Telephone and Data Systems, Inc. (TDS) Q3 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the TDS and U.S. Cellular Third Quarter Operations Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Jane McCahon, Senior Vice President, Corporate Relations of TDS. Thank you, Ms. McCahon, you may begin.

Thank you, Tim. Good morning, and thanks for joining us in the home of the world champion Chicago Cubs. I want to make you all aware of the presentation we have prepared to accompany our comments this morning, which you can find on the Investor Relations section of the TDS and U.S. Cellular websites. With me today and offering prepared comments are from U.S. Cellular, Ken Meyers, President and Chief Executive Officer; Steve Campbell, Executive Vice President and Chief Financial Officer; and from TDS Telecom, Vicki Villacrez, Vice President Finance and Chief Financial Officer. This call is being simultaneously webcast on the TDS and U.S. Cellular Investor Relations websites. Please see the websites for slides referred to on this call, including non-GAAP reconciliations. As a reminder, we provide guidance for both operating cash flow and adjusted EBITDA. For TDS Telecom, these are basically the same number. For U.S. Cellular, however, the adjusted EBITDA measure includes imputed interest income from EIP and the significant contributions from our partnership, which we want to continue to highlight for investors. The information set forth in the presentation and discussed during this call contain statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Please review the Safe Harbor paragraph in our press releases and the extended version in our SEC filings. As mentioned on our previous calls, U.S. Cellular filed a short form application for the ongoing forward auction for the 600 megahertz spectrum known as Auction 1002. As the anti-collusion rules are still in effect, we are prohibited from speaking about it further, we will not entertain any questions related to spectrum or the auction. Shortly after we released our earnings and before the call, TDS and U.S. Cellular filed their SEC Forms 8-K, including today's press releases and Form 10-Qs. TDS will be hosting one-on-one at the RBC Conference in New York on November 9 and presenting at the Wells Fargo Conference in New York on November 10, and presenting at the IDEAS Conference in Dallas on November 16. Also keep in mind that TDS has an open door policy. So if you're in the Chicago area and would like to meet members of management, the Investor Relations team will try to accommodate you calendar's permitting. And now, I'd like to turn the call over to Ken Meyers.

Good morning. I’ll start on slide 4. And overall, we had a pretty good quarter. We saw record growth and strength in the prepaid product line and generated better operating profitability. I would like to say upfront that our whole organization really pulled together to work around a couple of unexpected challenges. And in spite of these as well as the extremely competitive market, we continue to expect to deliver on the guidance we provided at the beginning of the year. Let’s start the discussion with customer results. We saw a sizeable shift with postpaid adds declining but a huge pickup in our prepaid business combining to generate 61,000 retail net adds. On the postpaid side, we saw unprecedented disruption in our new Smartphone availability with the recall and eventual termination of the note 7 and even though we had strong preorders for the new iPhone, we had significant supply constraints during the launch. All of this contributed to a net loss of 6,000 postpaid users. Churn remained low at 1.34% in the quarter compared to 1.41% a year ago. And breaking it down further, postpaid handset and connected device churn, which was 1.22% and 2.04% also showed significant improvement from a year ago. Our customers overall satisfaction is largely influenced by our network strategy. We were very pleased to be added back into the consideration set by J.D. Power for the network quality award in the north central region and very proud to once again be at the top of that list. We are excited to receive this third-party validation of our network strength. Staying with the network theme for a second, 99% of our postpaid connections are now covered by our 4G LTE network and that network is now carrying about 90% of all of our data traffic. Additionally, our customers are now receiving even better data experiences as they travel as a result of the multiple 4G roaming agreements that are now in place. Importantly, for reasons I will discuss in a minute, our network team is on track to launch our first commercial deployment of VoLTE or Voice-over-LTE early next year. And finally, thinking further down the line, we recently had our first successful test of 5G technologies for fixed wireless applications. I think it is important to reiterate what I said last quarter about the inflection point we have reached with our roaming arrangements. This year is one of significant transition as we move from 3G CDMA agreements to 4G LTE agreements that significantly lower the price per gigabyte, both from a revenue and an expense point of view. Our engineering group has implemented technology that allows for data roaming on one network that will fall back to another carrier for voice services. This has enabled us to provide data roaming with more than just CDMA-based carriers and allows to better manage the quality and the cost of our customers roaming experiences. And as we look forward towards deployment of Voice-over-LTE, we will be able to offer our roaming services to all carriers, effectively doubling the addressable market for roaming revenues over the next several years. We continue to see good progress from our increased focus on small and medium-size businesses and regional government entities. Handset gross additions from this segment continues to grow and our end-to-end sales while still small are really starting to gain momentum. The team has seen success not just selling Smartphones but bringing these local businesses and municipalities, mobility and connected solutions that help make them more effective and more efficient. As I mentioned, one area that really stood out this quarter was the growth in prepaid. We saw record levels of both gross adds and net adds, and this replicate significant growth we’ve seen by other carriers in their prepaid product lines recently. Underneath these results I believe are both industry wide and company-specific trends. Starting at the macro level, a few trends that are growing the overall prepaid market are: A, the increase in the value of these plans. Prepaid plans are now full feature offerings allowing consumers to buy or pay in a different manner. This trend fits with research that shows budget conscious millenials preferring this pay-as-you-go approach and the widespread adoption of EIP pricing pushes consumers looking for less expensive phone options to prepay products. I believe all of these factors are stimulating growth in this segment of the market. This quarter, we successfully tapped into these trends by increasing our advertising committed to this product line and by working with one of our handset partners to be able to offer a very good Smartphone at a very attractive price. Just how far or how long this trend will run is uncertain right now. Interestingly, we’ve been asked, is this just postpaid customers moving to prepaid? It might be at the macro level, but at least over the last few quarters, it has not been US Cellular postpaid customers moving to prepaid. Every quarter, we see some small amount of migration in the base from prepaid to postpaid and some moving from postpaid to prepaid. But overall the level of switching between products remains small. I’ll spend a few minutes on revenue trends. Overall, total revenue growth is just about where we thought it would be. Service revenues are down due to multiple forces, some of which are accounting or income statement geography related, some of which are much more real. First, impacted EIP adoptions which have the effect of moving service revenue to the equipment revenue line and then there is also the ongoing competitive pricing environment. These two factors more than offset the positive impacts of Smartphone adoption now 78% of postpaid handset base, and the growth in prepaid and connected devices. With an EIP sales mix of 79% in the quarter, our EIP penetration continues to grow rapidly and is now at 40% as compared to just 23% a year ago. Effective in September, new postpaid handset sales to retail customers are only made under EIP plans. Also, when looking at revenue comparisons, remember that last year we recognized $58 million related to the termination of our rewards point program. Our upgrade rates for the quarter was 9%, in line with our expectations. And as I discussed last quarter, we don't look at upgrade rates the same way we did in a subsidized handset world given the significantly lower cost associated with upgrades in an EIP transaction. I now look at renewal rate as a measure of customer satisfaction and their willingness to renew with the company. In the terms of the financials, I think you’ve heard me say that we won't chase growth at any cost. We were disciplined in the quarter. We did offer a free iPhone 7 and the free pay offerings are all expected to drive incremental profitability. As a result of the lower postpaid growth, we delivered more profitability. Given a couple of discrete events that impact our profitability metrics both this quarter and the same quarter a year ago, I’ll let Steve walk you through it but the bottom line is I like where profitability ended for the quarter. And heading into the all-important holiday season, we feel like we have a solid game plan in place and a talented motivated team to make sure it is a successful selling season. And now I will turn the call over to Steve.

Thank you, Ken, and good morning, everyone. I will begin with a few additional comments on customer results which are shown on slide 5 of the presentation. As Ken already mentioned, we had 61,000 retail net additions for the third quarter of 2016, up from 29,000 retail net additions a year ago. That growth reflected very strong results in the prepaid segment. Prepaid net adds for the quarter were 67,000 compared to only 12,000 a year ago with improvements in both gross adds and churn. As Ken said, we’ve seen only a very small amount of migration in our base from postpaid to prepaid, rather the drivers for the increase this past quarter included our strong promotion and advertising, along with the macro trends that are stimulating prepaid growth such as increased value in prepaid plans, budget conscious consumers preferring a pay-as-you-go approach and the widespread adoption of equipment installment plans that is pushing some customers looking for a less expensive phone to prepaid products. In the postpaid segment, we had a net loss of 6,000 customers. This was largely the result of lower growth additions which decreased 13% year-over-year to 174,000 due to a combination of factors including low churn across the industry, extremely aggressive promotional activity by other carriers, and unforeseen device supply issues. In the device supply area, our ability to satisfy customers’ desire for iconic Smartphones was impeded by both the recall and eventual termination of the Samsung Note 7 and the supply constraints on the new iPhone at launch. Postpaid churn remained low this quarter at 1.34% compared to 1.41% a year ago. As shown at the bottom of the slide, there was a net loss of 27,000 postpaid handsets in the third quarter, which is pretty comparable to the net loss of 22,000 handsets in the prior year. Total Smartphone connections actually increased by 29,000, primarily as a result of upgrades from feature phones. We are providing a bit more information about Smartphones on the next slide. Smartphones represented 92% of total handsets sold this quarter and Smartphone penetration increased to 78% of our base of postpaid handset connections, up from 72% a year ago. We know that some of our Smartphone additions this quarter were migration from feature phones and given the current Smartphone penetration level of 78%, we still have some opportunity to upgrade more of our remaining feature phone customers to Smartphones whether that is on postpaid or prepaid plans, and drive additional data usage revenues. The next slide in the presentation shows the longer term trend in our postpaid churn rate which remains low at 1.34% for the third quarter. We did see a small uptick in churn from last quarter's historic low point of 1.2% but that is a typical seasonal occurrence. Now I will talk about our financial results starting with revenues. As we discuss revenues in the year-to-year comparisons, I want to quickly remind everyone that service revenues for the third quarter of 2015 included $58 million related to the termination of our rewards program. This slide provides comparisons both excluding and including that revenue. In my comments on revenue, when referring to the 2015 results, I will be excluding the impact of the rewards program termination. Total operating revenues for the third quarter were $1,010 million, especially the same as last year's $1,011 million. I would also like to point out that total operating revenues increased sequentially again this quarter as they did last quarter. Service revenues were $771 million, down $67 million from $838 million last year. The largest component of service revenues, retail service at $681 million decreased by 8% driven by lower average revenue per user. This decrease in ARPU was partially offset by the impact of growth in our customer base. I will come back and say more about ARPU in a minute. The other item contributing to the reduction in service revenues was lower roaming revenues which declined by $14 million primarily due to lower rates for data usage. Keep in mind that we benefit from lower rates on our outbound roaming traffic. For the third quarter of 2016, the benefit to outbound roaming expense due to lower data usage rates was greater than the rate-related reduction in revenue. Equipment sales revenue grew 38% to $239 million driven by higher equipment installment plan sales. The percentage of postpaid device sales on installment plans increased to 79% in the third quarter of 2016 compared to 44% a year ago. We expect that the installment plan take rate will continue to increase over the course of the year as the majority of our retail device sales are now being done on installment plans. Next I want to go back and say a few words about our postpaid average revenue metrics. Excluding the impact of the rewards program termination, postpaid ARPU was $47.08, down 12% year-over-year. The biggest factor in this decline in the continued migration to unsubsidized equipment pricing. Other factors include overall industry price competition and the growth in connected devices, which have lower average revenue. Since the ARPU metric excludes equipment installment plan billings to customers, another metric which includes those billings, average billings per user, may provide a better representation of the total amount of revenue being collected from customers every month. Reported this way, average revenue per user shows a decrease of 4% year-over-year mostly reflecting competitive pricing pressure and dilution from connected devices. Average revenue per account benefits from the increase in connections per account which grew by 5%. For the third quarter, average revenue per account was down 8% after adjusting for the impact of the rewards program termination. But when equipment installment plan billings are included, average billings per account actually increased 1% year-over-year. We expect that there will be continuing downward pressure on service revenues, but that equipment sales revenues will continue to grow as more of the customer base moves to unsubsidized equipment pricing. Moving to Slide 10, which shows total operating revenues and cash expenses as reported in our statement of operations together with operating cash flow and adjusted EBITDA. Operating cash flow for the third quarter of 2016 was $164 million, compared to $208 million a year ago. The decrease is the net effect of 6% lower revenues offset by 2% lower expenses overall with reductions across all major expense categories. Adjusted EBITDA shown next incorporates the earnings from our equity method partnerships along with interest and dividend income. Adjusted EBITDA for the third quarter was $216 million, compared to $257 million a year ago. Earnings from unconsolidated entities were $38 million including $17 million from the LA partnership. Interest and dividend income totaled $14 million consisting largely of imputed interest income on equipment installment plans. Before discussing our guidance for the full year, I want to provide some additional insight into our comparative operating results. The next slide shows our total operating revenues, operating cash flow, and adjusted EBITDA for the third quarter as they are reported in the statement of operations. These are the numbers that I’ve just reviewed with you. However, when analyzing the results for the quarter, you should note the impacts of two discrete items. In the 2016 period, operating cash flow and adjusted EBITDA were reduced by a charge of $13 million related to the termination of a naming rights agreement. In the 2015 period, total operating revenues, operating cash flow and adjusted EBITDA were increased by $58 million related to termination of the rewards program. The numbers at the bottom of the chart exclude the impacts of these two discrete items. As you can see, the exclusion of these items presents quite a different picture with respect to the year-to-year comparisons. Total operating revenues were essentially the same whereas operating cash flow and adjusted EBITDA increased by 18% and 15% respectively. Next I want to cover our annual guidance for 2016, which is shown on Slide 12. For comparison, we are showing our 2015 results both as reported and excluding the impact of the termination of the rewards program. Our guidance for the year is unchanged from that provided initially in February and confirmed in May and August. The year is playing out as expected with current estimates of results still within the published ranges. Therefore, there is no change. I will briefly review our estimates. For total operating revenues, we expect a range of approximately $3.9 billion to $4.1 billion. For operating cash flow, we expect a range of $525 million to $650 million. That estimate flows through to the estimated range for adjusted EBITDA, which is $725 million to $850 million. Capital expenditures are expected to be about $500 million with quite a few project still in progress as we approach year-end, there is some uncertainty around this number. However, I believe it’s unlikely that our total expenditures for the full year will exceed $500 million. Finally, I want to make just a couple of comments about U.S. Cellular's cash flows and liquidity. Cash flows from operating activities for the nine months of 2016 were $415 million, while cash flows used for investing and financing activities totaled $456 million, resulting in a net decrease in cash and equivalents of $41 million. As of September 30, cash and equivalents totaled $674 million. In addition to these existing balances, U.S. Cellular has $284 million of unused borrowing capacity under its revolving credit facility. We believe that these resources are sufficient to meet our operating, investment and debt service requirements for the remainder of this year. Now, I will turn the call over to Vicki Villacrez to discuss TDS Telecom’s results.

Okay, thank you, Steve, and good morning, everyone. Our overall results for the third quarter were mixed with total operating revenues down 4%, certain strategic areas showed solid growth. First, wireline revenues were nearly even with last year with residential revenues increasing 4%. Second, cable revenues grew 5% over last year, reflecting another quarter of strong broadband subscriber growth of 14% year-over-year. We also had positive residential video net additions in the quarter, which have been on an improving trend this year. And third, HMS revenues were down mainly on lower equipment sales compared to a strong third quarter last year. Cash expenses decreased, although not as much as total revenues, as a result, adjusted EBITDA on a consolidated basis was down 7% to $71 million for the quarter. However, capital spending was also down by $16 million in the quarter as we have substantially completed our fiber builds this year and completed data center builds in 2015. As a result, free cash flow improved in the quarter. With one quarter left in the year, we are tracking against our expectations. We have maintained our focus on those strategy priorities that we shared with you in February, which will be highlighted again in the upcoming slides. Beginning with wireline on Slide 15. Investments in our network and efforts to make higher speed options available to customers continue to drive growth in IPTV connections. We completed our planned IPTV market rollouts this year, but continue to build out service in those 28 markets, now enabling 183,400 service addresses. Our planned fiber builds are almost complete and will reach approximately 22% of our ILEC service addresses. When combined with copper service, our IPTV enabled markets will cover approximately 25% of our ILEC service addresses. We have been focusing on further driving IPTV and high speed broadband bundles in these markets. To further strengthen our broadband offerings, we are deploying bonding technology up to approximately 20% of our ILEC service addresses to drive higher speeds in our middle tier ILEC copper markets. In our remaining markets, generally those with no cable competition, we are evaluating how the FCC’s modified universal service funding mechanism will further support broadband build outs. On that point, recall that the FCC announced a modified USF mechanism that is providing greater return carriers with two paths to receive support funds, to extend broadband services to both un-served and underserved areas. The two paths are: an alternative to connect America Cost Model, commonly known as A-CAM or revised USF mechanism to stay on greater returns. In August, we received an offer from the FCC of the amount of support that would be received if A-CAM path was selected. The offer was for $82.3 million of support revenue annually for 10 years. That’s replacing approximately $50 million of declining annual support that we received today. Unlike the current program, this support comes with an obligation to build defined broadband speeds to reach approximately 160,000 homes. This will result in capital spending over the 10-year that could be significant. In October, we notified the FCC of our decision to elect A-CAM support and the associated obligations for all of our states. Whether our notification will be accepted or not was dependent on the number of carriers opting into the model and whether the support funds would be sufficient to meet that demand. On November 2, the FCC released a notice indicating that more rate of return carriers elected the A-CAM model than , which would require an additional $160 million annually to meet demand. The FCC has requested parties to file recommendations on measures they should consider to address the budget shortfall and those comments are due November 14. We intend to stay actively engaged with the FCC to advocate for measures that are in our best interest. For example, making sure that there continues to be a link between the level of support and the obligation. Should the FCC revise its offer to us, as we now expect, we will have another 30 days to respond. Depending on how the FCC addresses the budget shortfall, we are hopeful the program will still be effective January 1, 2017. We will update you regarding the final outcome of the A-CAM offer and if known, we will incorporate the expected 2017 revenue and capital impact in our guidance that will be shared with you in February. Given the timing, we do not expect a significant impact to our 2016 capital spending. Now back to Slide 15. Looking at the metrics on the bottom of the slide, you can see IPTV connections grew 44% adding 13,300 compared to the prior year and we added 3,000 broadband connections after considering the impact of divestitures. We are offering a variety of speeds up to 1 gig service in all IPTV markets. The uptake on IPTV has grown steadily and is now at an average penetration rate of 30% of residential service addresses. It is important to remember 97% of our IPTV customers subscribe to a triple play bundle, which results in a low churn rate and continues to increase average revenue per connection, now up 3% to $44.25 in the quarter. Reflecting both our fiber and bonded copper deployments, residential broadband customers in these ILEC markets are continuing to choose higher speeds with 52% choosing speeds as 10 megabits or greater and 21% choosing speeds of 25 megabits or greater, which also contribute to the higher ARPUs we have experienced. Looking at Slide 16, wireline results were strong, even with the 2015 ILEC divestitures, which reduced revenues and expenses about 1%. As reported, residential revenues increased 4% as growth in IPTV and broadband more than offset the decline in legacy voice services. The year-over-year decrease in ILEC residential voice connection was only 2% after considering the impact from divestitures. Commercial revenues decreased 4%, however, we are seeing managed IP connections continue to increase. Wholesale revenues, which include regulatory support, decreased 2% in the quarter as expected. Total wireline service revenue was held nearly even with the prior year at $174 million. Wireline cash expenses increased 3% as increases in employee-related expenses and IPTV’s programming costs outpaced the reduced costs of provisioning legacy services. As a result, wireline adjusted EBITDA decreased 6%. As we stated in our strategy, we plan for capital intensity to decline this year as we completed out our fiber build out. In the quarter, capital spending declined $11 million, which resulted in a higher free cash flow compared to prior years. Moving to the cable segment, Slide 17 shows cable connections grew 14,100 or 5% to 291,000. On the residential side, connections increased driven by a 14% growth in broadband and a 13% growth in voice. The residential broadband connection growth drove a 400 basis point increase in broadband penetration. Total commercial connections declined due to a dropoff in video, however, broadband grew 11%. One strategic project we shared with you earlier in the year was analog reclamation. We have substantially completed this work. This initiative transitioned our analog cable markets to an all digital video service and the main benefits are improved customer experience and reclaim spectrum to provide higher broadband speeds in our markets. We offer up to 300 megabit in our largest markets and will expand to cover approximately half of our cable service addresses by year end. On Slide 18, total cable revenues of $46 million reflect an increase of 5%. This was primarily driven by a 6% increase in residential revenues from connections growth offset by continued promotional offerings. Our investments in the cable network and products and services coupled with our rebranding efforts are generating this revenue growth. Cash expenses increased 7% due to higher employee expenses associated with analog reclamation, network maintenance and video programming costs. As a result, cable adjusted EBITDA was flat. Turning to the HMS segment and speaking to both Slides 19 and 20, HMS had a soft quarter primarily due to the timing of low margin equipment sales. In total, HMS revenues decreased 17% in the quarter. This was driven by a 25% decline in equipment revenue year-over-year. Service revenues also decreased 5% from fewer professional services, which primarily track with equipment sales. Hosting revenues were flat in the quarter as higher customer churn and compression offset revenue growth. Cash expenses were down 15% compared to the same period in the prior year primarily due to the lower cost of goods sold. Other expenses were also down due to cost containment efforts. Adjusted EBITDA of $3 million was down in the quarter. However, on a year-to-date basis, adjusted EBITDA was up 31%, compared to the year-to-date period last year. Turning to 2016 guidance on Slide 21. We’ve provided our guidance, which is unchanged from the guidance we shared in February as we anticipate the remainder of the year to be in line with our initial expectations. Again, we do not expect A-CAM to impact 2016 capital spending, we will incorporate any known revenue and capital impacts from A-CAM adoption into our 2017 guidance, which will be shared with you in February. Now I will turn the call back over to Jane.

Thanks, Vicki, and Tim, we're ready to take questions.

At this time, we will be conducting the question-and-answer session. [Operator Instructions] Our first question comes from the line of Ric Prentiss of Raymond James. Please proceed with your question.

Thanks, good morning. Can you hear me all right?

Good morning, Ric. Yeah.

Yeah.

Yeah.

Yeah, no problem. The delay with the cubs winning the World Series. I guess the phone lines are still jammed in Chicago.

Right now it is the roads.

Both my kids are millennials living in Chicago and they will be at the parade that’s epic. Congrats. Hopefully happens more than once every 100 years. Now to the real business. Slide 11, I think, is one of more interesting slides in the deck. I want to make sure I understand everything correctly on that. The termination of the naming rights. $13 million payment seems like a one-time payment. Can you help us understand, one, will you save money now on an ongoing basis because you’ve terminated that agreement?

Sure. The way you said that, is there another part to that question, Ric?

There will be. You know there is no one-part questions from me.

So, I thought I had one, I was waiting for two, that’s all. Two things. So to talk about that $13 million is primarily what I think of at least a noncash charge. I can't use that term. But what it represents is that the original deal that we structured with the SOX had us paying cash over a period of term that supported some of their financing. Turning out, we got done with the deal, they had like a three-year period that was the difference between our original term of our deal and their lease on the stadium. And so knowing that you aren't going to find somebody for three years, they just added that three years to our term. What that meant is that we wound up having to take the payments that we have made and amortize them over a longer period of time. So a little bit of cash that was paid 10 years ago, 9 years ago, 8 years ago was sitting on the balance sheet that would reverse out in the final years of our deal. So that we’ve got written off now. Okay. Going forward that deal wasn't very big. It was, you know, under 2% of our total advertising PR budget. And, you know, while there may be some savings, primarily we are going to see that redeployed into our local market activity, instead of Chicago-based activity, we will be doing things in Milwaukee and in Iowa and in Nebraska.

Makes sense. Too bad it was Comiskey instead of Wrigley.

We wouldn't want to give it up then.

Right. So just make sure that it is clear then, so this item it really nonrecurring. So Slide 11 that shows your operating cash flow at U.S. Cellular for the quarter really was $177 million that’s what we should be using maybe versus our estimates and consensus estimates to compare?

I think that’s correct, Ric.

Okay. And was this anticipated in your guidance, the $13 million payment?

Well, it wasn't anticipated in the guidance when we established in the very beginning of the year. It is considered in the reaffirmation of the guidance for this quarter.

Right. So I guess, just thinking through it, if we think of guidance this is something that most of us probably will not include in our analysis of your results. So if your guidance includes this item, we can use that in our math, okay. When we think of your guidance, I told you it was multipart. We are now three quarters through the year. It looks like the high end/low end of your guidance would suggest fourth quarter would fall somewhere between $37 million or $162 million for OCF. That’s a pretty wide range. What would cause you to go towards the low end of that range versus the midpoint or high end of that range?

Two things, Ric. Let’s start with the fact it is annual guidance. Okay? And we put out annual guidance back in February, things haven't changed significantly and so we are staying with annual guidance as opposed to getting into the boxes in effect giving fourth quarter guidance when you start to narrow things down a lot after three quarters. But having said, the dynamics are unchanged and that is big swings in promotional activity, one way or another that drive either a lot of volume or don't drive volume are what is going to cause that difference. There is not big changes around the roaming side. Earlier this year, we had concerns about current year impact on some of the support mechanisms out of DC. Those haven't materialized. So it is all going to revolve around promotional and sales activity in the fourth quarter.

Okay. So it makes sense. So we should – most of us will probably exclude the termination of rights and most of us think guidance includes it, so you can say don't include it if you want to and the guidance ranges mostly just helps competition play out in the quarter. Okay. The second question is just, I get it, disruption in the supply chain with the iPhone constraints, the Samsung Note 7. Can you help us quantify with gross adds being down 13% year-over-year, how much was this device disruption impactful in the quarter do you think as we look forward to thinking about what fourth quarter it could be looking like seasonality and 2017? How much of the anomaly in third quarter is related to the device issues?

Ric, we asked that question, looked at it three different ways. And I don't have a good way to tell you what didn't happen, okay. However, a bigger question I'm looking at is, is it how much of the shift is really just a change in how people are buying now. We keep calling this prepaid. But, in fact, if you go back to the early days, prepaid was a poor product to a segment of the consumer population that people didn’t necessarily want, right. It was higher priced in effect, less full featured. And what you are seeing now is it’s not so much that it’s the old prepaid, as much as it is a full service offering that has all of the features of a postpaid product, but packaged differently. And I believe we are seeing just like we talk about upgrade rates not being that important, it is an old metric, but doesn't really show where the business is going, I'm starting to question how the change between products, between postpaid and prepaid, how much of it is, again, old language that we are using versus real changes in the business.

Okay. But you do feel the disruption of the supply chain had an impact on your gross adds. If you were to say throw gross adds prepaid and postpaid together, there was an impact and it was worth calling out?

It absolutely was because we had orders that we couldn't fill. We had stores that didn’t have one of the iconic devices that was being advertised. And oh, by the way, then we had stores that were busy taking care of customers that had problems with phones as opposed to customers that could have been buying. So it had – definitely had an impact. I just can't measure it.

Okay. That helps a lot. Thanks, guys. And at least maybe watch the parade on TV.

Thanks.

Our next question comes from the line of Simon Flannery of Morgan Stanley. Please proceed with your question.

Hi, it's Spencer for Simon. Thanks for taking the question. I wanted to follow-up on prepaid. Obviously, a very strong quarter. You mentioned you are adjusting your marketing strategy based on the trends you are seeing, just to clarify, are you just going to spend more in prepaid or is it really shifting marketing dollars from postpaid to prepaid given the relative success you are having there? And then lastly, we’ve seen a slowdown from Verizon and Sprint in prepaid. How much of your success do you think is from less competitive behavior from your peers? Thanks.

So let’s start with – it’s a shift within our marketing allocation. It’s not putting more dollars on top of our marketing programs, number one. Number two, yes, we’ve seen a slowdown recently, but you were talking about the month here of July, August and September. And I would suggest that the market was very competitive during the third quarter. So I don't know that it’s a reaction to somebody else changing because we were – that product line was hot for us during all three months of the quarter.

Okay. So probably spending a little bit less on postpaid then, but the overall marketing budget stays the same.

Yeah.

Okay, great. Thanks.

Our next question comes from the line of Sergey Dluzhevskiy of Gabelli & Company. Please proceed with your question.

Good morning, Sergey.

Good morning, guys. Thank you for taking my questions. A couple of questions for Ken on the wireless front. So first question, obviously, I understand your comment about postpaid versus prepaid changes in the business. But I mean just looking at I guess fourth quarter and looking into 2017, what are the steps that you are taking to improve postpaid gross adds and particularly postpaid handset gross additions? And the second question is, your large wireless competitors are getting bigger and more diversified, obviously, we saw AT&T buying Time Warner, Verizon is buying Yahoo, they are focusing on [indiscernible] reentered content OTT. So what are your thoughts on kind of mobile centric video offerings and impact on competitive environment in your markets and what are some of the things that U.S. Cellular is doing on that front?

Good morning, Sergey. Let's start with adds. And let's kind of peel it back and go one step deeper, right. Adds are one way of driving revenue. It’s all about how do we drive revenue. And as we look at that, there are a lot of different initiatives underway that include continuing to get new line signup. But I am going to say line signup, so I get away from this prepaid/postpaid thing because I really think we are seeing a different type of shift going on right here. So, if I can drive the economics out of full featured prepaid lines to get them to the point where they are the same as what we got on the postpaid, the difference becomes meaningless. So, we are going to continue to drive add growth. And one of the tools that is really continuing to strengthen for us is the work I’ve talked about before that we are doing in the business and government sector. We see that as market development type of work where we are selling solutions into these organizations and getting our network strength better understood. Really happy, like I said, about us being back in the J.D. Power consideration set. Just because of the size of our operation when we got rid of Chicago we dropped off the radar screen for the last couple of years and we weren't able to compete for it. This year we were back in the consideration set and we won it again, okay, which fits to the strength of our networks, which is at the end of the day still the most important thing in the mid-sized and rural markets that we sell. So getting that message out there, getting people to understand it, which is what we do with the business to business channel, that helps us in the retail channel no matter which product we are selling. Similarly, we’ve rolled out other products this last quarter that will drive different revenues streams, one of which was a new insurance product that actually brought with it some different support for the iPhone that heretofore weren't in any of the programs and that has a higher revenue attached to it and a nice improvement in margin. We continue to use our stores to sell more accessories to the point where our accessory margins start to cover some of the fixed costs of our distribution system. So, a lot of different things working on revenue. I didn’t even talk about all the work we’ve doing on the roaming side that position us for VoLTE roaming and being able to serve more carriers. On the consolidation – not consolidation, the expansion of the business, a question that we keep looking at, right, and that is the economics around content. And I said this a year ago, but I don't understand how exclusive content really works from an economic standpoint that my content is so valuable, I want to sell it to as many customers as possible, not just the 25% of the market that I might serve. And as we explore this deeper, there is actually FCC rules that get in the way of really capitalizing on exclusive content. So I'm still unconvinced around the economics of owning content. I think we have to make sure that it is accessible to us. I think we have to make sure that we’ve got a network that can deliver a very strong video experience for the customer, that the customer can get access to it wherever they're at. But I'm not convinced of the economics around it, and we'll continue to monitor it, we'll continue to drive the network experience so that our customers have a great experience wherever they are at, but I'm not ready to jump on that ship yet.

Okay, great. And a couple of questions on the wire line side for Vicki. One on A-CAM. So, obviously you had the initial offer of $82 million and as you mentioned the program got oversubscribed by about 160 million per year. I guess what are your expectations as far as how this over subscription will be handled given its relative size to the world size of rate of return available funds available to ILECs and if you have any expectations how different could the final offer be when you – after obviously the FCC processes all of those comments, I guess. What looks realistic to you? And my second question is on the cable side on the competitive environment if you could share your just thoughts and view for competitive environment in your cable markets. And how – what are your thoughts on how it could evolve I guess over the next few years?

Sure, thank you, Sergey. As I had said in my comments, with the revised offer and the oversubscription, right now the timing from a timing perspective we have comments, the FCC is looking for comments by November 14. I know that a number of comments have already been received. I just don't know yet and I don't know by how much. I think it will likely mean that the offer will be something less but we just really don't know right now. And we're going to have to wait and see as the FCC revises its offer. We are hopeful that we are still going to have a decision and a program in place by January 1. In terms of expectations, how will they handle it, I think that will depend on a number of factors. And I just can't comment on those right now. I will say, though, that I do expect that revised offer will come with less location build out obligations as well if it is revised downward. With respect to the cable competitive environment, we were really pleased with the growth that we saw in the third quarter and that has really been about our investments that we’ve been making in our products and services. And we’ve been seeing a significant shift of moving our customer base from lower broadband speeds to higher broadband speeds and I think that is really driving our success. The competitive environment we have seen the Telco primarily upgrading its copper networks with bonded copper capabilities which is up to a 60 megabit product and as you know, we have 100 megabit speeds, broadband speeds across our cable markets and by the end of the year we expect to be up to 300.

Great.

Analog reclamation has been a key initiative this year that we are substantially completing here as we speak. And that is providing a much better viewing experience for our customers. And so I think as I said, we had positive net adds for the first time in this quarter in our video net adds and that is reversing and declining trend.

Thank you.

We will take one more question, Tim.

Our final question comes from the line of Barry Sine of Drexel Hamilton. Barry, please proceed with your question.

Good morning. I wanted to go back to some of the trends around the postpaid subscriber growth adds. So first of all, on the iPhone, on the one hand you talk about record numbers of preorders but obviously there is supply constraint. So I think it’s about the fourth quarter that implies you have pent-up demand that might benefit you there. And on the Samsung issues, on the call you talked about the distraction of having customers coming into the store were flapping galaxy Note 7s. Presumably that is over, they’re not bringing them anymore so you can focus back on sales. And then also I'm wondering how tarnished are you seeing the Samsung brand. If customers are bringing in a Note 7 are they opting for an iPhone or another brand and is that brand damage likely to have an impact on the U.S. Cellular’s postpaid growth adds in the fourth quarter?

Barry, so I’m going to let Jay answer some of those questions. But needless to say, the hyperbole is a little bit misplaced. There weren't any flaming, anything involved with our customer base. In the Samsung brand is strong, has been strong, and remains strong. There is, there is clearly, a little bit of shifting that happens when someone has got a phone that they want right now and you don't have something in inventory but I don't think there has been any major shifts one way or another.

Barry, Jay Ellison here. On the supply question, we are in really – we really are in fairly good shape going into Q4 and into the holiday season. Maybe with the exception I think everybody is still seeing this on the higher memory configuration of the phones and some of the color. But otherwise, I think except for Ken commented relative to the launch where we really did see some significant constraint. We are getting in pretty good shape there. I think Ken is right also on the brand imagine and the customers are showing extreme – they get comfortable with certain brands and they stick with it even with what is going on. And even surprisingly, as much as has been out there, there are still some people that are even unaware of this issue in some of the marketplace out there. And finally I think Ken also alluded to, we really did not see much of a brand shift from Samsung to anyone of our other products that we carry really in all of our stores. And I’ve just spent several days out in the market and asked those very specific questions and my comments reflect what is going on in the stores themselves.

Okay. And then the kind of the shift in popularity on prepaid versus postpaid. If I look at your offers out there, you’ve got a very attractive offer on postpaid 7 gigabit, $49 a month. On prepaid, it is $45 for 2 gigabit although you’ve got a very attractive price point I should mention. I think it’s a Motorola phone. Are those the trends you are talking about because pricing wise it is still different if I look at your promos.

It is different but then you have to add in the equipment cost on the postpaid phone, right. It’s a different phone but a different overall package for the customer by the time they are done. You only wind up with an equipment financing plan on the postpaid. So there is still a little difference but the economics are much – in total are much more aligned than they’ve ever been.

Okay. On VoLTE, you guys have talked about VoLTE quite a bit and you are really moving ahead now. So what does VoLTE do for United States Cellular? Do you need the capacity that it frees up? Does is offer better voice? What are the benefit to the company and to the customer?

Okay. Mike, do you want to talk – Mike is our ETO.

Good morning. The main benefits we expect VoLTE to deliver to our customers is hire quality voice. A feature called high definition voice that would be immediately available to our customers. It also allows for simultaneous voice and data features on the device. And then lastly, we would be able to roll out a presence capability that allows customers to know where they are at in video.

Video calling is another one of those customer benefits that comes with it. On the other side, it also eventually frees up capacity because you aren't using CDMA radio channels anymore. And from an industry level, it allows us to serve any other carrier that is also using VoLTE from a roaming standpoint.

Okay. My last question is, first of all, congratulations on again winning the JD power award. Question about that and what that means. In the past, a lot of carriers use net promoter score instead or in addition to that. And one of the critiques of JD Power has been it may not measure actual customer satisfaction. Do you look at other measures? Net promoter score and I don't know if you would be willing to reveal what your score actually is.

We look at a lot of different metrics. We, in fact, touch our customer base every month. When you walk out of the store with a transaction, we are going to take a sample and see what you think about that “star”. What did you think about your customer service interaction? What did you think about the network? And so while there are multiple internal measures that we look at, what the JD power award does is it gives us third-party independent validation of where our network and how our network strategy play. And that is critical because today's world, advertising, everybody shouting something, something loud, trying to shout louder and consumers trust that JD power and promoter to say that we have looked at this and this is the best there is. And so, yes, it is gratifying and it is an important part of our marketing strategy going forward and it has been in the past.

Okay. Thank you very much.

There are no further questions over the audio portion of the conference. I would like now like to turn the conference back over to management for closing remarks.

We would like to thank everybody for joining us and please follow-up with additional questions and look forward to seeing folks as we travel about next week. Thanks.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful rest of your day.