Telephone and Data Systems (TDS) reported second-quarter results yesterday with earnings per share of 63 cents, down 20% year over year, while beating the Zacks Consensus Estimate of 58 cents. Net income came in at $69.7 million compared to $87.8 million reported a year ago.

The Chicago-based company reported operating revenue of $1.2 billion, reflecting a 3% year-over-year increase, with most of the contribution coming from its wireless subsidiary U.S. Cellular (USM). Quarterly operating income was $154.6 million, up 3% year over year compared to an operating income of $149.7 million reported in the prior-year period.

U.S. Cellular (Wireless):

Reported net income of $83.4 million represents a 15% year over year increase due to lower operating expenses, while operating revenue declined 1.7% over the prior-year quarter to $1 billion. The segment reported a 1.3% year-over-year decline in service revenues to $974.8 million in the quarter.

Data revenue increased 31% over the prior-year quarter to $162 million, accounting for 17% service revenue. Reported ARPU of $52.41 reflects a year-over-year decline while post-paid churn increased on both sequential and year-over-year basis to 1.7%.

US Cellular was hit by weak economic conditions in its service territories and intense competition as it lost 88,000 customers during the second quarter, bringing the total subscriber base to 6.16 million. Competition has increased after the launch of exclusive premium wireless handsets by Tier-1 carriers such as iPhone 3GS by AT&T (T).

The subscriber loss is compared to net additions of 47,000 and 16,000 registered in the previous and year-ago quarters, respectively. Both prepaid and postpaid segments registered subscriber losses in the second quarter.

TDS Telecom (Wireline):

Operating revenue in the wireline segment declined 6% year over year to $196 million. ILEC high-speed data customer base grew 20% year over year, reaching 197,100 at the end of the quarter. The segment reported 17% growth in ILEC data revenue to $25.5 million. ILEC equivalent access lines grew by less than 1% year over year to 775,800 (down sequentially), while physical access lines declined to 548,000.

The company updated its 2009 outlook with respect to the wireless and wireline business segments. Based on uncertain economic conditions, US Cellular withdrew its net subscriber addition target for the year. Projected service revenue of the wireless segment was revised to $3.9-$3.95 billion with expected operating income of $300-$375 million. Depreciation, amortization and accretion is expected to be approximately $600 million with a capital expenditure target of $575 million, both kept unchanged.

The revised operating revenue guidance for the wireline unit is between $775 million and $800 million for 2009. Operating income forecast for the segment has been lowered to $85 – $105 million. Depreciation, amortization and accretion is estimated at $165 million with a capital expenditure target of $125 million.

The company repurchased approximately 2.68 million shares for $73.9 million during the second quarter and made a dividend payment of $0.1075 per share.

U.S. Cellular continues to expand coverage of its Evolution-Data Optimized (EV-DO) technology based 3G wireless network with a target of achieving 70% penetration of its subscriber population by the end of 2009. Efforts are also underway to upgrade more than 60% of its cell sites with EV-DO by the end of the current year. Moreover, US Cellular is evaluating potential adoption Long Term Evolution (LTE), a fourth-generation (4G) wireless technology, with technical trials expected in late 2009.

On the wireline front, the company is aggressively rolling out “Triple-Play” offering that bundles voice, high-speed data and Dish Network TV services, providing opportunity to effectively compete with cable TV operators.

Although the company’s ongoing business initiatives look promising, we believe high cost associated with expansion wireless network will affect near-term earnings and cash flow. U.S. Cellular’s high-margin roaming revenue also remains under pressure. Moreover, TDS continues to face a volatile economic environment which may hurt subscriber retention moving forward.

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