T-Mobile US, Inc. annual report, FY2017

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T-Mobile US, Inc. — 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results. Amounts are in U.S. dollars; financial figures are generally in billions unless stated otherwise.

Business context and reporting period

T-Mobile provides wireless services and sells or leases devices under the T-Mobile and MetroPCS brands. It reported 72.6 million total customers at year-end and operates as a single segment. Management attributed growth to its Un-carrier offers, network investment, and expanded distribution; it also noted intensifying competition, including rivals’ unlimited plans.

Financial and operating performance

  • Revenue: FY 2017 total revenue was $40.6 billion, up 8% from $37.5 billion in 2016. Service revenue rose 8% to $30.2 billion; equipment revenue rose 7% to $9.4 billion.
  • Profit: Operating income increased 21% to $4.9 billion. Net income was $4.5 billion, compared with $1.5 billion in 2016; diluted EPS was $5.20 versus $1.69. The year-over-year net income increase was substantially driven by a $2.2 billion net tax benefit from the 2017 Tax Cuts and Jobs Act (TCJA).
  • Margins and adjusted EBITDA: Operating margin was approximately 12.0% of total revenue. Adjusted EBITDA, a non-GAAP measure, was $11.2 billion, up 5%; it equaled 37% of service revenue, versus 38% in 2016. Net income was 15% of service revenue, versus 5% in 2016.
  • Cash flow and investment: Operating cash flow was $8.0 billion, up 30%. Free cash flow, a non-GAAP measure defined as operating cash flow less cash property-and-equipment purchases, was $2.7 billion, up 90%. Property and equipment purchases were $5.2 billion; spectrum and other intangible asset purchases were $5.8 billion.
  • Debt and liquidity: Total debt, excluding tower obligations, was $28.3 billion at year-end, compared with $27.8 billion a year earlier. Cash and cash equivalents fell to $1.2 billion from $5.5 billion. Current assets were $8.9 billion and current liabilities $11.5 billion. The company said it was compliant with restrictive debt covenants and expected available funding to meet anticipated operating liquidity needs for the next 12 months, excluding potential spectrum or other asset acquisitions.
  • Customer indicators: Branded customers increased 8% to 58.7 million. Total net customer additions were 5.7 million, down 31% from 2016. Postpaid phone churn improved to 1.18% from 1.30%; prepaid churn worsened to 4.04% from 3.88%. Postpaid phone ARPU declined 1% to $46.97, while prepaid ARPU rose 2% to $38.69.
  • Fourth quarter: Revenue was $10.8 billion, operating income $1.1 billion, and net income $2.7 billion. Fourth-quarter 2016 figures were $10.2 billion, $1.0 billion, and $390 million, respectively; the 2017 quarterly net income comparison reflects the significant tax benefit noted above.

Material changes versus 2016

  • Revenue and operating income grew, but adjusted EBITDA growth was slower and its service-revenue margin declined by 1 percentage point. Management cited higher selling, general and administrative costs, cost of services, equipment costs, lower spectrum disposal gains, and hurricane impacts.
  • Branded net customer additions declined 32% to 4.5 million, primarily as prepaid additions fell 66%; postpaid phone additions also decreased. Reported wholesale customers fell partly because 4.5 million Lifeline customers were excluded from the reported base, rather than solely from customer losses.
  • Cash increased from operations, but substantial spectrum and network investment drove investing cash use to $11.1 billion and reduced year-end cash. The $8.0 billion 600 MHz auction purchase was a major investment.
  • Debt composition shifted materially: the company repaid $8.25 billion of notes and issued debt, including $4.0 billion of term loans from majority shareholder Deutsche Telekom (DT). Interest expense to affiliates rose to $560 million from $312 million, while third-party interest expense declined.
  • The company retrospectively reclassified imputed EIP receivable discount amortization from interest income to other revenue. This increased reported revenue and operating income for comparative periods but did not change net income or EPS.

Outlook, commentary, risks, and unusual items

  • Outlook: Management expected full-year 2018 branded postpaid phone ARPU to be generally stable versus 2017 under then-current revenue standards, with quarterly variation. It forecast 2018 cash property-and-equipment purchases of $4.9–$5.3 billion, excluding capital leases and spectrum purchases. The company targeted 325 million people covered by LTE by year-end 2018 and expected a nationwide 5G network by 2020.
  • Network and spectrum: T-Mobile won 1,525 600 MHz licenses for $8.0 billion and began deployment in 2017. Spectrum clearing and deployment timing remain important; the company targeted clearing coverage of more than 100 million POPs by year-end 2018 and 250 million by year-end 2019.
  • Hurricanes: Hurricanes affecting Texas, Florida, and Puerto Rico reduced 2017 operating income by $201 million net of $93 million of recognized insurance recoveries. Further expenses and customer impacts, especially in Puerto Rico, were expected in first-quarter 2018; additional insurance recoveries were possible.
  • Accounting and tax: The TCJA produced a $2.2 billion 2017 net tax benefit, primarily from remeasurement of deferred tax assets and liabilities; state tax effects remained subject to further assessment. Adoption of the new revenue standard in 2018 was expected to change revenue timing and allocation and affect ARPU. Adoption of the new lease standard in 2019 was expected to materially affect the balance sheet.
  • Other material risks: Intense price and customer competition; network capacity, 5G execution, and spectrum availability or clearing delays; substantial debt and capital needs; interest-rate exposure; cybersecurity, system outages, and third-party supplier dependence; implementation of a new billing system; regulation and litigation; and DT’s control and related-party influence. The trademark license royalty rate was subject to an adjustment process in early 2018, potentially affecting the rate from 2019.
  • Contingencies and subsequent events: The company reported ordinary-course litigation and investigations, with no accruals considered material individually or in aggregate, while acknowledging that unfavorable outcomes could affect a particular period. In January 2018 it completed the approximately $325 million Layer3 TV acquisition, acquired the remaining IWS interest for $25 million, and issued new notes as part of debt refinancing. No cash dividends were planned for the foreseeable future.

Most important facts for investors to verify

  1. How much of the 2017 earnings increase is attributable to the one-time TCJA benefit, and what is the sustainable post-TCJA tax rate and earnings base?
  2. Whether growth in service revenue and customers can be sustained amid lower net additions, promotional pressure, and declining postpaid ARPU and adjusted EBITDA margin.
  3. Whether the 600 MHz spectrum deployment, 5G timetable, and planned network capital spending meet coverage, capacity, and return expectations.
  4. How the company’s lower cash balance, $28.3 billion debt load, debt service, spectrum commitments, and receivables-sale arrangements affect liquidity and financial flexibility.
  5. Actual hurricane losses and recoveries, the effect of 2018 accounting changes on reported revenue and cash-flow measures, and the outcome of the DT trademark royalty reset.