Telephone and Data Systems Inc.’s(TDS - Analyst Report) second quarter 2012 earnings per share of 39 cents missed the Zacks Consensus Estimate of 43 cents. Results also deteriorated 54% year over year from 84 cents per share earned in the year-ago quarter.

Revenues increased 3% year over year to $1,323.2 million in the reported quarter, surpassing the Zacks Consensus Estimate of $1,310 million. Adjusted OIBDA was $293.1 million compared with $323.6 million in the year-ago quarter.

U.S.Cellular (Wireless)

Revenues from the company’s wireless subsidiaryU.S. Cellular Corp.(USM - Analyst Report) rose 2.6% year over year to $1,104.4 million in the second quarter. Service revenues grew 3% year over year to $1,029.7 million on account of higher inbound roaming and retail service revenues along with higher smartphone sales that drove data revenues.

Total retail service ARPU (average revenue per user) improved to $50.99 from $48.28 in the year-ago quarter on the back of strong adoption of smartphones and data plans. Post-paid ARPU increased to $54.42 from $51.84 in the year-ago quarter, while churn rates deteriorated to 1.6% from 1.4% in second quarter 2011 due to severe competitive pricing.

U.S. Cellular lost 28,000 net retail customers in the reported quarter, bringing the total subscriber base to approximately 5,799,000 (including 5,542,000 retail customers). Post-paid customer losses totalled 48,000, while prepaid business registered an addition of 20,000 customers.

TDS Telecom (Wireline)

Revenue from the wireline segment grew 5% year over year to $208.5 million.

In the reported quarter, incumbent local exchange carriers (ILEC) high-speed data customer base (residential and commercial) grew 2.4% year over year to 240,800. However, ILEC physical access lines (residential and commercial) slid 5.1% year over year to 471,200.

The competitive local exchange carrier (CLEC) high-speed data customer base (residential and commercial) and CLEC physical access lines (residential and commercial) declined to 22,300 and 173,000 from 28,700 and 204,800 in the year-ago quarter, respectively.

Liquidity

Telephone and Data Systems exited the second quarter with cash and cash equivalents of $613.8 million compared with $563.3 million at the end of fiscal 2011. Long-term debt was $1,529.8 million compared with $1,529.9 million at year-end 2011. Free cash flow was a negative $33.9 million, down from a positive $36.2 million in the year-ago quarter.

Guidance

The company reiterated its guidance on the wireless segment for fiscal 2012, the company expects service revenue in the range of $4,050–$4,150 million and operating income in the range of $200–$300 million. Adjusted OIBDA is estimated in the range of $800–$900 million. The company’s capital expenditure is expected to be approximately $850 million.

For the wireline segment, the company raised its total revenue estimates to $850-$880 million from prior projection of $810–$840 million. Adjusted OIBDA are estimated in the range of $245-$265 million compared with previous estimates of $245–$275 million. Operating income estimates are reduced to $50-$70 million from $55–$85 million. Depreciation, amortization and accretion expenses and net gain or loss on asset disposals and exchanges are estimated to be approximately $195 million, up from $190 million. Capital expenditures are estimated in the range of $170-$190 million, up from $150-$180 million.

Our Analysis

Telephone and Data Systems continues to benefit from its several growth initiatives like 3G network expansion, increasing handset offerings, adoption of the Long-Term Evolution (LTE) technology in the wireless business, and aggressive deployment of Triple-Play bundled wireline services. Additionally, the company’s expansion of IPTV services in new markets is also expected to aid revenue going forward.

However, fierce competition and heavy investment in an uncertain market condition may limit any upside to the company’s earnings. Further, regulatory issues regarding Universal Service Fund are also likely to weigh on the company’s near-term revenue growth.

We are currently maintaining our long-term Neutral rating on Telephone and Data Systems supported by a Zacks #3 (Hold) Rank.