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Telephone And Data Systems Inc (TDS 0.92%)
Q2Â 2019 Earnings Call
Aug 2, 2019, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. My name is Aaron, and I will be your conference operator today. At this time, I'd like to welcome everyone to the TDS and U.S. Cellular Second Quarter Conference Call. [Operator Instructions]. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Jane McCahon, you may begin your conference.
Jane McCahon -- Senior Vice President of Corporate Relations and Corporate Secretary
Thank you, Aaron. Good morning and thank you everyone for joining us today. Based on the positive feedback we received last quarter, we have again released our results and posted all of our documents to the Investor Relations sections of the TDS and U.S. Cellular websites after the market closed yesterday.
With me today and offering prepared comments are from U.S. Cellular, Ken Meyers, President and Chief Executive Officer; Steve Campbell, Executive Vice President and Chief Administrative Officer; Mike Irizarry, Executive Vice President and Chief Technology Officer; from TDS Telecom, we've got Vicki Villacrez, Senior Vice President of Finance and Chief Financial Officer. This call is being simultaneously webcast on the TDS and U.S. Cellular Investor Relations website. Please see the websites for slides referred to on this call, including non-GAAP reconciliations. We provide guidance for both, adjusted operating income before depreciation and amortization, and adjusted earnings before interest, taxes, depreciation and amortization to highlight the contributions of U.S. Cellular's wireless partnership.
As shown on Slide two, the information set forth in the presentation and discussed during this call contains statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Please review the Safe Harbor paragraph in our press releases and the extended versions in our SEC filings. TDS and U.S. Cellular filed their SEC Form 8-K yesterday including it's press releases in addition to our SEC Form 10-Q.
Taking a quick look at the upcoming IR schedule on Slide 3; I'll be attending the Morgan Stanley Media and Communications Corporate Access Day in New York on August 8. We are hosting a Madison-Wisconsin field trip with B. Riley FBR on September 9. Ted Carlson and I will be doing our Annual European Roadshow, the week of September 23rd; and Ted Carlson, Doug Chambers and I will be doing a city non-deal roadshow in Boston and New York on November 13th and 14th. Now we've got Ken, Mike Irizarry and myself attending the UBS Global TMT Conference on December 11th in New York. Also, 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 management, the Investor Relations team will try to accommodate you, calendar permitting.
And with that, I'll turn the call over to Ken Meyers.
Ken Meyers -- President and Chief Executive Officer
Thanks, Jane. Good morning and thanks for joining us today. It's been a busy first half for us. Overall, I'm pleased with our second quarter financial results and generally with how the first half of the year has played out; so there remains areas for improvement. In the quarter, service revenues grew 2% driven by positive trends in average revenue per user and roaming. Also, operating cash flow or operating income before depreciation and amortization grew 4%. Equipment sales remained weak again this quarter and new subscriber activity, by that I mean gross adds, were not at the level I'd like to see; I'll talk more about that in a moment.
We are progressing nicely on our 5G and network modernization projects and we are just completing some significant [indecipherable] work also. In the quarter, we completed the most recent Millimeter auction, we're now able to show the success we had in securing Millimeter Wave Spectrum which will be important for our future. Later in the presentation, Mike Irizarry will provide a mid-year update on our network activity, and then Steve Campbell will provide more detail on the financials.
Turning back to sales activity; in addition to customers holding on too expensive phones longer we faced a few additional headwinds this quarter. Our prepaid sales has been hampered by handset availability, some of the global issues required us to change our supply chain and it took us a while to qualify new vendors and restock our channels; that issue is now behind us and now I expect to see a pickup in the second half. Also during the quarter, store traffic was slower than expected. We did not have the beneficial impact, usually associated with the new phone launch, and we had the impact of flooding in some major market areas, and also felt the impact of some new entrant activity in the quarter.
So all in all, while the quarter was competitive it was slower than expected. Despite the slow sales, postpaid handset churn remained strong and our upgrade rate was what might have been a historical low at 4.9%. Looking forward, I'm optimistic about the second half addition to resolving the prepaid supply chain issue and absorbing the initial new entrant impact. We have some exciting new capabilities coming online in conjunction with our system modernization work and other system investments. Given our lower than expected transaction volume, we are lowering our guidance for equipment revenue, again. Let me reiterate that this has no meaningful impact on our profitability measures; service revenues are what really drives our profitability and our guidance on our profitability metrics remains unchanged.
Talking about service revenue, we saw a 2% increase driven by growing average revenue per user as customers continued to migrate to our total plans, including unlimited plans along with customers purchasing additional services such as device protection plans. At the end of June, 68% of our postpaid customer base was on our total plans with 32% on unlimited plans. Device protection plans cover about 47% of our postpaid base, meaning we have room to grow that revenue stream. We are finding that as customers pay for the higher priced phones themselves to become more interested in protecting their investment in devices.
Moving on, roaming revenues grew 13% year-over-year. The team has positioned us well in the roaming over a year now [Phonetic] by successfully migrating from 3G to 4G agreements and expanding the carriers we serve, and improving our net roaming position. Another focus for the company is our ongoing initiatives and controlling costs. For example, even though data usage increased 33%, and despite more sites and increased maintenance on sites; systems operations expenses grew only 3%. Similarly, rates for roaming have been substantially lower. We continue to identify and work on cost savings opportunities across the company.
The final key focus area for this year is our network. We continue to believe excellent customer service coupled with an outstanding network is what differentiates us from our competitors. And again, customers recognize this difference and awarding us the JD Power Award for network quality. As we said at the beginning of the year, we are making a number of investments to ready our network for 5G but also provide benefits such as increased speed and capacity. I'll let Mike update you on the progress in greater detail in a bit.
Turning to Slide 6; spectrum is the life-blood of this industry. We are at a critical juncture as our industry looks to equip itself for 5G and the innovations it will bring. U.S. Cellular's network strategy envisions the use of low-band, mid-band and high-band spectrum overtime. Over the past 30 years U.S. Cellular has amassed a significant amount of low-band spectrum, including 600 and 700 megahertz Spectrum, Cellular AWS and PCS spectrum. Now with the purchase of Millimeter Wave Spectrum from the most recent auctions, we won a sizable amount of Millimeter Wave Spectrum also. However, as we continue to meet the growing demand for data services and further identify and define potential 5G used cases, we implore the FCC to bring us much mid-band spectrum to market as soon as possible, and within a framework that will allow regional and smaller wireless carriers to continue to meaningly participate in this industry.
Finally, as we continue on our network modernization path we're doing a lot of work on our towers; and for that reason we continue to believe that owning our towers is critical to our network strategy. However, we also recognize that they are valuable assets and we consider them as a potential source of liquidity, and if faced with compelling need for cash, would weigh them versus other financing alternatives. Today as we work through our network modernization in 5G strategies, our towers remain strategic to us.
And now let me turn the call over to Mike Irizarry who will update you on our mid-year network modernization.
Mike Irizarry -- Executive Vice President and Chief Technology Officer
Thanks, Ken and good morning. Network quality is foundational to U.S. Cellular, our goal is to ensure our customers have a great experience whenever and wherever they use their devices. And proof that we are succeeding is the recognition that U.S. Cellular won another JD Power Award for highest network quality performance among wireless cellphone users in the North Central region. I want to recognize and thank our engineering team for the hard work, dedication and focus they put into the experience our customers enjoy on our network.
Throughout the year we have continued our deployment of Voice-over-LTE. We have commercially deployed VoLTE in Iowa, Wisconsin, and our Northwest markets, and plan to rollout VoLTE in our New England and Mid-Atlantic markets in the third quarter. We now have 1.2 million customers on our VoLTE service. We are also working with multiple carrier partners on LTE and VoLTE roaming to ensure our customers have a great experience wherever they use their devices and to generate additional roaming revenue. As I shared during our February call, this year we are committing capital to a multi-year project to modernize our entire network, so it is ready for 5G NR. The modernization project will use various technologies, including 4x4 MIMO, LAA, 256-QAM and LTE M to bring LTE advanced features to our customers. These features improve coverage, throughput and capacity of the network. The modernization will support and utilize our existing low-band and mid-band AWS PCS spectrum holdings. The equipment being deployed is an enabler for supporting future 5G bands too.
As a reminder, we will start the deployment in our largest markets and look to commercially launch these services and 5G in those markets in 2020. Like with other technology evolutions, we are pacing these investments so we are ready when our customers are ready. This multi-year approach has served us well with previous generation technology deployments such as VoLTE, 4G and 3G. The work involved includes replacing the base stations with software upgradable base bands; new 5G features can be incorporated with simply a software upgrade rather than a hardware-upgrade. Moving the radios up to the top of the tower, this improves coverage, and software upgrades to the core of our network.
We are pleased with our progress to-date, our infrastructure vendors thus far are meeting our hardware delivery needs. We have started the tower work required to support the new antennas and coax lines at the cell sites, and we are making good progress upgrading the key components of the network core. By the way, you can't have a 5G offering without a device, and we are working very hard with our major handset partners to ensure we have 5G devices to go with our 5G commercial launches.
Now, I will turn the call over to Steve Campbell. Steve?
Steve Campbell -- Executive Vice President and Chief Financial Officer
Thank you, Mike and good morning everyone. I want to talk first about postpaid handset connections shown on Slide 8.
Postpaid handset gross additions for the second quarter were 102,000, down from 111,000 a year ago. Ken talked about the factors influencing these results in his comments earlier. Postpaid handset net additions for the second quarter were negative 11,000; down from 5,000 last year, driven by the decline in gross additions and slightly higher churn. On a sequential basis, handset gross and net additions were both about the same. We continue to have existing handset customers upgrading from feature phones to smartphones. Including the upgrades total smartphone connections increased by 10,000 during the second quarter, and by 104,000 over the course of the past year; that helps to drive more service revenue given that ARPU for a smartphone is about $22 more than ARPU for a featured.
Next, I want to comment on the postpaid churn rate shown on Slide 9. Postpaid handset churn depicted by the blue bars was 0.97% for the second quarter of 2018, with only small variations compared with the year earlier and sequential quarter results. In fact, handset churn has been right at/or below 1% for several consecutive quarters, which is indicative of high customer satisfaction. Total postpaid churn combining handsets and connected devices also has been consistently low over the period shown; it was 1.23% for the second quarter and has been trending down slightly for the past couple of quarters.
Now let's turn to the financial results. Total operating revenues for the second quarter were $973 million, essentially flat year-over-year. Retail service revenues increased by 2% year-over-year to $662 million; the increase was due largely to higher average revenue per user which I'll cover in more detail on the next slide. Inbound roaming revenue was $44 million; that was an increase of 13% year-over-year driven by higher data volume. Equipment sales revenues decreased by $17 million or about 7% year-over-year; this was driven by a decrease in the number of devices sold. The impact of reduced volume was partly offset by an increase in the average revenue per device sold. We're continuing to see that customers are holding on to their devices for increasingly longer periods driving the number of device transactions lower. Just as we said last quarter, equipment sales have continued to fall short of our expectations coming into the year causing us to again adjust our thinking about full year revenues.
Now few more comments about postpaid revenue shown on Slide 11. The average revenue per user or connection was $45.90 for the second quarter, up $1.16 or 3% year-over-year; that increase was driven by several factors including a shift in device mix to smartphones, increased device protection revenue, and the shift in service plan mix to the higher price plans. 32% of our postpaid connections are now on unlimited plans versus 20% a year ago. Partly offsetting these increases was a decrease in universal support fund revenues resulting from the FCC's December 2018 rolling that revenues from text and multimedia messaging services are no longer assessable under the universal support fund. As a result, this year U.S. cellular stopped charging customers and is no longer paying the FCC USF fees on these revenue streams. Because the change also affected general and administrative expense by a like amount, it is neutral to earnings.
Looking through the change, ARPU on a comparable basis increased by $1.49 year-over-year versus the reported increase of $1.16, a pretty strong result. On a per account basis, average revenue grew by just under 1% year-over-year. And excluding the USF impact I just mentioned, ARPU would have grown by 1.5% year-over-year.
So let's move next to our profitability measures. First, I want to comment on adjusted operating income before depreciation, amortization and accretion, and gains and losses. To keep things simple, I'll refer to this measure as adjusted operating income. As shown at the bottom of the slide, adjusted operating income was $212 million, up 4% from a year ago. Correspondingly, the margin as a percent of total operating revenues increased by about a percentage point from 21% to 22%. For those watching service revenue margins, the current quarter number was 28%, consistent with the prior year.
As I commented earlier, total operating revenues of $973 million were essentially flat year-over-year as a result of a decrease in equipment sales revenues. Total cash expenses were $761 million, down $8 million or about 1% year-over-year. The primary driver was a decrease in cost of equipment sold due to a decrease in the number of devices sold, partially offset by higher average cost per device sold. Excluding cost of equipment sold, other cash expenses increased slightly year-over-year by $8 million or 2%, similar to the increase in service revenues.
Total system operations expense of $193 million was up 3% year-over-year reflecting higher usage by customers, both on our network and while roaming. SG&A expenses were essentially flat year-over-year. Shown next is adjusted EBITDA which starts with adjusted operating income and incorporates the earnings from our equity method investments along with interest and dividend income. Adjusted EBITDA for the second quarter was $257 million, up 3% from the year ago. Most of the improvement is due to the increase in adjusted operating income.
We also had an increase in interest and dividend income year-over-year reflecting both higher interest rates and investment balances. Adjusted operating income and adjusted EBITDA do not include depreciation, amortization and accretion expense. In connection with the network modernization in 5G initiatives that Mike discussed earlier, we are upgrading several of the network equipment elements; this results in the recognition of accelerated depreciation on the assets being replaced. As shown in our press release; depreciation, amortization and accretion expense for the first half of 2019 is up about 8% year-over-year, and we expect that trend to continue for the remainder of the year.
Next I want to cover our guidance for the full year 2019. First, is total operating revenues; getting underneath that we expect service revenues for the full year to grow at about the same rate that we've seen in the first half, low single digits. However, as I said earlier, equipment sales revenues so far this year have been below our expectations coming into the year. We haven't seen the lift in gross additions that we would like, and our existing customers are holding their devices for increasingly longer periods. Therefore, we've reduced our expectation for equipment sales revenues for the full year, and as a result, we currently expect total operating revenues to be in the range of $3.9 billion to $4.1 billion.
The expected reduction in equipment sales revenues will have a corresponding reduction to cost of equipment sold, and thus a negligible impact on adjusted operating income and adjusted EBITDA. Therefore the guidance for those two measures is unchanged at $725 million to $875 million, and $900 million to $1.05 billion now. The guidance for capital expenditures, also is unchanged, still at range of $625 million to $725 million.
Now I'll turn the call over to Vicki Villacrez. Vicki?
Vicki Villacrez -- Senior Vice President of Finance and Chief Financial Officer
Okay. Thank you, Steve and good morning, everyone. I am pleased to report favorable results for the second quarter and through the first half of the year. This puts us in a strong position to achieve our strategic growth initiatives as outlined on Slide 16.
We continue to benefit from the cost saving initiatives we've set in motion last year while we sustain revenue growth. For the second quarter, we had both top line revenue growth and expense reductions which resulted in a 9% increase and adjusted EBITDA. From a capital perspective, we continue to invest in our fiber deployment and rural broadband expansion projects. I'll give you a complete update on these programs in a moment after I summarize TDS Telecom's overall results for the quarter beginning on Slide 17.
On a combined basis, total revenues were up over 1% and cable revenues increased 9% and wireline revenues were flat. Also on the quarter, total cash expenses decreased 2%, wireline cash expenses decreased 3% due to cost reduction efforts while we held cable expense increases to just 2%. This net reduction is a direct result of actions we implemented last year to make room for the scaling up of sales and marketing expenses we will have later in the year with the launches of our new out-of-territory fiber markets. As a result, adjusted EBITDA increased 9% to $82 million from a year ago, and margins increased to 35%. Capital expenditures increased significantly when compared to last year; however, we expect our capital spending to increase at an even greater rate through the second half of the year as it relates to our fiber deployment strategy.
Now let's turn to our segments beginning with Wireline on Slide 18. Wireline residential video connections grew 9% compared to the prior year. On average our IPTV markets continue to achieve about 30% video penetration with some markets near 50%. About 80% of our IPTV customers are on triple-play bundles as customers continue to find value in taking all three services given the rural nature of our geographical footprint and the bundling pricing we have in place. In addition, churn on these bundles continues to remain very low. Our second quarter results highlight the success of our video strategy and it's importance to our customers. Our plans with regards to Cloud TV platform called TDS TV+ remain an important initiative. While we're targeting a second quarter launch in our Bend cable market, we are now working toward a launch later this year and will take a phased approach for the remaining wireline and cable markets.
From a broadband perspective, residential connections grew 3% and customers are continuing to choose higher speeds of upto 1 gig in our fiber markets. On average 26% of all broadband customers are now taking 100 megabit speeds or greater, and that's compared to 20% a year ago helping to drive an increase in average residential revenue per connection in the quarter. We also continue to make progress on our network construction under both the A-CAM and state broadband programs. On the A-CAM front, we earmarked $30 million of capex in 2019 to continue to extend fiber to the outermost edges of our network, in order to deliver higher broadband speeds required under this program. As a result, we are well under way to meeting our first stated obligations under the program as we've completed 27,000 of our required 64,000 service addresses with broadband speeds of upto 253 [Phonetic] which come due at the end of next year. We also continue to improve speed capabilities to additional service addresses that are enhanced by our construction under this program.
Slide 19 provides an update on our fiber deployment strategy, both in and out of territory. Last quarter we announced that we launched our second new out of territory fiber market in our Southern Wisconsin cluster and are pleased to announce that our market share gains while still early are tracking to our expectations. We are in various stages of construction and expect to launch four additional markets in the Southern Wisconsin cluster throughout the year. And we've begun construction in two new out of territory clusters targeting 80,000 total service addresses; one in Mid-Central Wisconsin which is comprised of 8 communities, and around Steven's Point in Wasa [Phonetic], and a second one in Coeur d'Alene, Idaho which includes three surrounding communities. These clusters are terrific examples of the criteria we are targeting for our growth. They are underserved for broadband and have attractive demographics with potential for household growth. As a result of our fiber deployment strategy over the last several years, 27% of our Wireline service addresses are served by fiber. It is this fiber that enables our ability to provide the services our customers demand, including both high-speed broadband and video.
Looking at Wireline financial results, on Slide 20, total revenues decreased 1% to $172 million. However, residential revenues increased 1% due to growth from the video and broadband connections, as well as growth from within the broadband product mix, offset by a 5% decrease in residential voice connections. Wholesale revenues increased 5% due to additional A-CAM funding. During the second quarter, the FCC authorized the payment of revised support under an order for TDS Telecom to receive an additional $4 million per year. The support includes additional speed requirements and importantly extends the term of full annual funding of $82 million by two years through 2028. As a result, we recorded $2 million of additional A-CAM support during the quarter.
Commercial revenues decreased 8%, primarily driven by lower connections as we continue to execute on our strategy to maximize cash flow from these markets which are coming under renewed pressure from deregulation. Wireline cash expenses decreased 3% due to lower employee-related expenses, remember in the second quarter of 2018 we recorded $2 million of severance expense associated with our cost savings initiatives. We also continue to see the reduced cost of providing service for our declining legacy products, offset by higher programing fees associated with our video offering. As a result of the decreased expenses, Wireline adjusted EBITDA increased 4% to $62 million.
Moving to Cable on Slide 21; Cable total revenues increased as customers continue to value our broadband services. Total cable connections grew 5% to 339,000 driven by 8% increase in total broadband connections. As a result, broadband penetration increased 300 basis points to 44% compared to the prior year.
On Slide 22, total Cable revenues increased 9% to $62 million driven primarily by growth in residential connections. Our focus on broadband growth has led to a 2% increase in average residential revenue per connection. Cash expenses increased 2% due primarily to higher programming content costs and circuit expenses. As a result, Cable adjusted EBITDA increased 29% to $20 million in the quarter. In addition, EBITDA margin increased to 33% from 28%.
On Slide 23, we have provided our 2019 guidance which is unchanged from the guidance we shared at the beginning of the year. We expect our revenue trends to continue but anticipate expense growth in the second half of the year as we continue to launch our new fiber market. As I mentioned earlier, our capital spending will increase throughout the year to support fiber build-outs, and I'll continue to update you on our progress and capital spending as it relates to these investments.
And in closing, I'd like to thank all of our employees for their continued effort to evolve our business and look forward to updating you on our progress in the third quarter.
Now I'll turn the call back to Jane.
Jane McCahon -- Senior Vice President of Corporate Relations and Corporate Secretary
Thanks, Vicki. And Aaron, we are ready to take questions.
Question-and-Answer Session
Questions and Answers:
Duration: 61 minutes
Call participants:
Jane McCahon -- Senior Vice President of Corporate Relations and Corporate Secretary
Ken Meyers -- President and Chief Executive Officer
Mike Irizarry -- Executive Vice President and Chief Technology Officer
Steve Campbell -- Executive Vice President and Chief Financial Officer
Vicki Villacrez -- Senior Vice President of Finance and Chief Financial Officer
