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Telephone and Data Systems (NYSE:TDS)

Citi Entertainment, Media and Telecommunications Conference Call

January 4, 2012 12:50 pm ET

Executives

LeRoy T. Carlson, Jr. – President and CEO

Kenneth R. Meyers – Executive Vice President and CFO

Analysts

Unidentified Analyst

Happy New Year to the 22nd Annual Citi Global Entertainment Media and Telecom Conference. Very pleased to host it in San Francisco today, which has been my home city, at Citigroup for the last 13 years, so welcome.

I wanted to take this time to introduce our management of TDS who is with us here today. Welcome back (Inaudible) at this conference for many years. Ted Carlson, President and CEO of TDS; Ken Meyers, Executive Vice President and CFO of TDS and as well in the audience we have Julie Mathews from Investor Relations. The format today is just some opening remarks from management. I will ask a few questions and then we will open it up to the investors at the end of the presentation.

So, with that let me turn things over to Ted.

LeRoy T. Carlson, Jr.

Thank you very much Todd and it is a great pleasure for us to be here at the Citigroup Conference and see so many familiar faces but also meet some people that we haven’t met before, so we look forward to welcoming you. I think there are few, a couple slides anyway that are still open in for one-on-ones in any case any would like to signup for one of those this afternoon.

TDS for those of you who don’t know or may not be familiar with us operates in two primary businesses in the telecom industry. Our largest business unit is 84% owned. It’s also publicly traded called United States Cellular, U.S. Cellular, which is a significant regional operator in the United States with about six million customers. And our other business is a 100% owned and that's called TDS Telecom.

TDS Telecom operates as an ILEC, an Incumbent Local Exchange Carrier. It also operates as a CLEC and it is now in the hosted and managed and data center services business. So, those are our two businesses and we’re excited about both of them. Both businesses operate on what we would call a customer satisfaction, a wonderful customer experience strategy.

In other words, we’re not trying to be a technology leader, we’re not trying to be the lowest price, but we are trying to give the absolute best customer experience in each of the businesses that we enter compared to the national competitors; in other words, out-computing them in terms of customer satisfaction.

And I’m delighted to say that as an example, at U.S. Cellular we've been had our highest customer satisfaction levels that we’ve ever achieved this past year. We’ve opened up a gap between us and the closest National Wireless Company in terms of customer satisfaction is measured by Net Promoter Score.

We recently received the Consumer Reports award as the best large postpaid wireless company in the United States. And if you look at that issue of their magazine you'll see that we actually scored significantly higher in terms of number of points compared to the best of the national carriers. And in addition to that we won I think 11 J.D. Power awards for best network in the North-Central region of the United States. So, it's not just talk about delivering customer experience, customer satisfaction, it’s an actuality.

On the telecom side, I would point to the fact that we have about 55% share of the broadband business in our ILEC territories. That’s very different than the other ILECs around the United States, which has typically a 40% share compared to cable, 60%. So again, I attribute that to the fact that we’re delivering an outstanding experience to our telecom customers.

In terms of priorities for 2012, we are here in 2012, so let's talk a little bit about those. In terms of priorities at U.S. Cellular, clearly one of the biggest priorities is rolling out LTE to our first markets. We’ll be rolling out in about 24 markets this year; 1,250 cell sites, about 25% of our total customer base will be covered by LTE. And then we will be embarking on Phase II of LTE before this year concludes. So, this is a big year in terms of LTE rollouts for us at U.S. Cellular.

We’re also intensely focused on growing our gross adds in the postpaid business. We’re primarily postpaid. 90% of our customers are postpaid. We are not happy with where we are in terms of postpaid gross adds because we’re not getting those up to the level to achieve net ads in postpaid yet. But we're getting closer and I think that there’s going to be a continued strong emphasis on this during 2012 driving postpaid customer acquisition.

Another major priority for U.S. Cellular is the rollout of our new billing system. That new billing system we’ll have its initial rollouts in the last quarter of this year, and then we’ll wrap that up in 2013.

That's a major, major change. It's going to give a much better customer experience. We’ll have the newest and greatest systems on [NDox]. Really, I think there's only one other carrier in the world, I think it's in Europe, one of the small countries in Europe that will be rolling out the complete NDox new system this year.

And then finally, we’ll be adding to our distribution this year. We have discovered that there is a significant portion of customers who are interested in buying their wireless, or at least their initial wireless service through big-box retailers. So we are making an effort this year to expand our distribution into the big-box stores, where we have not been as a company. So that’s an opportunity for us.

TDS Telecom, TDS Telecom in terms of its priorities for 2012, we’ll be rolling out 19 new IPTV markets. We have two IPTV markets already in service. In those two markets we’ve gained over 30% share against two of the national cable operators in just three years. And based on that success we’re planning to roll out to these 19 markets during 2012. And then we’ll see whether there are additional markets that we should roll out to in future years. That’s a big opportunity for us.

And then, of course, we have the broadband stimulus funds over $100 million of grant funds that we are entitled to from the Federal stimulus program and will be rolling out quite a few of those markets during 2012. We are planning to complete those in 2013.

And then a new element of TDS Telecom that I mentioned briefly as part of our operations there is the hosted and managed services, data centers and cloud offering. That activity is a high priority for us. We think it's enabling us to achieve positive momentum and positive growth on top line at TDS Telecom. So that will get additional emphasis both from a M&A perspective as well as working to fill up the two data centers that we built on a Greenfield basis since we acquired two operators in the last couple of years.

So those were a few comments. Ken, do you want to comment anything that you would like?

Kenneth R. Meyers

No, I think you said it up for all.

LeRoy T. Carlson, Jr.

Okay, great.

Unidentified Analyst

Well, I think one of the biggest things that’s happened since your last, some of the industry conferences; in early December was the AT&T announcement that they were calling off the deal with T-Mobile USA. So you step back, I guess to what degree were you handicapping that happening and the potential fallout of divestitures and other opportunities for bolt-on acquisitions in the wake of that? And in light of this new development, what are you thinking now in terms of 2012 strategic priorities when it comes to capital allocation, M&A, dividends, our spectrum, et cetera?

LeRoy T. Carlson, Jr.

Well, I think, nobody knew what was going to happen. I think we were probably more conservative than others were in thinking that the deal would be allowed to go through, but we were not opposed to it, because we felt that if it did happen there were just other protective measures that the government needed to take.

Now, the fact that the deal isn’t going through, doesn’t mean that the government shouldn’t still take those protective measures, because if you were to plot the concentration of our industry, the wireless industry that is over the last five years, you’d see that the industry even without consolidation has continued to get more and more concentrated.

So unless the FCC takes some measures, that concentration could well continue to occur even without acquisitions. And that we think would be harmful not only to the American consumer, but to maintain in a thriving competitive environment in the U.S. wireless industry.

So we will continue to advocate for limitations on things like handset exclusivity for the opportunity to have a reasonable roaming arrangement for the opportunity to have interoperability, for example on the 700 megahertz band and for reducing the special access rates. So, I think it’s important to know that our, if you want to call it regulatory agenda hasn’t changed is because the acquisition has been going through.

Certainly, if it had gone through and there were divestitures, there were markets we would have been interested in. And so I think from our perspectives since that’s not going to be here, we’re going to need to find other ways to either make spectrum acquisitions or do more bolt-on acquisitions to grow our wireless business in addition to the organic growth that I mentioned we are working on in terms of driving our gross add.

We also have been building up cash of U.S. Cellular and maybe Ken would like to talk about that because without the T-Mobile divestitures happening, there is some opportunities perhaps for using that cash. So Ken, can you talk about that?

Kenneth R. Meyers

Yeah. From the capital structure standpoint, we had been holding cash at U.S. Cellular for the opportunity that may have come out of any divestitures there. We continue to use some of that to help push forward our LTE rollout and use it for some acquisitions of spectrum as it comes available; but those have been relatively minor. And so, as we look forward to 2012 and ’13, use of cash at Cellular, the opportunity around that will be some of the quick breakaway that hasn’t been on the Board’s agenda in the past. That’s something I do expect we’ll be addressing this year.

Unidentified Analyst

Okay. Maybe if you could just quickly shift over to the topic of the tender offer for the special class of shares. I believe January 13 is the date and over the past several weeks and into the next couple of weeks, I’m sure you’ve been meeting with investors and we’ll be meeting with investors, what kind of feedback are you getting on the tender offer and how do you think things are proceeding?

LeRoy T. Carlson, Jr.

Ken?

Kenneth R. Meyers

Well, this is something actually that we’re really excited about right now. Over the last year now almost 18 months, we’ve been looking at some of the challenges that our current capital structure puts in front of us and the chance to put these two stocks together in two ways is to build liquidity for both one; it’s something that I think will benefit all holders.

We have a shareholder meeting a week from Friday for the vote; just last week both ISS and Glass Lewis came out recommending for the transaction for both classes of stock, so we are very optimistic about it. We’ve been getting a lot of good feedback with the shareholders that we have had conversation with recently, yeah, they (Inaudible).

Unidentified Analyst

Okay. Will this then lead to some eventual discussion of the U.S. [unstab] and whether or not it makes sense to pull that into the TDS framework or do you kind of continue to see that U.S. [unstab] kind of hanging out there at least for the intermediate period?

Kenneth R. Meyers

The U.S. [unstab] hanging out there. I wonder where you are in this one. Actually I see them as two separate questions. One is just fixing the capital structure at the parent company and making sure that we have a security that is fairly valued and trades appropriately.

Second question is whether or not there is value that can be created either by bringing in the stub or not. Okay, we looked at that back a few years ago, and the value that we would pick up, okay, quite frankly wasn’t worth a dilution that it would cause all the shareholders at the TDS level. So few years ago we put that on the shelf.

We announced publically that we weren’t looking at it and we haven't looked at it since then. And quite frankly, won't look at it until who knows what, but we aren't looking at it now and it’s not something that’s on the table at this point.

Unidentified Analyst

Okay. Just going back to the wireless side of the business really quickly, you’ve been very clear on the record that you consciously and from a business strategic standpoint weren’t going to go with a certain handset designer that’s south of San Francisco.

Absent that and understanding that you do that for reasons that you thought were good for your business; how do you see the really, what can you do to grow gross adds over the course of 2012, as I guess Sprint and others now have that certain plays, what kind of initiatives can investors look forward to feel a change or a inflection in gross adds?

LeRoy T. Carlson, Jr.

Well, I think that some of the things that we’re continuing to do; first I think we need to talk about what makes you a cellular, the company that won the Consumer Reports Award as the best postpaid company in the United States of any size; and postpaid is 90% of our business. So it's a great network. It’s great customer service. It's a fine handset lineup and its dependability as a career.

So, we have these wonderful attributes that give us a low churn rate in our own subscriber base at U.S. Cellular. And so our own customers understand why they like us, and why they’re staying with us and why they’re willing to promote us to others.

What we have found under Mary Dillon’s leadership as we’ve gotten further into analyzing the customer base is that the customers of our competitors do not understand these great things about U.S. Cellular. They don't know that we have a great network. They don't know that we give great customer service.

They don't know that we have a fine handset lineup, that handset for handset lineup perfectly well with the iPhone 4S, the iPhone 4 and the iPhone 3. We have handsets that are just as good as each of those three. But consumers don't know that, the consumers who belong to our competitors to understand that.

So we’ve had to redirect our advertising and promotional efforts to get that message through to the consumers who belong to our competitors. And we’re starting to get some traction there in terms of recognition for what U.S. Cellular really is. But we have to go beyond recognition or awareness. We have to get to what it’s called consideration. And consideration means a level of awareness that’s high enough to get people up of their cultures when they’re going to make a buying decision and shop U.S. Cellular.

Typically a customer will only shop two stores when they are out looking to decide on who their next wireless carrier is going to be. So we have to get into that consideration set of the two that they go and shop. So that means raising the awareness level to a level that’s high enough to get that consideration.

Once people come in the door at U.S. Cellular, our close ratio in terms of the percentage of people that come in the door that we can actually convince that U.S. Cellular is the right place for them is higher on average than any of the four national carriers. So that's not where we’re losing them. Where we’re losing them is not getting them in the door in the first place. So we're working on that as mostly having to do today with advertising, because we do have a great network, we do have great service, we do have a fine handset lineup.

Unidentified Analyst

And, I get them on those lines is the Project Belief giving you those leads and referrals that are allowing more customers to come in through the doors to that loyalty program?

LeRoy T. Carlson, Jr.

Well, it's very interesting. See, Project Belief and I should have mentioned that, the Belief Project falls into the same bucket. The customers, the 2.8 million customers who are our customers who have signed up for Belief understand what Belief means. The customers of our competitors don't know what the Belief Project is; don't understand its benefits, no one contract has been done, handset replacement, battery slot, the rewards point. And that’s probably the most important of all. So, thank you for mentioning that.

We're the only carrier, major carrier that offers the rewards program and the rewards program, its greatest benefit is allowing customers by accumulating the reward points for being good players and for signing up for higher value plans to accelerate the handset replacement cycle to as little as 10 months. And in today's world of rapid technological change customers want to upgrade. I mean particularly you think about a customer on the Android platform, Android is evolving and getting better and better phones very quickly.

So being able to upgrade on a rapid basis by accumulating the reward points is extremely attractive. We have to get that message through to the customers of our competitors. Our own customers get it, right.

Our churn rate on our customers who signed up for Belief is lower than our churn rate overall. So the Belief program, the Belief plans have actually had a beneficial effect for U.S. Cellular in reducing our churn, making our customers more sticky. But they haven't succeeded in doing yet, is attracting significant numbers of customers from our competitors. The primary reason I believe that that hasn’t happened is because we haven't gotten the message through about our rewards program and how strong it is. Now we’re starting to get the message through, but it takes time to build up this awareness to the consideration level that I mentioned.

Unidentified Analyst

It seems to make infinite sense to use the care rather than stick approach to keeping customers, but why is this something that we’re not seeing the larger carriers do? And is it very difficult to manage and can you describe kind of like the investment and time and infrastructure to put something like that into place and…?

LeRoy T. Carlson, Jr.

Well, it took us, virtually it took us two years to figure out what the pain points were that customers in the American wireless industry were experiencing to identify the major pain point and try to give the customers a solution. And of course, building up a rewards program that was very complex undertaking, I mean previous to that the whole Battery Swap program, that's a very complex logistically to maintain batteries in your stores, which you can then charge up and offer to people on current, on handsets that have been sold recently.

So, these things take time, they take effort. And there is an expense associated with it. I mean, providing a level of service to U.S. Cellular provides in terms of the total customer experience. It doesn't come without a cost. There is a cost and if you choose to go the route we’ve gone, maybe you can’t choose to be the technology leader and maybe you can’t choose to be the low price carrier. There are three basic [pay outs] that companies can take and we've taken the one of the customer experience, rather than to be the technology leader or to be the low price carrier.

Unidentified Analyst

Okay. So you've mentioned briefly earlier about the handset lineup for 2012, you’re excited about it. Can you describe some of the products that you have in the handset lineup for 2012? And how you factor in kind of transitioning people from 3G and into the LTE kind of environment?

Kenneth R. Meyers

Well, I’m very excited about it. We have three; well actually we have four LTE devices that are pretty well locked in now. We have three that are, will be rolling out a tablet. It will be the first LTE device probably before the end of the first quarter. Handset, shortly thereafter and then followed by a MiFi device.

So those would be our first three devices. And then towards the back end of the year, we’ll be getting three to four additional LTE devices. So, by the end of the year five, six, or seven devices roughly speaking for LTE including handsets, tablets and data devices. So, that’s good. On the smartphone front, we’ll have a total including the LTE. We’ll have 12 smartphone devices that we’ll be launching this year. Many of them wonderful products and I, not at liberty at, name to name because the company doesn’t want to [tip the sand] at this point.

Unidentified Analyst

Understood. I’d just want to get a question or two in here, on the wireline and regulatory front before we open up to the investors, but when you look at the ability to grow wireline revenue. Can you frame how you are looking at the business and the right potential side of it and some of initiatives you haven’t placed to try to grow those and kind of how are you doing your investments towards those two segments of wireline?

LeRoy T. Carlson, Jr.

Right. Well, on the wireline side, it’s really the residential business, the consumer business is really in the ILEC. We’ve had a small consumer business in the CLEC and we’re not putting any emphasis on that, that’s gradually disappearing, but that was very small. So on the ILEC side, the primary drivers of growth in that business have been pushing DSL further out into our base where up to 61% of our consumer lines now have some form of DSL, and we’re pushing faster speeds out there, and the ARPU is holding up, at around a $37 level.

But what we are adding on top of that is the IPTV, and what we found is that when we have three services in a household, our churn rate drops from around over 2% for a single service down to about 1.2% to 1.5% for two services, down to between 0.5% and 0.6% when we have three services.

So as we add the DSL on top of the voice, and then we add the video on top of the voice and the DSL, we dramatically reduce our churn in the consumer household, which is really important for moderating our traditional voice loss, but it's also very important in terms of driving our total revenue, the top line, in our consumer business.

So we’re really excited about IPTV, I mean the fact that we could tick the actual numbers, 32% share after three years in two markets against national cable operators, it's just amazing to think about in our two test markets, and that was without the benefit of the Microsoft Mediaroom Customer Interface. What we are going to be rolling out this year is the Microsoft Mediaroom experience, which is the same experience virtually that AT&T has had with its U-verse.

And if you look at the consumer ratings of the U-verse experience compared to the cable industry, you’ll see that the experience level is at the very top. I think there is only one relatively small cable company that’s up there with the AT&T U-verse experience. So, it’s a great experience from a consumer standpoint, and that’s what we’re implementing.

Unidentified Analyst

Many people view the AT&T T module as really about the spectrum, and that there is a concern that there is either currently or will be soon a spectrum shortage out there. How – what is your spectrum strategy look like for the next couple of years? And do you see anything coming along the lines from the FCC to kind of loosen or debottleneck the outlook a little bit?

LeRoy T. Carlson, Jr.

Well, we are interested in acquiring more spectrum. We’ve been primarily focused on acquiring more 700 megahertz spectrum, because the propagation characteristics of 700 megahertz are particularly suitable for our rural type of environments and we have a lot of rural area that we serve at U.S. Cellular. So we’ve been focused there, but we’ve also been interested in deepening our spectrum position with PCS and AWS licenses as well.

I wish I could be more optimistic about the FCC releasing spectrum, but it’s a very slow goal. And if you were to look at the history of spectrum release of the FCC, I think on average, it takes eight years from the time that the FCC gets an idea and it's about possible release of the spectrum until the time that spectrum actually gets released.

I don’t know of anything that’s going to be released in 2012. So and I think we know about it now if it will really come in this year. So I think unfortunately, I think we’re going have to wait probably for 2013. I know it's an unfortunate message to sit up here again, but that's what we see at the moment.

Unidentified Analyst

Okay. Any questions from the audience, we have a microphone certainly.

Question-and-Answer Session

Unidentified Analyst

Taking that the outcome of perhaps you’re not able to grow net subs in the wireless area, how does the value of this business increase over time? And then there is a follow-up question to that. And let's just assume you can’t grow in the wireless area, how do you increase shareholder value? Is there a fallback plan?

LeRoy T. Carlson, Jr.

So the question is, if we can’t grow subs in the wireless area, how are we going to grow the value of that business? Well, I think what you’re seeing this year is that we actually didn't grow subs in 2011, but we actually increased our revenue. And so the revenue is growing from increasing our ARPU due to rapid adoption of data plans. And we’re only 26% penetrated with smartphones at U.S. Cellular. My personal belief is that overtime that will probably go north of 80%. So there's a lot of room to grow the ARPU at the U.S. Cellular from data plans.

We've also been growing our roaming revenues that we provide to other operators. And we provide roaming services today to three of the four national through U.S. Cellular and the fourth national through another company that we recently acquired control of.

So I think there's an opportunity in the roaming side as well to grow our revenue. But let me say that we are fully confident that we will be able to grow subs at U.S. Cellular, because we are offering the best wireless experience in the United States and the message just has to get through.

Unidentified Analyst

So you're going to use marketing to get the message through, and the problem I have with that is now you’re up against Apple's marketing, you’re up against Sprint’s marketing, which is now using Apple in its marketing; and you’re up against this what I would call, incredible viral problem, and if you wanted to see this at work, I’d recommend you go to Grand Central Station in New York where what's happening with that Apple Stores, it’s simply mind-boggling, and I can’t see how you can fight this with dollars. It just, there's no way you can win.

LeRoy T. Carlson, Jr.

Well, you are entitled to your opinion on that sir, but I beg, respectfully disagree. We've seen brand names come and go. The Nokia brand at one time was very popular, the Motorola brand one time was very popular, the Rim brand today was challenged. Brands come and go, and what I would respectfully submit is that what you have to have is a handset lineup that truly delivers value to your customers, not just a brand name.

And our customers know that what they're getting is wonderful, including their handset lineup, because our customers wouldn't have given us the rating as the best wireless provider in the postpaid space in the United States if they didn't feel that way about us.

Unidentified Analyst

Yeah, hi, I'm just trying to understand what's your, frontline, what’s your resistance to carrying the Apple product line; is it the subsidy that's required to support it? Is it the CapEx strain that it could put on your network? With all due respect, Consumer Reports is one view of the world; unit growth, the adoption, the previous questioner's comments on just the range of that. So, I just, I'd really like to finally understand what it is about the Apple device that you’re unwilling to step up to the plate on?

LeRoy T. Carlson, Jr.

Well, I think what the best thing for me to do would be to repeat the comments that the U.S. Cellular CEO made and that was that the risk outweigh the reward. And I would, and because we’re not allowed to talk about the discussions that we had with Apple, I don’t think it would be wise for me to go further than that.

There were some revelations about another carrier's discussions and what it had to offer to achieve a relationship with Apple. So, I would suggest you look there. I mean I, and I can’t comment whether those discussions were similar to ours, but I would suggest you look there. Those are a matter of public record.

Kenneth R. Meyers

Network quality was not our concern. That we have extraordinarily high network standards, we have continued to maintain those through rather explosive data growth without a network issue.

Unidentified Analyst

But I mean, expressly what…

Kenneth R. Meyers

The terms and conditions were unacceptable.

Unidentified Analyst

So it’s the financial terms and conditions?

Kenneth R. Meyers

Terms and conditions, yeah, were just unacceptable. I think we have time for one more quick one, and I just remind you that we’re going to do a breakout just following this in the Presidio room, which is just across the hall, kind of diagonal. Any other questions? Thank you very much for joining us. Thank you very much.

LeRoy T. Carlson, Jr.

Todd, thank you very much.

Kenneth R. Meyers

We enjoyed it.

LeRoy T. Carlson, Jr.

And thank you for your questions and we welcome you to all come to the breakout and ask more good questions.

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