Array Digital Infrastructure Inc (AD) Q1 2008 Earnings Report, Transcript and Summary

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 and 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.

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 with TDS, Steve Campbell, Executive VP, Finance, CFO and Treasurer at U.S. Cellular, Bill Megan, Executive VP Finance and CFO with TDS Telecom and also joining us are Jack Rooney, CEO, U.S. Cellular and Jay Ellison, Executive VP and Chief Operating Officer. A replay of the teleconference will be available today at 1:00 PM Chicago time and will run through midnight, Thursday, May 8. 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 on the conference call archive. Please recall that archived calls are not updated. Some information during this call and subsequent Q&A period contain statements about expected future events and financial results that are forward looking and subject to risks and uncertainties. So please review the Safe Harbor paragraph in our releases in the more extended version on our website 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-Ks. The 8-Ks 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 has 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 reconciliation of a 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 the Reconciliation" to make it easier to find. The information can also be accessed on the conference call page of the investor relation sections of both websites. Please note that the comparisons made by the speakers today in their prepared remarks, our 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 13, at the Baird Growth Stock Conference in Chicago. May 14, at the Morgan Stanley, 13th Annual Communication Conference at Washington DC, May 28th Lehman Brothers Worldwide 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 will also be meeting with 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 to Ken Meyers.

Good morning. And thank you for joining us today. I have a few comments to make before turning the call over to Steven and Bill, who will cover the operating results of their respective businesses. Then we will all take questions at the end of the prepared remarks. I am please to report first quarter results for TDS with operating revenues and operating income each up 8%. Quickly, we cover our Q year-over-year non-operating comparisons on the income statement. First, interest and dividend income is down about $6.5 million, due to lower rates on interest bearing cash investments. We have made a decision in the fall of 2007, to move our cash investments into treasuries knowing that while we were giving up some yields, we 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 Telecom shares in settlement of the forward contracts, which matured during the quarter and sold remaining shares. In the quarter, TDS adopted statement of financial accounting standards 159. By adopting SFAS 159 for both the Deutsche Telecom stock and the related callers, gains and losses on both of these items are expected to largely offset each other, which should reduce large income statements swings. That resulted from the application of SFAS 133 is a fair value adjustment, a 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 into beginning retained earnings. As noted in our release under TDSs current stock repurchase authorization to-date the company has bought back of 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 its de minimis program purchasing 150,000 shares in the first quarter. Also during the quarter, the FCC auction spectrum in the 700 megahertz band, on its auction 73, U.S. Cellular participated in the auction indirectly through its interest in King Street Wireless L.P. King Street Wireless was the provisional winning bidder 152 licenses for an aggregate bid of $300.5 million, net of it designated entity discount, which was recorded as licenses on U.S. Cellular’s balance sheet as of March 31. The U.S. Cellular made a contribution in the first quarter to King Street about $97 million and in April made an additional contribution of $203 million. U.S. Cellular financed these amounts with cash on hand and through its revolving credit agreement. As you know, we remediated to two of the three material weaknesses as of 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 filing of this year’s 10-K. For the year, we expect the effective tax rate for both companies to be approximately 40%. Finally, we’ve ended the quarter with a very strong balance sheet of $1.2 billion in cash, all of which is invested in treasuries. Virtually all of the credit facilities are unused. We’ve a lot of financial flexibility. With that, let me turn the call over to Steve Campbell to talk about the operations of U.S. Cellular. Steve?

Thanks, Ken and good morning, everyone. I’ll begin with a few general comments about the business and then I’ll highlight some of the key results for the quarter. The first quarter was a challenging one for us. Although our results in some areas were not as strong as 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 for 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 on margins, we are taking actions designed to reduce or limit growth in 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 have seen increased demand for smartphones and the advanced data services that they enable. As a result, we decided to expand our deployment of EVDO 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 is a foundation for future growth, we participated through our interest in King Street Wireless in the recent FCC auction of 700 megahertz spectrum. King Street Wireless was the provisional winning bidder for 152 licenses covering 42 million pops in areas that primarily overlap or approximate or contiguous to areas covered by licenses that we currently own. Consistent with our objectives going into 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 North Central region. As you probably know on April 29, the FCC adapted an order placing an interim cap on disbursements 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 order, we understand that the cap will have an indefinite duration, be imposed on a state-by-state basis, and limit funding to wireless ETC’s to the amount being received in any given State in March 2008. Thus 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’ll 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 will 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 post-paid segment our primary area of focus, we added 72,000 net new customers. Post-paid customers represent approximately 95% of our total retail customer base. Retail post-paid churn remains low at approximately 1.4%. This is up about 10 basis points year-over-year, but is down by about 10 basis point 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 as $119 million, up about 10% year-over-year, while operating cash flow was $265 million up about 3%. As I mentioned earlier, higher cost 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’ve 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%, the increase reflected an increased number of Cell sites in service, higher total customer minutes of use and higher expenses incurred when customers used other carriers networks when roaming. In the SG&A category, advertising expenses increased almost $16 million or 38% primarily due to media purchases. This expenditure reflected efforts to stimulate higher gross adds following disappointing results in the fourth quarter. Investment and 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 spent 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 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 unused. Shortly after quarter end, we borrowed $100 million under the revolving credit facility, these proceeds, together with cash on hand of $103.5 million were contributed to King Street Wireless to in turn use 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 with both retail net adds, and operating income. We also reduce the range of spending on capital expenditure. As I indicated earlier, we are taking actions designed to reduce or limit growth on our discretionary spending over the balance of the year. Our goal is to continue to drive for growth in revenues, operating income, and cash flow, while not compromising our customer satisfaction strategy and relative competitive position in the market. Now, I will turn the call over to Bill Megan for discussion of TDS Telecom’s results. Bill.

Thank you, Steve. Good morning, everyone. The headline of the quarter at TDS Telecom is that not withstanding a revenue decline. We reduced cost to whole cash flow even, we increased DSL subscribers by 31% and we improved our quarterly access lines loss rate to the levels of a year ago. For the quarter, combined ILEC and CLEC revenues declined by $11.5 million or 5%, where 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 pools, 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 lowered churn. Over the past nine 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 guarantee lower price for a more extended period and so forth. These each present different value propositions and it kept the program fresh and customers have responded favorably. Also contributing to the increase in data revenue 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, cost expenses for our combined operations decreased by the same amount as revenues and that’s where we are able to keep operating cash flow even with last year. Importantly, we have been able to combine support functions and make other process improvements permitting us to lower headcount by 7%, while still maintaining high levels of customers’ 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 speed 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% at speeds from 3 megabits to 6 megabits. Currently in key markets, we are beginning to launch 10 megabit service over copper facilities and 15 megabits and 25 megabits service where we have fiber facilities. And finally with respect to guidance. We are confirming the range for operating cash flow and 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 have made progress toward 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.

Thank you, Bill. Michael, we all are ready to start the Q&A portion of the call please. QUESTION AND ANSWER

[Operator Instruction] Your first question comes from Simon Flannery, with Morgan Stanley.

Okay, thank you very much and good morning. I wonder if you could just talk about the guidance for a second. You in particular the net add guidance for wireless, you had a solid result for the first quarter and if you annualize sort of first quarter run-rates, its 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’s caused you to pull that guidance down. Is it that results in March and April have really started to slow? Is it something else you’re seeing on the economy or competition and about this stimulus package how that plays into it and then just very quickly if you could on 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.

I will take the last, this is Jay, I will take your last part first and chime in a little and let Steve on the first part. On the EVDO deployment, we are… we believe we’ll have approximately 40% of our pops covered sometime in the fourth quarter, at this point. We started our construction, our rollout and everything is on or ahead of schedule. So we don’t anticipate any delays we might see in the launch to cover that percentage of pop. Relative to some of the changes that Steve mentioned, in some of our markets, we are paying close attention to some of the economic drivers. In particular, in some of those markets 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… a bit of slowdown that, we are paying very close attention to it. We’ve also seen some of those customers do… not giving up wireless but really doing some consolidation relative to their accounts and points [ph] in stiff lines where they may have been single line accounts in the feature. So I guess, we re just playing… watching those markets that we saw hard hit by the winter both from a length and the fuel cost. And we’ve 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.

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

If you look at the churn results you will see the churn on the postpaid side is still feels very, very strong. So that’s why you aren’t seeing that at all.

Yeah. Okay. Great. Thanks very much.

Your next question comes from Patrick Rien with Lehman Brothers.

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 also just looking at that and the amount you purchased during the quarter, it seems just doing rough math, you’ve purchased about 15% of your flow on a daily average. If you could, would you like to brief us just more and then also on the U.S. Cellular side, is it possible to do repurchases beyond the current de minimis repurchase program? Thanks.

Boy, a lots of questions here, 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 but $78 million of that $250 million authorization. The only authorization at U.S. Cellular currently is this de minimis one. Yes, the Board has the ability to authorize something different. That’s what they choose to do but the its only the de minimis one which is how… which is designed to offset the effect or eliminate the effect of any delusion caused by compensation plan.

Got you. And then, just on the amount of the repurchases on TDS special, looks like you’ll also probably buy as much as you can given any other restrictions with the exchanges. How do you guys set that up as cost, if you had a higher volume, would you be repurchasing more?

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 don’t know how else to answer that?

Great, thank you.

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

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

I take the ARPU piece and cellular, this is Jay again. We are obviously walking that ARPU as it relates to the economic conditions. But I think as Steve pointed, we have washed our data revenues continued grow on top of our very healthy results in smart phone sales which is driving a big chunk of that. We think any kind of voice ARPU decline will be offset by ARPU growth on the data side of the house and that’s kind of been, what we’ve been seeing and saying for the last couple of reporting periods. So, and we have a pretty strong line up of Smart Phones over the next three months. So, we are pretty excited about where we stand in that period. And on top of that, when we get those other 40% on pops and EVDO, that expense will improve on our embedded days with Smart Phones. So, we see some upside down the road with that as well.

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

Yes, I am happy to answer. I think if you sort of reflect down the comments on what drove revenues in the year-on-year comparison, its more of the same. Access line loses were 5.1% and we expect that to continue. We also talk about minute of use and that affects our access revenue and we expect that to continue. And the third component I talked about, it’s a little bit technical but it has to do with our participation in the NECA pools. On the interstate we had participated in NECA pool for our data service, our DSL service and in the first quarter that was about $2 million worth of revenue. We do that because it improves out profitability and makes economic sense but it does impact our revenues and as I mentioned that’s going to continue to the second quarter here. So another 2 million we would anticipate in the second quarter. So, we’re going to see effectively continuation of those same three trends.

Okay, thank you.

So, in taking down the guidance, we mainly took down the top-end. It was a modest adjustment.

Right. Okay thanks.

[Operator Instruction] Your next question comes from David Bove [ph] with Elk Partners

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

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

Okay. That was my only question. Thanks.

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

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

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