financial flexibility. With that let me turn the call over to Steve Campbell to talk about the operations of the U.S. Cellular. Steve?

[Steven T. Campbell:]

Thanks Ken and good morning everyone. I will begin with a few general comments about the business and then I will highlight some of the key results for the quarter. First quarter was a challenging one for us. Although our results in some areas were not as strong we intended, on balance we delivered pretty solid results. Total customers increased to 6.2 million at March 31st up 4% from the prior year. We added 85,000 net retail customers during the quarter. This was down about 42% from the exceptionally strong quarter we had a year ago but on the positive side it represents an increase of 33% on a sequential basis. Also on the positive side we are reporting double-digit growth in service revenues and operating income and growth in operating cash flow. Growth in data revenues was especially strong again this quarter. However, competition in the industry continues to be intense and this is driving increased cost with customer acquisition and retention in a number of areas of our business. In turn, these increased costs have exerted some pressure on our operating margins. To alleviate some of that pressure and margins we are taking actions designed to reduce or limit growth and our discretionary spending over the balance of the year. We are also taking steps to promote additional growth in revenues. For example, over the past couple of quarters we've seen increased demand for smartphones and the advanced data services that they enable. As a result we have decided to expand our deployment EVDO [ph] Technology and Services to additional selected markets. Work on this expansion has started and we expect to offer EVDO services in these additional markets in the fourth quarter. As Ken mentioned, to strengthen our operating footprint as a foundation for future growth, we participated through our interest in King Street Wireless in the recent FCC auction of 700 megahertz spectrum. Kings Street Wireless was the provisional wining bidder of 152 licenses covering 42 million props in areas that primarily overlapped or are approximate or contiguous to areas covered by licenses that we currently own. Consistent with our objectives going in to the auction, we were able to increase the depth of our footprint to meet future capacity and new technology requirements. We didn't launch any new markets during the first quarter and don't have any plans along those lines at the present time. For the balance of the year, we intend to focus on increasing customers, revenues, and profitability within our existing markets and of course, we continue our relentless focus on customer satisfaction, including a commitment to ensuring that our customers have access to a high quality network. During April 2008, we received our fifth consecutive J.D. Power and Associates Award for highest call quality in the middle central region. As you probably know, on April 29th, the FCC adopted an order, placing an interim cap on dispersements from the universal service fund high cost program. U.S. Cellular is disappointed by the FCC's action because we believe it will slow the expansion of affordable and dependable wireless services into rural and underserved areas. Although we are still analyzing the order, we understand that the cap will have an indefinite duration, be imposed on a state-by-state basis, and limit funding to wireless CTCs for the amount being received in any given state in March 2008. Plus while that cap is in effect, U.S. Cellular likely will receive less support than it otherwise would have been eligible to receive. During the first quarter, we received ETC funding of approximately $30 million. The level of ETC funding that we will receive in the future is somewhat uncertain but we don't expect much of a change over the next couple of quarters. With that overview, now I'll discuss some of the details of our first quarter results. As I mentioned, retail net adds for the quarter were 85,000 and the retail postpaid segment, our primary area of focus, we added 72,000 net new customers. Postpaid customers represent approximately 95% of our total retail customer base. Retail postpaid churn remains low at approximately 1.4%. This is up about 10 basis points year-over-year but its down by about 10.10 basis points sequentially. Service revenues of $962 million increased 12% year-over-year and ARPU of $52.06 was up 7%. We continue to see substantial growth in our data revenues which were up 49% to $116 million. Data now represents about 12% of our total service revenues up from 9% a year ago and with plenty of room still to grow. Operating income for the quarter was $119 million up about 10% year-over-year, while operating cash flow was $265 million up about 3%. As I mentioned earlier higher costs in a number of areas put some pressure on margins. The net equipment subsidy for the quarter was $98 million up 28%. Factors here include a higher net subsidy per unit reflecting handsets with expanded capabilities including smartphones and very aggressive promotions across the industry. We have experienced solid growth in service revenues and data revenues in particular and the equipment subsidy as a cost of getting those additional revenues. We expect the expanded capabilities of the handsets to drive additional growth in data revenues in the future. System operations expenses for the quarter were $191 million, up about 14% of the increase reflected, an increased number of sell sides and service, higher total customer minutes of use, and higher expenses when customers used other carriers networks when roaming. In the SG&A category, advertising expenses increased almost $60 million or 38% primarily due to media purchases. This expenditure reflected efforts to stimulate higher gross ads following disappointing results in the fourth quarter. Investments in other income totaled $3.1 million compared to $13.8 million in the prior year. The decrease is related primarily to the gain on fair value adjustment of derivative instruments recorded in 2007. As a reminder, U.S. Cellular settled those derivatives in May 2007. Net income for the quarter was approximately $71 million or $0.80 per diluted share. As I mentioned earlier, the company generated operating cash flow of $265 million during the quarter. We used some of that cash to fund capital expenditures of $112 million, about the same amount as we spend in the prior year and to make a capital contribution of $97 million to King Street Wireless to allow it to participate in the 700 megahertz auction. As Ken mentioned, we also repurchased a 150,000 of our common shares at a cost of 10.8 million. At March 31st, the company's cash balance was $216 million and its revolving credit facility was on use. Shortly, after quarter end, we borrowed $100 million under the revolving credit facility. These proceeds together with cash on hand of a $103.5 million were contributed to King Street Wireless who in turn used them to pay the FCC for its remaining obligation incurred in the spectrum auction. Finally our updated guidance for the full year 2008 is contained in today's press release. We are confirming our guidance for service revenues. In light of our first quarter results and the uncertain economic and competitive outlooks, we are lowering our guidance for both retail net adds and operating income. We also reduced the range of spending on capital expenditure. As I indicated earlier we are taking actions designed to reduce or limit growth by discretionary spending over the balance of the year. Our goal is to continue to drive the growth in revenues, operating income, and cash flow, while not compromising our customer satisfaction strategy at relative competitive position in the market. Now I'll turn the call over to Bill Megan for a discussion of TDS Telecom's results. Bill.

[Bill Megan:]

Thank you Steve, good morning everyone. The headline for the quarter at TDS Telecom is that notwithstanding a revenue decline we reduced cost and hold cash flow even. We increased DSL subscribers by 31% and we improved our quarterly access line loss rate to the levels of a year ago. For the quarter, combined ILEC and CLEC revenues declined by 11.5 million or 5% with the decline split evenly between the segments. The principle drivers on the ILEC side were access line losses which were 5.1% year-on-year but improved sequentially down from a loss of 9500 lines in fourth quarter of 2007 to 6400 lines in the current quarter. We also received lower access revenues as intrastate minutes of use declined 16%. Revenues were also affected by our election to exit certain revenue pools in mid 2007. The decision to withdraw from the pools for our DSL service was an economic one. In exiting the pool, revenues were reduced by $2 million but the corresponding expense of contributing to the pools was reduced by nearly twice that amount. This will continue to affect revenue comparisons by a similar amount through the second quarter. Clearly a positive element in the quarter was the increase in ILEC data revenues which grew 29%. We had good success with our promotional campaign selling DSL adding 11,000 net subscribers sequentially and 37,000 year-on-year. Our gross adds picked up in the quarter and at 18,000 were higher than they have been since first quarter of last year. We also had success in selling our triple play adding nearly 9,000 net subscribers in the quarter and we now have 42,000 in total. We have a very strong partner in Dish Network for the video component and our experience has been the triple play customers have significantly lower churn. Over the past 9 months we have introduced a series of promotions in key markets including free service for a limited period, a gift card to be used as the customer wishes a guaranteed lower price for a more extended period and so forth. These each present different value propositions and have kept the program fresh and customers have responded favorably. Also contributing to the increase in data revenues was the introduction of high capacity Ethernet services for commercial customers. With specialized equipment we can bond together copper or fiber facilities to expand bandwidth and the bandwidth is symmetric, often an important feature for commercial customers. In our CLEC segment the revenue decline was driven by our decision to improve profitability by focusing our marketing and sales efforts on small and medium businesses and limiting our investment in acquiring residential customers. Another positive element in the quarter was expense control. Cash expenses through our combined operations decreased by the same amount as revenues and thus we are able to keep operating cash flow even with last year. Importantly, we've been able to combine support functions and make other process improvements permitting us to a lower head count by 7% also maintaining high levels of customer satisfaction. We continue to invest in our network. Capital expenditures were 18 million for the quarter on a consolidated basis, roughly flat with 2007. We will continue to evolve our network and put the necessary infrastructure in place to offer broadband speeds that are very competitive. 87% of our ILEC lines are equipped for DSL service, with 82% of our customers taking speeds of greater or equal to 1.5 megabits and 42% speed is from 3 to 6 megabits. Currently in key markets, we are beginning to launch 10 megabit service over copper facilities and 15 and 25 megabit service where we have fiber facilities. And finally, with respect to guidance, we are confirming the range for operating cash flow as cost control will continue to be a focus for us. We are also confirming the range for CapEx. We are reducing the range for revenues modestly to $810 million to $840 million. In summary, we've made good progress towards our goal of becoming the preferred broadband provider. We have effectively managed cost and we have a good team of people moving in the same direction. And now I'll turn the call back to Mark Steinkrauss.

[Mark A. Steinkrauss:]

Okay, thank you. Michael we are all already to start the Q&A portion of the call please. Question And Answer

[Operator:]

Operator Instructions]. Your first question comes from Simon Flannery with Morgan Stanley.

[Simon Flannery:]

Okay, thank you very much. Good morning. I wonder if we could just talk about the guidance for a second, in particular the net add guidance for wireless. You had a solid result for the first quarter and if you annualize for the first quarter run rates it certainly is well ahead of where the new guidance is. So can you talk about what you see happening in the rest of the year that has caused you to pull that guidance down, is that results in March and April have really started to slow, is it something else you are seeing on the economy or competition, and you have got the stimulus package, how that plays into it? And then just very quickly if you could on the EVDO, could you give us a sense of what percent of your pops you might cover by the end of the year with EVDO, thanks?

[Jay M. Ellison:]

I will take the last. This is Jay. I will take your last part first and try a little on the first part. On the EVDO deployment, we believe we'll have approximately 40% of our pops covered sometime in time in the fourth quarter at this point. We started our construction, our role out, and everything is or ahead of schedule. So we don't anticipate any delays in the launch to cover that percentage of pops. Relative to some of the changes that Steve mentioned, in some of our market we are paying close attention to some of the economic drivers, in particular in some of those marking that I referred to like in the northeast and some of those markets that were hit very hard by winter and fuel cost. We have seen some bit of slow down that we are paying very close attention to. We've also seen some of those customers do... not giving up wireless but really doing some consolidation relative to their accounts in the fourth and the fifth lines where they may have been single line accounts in the future. So I guess we are just playing, watching those markets that we saw hard hit by the winter both from the length and the fuel cost and we have seen some activities in our call centers that would... accounts trying to really make sure they don't give up wireless but have smart spending with their cash flow.

[Simon Flannery:]

Okay. And so is it more of a gross add or a churn sort of change or is it a bit of both?

[Steven T. Campbell:]

If you look at the churn results you will see the churn near the postpaid side still stays very, very strong, so you aren't seeing that at all.

[Simon Flannery:]

Okay. Great, thanks so much.

[Operator:]

Your next question comes from Patrick Ryan with Lehman Brothers.

[Patrick Ryan:]

Good morning and thanks for taking the question. Just a quick one on share repurchases, can you remind us when the TDS special program expires and then also just looking at that and the amount you purchased during the quarter it seems just doing rough math you purchased about 15% of your flow on a daily average. If you could, would you like to fully purchase more and then also on the U.S. Cellular side is it possible for you to repurchase it beyond the current deminimus repurchase value? Thanks.

[Kenneth R. Meyers:]

Boy, lot of questions there. But the TDS plan started last May or June and it was a three year $250 million authorization. And as I said, since June of last year we purchased all the 78 million of that $250 million authorization. The only authorization at U.S. Cellular currently is this deminimus one. Yes, the Board has the ability to authorize something different, if that is what they choose to do. But at the current time there is only the deminimus one out there which is designed to offset the effect or eliminate the effect of any dilution caused by compensation plans.

[Patrick Ryan:]

Got you. And then just on the amount of the repurchase with the TDS special, we think they are probably buying as much as you can given any other resistance with the exchanges, how do you set that up, if possible if you get a higher volume would you be repurchasing more?

[Kenneth R. Meyers:]

There are limits in terms of what we can buy in the open market and if there was more liquidity in the stock, that would be a higher number. I obviously answered that.

[Patrick Ryan:]

Great, thank you.

[Operator:]

Your next question comes from Will Power with Robert W. Bair.

[William Power:]

Yeah, thanks for taking the question. Good morning. I guess, maybe a couple of things, first on the ARPU front you have had very nice growth driven by data, I wonder moving forward as you think about earlier comments, on the economy, what kind of impact in ARPU do you think you might see from the economy or you are already starting to see this ARPU growth, I guess started to flatten out? And then my second question on the TDS side, and I may have missed it, what are the principal drivers behind the lower revenue guidance there? Thanks.

[Jay M. Ellison:]

I'll take the ARPU piece, this is Jay again. We are obviously watching that ARPU as it relates to economic conditions but I think as Steve pointed, we've watched our data revenues continue to grow on top of our very healthy results in smartphone sales which is driving a big chunk of that. We think any kind of voice ARPU decline will offset by ARPU growth on the data side of the house and that's kind of... what we are doing... been seeing and saying for the last couple of reporting periods. So,... and we have a pretty strong line up of smartphones over the next three months. So, we are pretty excited were we stand in that period. And on top of that, when we get those, other 40% on top of EVDO that stands improved on our embedded base with smartphones, so we see some upside down the road with that as well.

[Kenneth R. Meyers:]

Bill, I think that second part of Will's question was directed to you.

[Bill Megan:]

Yeah, I am happy to answer. You know, I think if you... just to reflect on the comments on what drove revenue in the year-on-year comparison, it's more or the same. Access line losses were 5.1% and we expect that to continue. We also talked about minutes of use and that affects our access revenues and we expect that to continue. And then the third component we talked about, it's a little bit technical but it has to do with our participation in the NECA pools. On the interstate side we had participated in NECA pools for our data service, Idea cell service, and in the first quarter that was about $2 million worth of revenue. We do that because it improves our profitability and makes economic sense, but it does impact our revenues. And as I mentioned that's going to continue through the second quarter here. So another 2 million we would anticipate in the second quarter. So we are going to see effectively continuation of those same three trends.

[William Power:]

Okay, thank you.

[Bill Megan:]

Okay, in taking down the guidance we mainly took down the top end, it was a modest adjustment.

[William Power:]

Alright. Okay, thanks.

[Operator:]

[Operator Instructions]. Your next question comes David Boe [ph] with ELF Partners.

[Unidentified Analyst:]

Hi, I just wanted to ask about the LA partnership that you guys provide very good disclosure on that and the financials, as I look at it the equipment subsidy in the LA market is, a fraction of it is of what it is at U.S. Cellular. I am just wondering about what the difference is in operations and May we some day at U.S. Cellular get to the LA type of metrics?

[Steven T. Campbell:]

First of all I don't think that it is the company's mission to comment about the operations of the LA market at all. There are significant differences in presentation as well as in actual operation. The fact is that the equipment subsidy at U.S. Cellular has been growing over the last year and half, there is more and more data capable phones have been becoming part of the take rate of the customers. I think we have seen that in other companies too, I am not going to comment on the LA Financials.

[Unidentified Analyst:]

Okay, that was my only question. Thanks.

[Operator:]

There are no further any questions at this time. Gentlemen are there any closing remarks.

[Mark A. Steinkrauss:]

No I think we are all set Michael. Thanks very much.

[Operator:]

Ladies and gentlemen thank you so much for dialing in for today's conference call. You may now disconnect.