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United States Cellular Corporation (NYSE:USM)

Q3 2011 Earnings Conference Call

November 4, 2011 10:00 AM ET

Executives

Jane McCahon – Vice President and Corporate Relations

Kenneth Meyers –Executive Vice President and CFO

Joseph Hanley – Vice President of Technology, Planning, and Services

Mary Dillon – President and CEO

Steve Campbell – Executive Vice President and CFO

Vicki Villacrez – VP, Finance and CFO

Alan Ferber – Executive Vice President, Chief Strategy and Brand Officer

Analysts

Phil Cusick – JP Morgan

Simon Flannery – Morgan Stanley

Robert Dezego – SunTrust Robinson Humphrey

Phil Cusick – JP Morgan

James Moorman – Standard & Poor’s

Kevin Roe – Roe Equity Research

Steven Need [ph] – Angkor Capital Advisors

John Lee [ph] – Etika Partners

John Frank – Harbert Management

Ric Prentiss – Raymond James

Operator

Greetings and welcome to the TDS and U.S. Cellular Third Quarter Operating 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 and Corporate Relations for TDS. Thank you, Mr. McCahon. You may Begin.

Jane W. McCahon

Thank you, Christine and good morning, everyone. Thank you for joining us. I want to make you all aware of the quarterly conference call presentation we have prepared to accompany our comments this morning which you can find on the Investor Relations pages of the TDS and U.S. Cellular website.

With me today and offering prepared comments are from TDS, Kenneth R. Meyers, Executive Vice President and CFO, Joseph Hanley, Vice President of Technology, Planning, and Services, from U.S. Cellular, Mary Dillon, President and CEO, Steve Campbell, Executive Vice President and CFO, and from TDS Telecom, Vicki Villacrez, VP, Finance, and CFO.

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

The information set forth in the presentations 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 versions that will be included in our SEC filings.

Shortly after we release our earnings results this morning and before this call, TDS and U.S. Cellular filed SEC Form 8-K current reports, including the press releases we issued this morning. Both companies plan to file their SEC Form 10-Q report next week.

Between now and year-end, we will be attending three conferences all being held in New York. The Wells Fargo conference is in November and the J.P. Morgan and UBS conferences are in December.

If you’d like to meet with us at either of those conferences, please let me know and we’ll try to accommodate you as well if possible. Please keep in mind that TDS has an open-door policy. So if you are in the Chicago area and would like to meet members of the management from TDS Corporate, U.S. Cellular or TDS Telecom, the IR team will try to accommodate you if calendars permitted.

And with that, I’ll turn the call over to Ken Meyers.

Kenneth R. Meyers

Thank you, Jane. Good morning. I have a few comments before turning the call over to the rest of the team. First, the financial results for both of our businesses were solid with TDS’s consolidated operating revenues and profitability showing improvement.

There was an unusual item in the quarter with TDS recording a $12.7 million net gain related to its acquisition out of bankruptcy of the 63% interest in the Wisconsin base wireless provider.

I pointed out that historically one would not expect a gain in an acquisition. But here is – here we have one.

Also you will note there are two additional pages attached to the press releases for both TDS and U.S. Cellular detailing some non-material corrections to prior financials. This error is related to atoning for asset retirement obligation and the amount are immaterial we will revise prior periods in the third quarter 10-Q and future filings in the quarter with the applicable literature.

To update you on the share consolidation, the TDS board of directors is currently considering potential changes to our share consolidation proposal and anticipates completing this review process in the near future.

Management in the TDS board of directors continue to believe that the share consolidation is in the best interest of all TDS share owners. It will simplify TDS’s capital structure, improve market liquidity, and provide greater financial flexibility.

Because of the ongoing work in this project, we did not repurchase any stocks in the quarter. We ended the quarter with a strong balance sheet and ample liquidity. Over the past few quarters, we have turned out our debt maturities. We have no unfunded pension liabilities. All in all these provide us with a strong financial platform to support our businesses going forward.

Now I’d like to turn the call over to Joe Hanley. Joe?

Joseph Hanley

Thanks, Ken. As we turn to the regulatory area shown on slide four, the most significant development and it affects both businesses is the FCC’s recent action on universal service and inter-carrier compensation.

We support the FCC’s goals to modernize and evolve USF and ICC and we continue to urge the FCC to do so in a way that will enable road carriers to deliver broadband services both fix and mobile. They are affordable and comparable to those in urban areas.

On October 27th, the FCC adapted an order and a further notice of proposed rulemaking. The full text of the order and the further notice expected to be 500 pages in length has not been released yet.

The FCC has released an executive summary which provides the basis for our high level analysis at this point. Also a member of important issues will be taken up in the further notice which means that some key decisions have been deferred. But here’s what we know.

On the wireless side the FFC has established a dedicated mobility fund deployed in two phases. Phase one is a onetime distribution of $300 million expected next year. Phase two will provide $500 million per year beginning in 2013. As this is fine is brought online, the FCC will step down legacy support for wireless carriers and a rate of 20% per year beginning July of 2012.

Further reductions in legacy support will continue annually with the legacy funds going to zero in July 2016. And important qualifier however is that if the FCC for some reason is not able to put the $500 ongoing mobility fund in place by June of 2014 to step down stocks at 60% of the 2011 level.

So what are the impacts of U.S. Cellular. U.S. Cellular currently draws approximately $160 million per year in universal service high cost support which we refer to in our financial statement as ETC revenues and which represents taxable revenue to the company.

Following court action, ETC revenues will begin stepping down in July 2012. One potential source of upside however is the new mobility funds. The size of the U.S. Cellular opportunity will depend on how the FCC works out the details on the fund, and also which other carriers choose to participate.

The new fund does carry new obligations and companies including U.S. Cellular may weigh the cost and benefits of participating differently. Also as I mentioned earlier, the positive step down provides a backstop. If the FCC doesn’t put the fund in place. Another potential upside for U.S. Cellular is to pay down an eventual elimination of inter-carrier compensation in expense to U.S. Cellular and other wireless carriers.

That currently costs U.S. Cellular approximately, $60 million to $70 million per year. The FCC is mandating reductions in access rates and ultimately elimination of excess charges all together – referred to as bill and keep.

While some rate reductions began in the near term, the full migration to bill and keep is a long term process. As a result, the timing for full realization of this benefit is difficult to predict right now. But using the longer transition period should occur over roughly a ten-year period.

Further, it is unclear whether U.S. Cellular and other wireless carriers would actually realize this benefit or whether it would be competed away in the form of reduced pricing to customers.

Turning to TDS telecom on slide five, as a rate of return wire line provider, there are more moving parts and more questions to be answered in the further notice to proposal we’re making. We really need the full text of the order and resolution of the issues key up in the further notice to have a complete texture.

To start with – the access rate reduction which benefit U.S. Cellular takes some revenue away from TDS telecoms. The FCC is providing an opportunity for much of that loss in the early years to be recovered through the new Connect America Fund and through new end user charges.

Moreover as I noted earlier, there is an extended transition period with the longest adjustment period being applied to rate of return carriers like TDS telecoms. On the truth in billing funds, the FCC’s efforts to curtail were eliminate phantom traffic and asset stimulation to provide for a fair system with more predictable cost in revenues for all carriers.

With all these said, the FCC is also modifying some parameters in the existing USF programs and they proposed to phase out the safety net added fund which will have some impact on TDS. Finally the FCC will be taking a look at the interstate authorized rate of return, something that you perhaps revisited from time to time.

VIA telecom is a rate of return carrier so of course the adjustment in this rate would have some impact. Currently under all of the USF programs, TDS telecom receives approximately $90 million annually. As I noted earlier, there are many components to the support and a time frame for transition and opportunity for recovery are not fully knowable at this time.

But that said, given what we do know, we would expect the overall long term impacts on TDS telecom to be moderate. So to summarize the impacts of the FCC’s actions, clearly some legacy support will go away, offsetting that will be opportunities to access the new Connect America, and Connect America mobility funds.

The net impact will depend on the detail of how these funds are set up and who participates in them. The outcomes may also depend on the court as portions of the order may be challenged possibly in multiple firms. In any case, our companies will be active in the continuing rule making process and will be determining how to maximize the opportunities available to us.

Universal service has been a critical element enabling U.S. Cellular and TDS Telecom to provide great service to their rural customers. And they will continue to play that vital role even in the phase of significant change.

Before leaving the regulatory area, I want to touch briefly on one other issue. Congress has been considering spectrum legislation for some time. The past few months this issue has become part of the larger agenda of the so-called super committee that emerge from the debt fueling [ph] crisis.

We are mainly helpful that spectrum legislation will be adopted that will open up a new pipeline of spectrum for use by wireless carriers. This is an issue where there is broad agreement among wireless carriers and we are continuing to work with law makers, the FCC and our industry associations to secure spectrum opportunities for the future.

And now, I will turn the call over to Mary Dillon. Mary?

Mary N. Dillon

Thanks, Joe, and good morning, everyone. I’ll begin on prepared comments with an overview of the quarter and Steve will follow with a review of our financial and operating results.

So turning to slide seven. As has been the case for the past few quarters, our results were mixed. Key highlights include ARPU continue to climb as smartphone penetration increased to 26% of our postpaid base.

Migrations to our Belief Plans continued with customers choosing more data packages leading to higher ARPU. We now have nearly 2.8 million customers on those plans. Postpaid churn improves slightly. It’s important to know that as competitive as this industry is this is the seventh consecutive quarter of year-over-year improvement in our postpaid churn.

We’re also proud to report that U.S. Cellular continues to have the strongest overall satisfaction scores in the industry as measured by leading independent research firm. This is driven by superior network and customer service satisfaction among current customers. In fact we’ve experienced steady increases in overall satisfaction and would recommend scores corresponding with the launch of the Belief Project.

Inbound roaming requesting increase data usage and industry wide was a meaningful contributor to increase margins and profitability. And finally, we have numerous cost reduction efforts underway across all functional areas such as vendor contracts negotiations and network optimization which help to offset increases in areas related to smartphone and data adoption.

Describe our results primarily gross ads improved from recent quarters above and beyond normal seasonality but remain below our expectation. Stimulating gross ads is one of our highest priorities and we’re simply focus on innovative ways to highlight our unique customer experience and operating to the target a customer groups.

Metrics measuring the impacts of our current happiest customers and wireless advertising campaign continue to demonstrate an improvement over previous campaigns with key metrics reaching levels consistent with industry norm and that are consistently and significantly higher than earlier efforts.

This is important progress and we’re confident that this along with the impacts of other initiatives will translate into improve store traffic consideration and gross ads over time.

As we approach the important holiday season, we’re fully focused on continuing all efforts to improve our customer growth trends. We will have our strongest device line up ever for the holiday. High-end devices such the highly-rated Motorola Electrify which has been very well received since launch. The LG Majestic and the HTC Hero are all among the best Android devices on the market.

The Samsung Mesmerize continues to be one of our most popular phones and will be very competitively priced as it reaches end of life while HTC Wildfire and Samsung Repper outstanding entry level smartphones.

For the first time, we’ll be leveraging our rewards program in our promotional activity offering bonus points for our new customers that can be used immediately for items such as accessories or ringtones or accumulated over time to use for faster upgrades or even a free phone.

We’ll continue to drive strong interest in our great device lineup to aggressive offers and creative use of switch or credit. We recently also redesigned nearly all of our retail stores to provide a bright, sharp and more intuitive shopping experience. And we’ve been very pleased with the early results of our innovative use of social media and online sales to promote customer advocacy and referrals.

And finally, we’re optimizing the productivity across our marketing and promotional spend based on concentrated effort to deepen our consumer and analytic insight.

As for our 4G LTE launch, we’re on track with network readiness with the first wave of market before year-end. As we continue to work with our OEM partners to ensure that we have 4G devices that will meet our network and customer satisfaction requirements in the latter half of the first quarter. At the same time we’ll continue to refine our listed markets that will be included in wave two next year.

And finally, the launch of the new iPhone will keep competition for new customers as intense as ever. And while we have the opportunity to add the iPhone to our device lineup, the terms were unacceptable from a risk and profitability standpoint, it would have forced us to compromise on our commitment to offering an unparalleled customer experience.

Our plan for the fourth quarter was developed with all these considerations front end better. We believe the combination of our outstanding network, a compelling line up of cutting edge devices superior customer service, and unique product offering such as one and done contract, will allow us to successfully differentiate and grow in this market.

Now a stable review has increase our guidelines this quarter raising the range of OCF consistent with our year-to-date performance yet reflecting the uncertainty associated with the highly competitive and heavily promotional nature of the holidays selling season.

Now I focused more to my remarks this morning at our efforts to stimulate customer – because I hope you can see from our performance so far this year, we also remain committed to improve in the bottom line at the same time. And now I’ll turn this call over to Steve.

Steven Campbell

Thank you Mary and good morning everyone. U.S. Cellular’s results reflect the continuing challenges of the sluggish economy as well as an extremely competitive market in which carriers continue to fight for a dwindling pool of new subscribers and the cost of acquiring switchers are significant.

Retail gross additions is reflected on slide eight we’re 284,000 down from 301,000 in the prior year quarter, but up from 226,000 in the second quarter. In the postpaid segment, there was a net loss of 34,000 customers as a decline in retail gross ads was partially offset by a slight improvement in turn.

In the prepaid segment, we had an increase of 11,000 customers. So in total, we lost 23,000 retail customers in the third quarter this year compared to a higher net loss of 25,000 last year. Our term results are shown on slide nine. Postpaid churn improved slightly to 1.55% from 1.58% last year.

Remember that the third quarter has historically been our highest churn quarter. We continue to add customers to our Belief Plans 452,000 during the third quarter as customers recognize the value and exceptional service we provide.

The increasing level of family plans now 73% of postpaid customers is also contributing to the churn of the quarter [ph]. Slide 10 reflects our smartphone sales penetration growth and the impact on postpaid ARPU.

During the third quarter we sold 356,000 smartphones which represented 40% of total devices sold. This compares to the third quarter of 2010 when we sold about 216,000 smartphones or 24% of the total units sold.

Smartphones now represent almost 26% of our postpaid subscriber base compared to 12% at the end of the third quarter of 2010. While the cost to subsidize these devices is greater, we expect average revenue per customer will continue to benefit over time.

And you can see that in the third graph at the far right. Postpaid ARPU growth from strong smartphone sales beginning late in the fourth quarter of last year in addition to the Belief Plan migrations.

Despite the overall competitive environment and a significant downward pressure on voice pricing over the past several quarters, postpaid ARPU was up 3.1% to $52.41 in the quarter up from $50.82 a year ago. As part of the required accounting for the Belief Plans, U.S. Cellular defers a portion of it revenues to properly account for the loyalty reward program.

In the third quarter, the company deferred 10.7 million in net service revenue which had it been recognized as service revenue during the third quarter, would have added approximately $0.67 to postpaid ARPU. As the reward points are redeemed or used in the future, the revenue will be recognizes as either service or equipment revenues depending on how the points are actually used.

Turning to our PNL, as you can see on slide 11, service revenues for the quarter were $1,037,000,000 which is an increase of 53 million or 5% from last year. Breaking that down a bit further, retail service revenues were relatively flat at $871 million.

Competition on service plan pricing over the past several quarter has continued to put downward pressure on revenues as has a loss of subscribers but are increased in Smartphone penetration and its impact on data revenues has allowed us to offset this downward pressure.

Inbound roaming revenues increased once again this quarter growing $35 million or 48% year-over-year to $108 million primarily a result of increased data roaming traffic. We expect to see continued strength in this very high margin revenue stream.

System operations expenses of $242 million were up $24 million or 11% year-over-year. This was due primarily to higher usage and roaming expenses as our customers use more data services both on and off our networks.

Through September of this year, total data network usage increased over 350% from the same period last year. Net loss on equipment for the quarter was $120 million, up $8 million from last year.

We had fewer transactions as a result of fewer gross ads, but this was offset by an $8 or 7% year-over-year increase in the average loss per device sold which reflects the shift and mix to smartphones.

Given the 65% increase in smartphone sold, we believe that we’ve done a very good job of controlling our equipment cost by better balancing of the types of devices offered and introducing lower cost entry level smartphones into the lineup.

SG&A expenses of $442 million were down slightly year-over-year. Reductions in U.S. debt contributions, selling expenses, and advertising were offset by increases due to higher spending for Belief Project phone programs which was started in the fourth quarter of last year.

Operating cash flow for the quarter of $234 million was up 13% compared to last year’s $207 million. Operating cash flow margin was 22.5% compared to 21%.

Below the operating income line as shown on slide 12, total investment and other income net for the quarter totaled $11 million including earnings of approximately $17 million related to our interest in the Los Angeles partnership.

Net income attributable to U.S. Cellular shareholders totaled $62.1 million or $0.73 per diluted share versus $38.3 million or $0.44 per diluted share in 2010. The increase was driven by higher operating income.

The tax rate for the third quarter of this year was 38.4% compared to 36.7% last year. Now we generated cash flow from operating activities of $354 million compared to $180 million last year. And net of capital expenditures of $248 million, free cash flow of $106 million up substantially from $56 million in 2010.

As Ken said earlier, we ended the quarter with a very strong balance sheet and an ample liquidity.

Our guidance for the full year of 2011 is contained in today’s press release and is shown through slide 13. The guidance for service revenues, depreciation, and capital expenditure is unchanged. However we increase the ranges for operating income and adjusted operating income before depreciation and amortization up by $20 million on both ends consistent with our year to date results.

And now I’ll turn the discussion over to Vicki Villacrez. Vicki?

Vicki Villacrez

Thank you, Steve. And good morning everyone. As shown on slide 15, I’m pleased to report TDS Telcom’s third quarter performance was highlighted by the continued growth and ILEC data revenues including the effects of hosted and managed service acquisitions. Also the ongoing initiatives has stabilized traditional wire line revenues and our continued client control efforts.

As you can see on slide 16, revenues for telecoms combine operations including hosted and managed services were up 4.3% from last year. ILEC revenue grew 6.9% with HMS acquisitions in growth and high speed data more than offsetting declines in voice and network access revenues.

CLEC revenues declined 4.3% as commercial revenue stayed flat and the number of CLEC residential customers declined due to the company’s decision to no longer target residential customers. Turning to slide 17, ILEC data revenues increased 48% in the third quarter driven by our acquisitions of VISI and TEAM and most recently OneNeck which provide hosted and managed services and also by our high speed data subscriber additions.

High-speed data subscribers grew 6% year-on-year. We continue to attract new customers and they are taking higher speeds. The number of data subscribers taking speeds of 5 megabits or greater has nearly doubled 50% to 55% since last year. And 17% are taking greater than 10 megabit speeds.

Residential DSL penetration has advanced to 61%o of primary residential lines and residential DSL ARPU remains stable at nearly $37 as migration to higher speed service offsets competitive pricing pressures.

The decline on ILEC voice revenues was driven by the continued trend in physical access line loss. As you can see on slide 18, line loss was 5.2%. Our Star voice packages continue to help mitigate line loss.

At September we had 197,100 customers on these plans which are 55% of our residential customer base up from 42% at this time last year. As a result of our success with selling voice packages, we’ve seen an improvement in residential voice ARPU.

On slide 19, we continue to emphasize our Triple Play bundles; voice, data, and video. With video offered primarily through our partner dish network. We added 2600 net Triple Play subscribers in the quarter bringing our penetration of customers to 28%.

We know the importance of bundling and reducing churn. Churn on our Triple Play customers is very low at roughly 1/2% per month. We have had measurable success with our bundled offerings with 66% of our residential customers on a Double or Triple Play bundle up from 61% last year.

In the commercial segment slide 20, we continue to lead with our hosted IP service we call managed IP. For telecoms combined operations, we now have 39,400 stations installed. An increase of 12% sequentially and 68% more this time last year.

Turning to the PNL on slide 21 consolidated cash expenses were up 4.6 for the period. ILEC cash expenses increased 8.3% with HMS acquisitions. A discreet item reported in 2011 for the refund of prior period, prior year regulatory contributions decreased expense 2.4 million.

A 4% decrease in CLEC expenses is in line with fewer residential customers. We have maintained our focus on cost control and continue to seek greater efficiencies throughout our organization. All in operating cash flow for the quarter increased to 71.2 million from 68.6 million in 2010.

As you know on July 1st, we continue to expand into the hosted and manage services arena, slide 22, with the acquisition of OneNeck IT Services Corporation, a premier provider of hosted application management and managed IT hosting services to middle market businesses.

Our strategy is to have a robust suite of HMS offerings which will able us to leverage the datacenter assets. Recently acquired with VISI and TEAM. This is an exciting complement to our business as we move further into the rapidly growing hosted and managed services area.

Additionally, we continue to evaluate acquisition opportunities both in managed services as well as in our more traditional RLEC market.

And finally, slide 23. Let me note that we are maintaining our previous guidance as shown in the press release.

I will now turn the call back to Jane McCahon.

Jane McCahon

Thanks, Vicki. We’ve asked Alan Ferber, our Executive Vice President, Chief Strategy and Brand Officer at U.S. Cellular to join us for Q&A. And Christine, we’d like now to open the lines for questions.

Questions-and-Answers Session

Operator

Thank you. (Operator instructions).

Thank you. Our first question is from Phil Cusick with JP Morgan. Please proceed with your question.

Phil Cusick – JP Morgan

Hi. Thanks. Let’s start with the iPhone. I think I heard you say that it’s too expensive and you’re going to choose not to sell it. Is that fair?

Mary Dillon

Hi, Phil. This is Mary. Yes, that’s – what we said is that we have the option to carry it besides that, it didn’t make sense for our business economically. And so, we’re focused on really playing our strength and feel that we’re in a competitive position.

Phil Cusick – JP Morgan

I don’t blame you. And so given the competition up there, should we look for CPJ sort of up in the fourth despite a higher typical growth add mix as you try and fight back against that informal competition?

Alan Ferber

Phil, this is Alan Ferber. We don’t expect that and we expect to be competitive in the fourth quarter. We’re very pleased with our overall device line up. We do expect to sell more smartphones, but we don’t expect any meaningful increase this year.

Phil Cusick – JP Morgan

Okay. A couple of other things, prepaid was good this quarter despite sort of the typical seasonal weakness. Is there sort of a re-emphasizing there, and should we look for that to accelerate in fourth quarter?

Mary Dillon

Phil, You know, our focus in our business is largely postpaid, but we were pleased with our prepaid results as well because they did reflect some enhancements in the market place, we have smartphones, you know a couple of different price plans, but it will continue to be the smaller part of our focus. We’re really focused on the post paid side of the business.

Phil Cusick – JP Morgan

Okay. GNA in a wireless business dropped pretty dramatically sequentially, is something changing and there’s a new run rate?

Steven Campbell

So think, you know, there’s a couple of things there. I wouldn’t say you know, a new – run rate necessarily. But you know, the USF contribution number was down a little bit in the quarter, also you know, we’ve been running good results in that expense so we’ve seen a little bit improvement there.

But I think if you look at the guidance for the year, you kind of see you know, where we’re seeing the year come out. So I wouldn’t be projecting you know, significantly different run rate on GNA at this point.

Phil Cusick – JP Morgan

Okay. And then last – I’m not sure what you can say, but can you give us an update for what you can on the TDS and special share situation. Thank you.

Kenneth Meyers

Hi Phil, it’s Ken. Not a lot I can say except of what I just did. And that is – we did publicly announce that the board was considering making adjustments to the current proposal, working on that, we hope to have something done in the near future and we think it’s the right thing to do.

Within those four walls, I can say it about five different ways, but that’s about all I can say about it right now.

Phil Cusick – JP Morgan

Thanks, Ken.

Operator

Our next question comes from the line of Steve [ph] (inaudible). Please proceed with your question.

Steve

Hi, I had a questions just concerning the current ownership structure of U.S. Cellular within the TDS and the question is really whether there’s anything that would prevent the company from one day pursuing a tax-free separation of U.S. Cellular. And you know, a particular note is just how the valuation to TDS is sort of pressed in the current market that you know, it seems very apparent that the board could create a lot of value by pursuing a tax-free separation.

Kenneth Meyers

Hi Steve, this is Ken Meyers. There – when you say is there anything that prevents that, I don’t – from a legal standpoint, or a tax standpoint, I’m not aware of anything that we prevented except that strategically, we think that the company is stronger having both the wire line and wireless operation together.

It gives us some strength specially on the credit side, there’s some services that we share, so nothing prevents us to do it, it’s simply not part of the strategy currently.

Steve

Okay, and then just a follow up there. I know that the rationale for the shared classes collapse was that basically you’re providing increase liquidity in a simpler structure, but also that you don’t in effect have an acquisition currency with the shares trading at a discount to TDS.

And that you know, potentially by collapsing the shared classes, you would have an acquisition currency, it’s just that you know, with TDS trading where it trades, I think that line of reasoning is a bit off and I’m wondering you know, are you talking about some point in the distant future where TDS may have a better valuation in the stock market? Or when do you envision potentially having an acquisition currency if you did get the shared class accomplished?

Steven Campbell

I think those are two different questions. One is I think, strategically our company’s capital structure has to have a fully valued acquisitions currency. Once you get to fully valued, there are two different issues, right?

There’s one that we have a discount as between the two which is strictly a liquidity driven event. Separately there may be other matters that affect evaluation. Why think we’re working on one of them at the time right here?

Steve

Okay, thank you.

Operator

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

Simon Flannery – Morgan Stanley

Thanks a lot. I think on LTE roll out I think in the past you have said your initial roll out would be to about 25% of the footprint. And I assume that’s what we’re going to see here in the next couple of months. Perhaps you could update us on that and how are you thinking about the rest of your footprint on the timeline there?

And then on the roaming, good roaming numbers, I wanted to understand what you see on seasonality around that? And also Sprint has been talking with Network Vision about their ability to substantially reduce their roaming bill overtime. Do you see that as a risk? Thank you.

Mary N. Dillon

Simon, first I’ll take the LTE question. Yes, you’re right, that is our current game plan. We are, by year end, will have LTE network rolled out to about 25% of our customers. And we’re well in track for that and that we would towards the end of the first quarter be launching LTE devices to our customers.

And, you know, frankly we’re in the process right now of assessing the remaining market and time frame and when we launch the markets. But we’re absolutely planning to continue on the path of LTE, you know, for our entire footprint. It’s just a matter of pacing that and making sure that, you know, we look at which markets make the most sense to roll into next.

So we’ll get more detail in that soon.

Steve Campbell

Simon, on the – this is Steve. On the roaming questions, definitely there’s some seasonality. You know third quarter is a strong quarter for roaming. That said, we expect to – as we said in the prepared comments expect to see a nice strong stream and roaming continuing.

I think due to some seasonality, fourth quarter maybe down a bit. But I think it will still be up nicely year-over-year driven by data usage.

As far as the Sprint issue is concerned, Sprint is an important roaming partner for us. But that is not something, you know, worthwhile. I think first of all it’s not a major part of our revenue although it is substantial.

And as you know, these agreements aren’t take or pay. So it’s a little – there are some uncertainty and a little hard to predict that. But at least, you know, in the near term for the foreseeable future, we expect to see Sprint be a strong roaming partner for us.

Simon Flannery – Morgan Stanley

That’s helpful. Thank you.

Operator

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

Ric Prentiss – Raymond James

Thanks. I just want to go back to the first slide we have provided some of the details on the U.S. FCC changes. I just want to make sure thinking about it correctly on the phase one and the phase two and the step down especially now you’re running kind of $160 million a year on ETC.

So is the thought that a second half of ’12, we should see that coming down 20%?

Alan Ferber

So the FCC’s plans are to freeze a set of baseline based on – study area level based on year-end 2011. I think we would expect within that context to see revenues go down by 20% on maybe in the middle of the…

Ric Prentiss – Raymond James

Say that again?

Kenneth Meyers

Beginning midyear.

Alan Ferber

Midyear.

Kenneth Meyers

You know, so it would be roughly 10% of a normalized number. So if you’re working off to say, 150 or 160, you’d be talking about an impact for all of next year up 10% of that.

Ric Prentiss – Raymond James

Right. Right. And then looking into ’13, you picked up the other 10%. And then the second half of ’13, you’d get another step starting down?

Kenneth Meyers

That’s correct.

Ric Prentiss – Raymond James

Okay. And then the one-time payments, how do you think that’s going to work out?

Steven Campbell

So the FCC is planning on a $300 million fund to be distributed using a reverse auction. It will be targeted to (inaudible) that are currently viewed as unserved. And that’s about as much as we know pending the, you know, seeing the details and the order and also the way an auction notice would play out.

Ric Prentiss – Raymond James

Sure, Okay. And then on the – on the 4G devices for 4G late first quarter, I think that’s what I just heard, when do you think voice over LTE of volter devices become available. And as you think about the cost curve on those 4G devices compared to an iPhone what are you thinking?

Alan Ferber

This is Alan. In terms of voice over LTE, I think it’s almost too early to tell. We don’t believe it’s going to be 2012 or it will be 2013 at the earliest and probably later than that in terms of high quality phones. In terms of the cost of the 4G LTE devices, our current belief is it would be less than the iPhone.

Ric Prentiss – Raymond James

Okay. And then final question on the – pricing. Can you update us as far as what you guys are doing as far as are you seeing good smartphone sales, you’re seeing ARPU go up how are you managing the network?

Alan Ferber

Yes, so there’s really a couple of question there, there are a number of things we’ve put into place on the network side and on the handset side in terms of compression and wi-fi upload that’s helping us manage overall data growth.

Obviously LTE is a big piece of that as well. The last piece is a pricing piece. And we still plan to introduce pure data pricing in the first half of next year. That will not only help us on the monetizing the data growth, but we believe also in combination with lower cost smartphones will allow more customers to upgrade out of their feature phone into their very first smartphone.

Ric Prentiss – Raymond James

Can you give us what percent are you base upgraded in the quarter speaking of which?

Alan Ferber

It was just under 11%.

Ric Prentiss – Raymond James

Great thanks.

Operator

Our next question comes from the line of Robert Dezego with SunTrust Robinson Humphrey. Please proceed with your question.

Robert Dezego – SunTrust Robinson Humphrey

Hi, yes. I just want to go back to the iPhone for a second and just follow up here. Is the thought that it’s like cost of the actual handset? Or is there more of a concern with the network strains and the spectrum that you have if you’re adding all these subscribers that are using this kind of data, I’m wondering kind of what the – if you could talk a little bit about the decision to not take that phone.

Mary Dillon

Yes, you know, I’m not at liberty to discuss many of the details, I would just say that over all, the decision for all purpose we believe is right to play our offense and play our game and we have a very competitive line up of devices that we think you know, makes sense for our customers and makes sense for our business.

Robert Dezego – SunTrust Robinson Humphrey

Okay, and then a follow up is you know, your churn is obviously you know, still pretty impressive here in the postpaid side. With the lack of growth come in to the door, can you talk about you know, what the reason is for some of the churn that you’re seeing you know – are some of these plans reducing that churn? Are you still seeing a lot of plans churning come out of the base?

And then if maybe you could talk about you know, what your peers are really doing, you think that are – a lot still take share you know, what are the biggest competitive threats that you’re seeing.

Mary Dillon

Well I would start with churn which we are pleased with our churn numbers and we’re obviously going to continue to focus on that. And I think that starts with keeping our customers very, very satisfied.

And as I said in my prepared comments, you know, we know that in our footprint, our customers, give us the highest satisfaction rating scores whether it’s network quality or customer satisfaction and – or customer service.

And that said, you know, our customers are happy, our job is keep them you know even happier as we go forward. But also continues to target new customers obviously getting more gross ads – is the key priority for us. And so leveraging our great network, our customer service, but I say enhancing what we have in the market place with a more competitive device line up you know, very differentiated loyalty program through the Belief Project, then we believe those things combined with innovative breakthrough kinds of use of marketing tools, social media, better advertising will continue to attract new customers.

So it’s really a combination of keeping your customers satisfied, to keep that churn low and lower.

But also it’s a very competitive market place. So breaking through that clutter, isn’t easy, but we’re focused – we think we can do that.

Robert Dezego – SunTrust Robinson Humphrey

Can you talk about what your peers are doing you think to really – their taking share?

Mary Dillon

You know, I think it’s just a really competitive – you know how competitive this market place is. So there’s a lot of spending, there’s a lot of competition in price and device, and everybody’s plan is slightly different.

But I think we’re all playing it that way. And our approach at U.S. Cellular is to really focus on the customer experience and customer loyalty to differentiate within that.

Robert Dezego – SunTrust Robinson Humphrey

Okay and the final question is, for the postpaid business, do you see a trajectory to get to the positive ads at some point in the future? Or you think you run this business to continue to see kind of the subscriber count down by getting the higher ARPU and getting a better quality basically running a smaller subscriber business, but a higher quality subscriber business?

Mary Dillon

I can tell you we’re absolutely 100% focused on subscriber growth. And we’re going to continue to focus on that, and use tools in our tool kit to achieve that over time.

Phil Cusick – JP Morgan

And do you see introductory to get there?

Mary Dillon

Well, I can’t – I don’t have a crystal ball. I mean, we’re focused on it. We see – we believe that will happen over the next several quarters and stay posted.

Phil Cusick – JP Morgan

Okay. And then finally, just the last – the last question I have will be the impact to margins as you try to get the subscriber base back to grow.

Kenneth Meyers

Phil, again, say, in the short term you can see, you know, what we’ve got in the guidance that reflects some expansion year-over-year. We’ve said a number of times that, you know, our longer term goals are to deliver a return on capital that it – sorry, return on capital that exceeds our cost of capital. The goal is to do that over the next few years. That will require additional margin expansion.

Phil Cusick – JP Morgan

Okay. Great. Well, thanks for taking the questions. Best of luck.

Mary Dillon

Thank you.

Operator

Our next question comes from the line of James Moorman with Standard & Poor’s. Please proceed with your question.

James Moorman – Standard & Poor’s

Hi. Just a follow up on some of the earlier questions. First when you’re talking about the subsidy for the LTE phones. You said there’d be left on the iPhone but can we assume that’s more than what you’re paying on the current smartphones? And the second part of the question is – and you said you passed on the iPhone, could part of that be due to the strain of your CDMA network and would you consider an LTE version if it comes out in the first half of next year?

Mary Dillon

Let me start with the second question first and then I’ll turn it over to Alan for the first question. No, you know, we feel confident in our network progress capacity our, you know, the capability that we have in our network and that was not a strong consideration and I would say, in terms of the future, you know, we’re always open to possibilities, so I can never say never.

Alan D. Ferber

So, in terms of the handset cost, think about our current smartphone portfolio, we have a good spread from the low end to the high end to the average cost of a CDMA smartphone will be less initially than the LTE smartphone which will be focus more on the high end.

Over time, we expect that to scratch itself out and for the LTE device portfolio they’ll also become much more diverse.

James Moorman – Standard & Poor’s

Great. Thanks.

Operator

Our next question comes from the line of Steven Need [ph] with Angkor Capital Advisors. Please proceed with your question.

Steven Need – Angkor Capital Advisors

Yes, good morning. Just going back for the iPhone and you had – you said you had 356,000 smartphone sales and I was just curious as you look at the – but you can kind of share with us how many of those are actually former iPhone customers coming back to a, you know, a different type of phone?

Mary Dillon

I don’t think we have a way to measure exactly that. But what I will say is that, you know, when customers come to our stores, our frontline sales associates, they’re very well-equipped to help people understand their needs and to highlight for them the various of license that we have and how they stack up against competitive devices in the marketplace.

So, you know, that’s I think a good dynamic but I don’t think we have a data to answer that question.

Steven Need – Angkor Capital Advisors

Okay. And then as you look at in terms of I didn’t sort of hear the first part of the call but as you look at the guidance on your operating income and EBITDA or the cash flow number. And if you back in to sort of what that implies for the first quarter in terms of comparisons for the last year, I was trying to get a sense of whether there are certain things that had made that comparison more difficult this year versus last year.

Alan D. Ferber

Well, I think when you back into the number, you will certainly see that the queue – the projection for the fourth quarter is lower than either Q3 of the average and that’s, you know, reflects the seasonal nature of the business with the heavily promoted fourth quarter. That would be normal. I think year-on-year remember that we’re making substantial investments and enablement programs like our new billing system and so forth, so year-on-year, you know, those expenditures would be higher fourth quarter against from last year.

And also recognized that we did in fact raise the guidance this quarter reflecting a strong result with as year-to-date.

Steven Need – Angkor Capital Advisors

And then in terms of the impact on CapEx of the LTE expansion, how much of the getting to 25% coverage, you know, in the first quarter of 2012, how much of 2011 CapEx is part of that process?

Kenneth Meyers

Steve, this is Ken. I can get you the exact number. Well, in ’11 if you remember we raised CapEx in the first quarter when we announced our plan. And ballpark, the number I’m thinking is something like $120 millionish all in for this year for LTE, but I just – I don’t know the exact number. Pardon me.

Steven Need – Angkor Capital Advisors

Well, it doesn’t have to be exact. I’m just trying to get the sense. And then I also I was wondering in terms of the incremental cost to do that as we look into 2012 to get to, you know, much broader coverage of LTE what that impact on, you know, CapEx might be when you look at sort of putting together you ’12, 2012 number versus your 2011 number?

Kenneth Meyers

Well, I think Mary said that, you know, our expectation is that we are going to continue to roll out of LTE. We got the first 25% and the network kind of by the end of this year.

Now we will – we expect that’s going to be a multi-year project to continue to roll that out. The exact scope of next year’s kind of follow on and the markets that are going to be included aren’t – that work hasn’t been completed yet.

But if I think about this as being a multi-year project, I would not expect to see huge differences year to year.

Steven Need – Angkor Capital Advisors

And then when you – when you look at sort of what you need in terms of network capacity and what it takes to get there, I’m wondering in terms of once you get the coverage of LTE, where are you in terms of capacity versus if you look at the growth of data uses and devices and stuff like that?

How much capacity have you created? How much more do you need over time? Is there any way to kind of comment on that?

Mary Dillon

Yes. The comment I would make is that certainly as we are – as we are planning our build out of LTE or even just our day-to-day management of the network, it’s always with an eye towards current needs as well as future needs.

So we’re certainly modeling and predicting where that growth might go and building capacity, you know, and in anticipation of that.

Steven Need – Angkor Capital Advisors

Yes, Okay.

Mary Dillon

Well, I think it’s more specific right now, but that’s exactly, you know – certainly we are looking at that all the time.

Steven Need – Angkor Capital Advisors

Well, but I was just wondering whether, you know, you get to the end of 2012 and realize that, you know, we’re still pretty constrained here. Or in terms of data pricing, you know, both on the roaming side and your own customer base, you have to – and this is – this is why it’s important that people can actually price base upon usage.

Mary Dillon

I absolutely will. First off, if you look at the metrics on our network performance today, it’s very strong. We have a very strong compelling metrics on the performance of our – of our network today. So we don’t have that capacity issued today.

As we look to the future, we expect that data growth will continue to grow obviously. And as Al has mentioned earlier, you know, we’re going to look to doing more with peer pricing so that we can both manage on the high end of people use a lot of data as well as open, you know, open up opportunities for people who come into their first smartphone at lower end data plans.

So we are planning to do that.

Steven Need – Angkor Capital Advisors

Okay. I have follow-up questions, but I mean, I’ll turn the floor back.

Operator

Our next question comes from the line of Kevin Roe with Roe Equity Research. Please proceed with your question.

Kevin Roe – Roe Equity Research

Thank you. Good morning. Just one question on postpaid ARPU. Very nice growth in the quarter, 3%, only less than 30% of your postpaid. Sub dates had smartphones who would seems they have a lot of runway to improve postpaid ARPU going forward.

Is a 3% growth rate a good number near term or do you think it can accelerate or decelerate? Some thoughts there?

Alan Ferber

This is Alan. There’s obviously a lot of smartphone grows in front of us. And we’re – all of our plans anticipate that and are moving in that direction. Possibly the big unknown is what happens in that competitive environment.

So I think that’s a fine number used for now.

Kevin Roe – Roe Equity Research

The 3% growth rate?

Alan Ferber

It’s as good as any, right now.

Kevin Roe – Roe Equity Research

Very good. Thank you.

Operator

Our next question comes from the line of [John Lee] with Etika Partners. Please proceed with your question.

John Lee – Etika Partners

Oh, thank you, but my question has been answered already.

Operator

Our next question comes from the line of Ali Motamed with Robeco. Please proceed with your question.

Mr. Motamed, your line is live.

Our next question comes from the line of Jon Frank with Harvard Management. Please proceed with your question.

John Frank – Harbert Management

Hi, thank you for taking my question. A quick follow up to a previous caller’s question, assuming the company is successful and share collapse proposal which I actually hope you will be because it’s a shareholder friendly proposal that makes sense, regarding using equity as an M&A currency, would a negative theoretical value on the TDS shares, meaning taking the current value of TDS less the U.S. end market value which is currently negative and has been for some time, would that valuation, would a negative valuation prevent you from using that equity in the context of M&A?

Kenneth Meyers

I think it would make it very difficult to use. But you know, in a vacuum without analyzing the value of what’s being bought, okay, I can’t answer the question.

John Frank – Harbert Management

Okay. Ad further, again, I do applaud the company’s step to collapse the shares and again I hope you do reach the vote. And I get the sense that this perhaps is the first in a potentially series of steps that the board, the management is going to take to address this valuation that we were just speaking to.

I understand that there are sensitivities and an inability to speak explicitly perhaps about some of those steps, but can you offer anymore characterization or color in terms of how you view the current valuation of your equity? One. And two, maybe once we get through the share collapse, at what point do you think will have some more color regarding where the board’s mind and thought process is, in terms of addressing the valuation?

Kenneth Meyers

John, I’m in a severe box in terms of what I can say. We’ve got a proxy statement out there. But let me assure you that the board is very focused on building shareholder value. We think that like you, this first step is something that is – something that will benefit all share holders and hope to complete that process and then continue to address other factors that may help improve the valuation in the future.

John Frank – Harbert Management

All right, well. I hope to hear more soon.

Mary Dillon

Thanks. Christine, we have time for one more question please.

Operator

Thank you. Our last question is from Ric Prentiss with Raymond James. Please proceed with your question.

Ric Prentiss – Raymond James

Hey just one quick follow-up maybe also unanswerable, but with T&T mobile transaction out there, can you update us sort of what your stance is as far as that transaction and then what your appetite might be in case there’s any divestitures as far as if they’re regional or national.

Mary Dillon

Right. Well a couple of things, one is if there aren’t any divestitures, we’ll certainly you know, be open to considering things that might augment our geography and our market. In terms of our stance on it, you know, we are kind of neutral I’d say. We see some positives, we see some potential negatives, but really focused on conditions that we think would need to be imposed if the merger went through.

You know, along the lines of things that would help us to maintain competitiveness in the industry going forward. So you know, roaming, handset exclusivity, inoperability with LTE and spectrum access, those kind of items.

So that’s what we’ve been focused on.

Ric Prentiss – Raymond James

Great. Thanks.

Operator

Ms. McCahon, we have reached the end of the question and answer session, I would now like to turn the floor back over to you for closing comments.

Jane McCahon

I just like to thank everyone for their time today, and we look forward to speaking to you soon. Thanks.

Operator

Ladies and gentlemen, this does conclude today’s teleconference, you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.

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