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United States Cellular Corporation (NYSE:USM)

Q1 2013 Earnings Call

May 3, 2013 10:30 am ET

Executives

Jane W. McCahon – Vice President-Corporate Relations, TDS

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

Mary N. Dillon – President and Chief Executive Officer

Steven T. Campbell – Executive Vice President-Finance, Chief Financial Officer and Treasurer

Vicki L. Villacrez – Vice President-Finance and Chief Financial Officer, TDS Telecom

David Kimbell – Executive Vice President and Chief Marketing Officer

Analysts

Simon Flannery – Morgan Stanley

Michael Rowland – Citigroup

Phil A. Cusick – JPMorgan Securities

Sergey Dluzhevskiy – Gabelli & Company

Ric Prentiss – Raymond James & Associates, Inc.

James Moorman – Standard & Poor's Capital IQ

Operator

Greetings, and welcome to the TDS and U.S. Cellular First Quarter 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, Jane McCahon, Vice President, Corporate Relations for TDS. Thank you Ms. McCahon. You may begin.

Jane W. McCahon

Thank you, Melissa. Good morning and thank you for joining us. I want to make you all aware of the presentation that we’ve prepared to accompany our comments this morning, which you can find on the Investor Relations section of the TDS and U.S. Cellular website.

With me today and offering prepared comments from TDS, Kenneth R. Meyers, Executive Vice President and Chief Financial Officer; from U.S. Cellular, Mary Dillon, President and Chief Executive Officer; Steve Campbell, Executive Vice President and Chief Financial Officer; and from TDS Telecom, Vicki Villacrez, Vice President of Finance and CFO.

This call is being simultaneously webcast on the Investor Relations sections of the TDS and U.S. Cellular websites. Please see the websites for slides referred to on this call including non-GAAP reconciliations.

Turning to Slide 2, the information set forth in the presentation and discussed during this call contains 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 release and the more extended version included in our SEC filings.

Shortly after we released our earnings, and before this call, TDS and U.S. Cellular files SEC Form 8-Ks including the press releases we issued this morning and pro forma financial statements reflecting the deconsolidation of New York 1 and 2 and to the divestiture transaction. Both companies have also filed their Form 10-Qs. We will be hosting our Annual Analyst Day at CPIA in Las Vegas on May 22, and we also invite you to join us or listen to the webcast of our Annual Meetings. U.S. Cellular’s is on May 14 and TDS’s is on May 24.

We would also ask that our shareholders support our extremely qualified fleet of director nominees at both TDS and U.S. Cellular. As always, please keep in mind that TDS has an open door policy. So if you are in the Chicago area and would like to meet with members of the management team from TDS Corporate, U.S. Cellular or TDS Telecom, Investors Relations team will try to accommodate you calendars permitting.

Now, I’d like to turn the call over to Ken Meyers.

Kenneth R. Meyers

Thank you, Jane. Good morning, and thank you for joining today. I will use Slide 5 to make a few points at the beginning of today’s presentation and then turn it over to the rest of the team. We would love to share with you this morning. The bottom line is that we are making good progress on many fronts.

First, the Sprint deal is marching towards close, and is now expected to close this quarter, in the second quarter of 2013, which is slightly earlier than originally planned. Second, we’re continuing to move forward with our 4G LTE rollout in migration of our customer base to 4G smartphones. In fact, as Mary will cover, we are increasing our investment in 4G LTE to deploy some of it on our 850 megahertz spectrum building roaming potentials and enabling new devices.

Third, planning around our Baja acquisition is on track. We recently added a new executive, Mark Barber, to the team, who brings 32 years of cable experience. We have successfully launched the pilot of our new billing system at U.S. Cellular and we are starting to see some success in selling cloud services through Vital, the solution provider we acquired late last year. Also, we continue to work on value building options for the towers and spectrum assets that we retained in the divesture markets.

Finally, as you saw in early April, in the process of negotiating a 700 megahertz lease with Verizon and New York 1 and 2, we triggered a change in accounting under GAAP. This change requires us to deconsolidate the results of New York 1 and 2 in our financials beginning in the second quarter.

Steve will provide additional detail on how this flow through our financial statements and guidance. But let me repeat that it has no impact on our ownership interest in these profitable markets or their contribution to our bottom line.

We announced earlier this year that we will be using adjusted income before taxes as a metric for guidance. This is income before depreciation, amortization and accretion, and it excludes any gain or loss on the sale of business or other exit cost, interest, and income taxes. This metric brings visibility to the earnings of all of our assets including our investments in Los Angeles, Oklahoma City, and now New York 1 and 2.

Before turning the call over to Mary, let me try to clarify what’s goes on with guidance and specifically how the accounting and timing of the divesture transaction is impacting results.

First, with respect to guidance; we have updated our forecast related to the divesture transaction close date. We now expected to close in the earlier date than when we issued our original 2013 full-year guidance back in February. Accordingly, our revised 2013 guidance related to both service revenues and adjusted income before income taxes includes reductions to account for the debt that we will own and include the financial results of these divesture markets for a shorter duration in 2013 than expected in our original guidance.

Separately, we have been and we will be recognizing amounts in the financial statement line item labeled, gain, loss, and sale of business in other exit costs related to the divesture transaction, this amount is excluded from our non-GAAP profitability measure adjusted income before income taxes for which we provide full-year 2013 guidance and – but therefore this financial statement item does not impact our 2013 guidance.

In accordance with GAAP, we expect to recognize a net gain on the divestiture transaction from the period beginning in the fourth quarter of 2012 when we entered into the transaction through 2014 when we expect to have the impacts of the transaction fully recorded, including the net decommissioning costs.

Through the end of the first quarter of 2013 on cumulative basis, TDS and U.S. Cellular have recognized $31.6 million of losses related to the transaction so far, including $7.1 million of losses in the first quarter of 2013. We expect to recognize a large gain in the second quarter of 2013 upon the close of the transaction. After the second quarter of 2013, we will continue to recognize gains and losses on the divesture transaction through 2014.

I know it’s confusing, but in summary we expect to recognize a total gain and the sale of the business and other exit costs in the range of $289 million to $324 million for TDS and $229 million to $264 million for U.S. Cellular. This net gain has been and will be recognized from the period of fourth quarter of 2012 through 2014 with the majority of the net gain being recognized in the period when the transaction closes, which we expect to be second quarter of 2013.

Lastly, the divesture transaction has caused us to accelerate depreciation of certain property, plant and equipment and accelerate accretion on certain asset retirement obligations. This has caused increased depreciation, amortization and accretion expense beginning in the fourth quarter of 2012 affecting the first quarter of 2013 and expected to continue at increased levels through the fourth quarter of 2013. This is the non-cash expense and it does not impact 2013 guidance. At a high level, I hope that helps principally in a couple of the moving parts.

Now, let me turn the phone call over to Mary Dillon. Mary?

Mary N. Dillon

Thank you, Ken. First, let’s take a moment to look at slide seven to review key takeaways from the first quarter. Our year-over-year gross ad growth continued in the first quarter albeit at a slower pace since 2012. Early in the quarter, we saw some impact from the delays in tax refund and the expiration of the temporary reduction in payroll taxes, but experienced stronger results in the subsequent month ending the quarter with ads up 1% in our core markets.

Continued elevated churn led to postpaid net losses of 32,000 in our core markets. This was offset by prepaid growth resulting in total retail subscribers at a slight decline of 1,000 for the quarter.

Now importantly, we made significant progress against our strategic priorities in many ways in the first quarter. We continued to receive third-party recognition for our outstanding network and differentiated customer experience. J.D. Power and Associates awarded us with the highest network quality in the North Central region for the 50th consecutive time. Also, U.S. Cellular was named by PC Magazine Readers' Choice for best mobile carrier with highlights around overall satisfaction, network reliability, speed, and coverage.

Secondly, in our efforts to expand distribution, we continue to benefit from our distribution at Wal-Mart and are pleased to reach an agreement to offer U.S. Cellular postpaid products and services at select Sam's Club in our footprint. We continue to also make strong progress in providing our customers with a wide variety of compelling devices in Q1 led by the Samsung GS3 and Note 2 and the Motorola Electrify M. Our connected devices continue to grow with the addition of Samsung Note Tablet and strong sales of our LTE Hotspot.

We also saw continued adoptions in smartphones with penetration increasing to 43% in our core markets. More importantly, this is largely come to sales of our wide selection of 4G LTE devices. And while this increased our loss in equipment sold, it further lowered our expected capital spending on our legacy networks.

Our efforts to communicate our brand promise continued to improve. Our Hello Better marketing campaign has been in market for nine months, and continues to exceed industry benchmarks through breakthrough and branding. Our actions to effectively manage our upgrade rate resulted in a decline in our core markets from 9.46% in the first quarter of 2012 to 8.37% in the first quarter of 2013. We also successfully converted our first wave of customers on to our new billing and operational support system. We remain on track to complete this critically important project this year and it will enable us to launch new products and services such as share data later this year and it enables significant savings and benefits going forward.

And finally, we made good progress with our transaction to sell a set of underperforming markets in the Midwest to Sprint. We continue to believe, this transaction will be enable us to be stronger, more focused, and over time more profitable. We’ve received regulatory approval and expect to close the transaction this quarter.

Now, while we’re pleased with the results of these actions and many others we’ve taken across the business, we also need to do more to ensure we’re attracting and retaining customers, growing our postpaid customer base, and reducing costs. So in addition to our other strategic priorities, we’ve made a decision that we believe will help us to grow our customer base over time. We’ve signed a contract with Apple to begin to provide apple products later this year.

As we’ve discussed on previous calls, our postpaid churn has been unacceptably elevated for several quarters. And while we’ve taken a variety of actions to reduce this, we know that a high portion of this churn is driven by not offering Apple products.

Now importantly, we are comfortable moving forward with this relationship, because we have an LTE solution. In order to offer these in a variety of other devices, as well as to better enable future roaming arrangements, we will begin re-farming some of our 850 spectrum 4G LTE sooner than we had expected.

We intend to have this Band side LTE solution built and nearly matching our Band 12 network later this year. This is an investment that has many future benefits versus further investment in our 3G network. You’ll see this reflected and an increase in our CapEx guidance for the year.

Additionally, this relationship will have a short-term impact on our margins, which Steve will detail in updated operating income guidance. Before I turn the call over to Steve, let me recap our strategic priorities shown on Slide 8 for the remainder of 2013.

We plan to accelerate growth by expanding our device lineup and providing exceptional and innovated customer services that incurs loyalty and advocacy. In fact, we are among the first carriers to launch the Samsung Galaxy S4 earlier this week, several weeks ahead of the announced launched timing of our largest competitor. Additionally, we will be launching a Home Phone replacement product later this year to drive incremental revenue with our existing customers and attract new customers.

We’ll continue to drive growth with business customers as well. Just yesterday we launched celebrating small, our fully integrated, small business marketing and sales campaign. It was created from insights about entrepreneurs. The program give SMB customers greater flexibly to tailor their plans, devices, and data needs by line, a completely revamp web experience, industry specific app suggestions and many other innovative features that will helps us build penetration in the important segment.

We coupled this with a renewed sales focus and we are confident we’ll have success attracting and retaining these important customers. We’ll continue to enhance and integrate our channels to improve sales and service delivery and create more opportunities to be where customers shop. And we’ll drive smartphone penetration and ARPU with the 4G LTE network expansion and devices.

We’ll also take a step forward – important step forward and positioning U.S. Cellular for significant operational efficiencies as we implement our new billing and operational support system.

Lastly, we’ll continue our efforts to reduce complexity and costs across the company. We’re actively examining our entire operating expenditure base to find ways to continue to become more efficient while still delivering an exceptional customer experience. In conjunction with these efforts, we began the implementation of a number of organizational changes that will result in a modest reduction in our workforce.

I’ll now turn it over to Steve who will walk you through our first quarter results in more detail and financial expectations for this year.

Steven T. Campbell

Thank you, Mary, and good morning, everyone. U.S. Cellular’s core market results for the quarter reflected trends that we’ve seen over the past several quarters. We improved retail gross divisions, but are still challenged with retaining customers in this extremely competitive market. Prepaid gross and net additions continued to improve significantly due the success of our new prepaid offering through Wal-Mart. As shown on Slide 9, postpaid gross additions in the core markets were 184,000, up 1% from 182,000 last year. However, postpaid churn also increased resulting in a postpaid net loss of 32,000 customers for the quarter. Prepaid net additions in the core markets were 31,000, up significantly from last year, and total retail net losses in the core markets were 1,000 compared to 16,000 last year.

Next, we’re showing you the trends in smartphone sales, penetration and postpaid ARPU in our core markets. During the first quarter, we sold 449,000 smartphones, which represented 62% of total devices sold. This compares to the first quarter of 2012, when we sold 364,000 smartphones or 54% of the total units sold. 340,000 or 76% of the smartphones sold this quarter were 4G LTE devices and smartphones now represent 43% of our postpaid subscriber base, compared to 34% of the same period last year.

And as we have discussed before, while the overall cost to subsidize smartphones, especially the 4G devices is greater. We expect that the higher ARPU from smartphone users, as well as the migration of data usage of our 3G network on to our 4G LTE network will benefit our results over time. As you can see on the graph, [FFR] rate, postpaid ARPU generally has continued to trend up over the past several quarters, increasing 2% over last year.

Turning now to our financial performance, first, service revenues in the core markets. First quarter service revenues were $899 million, down just slightly from $913 million last year. Retail service revenues were $794 million, an increase of 1% with billed ARPU growing 1% year-over-year.

Inbound roaming revenues decreased $16 million or 21% year-over-year to $61 million, driven by lower negotiated rates, which also cause a similar reduction in roaming expenses. An increase in inbound data usage was offset by lower inbound voice usage, lower rates for both data and voice in the loss of some roaming revenue from our market that we sold in 2012.

Looking out into the future, we expect continued growth in data roaming usage both inbound and outbound, but both lower revenues and lower expenses due to significantly lower rates.

In the first quarter, ETC revenues declined about $9 million due to the phase out of Universal Service upon support. As you will recall such support is being phased out at the rate of 20% per year beginning in July 2012. For the total company, including both core and divesture markets, service revenues were $996 million, down about 3%. About half of the decrease occurred in the core markets as I just described and the other half was in the divestiture markets.

In the divestiture markets, billed revenue has declined as customers in those markets are now turning off higher than our average rates. System operations expense of $216 million decreased $17 million or 7% year-over-year. This was primarily due to a decline in roaming expense of $13 million as higher off-net usage was more than offset by lower rates.

And as data usage continues to grow rapidly, we’ve implemented a number of measures that have been effective and minimizing the impact on our expenses. Loss on equipment for the quarter was $156 million, up $38 million or 32% from last year, primarily as a result of increased smartphone sales and higher costs related to 4G LTE devices.

The average loss per device sold increased 30% year-over-year due primarily to the shift in the mix of devices sold to smartphones that I mentioned earlier from 54% to 62%, and in total, we sold 13% more smartphones than we did a year ago.

We expect equipment pricing will continue to be very aggressive across the industry, and then our costs will be impacted by this continuing shift in mix to smartphones, the continuing introduction of 4G LTE devices throughout the year and the introduction of Apple products later in the year.

Keep in mind that we are selling 4G devices in our 3G market, so that we can capture the costs savings immediately as we continue to launch 4G service in those markets. As we successfully migrate more customers to 4G, we expect lower capital expenditures for our legacy networks. SG&A expenses of $420 million or down 5% due to our ongoing efforts to tightly manage these expenses.

Operating income for the quarter was $1.5 million. This reflects $45 million of expenses related to the divestiture transaction. Excluding these divestiture related expenses, operating income was $46 million, which represents a decline of about $39 million from the $85 million reported for 2012. A major factor for the – in the decline was higher loss on equipment, which as I just mentioned was up $38 million or 32% from the year ago quarter. Changes in revenues and other expense line items likely offset it.

On Slide 13, we show the details of the divestiture related items that impacted operating income in the first quarter. The biggest item at $38 million is depreciation, amortization and accretion. As Ken mentioned earlier in his comments, the divestiture transaction has caused us to accelerate depreciation of property, plant and equipment, and accelerate accretion on our asset retirement obligations. We also encourage $7 million of employee related contract termination and other costs, which I reported in loss on sale of business and other exit costs in the statement of operations.

As shown on the next slide, total investment and other income net for the quarter was $16.6 million, including earnings of approximately $21 million related to our interest in the Los Angeles partnership, up from $17 million last year. Net income attributable to U.S. Cellular shareholders totaled $4.9 million or $0.06 per diluted share versus $62.5 million or $0.73 per share in 2012. The effective tax rate for the first quarter this year was 40.8% compared to 27.1% last year. Net rate was lower last year due to benefits related to the expiration of the statutes of limitations for certain tax years and a correction of state deferred taxes.

For the first quarter, we generated cash flow from operating activities of $224 million down from $257 million last year. Cash used for additions to property, plant and equipment in the quarter was $151 million reflecting significant expenditures related to our 4G LTE network as well as for our multi-year enablement initiatives, primarily in our billing system conversion. Free cash flow for the quarter was $73 million compared to $48 million in the prior year quarter.

As you can see in the press release, our balance sheet remains very sound and we have significant liquidity and financial flexibility together with expected cash flow from operations and funds available under our revolving credit facility to meet our financing needs for the foreseeable future. At March 31, cash in short-term investments totaled $530 million and we have about $300 million of unused borrowing capacity under our revolving credit agreement.

Next, I’d like to review our updated guidance for the full year 2013. As shown on Slide 15, we are providing visibility to our estimates for our core markets, as well as to what we expect to the divestiture markets to contribute through the costs.

I’ll walk you through our estimates for our core markets next, which is where we will be most focused going forward. For services revenues, we have lowered our estimate by $125 million and are now forecasting a range of $3.475 billion to $3.575 billion. This change has been made primarily to reflect the deconsolidation of the New York 1 and 2 markets and lower subscriber growth so far this year, offset by a small increase expected from the sale of Apple products later in the year.

Adjusted income before income taxes has now been provided as Ken highlighted earlier to provide visibility to the profitability of all of our assets, including our investments in partnership such as Los Angeles, Oklahoma City, and now New York 1 and 2. We have provided numerous reconciliations to help you understand its composition. I do want to call out how we treat the indirect costs that had previously been allocated to the divestiture markets.

In order to provide the most accurate picture of what our results will look like after the divestiture deal closes, the estimated results for the divestiture markets include only the direct costs related to those markets. The significant amount of indirect costs previously allocated to the divestiture markets will continue for a period of time and accordingly are included in the estimated results of the core markets.

Our (inaudible) resource expenses and align our overall expense structure without smaller size, but that will not happen over night. So for the core markets, we have lowered our guidance for adjusted income before income taxes by $205 million. A major factor in the reduction is higher loss on equipment and other expenses related to offering Apple products later this year. Other factors include both lower subscriber growth and higher loss on equipment overall so far this year, as well as an adjustment of approximately $30 million to reflect the deconsolidation of the New York 1 and 2 markets.

As we disclosed our ownership interest in these markets and therefore their contribution to net income remains unchanged. This is purely a change in the geography on the financial services.

Per capital expenditures, we are increasing our guidance by $130 million to reflect the cost of rolling out 4G LTE technology on some of our 850 megahertz spectrum. As Mary mentioned earlier in her comments, this deployment will support the sale of the Apple products later this year, as well as enabled potential future 4G LTE roaming arrangement.

We’re also incorporated into this forecast as a reduction due to the deconsolidation of New York 1 and 2 of approximately $25 million and a further reduction in our spending on our legacy networks, even the success we’ve had migrating customers from 3G to 4G.

For the divesture markets, we’ve adjusted our guidance to reflect our (inaudible) relation of an earlier closing date as Ken mentioned earlier, as well as the costs reduction actions that we’ve been taking in those markets.

And now, I’ll turn the call over to Vicki Villacrez

Vicki L. Villacrez

Thank you, Steve. Good morning. Before discussing the results of operations, let me first touch on each of our primary initiatives shown on Slide 18. With respect to IPTV, we provide service in ten markets as of March 31, and passed approximately 75,000 service addresses, up from approximately 65,000 at year-end. We continue we expand IPTV to new markets, but at a rate slower than 2012, as our primary focus is on expanding our service in current 10 IPTV markets and driving up penetration. We are excited about our IPTV service, which is meeting our high expectations for customer take-rate. Our 90% of these customers select an expanded package and 40% are purchasing the highest tiered products we are offering for both Internet space and channel packages.

Additionally, 95% of our TDS TV customers are taking all three of our services; video, data and voice. We continue to make S Phone progress on our Broadband Stimulus Projects. Construction is underway on 41 of the 44 projects for which we are receiving stimulus funding, and we should turn up services in the majority of these markets throughout 2013. When we have completed these projects, approximately 97% of our ILEC exit lines will have broadband access. Our HMS business is making solid progress towards becoming the end-to-end solution provider for our mid market customers’ IP need.

Vital, which we acquired in June of 2012 has begun to leverage it’s trusted IT advisor status with customers to gain traction in selling recurring services that shows our enterprise-class ReliaCloud offering. We are also encouraged by the sales pipeline so far this year, particularly with respect to our hosted application management services and would expect that translate into increasing revenue as we move through 2013. And lastly in February, we announced an agreement to acquire substantially all of the assets of Baja Broadband LLC. Everything is proceeding on track and we continue to expect the acquisition to close in the third quarters.

As shown on Slide 19, on a consolidated basis, revenues are up over 6% on the effects of the Vital acquisition, which is included in our Hosted and Managed Services segment. Cash expenses were up 11% for the period. Again, this is primarily due the Vital acquisition, which includes transition cost. Overall, adjusted income before income taxes declined 6%, reflecting the decline in high margin regulatory revenue.

Turning to Slide 20, I will discuss the ILEC and CLEC results on a combined basis. We have continued growth in our broadband IPTV and managed IP products. However, this growth has not been quite strong enough to offset the losses in our legacy and voice products, but the decline in total connection is slowing.

Residential revenue declined 2% due mainly to a reduction in our CLEC residential connections. We saw a 2% increase in commercial revenues driven by growth in managed IP. As expected, wholesale revenues declined primarily as a result of changes in regulatory recovery due to the reform order. Lower held cell rate and the continued decline in interest rate minutes of use.

As we’ve discussed previously, the SEC reform order was issued in November of 2011, while portions of the order are still forthcoming and the impacts are unknown. The portion that has been settled will reduce revenues and adjusted income before income taxes in 2013.

The impacts of the reform order along with other declines in wholesales revenues are forecasts to reduce adjusted income before income taxes by $10 million to $12 million in 2013. This has been incorporated into our guidance.

Turning to Slide 21, ILEC residential broadband connections increased 1% year-on-year, adding to an already high penetration rate to reach 66% of primary residential lines at the end of the period.

73% of these customers are taking speeds of 5 megabits or greater, up from 65% a year ago, and 29% are taking speeds of 10 megabits or greater, up form 20%. With the upgrades of super high-speed data for IPTV, we have enabled approximately 25% of our residential service agencies for speeds of 25 megabits or greater and are moving more customers to these higher speeds. Residential broadband ARPU has trended upwards to nearly $39 as migration to higher speed service offsets competitive pricing pressures.

On Slide 22, we continue to emphasize our triple play bundle, voice, data, and video with video offered to Dish Network and increasingly through our own IPTV service, TDS TV. Triple play subscribers now represent nearly 32% of our ILEC residential customers churn and our triple play customers continues to remain very low.

71% of our residential customers are on a double or triple play bundle, which is up from 68% last year. Sharing for our double play customer while not as low as a triple play is still significantly lower than sharing with a single service. On the commercial side, ILEC and CLEC together, Slide 23, we saw a 60% growth year-over-year in our flagship commercial voice and data communication solution called managed IP, which outpaced our losses in legacy physical access lines and data connection.

Turning to the HMS segment on Slide 24, acquisitions increased revenues by $16.9 million and cash expenses by $17.2 million, which includes transition cost. Adjusting for the effects of acquisition, organic growth was 6% for the quarter with growth in colocation and managed services revenue. We have been postioning for future growth by investing in the infrastructure support system and development of new products and services causing margin to be lower.

On a consolidated Telecom basis, we continue to focus on improving our cost structure. Total cash expenses excluding the impacts of the Vital acquisition decreased 1%. As shown on slide 25, our 2013 guidance is unchanged from your year-end call. As a reminder, we will not updated 2013 guidance for Baja acquisition until it closes.

Now, I’ll turn the call over to Jane.

Jane W. McCahon

Thanks, Vicki. Melissa, we will now open up the call for question.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Simon Flannery with Morgan Stanley. Please proceed with your question.

Simon Flannery – Morgan Stanley

Great. Good morning. Thank you. Congratulations on the Apple deal. A couple of questions; first on the Apple deal, I think in the queue you are highlighting at $1.2 billion three-year commitment. I just wanted to understand, how we should think about that in terms of proportion of smartphone sales, how you got comfortable with you ability to deliver that number? And you’ve talked before that economics being unattractive, what’s changed there?

And then T-Mobile is obviously revamped their go-to-market strategy on a number of direction increasing competition. I wondered if you had any thoughts on sort of how the competitive environment is trending and whether you would ever consider some of this installments financing type options for your customers? Thanks.

Mary N. Dillon

Thank you, Simon. Thank you for your questions. In terms of getting comfortable with that, certainly as we look at our business over the last several quarters as we’ve discussed we’ve experienced how they returned. And we know that, a portion of that – a significant portion of that is related to not carrying the iPhone. And in fact, we know that, 85% of the customers who have loved us for the iPhone, in fact, are quite satisfied with our security and overall experience.

So as we look at the upside growth potential that we have in terms of smartphone in our base, continue demand for the iPhone in the marketplace, in fact, that we know there is demand with our customer base to carry the iPhone. We felt confident and comfortable with the estimated range of that commitment.

In terms of the, what’s new about this is, frankly, probably the newest aspect is that we now have an LTE solution in order to offer these products. And that allows us to move forward with less investments if any and our legacy network and we think that makes a lot more economic sense for us. In terms of the competitive environment, there certainly is a whole lot going on that maybe the understatement of the year, and as we look at (inaudible), for example, there’s definitely interesting things that they are doing on their business model, everybody is working through different ways to think about subsidies, we’re watching and monitoring and certainly doing some of our own experimentation as well.

Kenneth R. Meyers

All right. Thank you.

Operator

Thank you. Our next question comes from the line of Michael Rowland with Citi. Please proceed with your question.

Michael Rowland – Citigroup

Thanks for taking my questions. First question is that you weren’t very specific with your timing for the deploying the iPhone in your handset lineup for customers, are there certain things that has to happen first that could either accelerate or delay the launch timing of iPhone? And then the second question, can you mention that you’ve potentially closed the divestiture sooner than you anticipated, can you talk about how you are thinking about the use of that cash potentially and when investors should expect an update on the direction of what the company has decided on that front? Thanks.

Mary N. Dillon

Sure, Mike. The only reason we’re not being specific as to the timing is that we are not ever specific about launches prior to – when we’re closer to the launch. So that is really the reason for that. In terms of the closing of the deal, yes, we are at actually a Board level discussion and when the deal closes, we’ll make a decision with our Board about the use of those proceeds and go from there.

Michael Rowland – Citigroup

Good. Is there something an investor should expect relative close proximity from once the transaction is closed to determining the use of that cash or do you think there could be a few months delay in terms of just thinking through those mechanics? Thanks

Mary N. Dillon

Ken, would you like to jump in on that?

Kenneth R. Meyers

Yeah, Mike, as we’ve talked in the past, we have been and we continue to work with the board on various strategic alternative support. I’m not in a position to speak exactly when the board is going to make a decision as much as I’d say that we have been working with them. We are aware of the acceleration of the – of close of this transaction and I have continued to work with them, and we hope to be out there very timely with information.

Mary N. Dillon

Mike, if you don’t mind, Mike, I just wanted to add one other thing on your question about timing. Our network will be ready for the launch whenever we’re ready to launch, so that’s not a concern.

Michael Rowland – Citigroup

When you say network is exactly LTE upgrades that you have to make or is that just a capacity qualification there?

Mary N. Dillon

That’s really the re-farming of our band 5 spectrum and that’s in process.

Michael Rowland – Citigroup

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Phil Cusick with JPMorgan. Please proceed with your question.

Phil A. Cusick – JPMorgan Securities

Hi, thanks. So not to be the dead horse here, but Ken, you and I spoke 2.5 to 3 years ago and the discussion was that the iPhone was just too expensive, and it didn’t make any sense for the company. At this point, do you feel like it’s price points that have come down is the pain threshold just too high. And then on the LTE side, you mentioned that Mary, but you are also going to hold carrying the CMA only versions? Thanks.

Steven T. Campbell

So I’ll try the first part that. I think, Mary, already answered it. And so that is that we look at economics, it is the cost of any subsidy, but it’s also in the network and that fact that we’re re-farming 850 LTE in advance, so that we can have LTE capacity for those and have a long road with LTE as opposed to the shorter life of CDMA has a dramatic effect and how we think about this?

Mary N. Dillon

Great. And then Dave, do you want to comment on the second part of those questions?

David Kimbell

Yeah, around CDMA certainly, we are working with that, we don’t have any specifics on the exact devices that we are offering, but obviously the trend in the marketplace is towards more LTE devices. So that’s what we’re building our entire vision and future of our business around.

Phil A. Cusick – JPMorgan Securities

Okay, I just want to understand that. It’s really the LTE devices that you would be selling up for CDMA to go along with Center Point. And then separately, can you give us an idea on the interest level for the Towers in those divested markets? Thanks.

Kenneth R. Meyers

Cusick, it’s Ken. We are in the early stages of that work, but we are no optimistic that there is a real value in both the 500 and some towers that we are retaining as a result of the divestiture transaction as well as the spectrum of that is no longer kind of strategic given that it’s not – if you want to have operations and even if those are two avenues that we continue to work down and with the expectation of having results to discuss by the end of the year.

Phil A. Cusick – JPMorgan Securities

On the towers, I guess, (inaudible) as the accounting on those towers sort of up to enough in terms of how tower is traded, is that all sat and you know the profitability and sort of the lease levels on each tower individually, or is that part of what has to be done over the next two months?

Kenneth R. Meyers

No, we have, we know where the towers are, what leases we have on which towers, all that information is pretty much readily available.

Phil A. Cusick – JPMorgan Securities

Okay. Thanks, Ken.

Operator

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

Sergey Dluzhevskiy – Gabelli & Company

Good morning, guys. Just a couple of questions, one on churn reduction, obviously [April] announcement is part of your strategy and should help with the reduction of churn as you launch those products, but Mary could you comment a little bit on some other actions that you are planning to take during the remainder of the year that you think are going to contribute to churn reduction and what are sound and most effective actions that you think are going to take place? And also Ken and Mary, maybe you could comment a little bit on the M&A activity in the space, kind of your reaction to recent deal activity and also given what’s happening in the sector, why you believe being a regional operator is a still a good strategy and there is still room for independent regional care in this consolidated space?

Mary N. Dillon

Okay, Sergey, firstly on churn, yes, we for several months now have been actively working, what I call, on the life cycle – a life cycle strategy and we’ve developed strong capabilities around using predictive analytics to help us really understand, who is likely to churn and why, and also the profitability of that customer. And we’ve put a series of tactics, sort of test and learn and then implement, strategies and tactics around how to predict and then prevent churn for multiple reasons. So obviously, the iPhone will be an important component of that, but we are absolutely going to continue because now everybody who churns would churn for that reason, and we see good response and good progress as it relates to that as a way to reduce churn. So you can give a couple of examples for that, Dave.

David Kimbell

Yeah, absolutely, we’ve looked across a variety of different metrics within the data that we have to try to understand the motivations for people are to be able to predict when people are possibly going to leave us. The good examples of that are certainly device driven and based on the device they are on today and other actions they are taking, we are able to predict a high likelihood of potentially leaving us and direct messaging and communication to that. We also find things like minutes used, either low minutes used or high minutes used overtime, also is a good predictor of churn and then we are able to come back with simple programs like plan evaluation that happens either in our stores or online and we’ve had high success with being able to retain those much higher than we had in the past.

So the analytic tools that we are doing, in addition to really our entire marketing program is centered around the idea of kind of delivering a broader customer experience and understanding of what we bring that’s unique to the marketplace, all intended to drive that churn down.

Mary N. Dillon

And that might be a good segue to the second part of your question, I mean, certainly there’s a lot going on in the industry. We really are focused on our business and really improving our business and serving our customers. And we believe that by focusing on the markets that we are going to be focusing on going forward, where we have very strong market share positions and really differentiating ourselves as Dave said, doing things to really make sure that we improve our subscriber trends, our revenue as well as improve our costs overtime are all the different levers of the business that we’re pulling to make sure that we deliver the returns and have a successful long-term business.

Sergey Dluzhevskiy – Gabelli & Company

Thanks, just one more question on the TDS side. Basically we are seeing the national carriers rolling out 4G LTE products as kind of wireline replacement products. We are seeing AT&T trying to reach 25% of their wireline customer locations with LTE, and also Verizon Wireless rolling out HomeFusion. I was wondering if you are seeing any of the services yet in your markets, and what are your thoughts as far as these services being a competitive threat to wireline? And also some of the steps that maybe you are taking to combat this potential competition?

Vicki L. Villacrez

Yes. Good morning. This is Vicki. We have not been seeing the effective broadband substitution in our market. Our porting has been very low. We – our churn has been very steady, and in fact, our wireline churn in our residential areas has been slowing. We’re really excited with all the fundamentals that we’re seeing, and as you know, we’ve been pursing our IPTV and super high-speed data strategy rollout that not only does the super high-speed data equips to enable our network within our TDS TVs or TV markets where we have our strongest cable, we are extending that super high-speed data even farther out into our network, and so we see this as a viable strategy. In addition, we’re really excited as well with the broadband stimulus markets that will expand our reach all way to 97% of our exercise

Sergey Dluzhevskiy – Gabelli & Company

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Ric Prentiss with Raymond James. Please proceed with your question.

Ric Prentiss – Raymond James & Associates, Inc.

Thanks. Good morning.

David Kimbell

Good morning.

Ric Prentiss – Raymond James & Associates, Inc.

I have a couple of questions. First, on the iPhone, Mary, we have seen other carriers – other regional carriers when they have picked it up, get a pretty quick adoption curve, sometimes 3% or 4% of their base per quarter coming on. Shenandoah just had their call today, and said the iPhones are the – like 20%, 21% of their base after just a short period of time. If you think about the iPhone, how fast of an adoption are you guys hoping or could you be seeing given the low smartphone percent of your base? And the other side of equation on the churn benefit, we’ve heard other carriers talk about 20 basis points, 40 basis points, and even 80 basis points of churn improvement over a period a time. So as you think of the algebra on why are you’re carrying at the high expense but the benefit, help us understand maybe a little bit about the adoption curve, and what the churn benefits might be?

Mary N. Dillon

Thank you, Ric. While it’s certainly early and we’re not even to launch yet, so, but we made this decision because of two things; we know that we will have a quick adoption and good benefit to our churn. And frankly, we also offer great devices from companies like Samsung and Motorola as well, and we like the notion of being able to a buy for users quick with current and future customer. So as we do the algebra across that entire equation, we feel good about that overtime. David, is there anything else that you can add to?

David Kimbell

Yeah, no, I mean, I think definitely our plan as we thought about both the balance of this year and going into next year, we see that will have a significant impact both on we think on gross adds as well as pretty quickly we think impact in our churn, we don’t – nothing very specific at this point, but we know that that will have an important impact on overall subscriber churns.

Ric Prentiss – Raymond James & Associates, Inc.

Okay. And then on the guidance, a lot of moving pieces there, could you maybe outline for us, particularly on the OIBDA line, or however you are pronouncing that new word these days, how much of the change was related to the deconsolidation versus iPhone, versus lower subs, versus higher loss on equipment, or at least rank order them, just so we can understand what the bigger drivers were?

David Kimbell

Yeah, so Ric on the adjusted income line, when you look at the changed guidance to guidance, in terms of rank ordering , the impacts associated with offering Apple products would be the biggest factor. New York 1 and 2, I think I mentioned in my prepared comments that that was probably a $30 million impact and then just when you look at the trend that we’ve seen so far this year, in overall, there’s a factor for that, but I sort of rank them in that order.

Ric Prentiss – Raymond James & Associates, Inc.

Sure. And then you mentioned CapEx was going up to buy LTE at 850. What exactly do you have to buy? Is that more antennas, is that something in the base station? What exactly are you going to be buying with that increased CapEx?

Kenneth R. Meyers

I think it’s more about the base station.

Ric Prentiss – Raymond James & Associates, Inc.

And one other quick one, since you are getting them fast, as the roaming is down, but we should see seasonality still kick in, right, so while roaming will be down year-over-year, I would expect we would probably see increases in the second and third quarter with the seasonality?

Kenneth R. Meyers

Yeah, I think you would expect to see normal seasonal trends. There’s nothing in our roaming performance or our guidance that reflects a change in what you normally see seasonally. The year-over-year impact that you are seeing in the first quarter as we said is all about renegotiating lower rates.

Ric Prentiss – Raymond James & Associates, Inc.

Right. So it’s more rate-related rather than some kind of overbuild attempt to buy them out completely?

Kenneth R. Meyers

That’s correct. In fact, again, when you drill down into the components we are actually seeing – still seeing very significant growth in data usage. As you would expect, some decline in voice, but data usage is still growing very significantly. The driver here is the rate negotiation that we’ve done.

Ric Prentiss – Raymond James & Associates, Inc.

Great. Thanks a lot.

Jane W. McCahon

Melissa, we have time for one more question.

Operator

Thank you. Our final question will come from the line of James Moorman with S&P Capital IQ. Please proceed with your question.

James Moorman – Standard & Poor's Capital IQ

Yeah, thanks for taking my question. The first is, you kind of mentioned it with the billing system being completed by the end of the year, you plan to offer shared data packages. Could you just give a little bit more detail, I guess, or if it’s too early, how – what you look to do in terms of, with family plans, and also sharing devices for individuals? How you kind of look to implement that? If there’s any additional cost in offering that or it’s pretty much just roll it right out once you complete the billing system?

And the second question in regards to what you are seeing about the other devices besides the iPhone, I guess, it’s a little bit of embarrassment of riches, but now that you have the S4, which has been very popular, is there anything that you’re going to look to do to control, like how you sell one more than the other, or is it going to be just however the customers want them? Thanks.

David Kimbell

Great, I’ll answer those, first on the shared data in the billing system as we’ve discussed in past, we do plan on rolling out our shared data solution later this year after the billing system is in. The timing, we’ll share as we get closer and as where we share the specifics around it and what exactly that looks like, but certainly the overall intent is to encourage and to monetize data usage, encourage additional adoption of connected devices, which is an area we had success with already, but we’ll see that after we see shared data as a opportunity to really accelerate the growth of our connected devices and to give people more options around different data solutions within their family.

So we are excited about that and we think it will have a really positive impact both on our subscriber trends as well as our ARPU. Related to the devices, we do believe that we have a very strong portfolio today. As Mary said, we’ve launched the S4 this week and have, well, it’s obviously early, really pleased with that results of our and our partnership with Samsung as well as Motorola and all the other device manufacturers. We will let the consumer going to decide how – what’s right for them. Our key is make sure that we are offering the right portfolio in the right option, so we can deliver a great customer experience. So we won’t be trying to manage that one way the other, other than our broader efforts to try to manage LOE.

James Moorman – Standard & Poor's Capital IQ

Thank you.

Operator

Thank you. We come to the end of our Q&A session. I would like to turn the floor back over to Ms. McCahon for closing comments.

Jane W. McCahon

Thanks Melissa. I would like to thank everybody for joining us. I know we had a lot of folks in the queue for question. So please follow-up with us for the rest of day today and hopefully we will be seeing you at CPIA and other trips that we are taking throughout the quarter. Thank you very much.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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