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U.S. Cellular Corp. (NYSE:TDS)

Q3 2007 Earnings Call

November 06, 2007 11:00 am ET

Executives

Mark Steinkrauss - VP, Corporate Relations

Ken Meyers - EVP and CFO, TDS

Steve Campbell - EVP, CFO, U.S. Cellular

Bill Megan - EVP and CFO, TDS Telecom

Jack Rooney - CEO, U.S. Cellular

Jay Ellison - EVP, Operations, U.S. Cellular

Analysts

Ric Prentiss

Phil Cusick

David Janazzo

Robert Shipman

Kevin Roe

Stephen Mead

Martin Loha

Operator

Good morning. My name is Arnika, and I will be your conference operator today. At this time, I would like to welcome everyone to the TDS and U.S. Cellular Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Steinkrauss, you may again the conference.

Mark Steinkrauss

Okay. Thank you, Arnika, and good morning, everybody. Thanks for joining us for the call. With me today are Ken Meyers, Executive VP, CFO with TDS; Steve Campbell, Executive VP, CFO U.S. Cellular; Bill Megan, Executive VP, CFO TDS Telecom, and also joining for the call are Jack Rooney, CEO U.S. Cellular and Jay Ellison, Executive VP Operations, U.S. Cellular.

A replay of this teleconference will be available today at 1:00 pm Chicago time and run through midnight, Wednesday, November 7th. The replay number is 800-642-1687, pass code 22669548. For international callers the number is 706-645-9291, same pass code.

This call is being simultaneously webcast on the Investor Relations section of both the TDS and U.S. Cellular websites. The webcast will be available for the next two weeks after which it will be available in the conference call archive, and remember archived calls are not updated.

We will be making some forward-looking statements today. So please review the Safe Harbor paragraphs in our releases and the more extended versions on our website, as well as our filings with the SEC in this regard.

Shortly after we released our earnings results earlier this morning and before this call, TDS and U.S. Cellular filed 8-Ks. The 8-Ks include both the press releases we issued this morning and some additional information, and our accounting and reporting staffs at corporate in the business units have done a great job and filed both companies' 10-Qs prior to this call.

I encourage you to take a look at these documents. Both press releases were posted to the TDS Internet homepage this morning shortly after going out over the wire. U.S. Cellular posted its release to its website as well.

You’ll also find posted on our websites additional information and reconciliation of non-GAAP financial measures that may be used by management when discussing the operating data during today's conference call as well as any changes to the company's forward-looking guidance.

U.S. Cellular did change its guidance, and Steve Campbell will comment on that in just a few minutes. All of this information is now included on a separate page entitled Guidance and Reconciliation to make it easier to define. TDS Telecom did not make any changes to its guidance.

The information can also be accessed on the conference call page of the investor relations sections of both company's websites. Please note that the comparisons made by the speakers today and their prepared remarks, third quarter year-to-year compares unless otherwise indicated.

There were three non-operating or one-time entries on TDS's statement of operations this quarter. Two are under Investment and Other Income, and the third is an extraordinary item. Ken will discuss these in a second, and it's important that we take them into account for modeling purposes.

We will be meeting with investors in Denver on November 14th. If you have an interest in meeting with us, please let me know. Additionally we will be attending the Citigroup, 18th Annual Entertainment, Media, and Telecommunication Conference on January 8th in Phoenix.

I'm now going to turn the call over to Ken Meyers.

Ken Meyers

Thank you, Mark. Good morning, and thank you for joining us today. We're pleased to report solid third quarter results with operating revenues at TDS up 11% driving a 22% increase in operating income.

Also TDS get $158.1 million in cash flows from operating activities in the quarter. Since Steve Campbell and Bill Megan will cover the operating results in some detail, let me comment on the three non-operating items.

First, TDS recorded a gain of $248.9 million related to the maturity of forward contracts covering 45.5 million shares of Deutsche Telecom. TDS delivered 41 million shares against those contracts and sold the remaining shares.

Also in the quarter, the company recorded a $54.8 million loss related to the fair value adjustment of derivative instruments primarily related to the remaining shares of Deutsche Telecom owned by the company.

Please recall that both these numbers affect TDS only as all of U.S. Cellular's prepaid over contracts matured in the second quarter. For the fourth quarter, TDS had one other contract for about $2.4 million, Vodafone ADR's, which matured last month.

Finally, TDS telecom discontinued with regulatory accounting set forth under FAS or Statement of Financial Accounting Standards 71 and recorded a one-time non-cash extraordinary gain of $42.8 million net of taxes. Bill Megan will expand on that.

Other items below line you will see interest expense down about 16%. That primarily related to the earlier prepaid forward contracts that matured, eliminating the related debt. We would anticipate that will continue to decline as other contracts mature in the fourth quarter of this year and the first three quarters of next year.

For the quarter, the effective tax rate on operations, that's excluding the gains and losses, was 39.4% at TDS. TDS repurchased nearly 1.3 million special common shares in the quarter and year-to-date has repurchased nearly 1.5 million shares for a total of $89.1 million.

The company has now completed a little more than 35% of the $250 million stock repurchase authorization approved by the Board of Directors earlier this year. Now, to go to the details on the operating results at U.S. Cellular, let me turn the phone call over to Steve Campbell.

Steve Campbell

Thank you, Ken, and good morning, everyone. I'm very pleased to report that U.S. Cellular achieved solid growth and financial results in the third quarter of 2007. At September 30 our customers totaled almost $6.1 million up 6% year-over-year.

Our retail customers totaled $5.5 million, up 7%. Total net activations for the quarter including both retail and re-seller customers were 57,000, up more than 100% from 25,000 in the prior year. Retail net activations for the quarter were $52,000 up 86% driven by continued strong results in the post pay segment, the part of the market where we focus.

Post pay net activations for the quarter were 73,000, up 92%. And at September 30th, post paid customers were approximately 95% of our total retail customers. We also achieved nice growth in the average monthly revenue per unit. ARPU rose to $52.71 for the quarter up 10%.

The retail post paid churn rate for the quarter was 1.6% compared to 1.7% in the prior year, and for the nine months the retail post paid churn rate was 1.4%. We achieved these strong results across the majority of our markets due to a number of factors.

First, the continuing strong popularity and acceptance of our new suite of national wide area and family calling plans, which were introduced in the second half of 2006. Customers appreciate the value inherent in these plans and continue to migrate to them faster than we anticipated. By September 30th, roughly 54% of our post paid customer base was on these plans.

Another factor is our expanded offerings of handsets and products. During the third quarter we introduced seven new handsets including two new smartphones, our first windows based mobile phone, the Motorola Q, and the Blackberry 8830.

We’re also excited to announce that we expect to launch the powerful and stylish Blackberry Pearl another smartphone offering multimedia functionality in the first quarter of 2008.

In addition, during the third quarter we launched Tone Room, a new application that provides customers with one stop shopping for browsing and purchasing ring tones either on their phones or on the web, and Your Navigator another new application that provides customers with both visual and audible turn by turn directions at a fraction of the cost of traditional in car GPS navigation systems all with the convenience of a wireless phone.

Near the end of the quarter, we launched Premium Short Messaging Content. The most popular applications in this service are those that enable customers to vote on television programs or sign up for text alerts and chat services, and just after quarter end we launched Napster To Go, a music side loading solution which provides customers with a huge music selection and enables them to listen to music whenever and wherever they want.

Napster To Go works with our new Motorola Rocker handset. And everything a customer needs to enjoy music on the go is included in the box with the rocker. There's no need to buy additional accessory packs or go hunting for special cables.

And all of this was launched at a very competitive price. These new handset offerings and products deliver customer value by providing a wider range of desired style and functionality, and they've enhanced our competitiveness in the market. They've also contributed to the significant growth in our data revenues, which were up 66% year-over-year.

The third factor in our strong performance is our relentless focus on customer satisfaction. We know from our surveys and other customer related research that overall network quality remains the number one criteria and that drives customer satisfaction. So we're committed to ensuring that our customers have access to a superior network and our associates are delivering on that commitment.

In early September, U.S. Cellular received the prestigious JD Power and Associates award for highest call quality in the North Central region for the fourth consecutive reporting period. In the first nine months of 2007, we added 330 new cell sites to our network, which now has about 6250 total sites in service, and we plan to add about 100 more sites during the fourth quarter.

Our financial performance during the quarter also was strong, reflecting higher revenues and improved operating income and cash flow. Total service revenues were $955 million, up 16% from the prior year. The increase in service revenues was driven by growth in the subscriber base as well as by higher ARPU, which grew 10% year-over-year to $52.71.

In fact this was the seventh consecutive quarter of growth in ARPU. Key drivers of that growth were, as I mentioned earlier, the popularity of our national wide area and family calling plans and higher data revenues. Data revenues for the quarter grew 66% to $97 million and represented just over 10% of total service revenues.

Other factors included increases in inbound roaming revenues, universal service fund contributions, charges to customers and ETC revenues. Inbound roaming revenues for the quarter were $61 million, up 39% reflecting both higher minutes of use and an increase in data roaming revenues. ETC revenues for the quarter were $27 million up from $17 million in the prior year.

U.S. Cellular is now eligible to receive funds in nine states compared to seven states in 2006. In light of the FCC's ongoing consideration of a recommendation to place an interim cap on funding to wireless carriers, the level of ETC funding that the company will receive in the future is somewhat uncertain. While we can't predict what the FCC ultimately will decide, we expect ETC revenues in the fourth quarter to be pretty consistent with the amount recorded for the third quarter.

The net equipment subsidy for the quarter was $103 million up $29 million or 40%. Factors in this increase include higher volume as well as a higher net subsidy per unit reflecting both a shift in mix toward higher end handsets that enable advanced data services and very aggressive promotions across the industry.

We've experienced very nice growth in ARPU overall and in data revenues in particular, and the equipment subsidy is one cost of getting those additional revenues. For example, given the choice between a low-end phone at no cost and a higher end phone that supports advanced data services and multimedia capabilities for a nominal incremental payment, many customers will opt for the higher end phone.

In that case, although the customer pays a little more for the handset, the net subsidy by the carrier is also greater. Also smartphones are among the most expensive models and generally results in a higher net subsidy by the carrier, but involves significantly higher ARPU, something in the range to 1.5 to 2.5 times traditional ARPU. As you know handset subsidies increased throughout the industry during the third quarter.

System operations expenses were $185 million up 12%. The increase was driven by a 9% increase in the number of cell sites in service, an increase in network usage by our customers and a 22% increase in average minutes of use per customer.

Factors, which helped to hold down costs in this category, were lower cost per minute of use on our own network and a decrease in outbound roaming cost per minute as we benefited from lower negotiated rates. Selling general and administrative expenses were $415 million up 16%.

Key components of this increase were higher selling expenses associated with the growth in customers and revenues and higher advertising expenses primarily related to media purchases. We mentioned last quarter that we expected advertising expenses to trend higher in the second half of the year.

Another significant factor was higher expenses related to universal service fund contributions. Remember that USF contributions are largely offset in revenues.

Also as you may know, several wireless carriers have been involved in litigation with various municipalities in the state of Missouri, related to the imposition of business license taxes on telephone services. The company recently entered into a settlement agreement related to that litigation resulting in a charge of $3.6 million during the quarter.

Operating income was $101 million up 31% as the growth in revenues exceeded growth in operating expenses. Operating cash flow for the quarter totaled $251 million up 12%. The operating cash flow margin was 26.3% of service revenues down one percentage point from 2006 reflecting the higher costs and expenses that I mentioned earlier, particularly the net equipment subsidy.

Remember, for the nine months, operating cash flow margin was 28.7% up 1.2 points year-over-year. Below the line total investment and other income for the quarter was $8 million, an improvement of $29 million from 2006.

The key factor in the improvement was the absence of a loss of $21 million incurred in 2006 related to the fair value adjustment on derivative instruments, which were settled during the second quarter of 2007. Also contributing was lower net interest expense.

Equity and earnings of unconsolidated entities was approximately $24 million for the quarter including $18 million from the company's investment in the Los Angeles partnership. The effective income tax rate for the quarter was 37.9% compared to 27.7% in 2006.

The lower prior year rate reflected the favorable resolution of state tax audits. Net income was approximately $64 million or $0.72 per share.

As I indicated previously, the company is generating strong cash flow from operations. Again, for the third quarter, operating cash flow was $251 million. The company used the strong cash flow to fund capital expenditures of $131 million and to repurchase 168,000 of its common shares for about $16 million.

At quarter end, the company's revolving credit line was unused, and the cash balance was $182 million. The company did not launch any significant new markets in the first nine months of 2007 and has no plans to do so this year or next. Instead, we expect to remain focused on increasing customers, revenues, and profitability within our existing markets. However, we will of course continue to consider attractive opportunities to expand our footprint as we did with the acquisition of the Iowa 15 market earlier this year.

So all in all, it was a strong quarter for U.S. Cellular, due to the significant efforts of our 8200 associates who are dedicated to providing the ideal customer experience to our customers. Looking ahead for the remainder of this year, we expect the favorable trends in revenues and operating income that we've seen for the first nine months of the year to continue.

Accordingly at this time we're raising our guidance for full year 2000 service revenues in operating income. The updated guidance is contained in today's press release.

That concludes my prepared remarks. Now, I'll turn the call over to Bill Megan who will discuss the quarter's results for TDS Telecom. Bill.

Bill Megan

Thank you, Steve, and good morning everyone. Let me begin with a brief description of the extraordinary gain we recorded at September 30th and then go on the review operating performance for the quarter.

As of September 30th, TDS Telecom discontinued the application of FAS 71 for reporting its financial results. FAS 71 specifies the accounting for the effects of certain types of regulation, and its application is required for businesses that meet three threshold criteria.

Although we have applied FAS 71 to our ILEC operations since the effective date of the standard in 1984, we have determined that as a result of increasing competition in our markets, FAS 71 should no longer be applied.

The principle effect of discontinuing FAS 71 is a reversal of the regulatory liabilities associated with the future estimated cost of removal of certain fixed assets. Removal of buried cable and public write away would be an example. This resulted in a one-time after-tax gain of $42.8 million as Ken mentioned, and we recorded that as extraordinary income. The company does not expect this change will have material effect on its continuing ILEC operations.

Moving on to review, our operating performance for the quarter, combined ILEC and CLEC revenues declined 3%, while operating cash flow increased by 1% compared to the third quarter a year ago.

I'll walk through the ILEC and CLEC results separately. ILEC revenues decreased 3%. The decline is due primarily to lower compensation for network access including compensation from state, national revenue pools and decreased local service. This decline was mostly offset by the growth in revenues related to DSL and long distance customers.

Operating cash flow decreased 5% primarily due to the decline in revenue particularly the decrease in high margin network access revenues. Cash expenses decreased by $1.8 million or 2% for the quarter primarily due to savings realized in selling, general, and administrative expenses associated with cost control efforts. ILEC access lines equivalents, access lines adjusted to reflect voice grade equivalents, grew 1%. Physical access lines declined by 4%.

Reductions in residential second lines accounted for 21% of the decline decreasing by 5900 driven in part by conversions to DSL. Telecom ended the quarter with 28,400-second lines in service, and that represents about 5% of our lines. With respect to our data service, DSL customers increased 44% to 135,500. Penetration of our physical lines is now at 22.7%.

Many of our DSL customers migrate from dial-up Internet service. Net accounts were a good portion of the decline in dial-up service that we have reported. We continue to invest in our network to offer broadband service, 86% of our physical lines are equipped for DSL service was about one-third its speeds above three and up to 15-megabit service.

On the CLEC side, revenues were essentially flat; we have shifted our focus in acquiring new customers to the commercial segment in most of our CLEC markets. Operating cash flow increased by 72% to $10.1 million.

On a consolidated basis, margin expansion has been driven by cost reduction initiatives including combining the support functions of ILEC and CLEC. As we've integrated those functions, we've been able to lower support head count by 7% over the past year while maintaining high levels of customer satisfaction.

For both our ILEC and CLEC, we continue to emphasize providing our customers with exceptional customer's service and access to advanced services. Competition continues to intensify and broaden its impact on our markets. We feel it from both wireless and cable, but we do see a very positive path forward for wire line companies like ours.

The high-speed data connection is going to be critical in so many respects, in the typical applications today to robust voice, data and video in the future. So, right now we are investing in our network while we are strengthening our relationship with our customers.

In the consumer segment, we are designing packages, bundles, of voice services including pigmented plans cell B, high speed data, Dish TV, and vertical services to attract as many households as we can. Our customers have responded favorably to our bundled service offerings. Penetration of voice packages to residential customers grew to 25.6% during the third quarter.

An aggressive Dish triple-play campaign was launched during the third quarter incorporating Dish with data and voice services. Dish is a key element, and our competitive response to cable. In the third quarter, customers subscribing to the triple-play grew by 6700. We have also implemented additional initiatives to help mitigate churn, including a sales program using a specialized sales teamed armed with a variety of tools including discounts, bundles and other promotions.

We also have a new mover program targeting referrals from builders, developers, real estate agents and other local contacts to ensure to new customers moving into our territory take our service.

I'll end there and I'll turn the call back to Mark Steinkrauss.

Mark Steinkrauss

Thank you, Bill. Arnika, we're ready for questions and answers now.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Ric Prentiss.

Ric Prentiss

Yeah, good morning, guys. Couple of questions on the U.S. Cellular side. First, you guys have talked about how you're getting the higher equipment subsidy to get the higher data revenue and the increased competition on the handset promotions. Give us a little thought on your trends there. They are obviously data's got a lot of room to grow.

But do you think we should expect higher handset subsidies for the foreseeable future? And then I'll come back with a couple others.

Jay Ellison

Ric, this is Jay Ellison. It seems to be the trend in this industry as Steve mentioned in his comments. We've seen it in virtually across the enterprise. We've seen a very shift in mix, and we kind of classify handsets good, better, and best, and we've seen a very strong shift out of the good into the better and best categories.

Steve also mentioned we launched the Q which is our first windows operating system. We've just had tremendous success across the enterprise with that handset which is a higher cost and higher subsidy phone. But along with that we are seeing tremendous utilization of all our data services, not only text messaging growing but we've seen tremendous legs around picture messaging, which I think we have commented on earlier this year continue.

We are seeing very good data revenues on all of those smartphone devices, and we're putting significant effort around and that many of the products that Steve mentioned earlier of the Tone Room and location based services have contributed as well to higher ARPU. So, albeit we are seeing higher handset subsidies, we also feel very confident that that is also contributing too much greater functionality and utilization of our data services.

Ric Prentiss

As we think of CPGA versus ARPU, where is CPGA kind of headed? What kind of level?

Jay Ellison

That's almost too hard to predict. We committed to be competitive for our customers. That has implications on activations and retention. But there's five or six players in every market, and we're going to stay right up where we can be competitive to get high quality customers.

Ric Prentiss

Okay. I usually wait for the queue, but what was CPGA within the quarter in that ARPU was up pretty high?

Steve Campbell

For the third quarter, it was about $500.

Ric Prentiss

Okay. And then, any update on your thoughts as far as 700-megahertz auctions, what your interest might be as far as adding spectrum in your current footprint or maybe looking at some edge out?

Steve Campbell

About that, as far as the 700-megahertz auction is concerned, as you know, we've participated in recent auctions and currently it's our expectation, and what I mean by that is it's more likely than not that we would participate in the upcoming auction.

As we have said before, our principal interest in net auction is to get spectrum to accommodate growth in customers and their usage in our existing markets and to provide the spectrum that we'll need for eventual deployment of either 3G or 4G technology.

Ric Prentiss

Okay. And then final question, lot of M&A activity in the whole space starting in May, with Alltel Private Equity with going to Dobson going to rural, which I think helped you guys' investment out there. And then some comment at the end.

What are you guys seeing as far as the M&A environment out there, as far as any licenses you might want to pick up or any licenses you might want to divest of in your different clusters?

Ken Meyers

Hi Ric. This is Ken Meyers. There's been a lot on. As we have talked in the past, a lot of what's going on has been other public companies where when we look at it. Only part of it is really strategic or could be strategic to us. And we aren't about to take the ARPU triage on buying 100% of something in order to get the 30% or 40% or 50% that makes sense for our footprint as it exists. We've seen it, but we haven't been really involved in anything right now.

Ric Prentiss

Okay. Thanks. Good luck, guys.

Operator

Your next question comes from Phil Cusick.

Phil Cusick

Hi guys; thanks for taking the question. First a follow-up on Ric's question. Can you give a little more detail on that smartphone space? First you said smartphones are 1.5 to 2 times traditional ARPU. Is that data or total ARPU?

Jay Ellison

It's total.

Phil Cusick

It's total, and about how many smartphones do you have in the base?

Jay Ellison

We don't have that number.

Phil Cusick

Okay. And then second of all, in terms of the outlook for the fourth quarter, it seems like as one of the later guys who are reporting in the economy, people keep wondering about it or at least asking me about it. Can you give us an idea of what you're seeing on a month-to-month basis and what's built into your fourth quarter guidance for sort of overall consumer growth? Thanks.

Jay Ellison

Well, so let's talk about adds activity. We mentioned that we had strong growth in Q3 in the post phase segment in particular, 73,000 net adds, which was up 92% year-over-year. And recognizing that Q4 is always a very competitive quarter, our guidance out there is still where we've been all year at 375 to 425,000.

Phil Cusick

So no recent changes in customer activity that would indicate any weakness?

Jay Ellison

No.

Phil Cusick

Great. Thanks, guys.

Operator

Your next question comes from David Janazzo.

David Janazzo

Good morning. On the roaming, both incoming and outgoing, Steve you ticked off some of the drivers. Are those trends sustainable, particularly on the inbound side? And you mentioned some of the new service plans. To what extent is that impacting the systems operations costs?

Steve Campbell

As I mentioned, inbound and you reminded us, inbound was up pretty good year-over-year. I think it was 39% was the number that we quoted. And we're enjoying, that's largely a function of inbound roaming minutes. We've had a significant increase in inbound minutes from our principal roaming partner. We'd certainly like to see that trend continue but certainly is subject to what our partner decides to do in terms of moving traffic.

On the outbound side, we have included some roaming minutes in our wide area national plan so we've had increase in terms of use. But frankly, as a percentage of our total usage, the off network percentage has stayed the same at about 4%.

David Janazzo

And Ken, you've got share buybacks going on in a couple of places. Can you pull that together for us and give us your overall strategy on the share buybacks across the three classes?

Ken Meyers

Sure. Starting at U.S. Cellular, we have a share buyback program in place to offset the dilution caused by ongoing compensation programs. And over the last couple of years, the company wasn't able to repurchase any shares. And we are simply in every quarter picking up about 1%, which is what's allowed under a diminimus program we have in place. That's 1% of the public shares.

Separate from that at the TDS level, we have a $250 million repurchase program that was authorized by the board earlier this year primarily focused on taking advantage of the discounts that we see in the special common. When we launched that program, it was a set dollar amount over about a three-year period, and we're about 35% of the way through in less than six months.

I expect that we'll continue to execute that plan as long as we see the opportunity in the marketplace. And once that is done, we'll look at what our next steps are. There's currently no repurchase program underway affecting the regular common shares at TDS.

David Janazzo

Thank you.

Operator

(Operator Instructions). Your next question comes from [Robert Shipman].

Robert Shipman

Good morning. From my perspective, it looks like with business risk, financial risk and now with accounting problems gone, it suggests that credit ratings should be closer to single A than certainly BB+ at S&P. I was wondering if you've had any recent conversations with them and when you anticipate ratings to go up?

Ken Meyers

Hi, Robert. This is Ken. We stay in very close contact with the rating agencies. And as disclosed in their prior releases, the credit metrics themselves as true measures look pretty good and continue to improve, and the company is making progress on re-mediating its material weaknesses.

My expectation as we continue to march down this path, the rating agencies will take note of our business and the credit ratings as well as our improved controls, and we'll make appropriate adjustments as we go forward.

Robert Shipman

Okay. Great. If you could press on, that would be appreciated.

Ken Meyers

Right.

Operator

Your next question comes from Kevin Roe.

Kevin Roe

Thank you. Good morning. A couple wireless questions. Given the importance of data growth and smartphones, can you give us an update on your EVDO plans, and also on wireless, can you give us an update on bad debt expense trends there and any change in credit scoring that may or may not have taken place year-to-date? Thanks.

Ken Meyers

On the EVDO, as you know, we have launched kind of a market trial is up in Milwaukee. And that is going very well. As a matter of fact, we just added this past week or so the selling of EVDO data cards in our retail arm up in the Milwaukee market so that we can further use that type of data information to evaluate what we may do next with EVDO.

I think we've always expressed that we won't rule anything out until rev A is available and ready for prime time, and at this point in time, quite frankly, rev A is mostly in the data cards themselves. So, that's why we're rolling that in Milwaukee. Then, we'll use that data along with some other more for doing here to evaluate our next steps or next markets that we would consider rolling out next year or beyond.

So, really, no concrete answers beyond taking those data from the data card trial we're putting up there along with the handset trial and looking at the metrics around that and backing that into some of our business case work. On the bad debt, I think it's…

Steve Campbell

On the bad debt, we actually relaxed our standards a bit late last year with the intention of promoting or driving more gross ads for the business. But over the year, bad debt expense has been in line with what we expected. In fact, for the nine months, it's right in line as a percentage of revenue with what we have seen in the prior year. And in fact, under 2% of revenue. About 1.7% actually.

Kevin Roe

And one more wireless question. On your unbilled markets, you've got a big license for Indianapolis and Minneapolis. And you mentioned in your prepared remarks that you're not looking to build out new markets in the fourth quarter and into '08.

I think in '08 maybe, and you comment I'm not sure, but given that, are those two licenses still important to your portfolio? Are they strategic? Could they be something that you could monetize?

Ken Meyers

Hi. This is Ken. Yeah, they are currently immediately adjacent to where we operate, which gives them an extra value in terms of how we think about them. However, as we have said in the past, it was important for us to meet some of the credit metrics that were thrown out in front of us, and we're going to launch any of those until such time as we had the current markets up and running, built out and strengthened our management team before we moved forward.

And given that it takes at least 18 months to build out something like that, and none of that has started, that’s why we're able to say nothing in '08, and that is not a new statement around '08.

Kevin Roe

So, no launch in '08, but you could theoretically start building one or either of those markets in '08.

Ken Meyers

We haven't built all of these plans. So, to comment now I think it would be inappropriate, and when we talk about our fourth quarter results, we'll be talking about our guidance and plans for next year.

Kevin Roe

Okay, thanks, Ken.

Operator

Your next question comes from Stephen Mead.

Stephen Mead

Hi, it's Stephen Mead. Just on the cellular side. Can you talk a little bit about - do you have a sense of in terms of the customer mix how many customers were actually paying for data services and as you look at the non-data ARPU? In terms of the percentage of the group that don't pay up for database services in terms of just voice business, what are the ARPU doing in that sort of segment of the market?

There's two questions there. Do you have a sense of what the mix looks like in terms of how many customers are paying for data?

Ken Meyers

Well, one of the unique things about the way we rolled out data at U.S. Cellular was we enhanced our billing system, so that people can use and experience it without buying a data package.

They can use it after they walk out of the store. And so while others can talk about a number of customers that are data capable or whatever, almost every phone that goes out the door at U.S. Cellular is data capable. So, the numbers aren't measured just the ways you are looking for.

Stephen Mead

Okay. Then what -- do you have a sense of sort of what the, more commodity end of the business is doing in terms of ARPU trends?

Ken Meyers

Not answerable right now, especially given the whole repackaging of a new rate plan that moved out last year. Wouldn't be surprised to see if they have increased also.

Stephen Mead

Okay. What about if you look at the hit to operating results from the loss on equipment sold, how much of the equipment sales are associated with people upgrading to another phone versus new customers?

Ken Meyers

Obviously, we've reported extremely strong churn rates and a piece of that is one component of that is the competitiveness outlined in the marketplace. Existing customers expect to be treated as would a new customer.

We offer basically the same programs on the handsets to our existing customers as well, and they are shifting mix as well to those better and best phones as they come in for contract renewal. We see a pretty big balance about on an ongoing basis.

Probably, we say about 70% of our gross number generally is about what we're retaining on our monthly basis, and that goes through cyclical time based on the holiday buying seasons whether it's the Christmas holiday, Valentine's Day, Mom, Dad's, Grads and then back-to-school, we see kind of peaks and valleys of that.

Stephen Mead

I was just wondering, as we look at 2008, whether in terms of the cost of equipment and stuff like that, what do you see as far as that trend? I mean is it going to be similar to 2007? Or could you actually get some benefit of the maturing of basically more customers have updated equipment, and they don't need to replace it.

Ken Meyers

I think two things. One, I think it's going to be more of the same, and two, I think we've all seen over the last two or three years the rapid introduction and then end of life of many handsets clearly, with each reintroduction of either a refreshed look of a handset or a new form factor.

We're talking increased functionality and user interoperability on those handsets. So, I really think it's looking very similar go forward.

Stephen Mead

And at this stage of the wireless business in the country, where does your new business come from?

Ken Meyers

We do a significant amount - we get our business a lot from those churning, through dissatisfaction with their current carriers, and we're very targeted in all of our markets try to get equal to or more than fair share of those intenders new to the market.

I think our strategy focusing on customer satisfaction lends very much towards getting those that are dissatisfied with other carriers out there.

Stephen Mead

I mean, of the net adds in the third quarter, how many of those were churned from some other network versus absolutely new cellular users?

Jack Rooney

This is Jack Rooney, there's no way for us to determine that. I mean it's, when you're sitting there trying to figure out what your gross adds are and trying to sit down and figure out how many are they.

So, you know you're getting a significant portion of your net adds or gross adds from another carrier. But try and sit down, we measure things like flow share or whatever. So, we know, what our, how our customers intake is measured against what our competitors are doing.

Stephen Mead

I’d just two more questions. On the SG&A line the increase, how much of that was advertising?

Steve Campbell

Advertising year-over-year was up about $8 million.

Stephen Mead

And then LA, what was the LA comparison as far as the equity and earnings this year versus last year?

Steve Campbell

I have it here, hang on a second. LA was $18 million this year and was $16 million for the comparable quarter last year.

Mark Steinkrauss

Up 11%.

Steve Campbell

Up about $2 million and change from last year.

Stephen Mead

Alright. Thanks.

Operator

Your next question comes from [Martin Loha].

Martin Loha

Thank you. Is it too early to get some general guidance regarding your 2008 capital spending plans?

Steve Campbell

Yes. As Ken mentioned, we're still in the process of planning. And it would be premature to say anything about that right now. When we meet later to discuss full year results, we may have some guidance at that point.

Martin Loha

Thank you.

Operator

At this time there are no further questions.

Mark Steinkrauss

Okay. Arnika, I think then the call is concluded. Thank you everybody for joining us, and I'm available for the rest of the day if you have any additional questions. You may terminate the call.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Telephone & Data Systems Q3 2007 Earnings Call Transcript
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