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United States Cellular Corporation (NYSE:USM)

Citi Global Internet, Media & Telecommunications Conference Call

January 8, 2013 6:00 pm ET

Executives

Kenneth R. Meyers – Executive Vice President, Chief Financial Officer and Director

Analysts

Michael I. Rollins – Citigroup

Michael I. Rollins – Citigroup

For those of you who might have missed that comment – before we get started, disclosures are available at the registration desk and good afternoon for those joining us via the webcast. I am Mike Rollins, telecom analyst at Citi. And our next fireside chat will focus on both the wireline and the wireless sectors with TDS. And I would like to welcome back Ken Meyers, Chief Financial Officer of TDS. Thanks for joining us today.

Kenneth R. Meyers

Hello Mike, thank you again. A great opportunity that you put together every year. So thank you.

Michael I. Rollins – Citigroup

Ken has been a long participant at our Citi conference and has been with the Company since 1987. So we really appreciate you coming out to share the latest updates for TDS and USM. So thank you.

Kenneth R. Meyers

Thank you.

Michael I. Rollins – Citigroup

Yeah, maybe just to kick us off, first question I always like to start with is just that we have a new year calendars turned over. What are you key operational and strategic priorities and we could start at the TDS level and incorporate U.S. Cellular within that context?

Kenneth R. Meyers

Okay. Actually I am really excited about 2013. Let me start at the wireline side of the business first of all, right? 2012 we put in the technology to launch IPTV in 10 markets. So we will be doing all the marketing in 2013.

And given the results of some of our test markets, we’re really enthused by what we can see in terms of hoping to add a little product line to the mix or one of the little bit different margin than some of the video products we sell today. And what we’ve seen is the more we bundle with that the better, it helps to churn on both the broadband and the voice side of the business.

The same time we will be finishing up some of the stimulus projects that we started last year. We’ve got about $130 million worth of capital projects that were – $100 million which was funded by the government in the stimulus program, so we’ll be finishing up that. We also will continue on the regulatory side making sure that the environment is such that we can continue to afford to rollout broadband and voice services throughout rural America.

And finally, this is the year that we’ve got real big expectations around all the investments we’ve been making in HMS. We bought four different companies to build a suite of services. The last two years have been putting those acquisitions in place and getting the company together and this year we expect to see some real nice momentum coming from that. So, that’s a lot going on at the telecom side.

Michael I. Rollins – Citigroup

And just to – for insight HMS, for those less familiar?

Kenneth R. Meyers

The hosted and managed services space, right. We’re building an operation to really meet the needs of the mid-market companies with everything from equipment and design solutions, through co-location, all the way to managing their systems and just rolled out a cloud of product with them too. So a lot going on in the telecom side of the house.

The wireless side, there are four major – I think thrust for this year. Over the last few years with under new leadership, a much more focused approach on marketing we – I think we’ve turned the corner on gross add side. We’d actually lost some share of gross adds and now for the last four or five quarters, we’ve actually increased gross adds on a year-over-year basis. Third quarter was up like 7%.

So I think we’ve got some really nice traction there. We saw in the third quarter an increase in churn and that’s the next battle, right. The same people that have gone after the gross add side are now focusing on how to better control the churn. So that’s one big initiative.

Next big initiative is, for the last two years we’ve been building a new billing system and put capital into that in the last two years. This year is the year of the launch. Actually we will see some operating expenses incurred as you start to train all your people and everything else. But this system was built to both drive future efficiencies as well as deliver future capability. So it’s a big year to get that launched both to stop the investment cycle but also be into reap the benefit cycle there.

Third big initiative this year is going to be the whole completion of the Sprint deal and follow-up activity around that. We sold customers and spectrum in some markets to Sprint, expect to close that midway through the year, but there is other assets that are still related to that we are looking to get value out of.

And then fourth, and not that it’s the smallest, but perhaps because going so well, it can kind of gets but the tail end is continue to push out LTE. We expect to have close to 90%, 87% to 90% of all our customers covered by the end of 2013.

Michael I. Rollins – Citigroup

And those would be – the 90% is within the territory that you're keeping?

Kenneth R. Meyers

Right, right. And that's really critical because our whole strategy is to get LTE out just as fast as possible. And what we have been doing is we have been selling LTE capable handsets in the markets that don’t even have LTE. Yeah we subsidize that to precede the market and the reason being is that last year we spent about $200 million in capital for 3G capacity and the faster that we can get LTE handsets into new customers hands, the faster we can turn off that spent.

Michael I. Rollins – Citigroup

Yeah, when you think about battling churn, one of the responses to lowering churn in the industry has been because of that company Apple in California and offering that product and in each successive Apple deal – you know, T-Mobile was speaking earlier saying that they didn’t have a large device commitment that they had to make. So with the LTE coming on next year and even ahead of that you willing to precede devices, is now the time to reconsider offering that product in the marketplace?

Kenneth R. Meyers

Could be. I mean when we crossed this bridge two years ago, we were just starting down the LTE road. And there was no – we couldn’t give a commitment around in LTE front, okay. And the idea of putting a lot of 3G data hungry devices on a network when you’re trying to move to LTE doesn’t work. But we walked away from table on very good terms, right. We continue to talk to all vendors about handset and technology and all continue to evaluate what the options are there. There isn’t – no decision has ever been kept in concrete that we’ll never do, just that it didn’t work at that point in time.

Michael I. Rollins – Citigroup

Yeah, if we move over to selling some of the operating footprint, by my math it’s roughly 30% with third of the operating footprint that you’re selling in this pending transaction. What served as the catalyst for you to do that? And how do you see the benefits for the company of divesting these assets?

Kenneth R. Meyers

So the catalyst is what I think of as Management 101, right? I mean, you’re constantly looking at the performance of all parts of your portfolio, where you’re getting returns, what you need to invest in to get a future return, what does it look like. And as we did that what we found was for years we’ve been looking for spectrum in Chicago, couldn’t buy it. Couldn’t buy it about at any price. And there were various opportunities and auctions where you remember what some of the prices went for there and the other way you can add capacity is you can’t split cell.

Right, well in order to rollout LTE, we start rolling the numbers and seeing the investment we have to make. We didn’t see a path with that level of investment to get the returns that we need. So we were in a place where we only had 20 megahertz of spectrum in Chicago, needed more. Sprint was in the same place. The chance of them selling their 20 megahertz to us and breaking up their national footprint seems pretty small and so we were able to work a deal the other way.

And yeah, as a result, yeah I think it was – I think conceptually the right decision. I think I’m very encouraged by getting as far as we are. There’s a lot of work to do. We’ve got to still provide transition services for up to a couple of years. And then we’re going to have to resize some of the operations afterwards. But yeah, I think this speaks volumes about some of the different work scenario in the last couple of years.

Michael I. Rollins – Citigroup

You mentioned that there was a follow on activity, a follow up activity that you could do as well. In our discussions you mentioned that you actually still own the towers in the operating markets that you're selling. You have spectrum that you don't need anymore, you’ve capped that, it’s still overlapping those markets that you're selling. So can these assets be monetized and how should investors think about the timeframe over which that could happen?

Kenneth R. Meyers

So, our view on towers has always been that network quality is one of the key presets to our whole competitive position. And one way that we’ve been able to advance our network quality is controlling the geography of the tower. We own it, we get to decide where to go. So we have not monetized our towers. We think of them as strategic assets.

Having exited these markets, they don’t fit in that same strategic bucket and so we are going to now in the first half of this year looking at you know – what – are they worth in someone else’s hands or what opportunities do we have to perhaps market them differently and get even more rental income as you may know on our portfolio of about 4,500 cell sites that we own.

We actually have a revenue stream of about $40 million that we generate by renting it to – renting on to other people. So we’ll be looking at that here. Similarly, while we sold the PCS spectrum in this transaction to Sprint, there is other spectrum including some AWS spectrum that we own. That was acquired in order to give us ways to meet future capacity demands especially in some of the southern – St. Louis and Southern property. Similarly you don’t need that same strategic screen right now. And so, similarly in the first half we’ll be looking at whatever the other options are on that.

Michael I. Rollins – Citigroup

At the time you made the announcement of the transaction, even before that, over the last, I can’t remember now that has been a year or two years, the Company and the management made a more formal articulation that you’re considering your options to improve shareholder value. You’ve invited investors to sort of call in or write in ideas. And on the conference call when you announced this transaction I know you said there was more to come eventually. Were you referring to simply the follow on activity or does the idea that there’s more to come clearly encompass other opportunities to improve shareholder value beyond the two things that we just talked about.

Kenneth R. Meyers

So, I think it’s our job, right? May be we didn’t articulate as well as we could have the things that we’ve been doing and that we’re going to continue to do. Right, I mean if you look back now, I think it’s like over the last five years we have bought back $860 million of stock between the parent and the sub. We have paid out about $50 million a year in dividends, okay. In addition to doing that we changed the – tried to simplify the capital structure of the parent – finished that last year. We’ve been reviewing some of the performance of different assets in this transaction. We continue to do the same thing in some of our telephone company assets. We’ve done four acquisitions starting up this HMS area. And so we’re going to continue to hopefully manage the business in a way that does drive value.

We’ve got a couple of other short-term things in front of us. As I said, we like the HMS area and we’re going to continue to look at that one. Similarly, we are in a position where when we did the Sprint transaction, we said that’s about $480 million cash sales that we’re expecting to come in later this year.

Well, Cellular at the end of third quarter had $500 million in cash. So, suddenly it’s at $900 million in cash and that is a use of proceeds, it is a topic for the U.S. Cellular Board that they are currently working their way through such that we don’t have the position or what we’re going to do with the cash now because quite frankly, cash isn’t there. All right, to say we’re going to do this and then have something happen with the FCC on this deal, so that makes sense. So once the cash is there, we now expect that we’ll be in a position to talk about use of proceeds at that level as one more step along this path.

Michael I. Rollins – Citigroup

When you think about the balance sheet in general, if you look pro forma for the proceeds from this transaction, do you think TDS and/or U.S. Cellular is under levered relative to internal targets that the Company has set?

Kenneth R. Meyers

No and yes, okay. And I say that because it’s interesting the way this works, right. Yes, we would like to maintain investment grade credit rating, okay. Investment grade credit rating 2.5 times EBITDA is kind of a threshold and that's on gross debt, not on net debt, okay. So when I think about the company, we’re probably two times today. Okay, so there is not a lot of room on the dept side, on the gross dept side. I think where the opportunity sits is on the balance sheet – it’s on the cash side, right. And so use of that cash is where you’ve got the best chance to kind of change what I would call net leverage as opposed to the gross leverage as the agencies may look at.

Michael I. Rollins – Citigroup

And when you think about the operating markets that remain roughly $32 million, $33 million operating cost that you’re marketing to, when you look at the futuristic step for those markets, do you need to edge out from where you are today or are your clusters pretty well-designed so that you really don’t need that much more from what you have?

Kenneth R. Meyers

There isn't anything that I've seen that’s what you must have, okay. We will continue to look at opportunities to leverage the network name and distribution. So there isn't like, this one you have to have. I think we're comfortable with that. I think we’ll continue to look at other services that you could put through either that distribution, sort of that customer base to fight for a greater share of wallet, but I don’t know that there is specific geography need at this time.

Michael I. Rollins – Citigroup

Does the idea, there’s so much cash potentially building at the U.S. Cellular level give TDS the incentive or the interest to try to collapse the structure?

Kenneth R. Meyers

Well, I think we’ve crossed that bridge years ago, looked at it. The security that was used never quite worked out. We got rid of that security. If I think about it today – now, I get this question all the time. But why would we think of it kind of on a simple cash-on-cash basis, right? I mean, if there is direct access to all the 15% of the cash, well then what’s the value of that 15% of the cash stream? And if you can bring it in at that price and simply them, great. But if you can’t – it’s not a critical – it’s not a must have.

Michael I. Rollins – Citigroup

Is that a uniform view on the board or is that up for debate?

Kenneth R. Meyers

You asked me what I thought, okay.

Michael I. Rollins – Citigroup

How would you rate, just thinking more about the wireless business, how would you rate the confidence that U.S. Cellular can grow service revenue on a one to three year view, again pro forma for that?

Kenneth R. Meyers

How would I rate comp? I’m confident, okay that they can. I’m really impressed with what we see out of the market, a new organization. I’m very pleased with the expansion of distribution that we’ve seen recently the continuation of the whole smartphone and data growth positioned ARPU in a place where it can continue to grow. And given that we’ve kind of confidence that I get out of the change around the gross adds applying those same resources around churn, I think they can, I’m confident they can.

Michael I. Rollins – Citigroup

In any given that one of your cellular market, there is going to be a Verizon, or an AT&T in all likelihood that doesn’t have Cellular like their, and does that give you special ability because you have that Cellular frequency to get better roaming access as you think about the importance of letting your customers roam on the 4G/LTE network on a data session going forward and how should investors think about your ability to stay competitive on that basis?

Kenneth R. Meyers

I think that is a major strategic question, okay. It’s a strategic question the company has faced from about day one and they have been very successful in managing the roaming risk to-date, they do with long term agreement. They do it by providing roaming to help as many parties as possible, while we are primarily a CDMA house today. They are actually markets where we put GS-7 to serve the roaming needs of some of the GSM carriers. We have relationships across the board. And it’s an interesting mix, right on one hand the 850 clearly allows us to cover areas other people can’t, and so they need us, okay and similarly we need them to make sure that we’ve got a full product set for our customers and it’s been a symbiotic relationship to-date.

I don’t see it changing year to mid term I think that’s an area that we have make sure we communicate regularly with the regulators and so they understand implications of that and we seem to have just gotten support in that area. So I don’t see anything dramatically changing, now it’s not that it is a kind of marketing products that issue, more than it is actually an economic one. I mean we think about it, our customers historically 5% to 6% of their usage is in off network, made no difference whether they were minutes of use or data, and what we saw was when minutes of use, back where 100 minutes a month, but five of them were off network, when minutes of use went up to 800, it’s still about 5%. So customers don’t change their travel habit, they change their usage habits and it’s kind of pretty constant.

Michael I. Rollins – Citigroup

And does the idea that moving in LTE world, then you have these handsets across all these different spectrum bands, in a way are you getting more potential partners going forward or is it still you’re locked in with CDMA fleet just because that’s where the 2G underway component comes from?

Kenneth R. Meyers

I think long-term, it opens up doors for everything, because what happens is, as we start down the LTE route, all of us have 3G networks in place, right. And so we’re curving out some spectrum somewhere to put in LTEs. But long-term, the whole network is going to be LTE, right, that’s where all the zoomy speed of the future comes when you get all this spectrum aggregate and everything else. And so now there will be a time when the LTE in the phone is going to be 850, it’s going to be PCS, going to be AWS and whatever 700 spectrum you may add, so I think that it may be that you get a year or two where there is a disconnection, but long-term, I see it actually is opening more doors.

Michael I. Rollins – Citigroup

With the sale of these operating foot prints, the spending, you alluded on the conference call that in total – you might be even losing a little bit of EBITDA. But that includes some corporate overhead allocations in that. Can you help quantify before overhead, what the cash looks like, cash flow looks like from these markets to get a sense for how pro forma the company is going to evolve once you complete the sale?

Kenneth R. Meyers

Well, no okay. And the reason I can’t is it’s not when the company – when the sales closes, that we’re going to see really the change. It’s after the transition is completed. And we’re going to have to support these markets for anywhere from six months to three years, up to two years, what the contracts says. But we’ll be running the network. We will be providing customer service, billing. And during that time, we’ll get paid for it. Okay, so you will have no P&L effect on us, but we’ll have those complete, even that overhead into our organization. And so between now and the time that we complete that transaction when about 10% of our revenue goes away, we’re going to be working on resizing the operation.

And one of the things that you saw was, the same time we announced this, we had a call center in Chicago that we – what they call it rebadged. All the employees became employees of Xerox. We hired Xerox to support us through this period. But after that period is over, those costs are to move away. So there are some steps that we’ve already taken so that we can see the margin improvement that you’d expect when you get there.

Similarly now one of the challenges we are going to have is through this transition period hitting with the first quarter of this year we are going to have the operations of what I’ll call the ongoing operations as well as the stub and then we will be incurring some costs and we’d be the first going forward, so we’re working on how we can create disclosures, that will be clear to everybody exactly what the ongoing part of the operation, what part of this is going to tail off?

Michael I. Rollins – Citigroup

One of the changes that you made this year from what I recall was you changed your handset, great policy, you may have lengthened that a little bit, added a fee, let’s talk about the impact of P&L for the test?

Kenneth R. Meyers

I can’t quantify it, yet but yes, we did like everybody’s trying to manage the handset costs. And I think it’s we are healthy, people are trying to manage that right, though we lengthened the fee, we lengthened the upgrade period like others, but we are probably a little bit more aggressive still not because we are this far up the smartphone adoption rate yet. Similarly we have increased the fee. The fee is something that applies to every renewal, right so it’s not that everybody gets it as of tomorrow. So it’s something that’s going to filter in over the next 12 months to most of our customers.

Michael I. Rollins – Citigroup

One of the things, you at Cellular you’ve also tried to do is create a rewards program, the Belief plan. How is that going? What kind of progress are you seeing from that?

Kenneth R. Meyers

Really excited about that and I request if you put together a program like that and how do you know if it’s working. You know it’s working when you see your customers actually using the plan right. So they’re getting values out of the transaction, and they are using that for their handset upgrades. They are using that to get these newer phones faster and a very good response.

Michael I. Rollins – Citigroup

Just switching gears to the wireline side, you talked about deploying IPTV and starting the marketing set in 2013. A lot of companies that have started marketing IPTV, there’s a level of delusion that they might incur from that. Is that something that investors should be thinking about that by pushing IPTV as there is an incremental, definable sense that they should be thinking through?

Kenneth R. Meyers

I don’t know that it’s going to be that measurable at the telecom level given the number of markets that we’re talking about, only ten of them. And the fact – there is some incremental capital to – for each individual sale, but well within the kind of parameters we’ve seen this year.

Michael I. Rollins – Citigroup

There is some time for question. If anyone has questions, please raise your hand.

Kenneth R. Meyers

Otherwise Mike has a whole stack here. So save me.

Question-and-Answer Session

Michael I. Rollins – Citigroup

When you look at the wireline business, can you just help shape how much of it today is in ILEC versus CLEC, and can this wireline business become a consistent revenue grower over time with the mix of assets that you’re putting together? Do you think so?

Kenneth R. Meyers

Well, to start with, our wireline business, if we go back to the traditional wired part of it. 80% of our ILEC is consumer, 20% is business, okay, and Vicki, tell me ILEC and CLEC percentages are what?

So, 75, 70-30, right. And the original move into the CLEC, one of the thrusts there was the size of our business operation on the ILEC side, wasn’t of sufficient scale to develop some of the products and services businesses need. So by getting into the CLEC not only it give us some growth opportunities, but it allows to develop the products we need here. And I think on the business side where the growth is going to come from going forward is the marriage of our Hosted and Managed Services in there, right.

We’ve got primarily small and mid size businesses that we operate with and IS is becoming increasingly complex, get in the way of them running the real business so we think a) we can do that, but b) it also turns around and becomes a growth opportunity for the CLEC because in addition to the services that we offer, we can also offer connectivity back to the location wherever these services are. And we’ll continue to see the line erosion, but the growth in broadband has helped really, the whole bundling we’ve done there has really helped slow that down a lot that combined with some IPTV. I think we can stabilize the revenue with the exception of we still have risk around the wholesale side of the house, right. Minutes of use continue to change and that’s something that we’re going to continue to battle, I know Verizon will make that go away right now.

Michael I. Rollins – Citigroup

How often does the board evaluate whether it makes sense to keep the wired business with the wireless business? And is there an update on the current thinking for that?

Kenneth R. Meyers

There’s no change in our thinking. We see benefits to the company being larger than it otherwise would be if it was two standalone operations. If the wireline piece was a standalone operation, there’s about no way it would be investment grade no matter what the balance sheet looks like given some of the risk profiles that would result in that side of business. Okay, so we see benefits from it. But like everything else, we constantly look at everything we’re doing.

Michael I. Rollins – Citigroup

And is there a thought when you’re looking to do acquisitions in the wireline side and kind of forcefully shift the asset mix to try to create a mix that allows it to stand more on it’s own two legs or is it just more about creating better projects or better level of scale to provide what you do there, which is in the telecom side?

Kenneth R. Meyers

So if we look at the wireline business, we haven’t bought a telephone company per se, quite a few years, okay. We are putting our investments in the HMS space in that business now. We continue to look for other opportunities where we could use networks and expertise, telecommunication expertise to enter different markets. But I don’t see us buying another telephone company right now. Prices change, there may be an opportunity. But we – that isn’t where our focus is. We are more interested in some of the growth opportunities that we see in other areas.

Michael I. Rollins – Citigroup

And finally, in terms of where you are in this smartphone mix right now, remind us where you are in a penetration basis? And are there still significant ARPU benefits you’re looking to extract just from the initial adoption of your base as you’re looking for a smartphone?

Kenneth R. Meyers

Yeah. We’re about 38% penetrated now. And if you remember, we’re about a year behind everybody else in terms of when smartphones first got launched with us. And so I think we’re doing a nice job with kind of following the demand curve we’ve seen, others kind of layout. Third quarter, 50% of the sales were smartphone. And in fact, half of those were LTE smartphones. And so I think as we continue to drive penetration on smartphone as well as continue to invest in the LTE experience with smartphone that we should see some continued ARPU increase.

Michael I. Rollins – Citigroup

Actually, one more, when you look at your spectrum in the remaining market pro forma, what’s the average debt and your confidence to do LTE services within that spectrum inventory that you have today?

Kenneth R. Meyers

I am real comfortable with our effort. So quite frankly, it’s not the average we worried about. We worried about the individual debt in each market. We’ve been in the market buying some 700 secondary markets, filling in different places. But we think of – I think of Iowa and I think of Wisconsin, two of our bigger markets between the 850 – we’ve got, there the 750. We’ve got some PCS in markets. We’ve got a pretty rich portfolio. So there’s a few places where we continue. They’re on our shopping list. And some of the spectrum we’ve got that we haven’t sold to-date has been held in order to allow us to trade with others. Some of the big guys, once they get it, is not coming back out for any amount of dollars. But if you’ve got some spectrum that they need, now we can talk trade. So there’s a few places we’d like to fill in a little bit. But I think overall, the portfolio looks pretty strong.

Michael I. Rollins – Citigroup

I want to thank you for joining us today.

Kenneth R. Meyers

Well, thank you very much.

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