Telephone and Data Systems, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; filed November 5, 2020. TDS is a diversified U.S. telecommunications company serving approximately 6 million connections through 82%-owned UScellular and wholly owned TDS Telecom, comprising Wireline and Cable operations.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 |
|---|---|---|---|---|
| Operating revenues | $1.324 billion | $1.321 billion | $3.849 billion | $3.840 billion |
| Operating income | $87 million | $29 million | $238 million | $171 million |
| Net income | $93 million | $23 million | $254 million | $132 million |
| Net income attributable to TDS shareholders | $78 million | $18 million | $212 million | $110 million |
| Diluted EPS | $0.66 | $0.15 | $1.81 | $0.93 |
| Adjusted EBITDA | $362 million | $325 million | $1.087 billion | $1.025 billion |
| Capital expenditures | $310 million | $253 million | $849 million | $664 million |
Consolidated operating margin was approximately 6.6% in Q3 and 6.2% year to date, compared with approximately 2.2% and 4.5% in the comparable 2019 periods. Net income attributable to TDS shareholders represented approximately 5.9% of revenue in Q3 and 5.5% year to date.
- UScellular: Q3 revenue was $1.027 billion, essentially flat year over year, while operating income rose to $65 million from $20 million. Year-to-date revenue was $2.964 billion, flat, and operating income increased 46% to $168 million. Adjusted EBITDA rose 10% in Q3 and 6% year to date.
- TDS Telecom: Q3 revenue increased 7% to $247 million and operating income increased 44% to $28 million. Year-to-date revenue rose 5% to $728 million and operating income increased 2% to $87 million. Cable benefited from the Continuum acquisition and broadband growth; Wireline revenue was flat year to date.
- Cash flow: Year-to-date operating cash flow was $1.166 billion versus $874 million in 2019. Cash paid for property, plant and equipment was $914 million, producing non-GAAP free cash flow of $252 million versus $243 million.
- Liquidity: Cash and cash equivalents were $1.076 billion at September 30, 2020, versus $465 million at December 31, 2019. Cash, cash equivalents and restricted cash totaled $1.096 billion.
- Debt: Long-term debt, net, increased to $2.970 billion from $2.316 billion, primarily due to $500 million of UScellular senior notes, a $125 million UScellular receivables securitization borrowing and a $50 million TDS term loan. The weighted-average interest rate on long-term debt was 6.3% at September 30, 2020, compared with 6.7% at year-end 2019.
- Credit capacity: At September 30, TDS and UScellular had approximately $399 million and $298 million, respectively, of unused revolving credit capacity, and $150 million and $217 million, respectively, of unused senior term-loan capacity. UScellular had $75 million of unused receivables-securitization capacity at quarter-end, before an October amendment increased total capacity to $300 million.
Material changes versus the prior comparable period
- Net income attributable to TDS shareholders increased 93% year to date, primarily from lower operating expenses and substantially lower income tax expense.
- The effective tax rate declined to 5.8% in Q3 and 6.5% year to date, versus 39.1% and 32.8%, respectively, primarily due to CARES Act benefits, including tax-loss carrybacks and bonus-depreciation provisions. TDS expects a tax refund in 2021 related to prior-year taxes.
- UScellular operating expenses declined 5% in Q3 and 2% year to date, driven partly by lower selling, general and administrative expense, bad-debt expense and depreciation.
- UScellular ended September with 4.907 million retail connections, including 4.401 million postpaid connections. Total postpaid churn improved to 1.06% in Q3 from 1.38% in Q3 2019; postpaid net additions were 28,000 versus a loss of 19,000.
- TDS Telecom growth reflected broadband and video expansion, higher speeds and pricing, and the December 2019 Continuum cable acquisition. Wireline commercial connections and CLEC commercial revenue continued to decline.
- Capital spending increased 28% year to date, reflecting higher UScellular network investment and increased TDS Telecom fiber deployment.
Guidance, outlook, risks and unusual items
- 2020 capital expenditure guidance was $850–$950 million for UScellular and $300–$350 million for TDS Telecom. Spending is directed toward VoLTE completion, 5G deployment, network capacity, fiber expansion, broadband upgrades and TDS TV+.
- UScellular had launched 5G in portions of nine states and expected to complete VoLTE deployment in Q4 2020. Management expects inbound roaming revenue to continue declining because of lower rates and the Sprint/T-Mobile merger.
- COVID-19 reduced certain service revenues, equipment sales, roaming activity and sales activity, while also reducing customer defections and increasing demand for connected devices and broadband. Management stated that the ultimate impact remains uncertain and could be material.
- UScellular was a provisional winning bidder for 243 licenses in Auction 105 for $14 million; the licenses were expected to be granted in Q4 2020. It also planned to participate in Auction 107. Spectrum purchases and future auctions could materially affect liquidity and debt.
- TDS and UScellular stated that they were in compliance with applicable debt and securitization covenants at September 30, 2020. TDS also disclosed that its credit rating was sub-investment grade.
- Pending False Claims Act litigation relates to UScellular’s participation in historical FCC spectrum auctions. The Department of Justice declined to intervene, but private plaintiffs continued the litigation; TDS could not predict the outcome.
- Management identified risks from COVID-19, competition, technology deployment, spectrum availability and costs, regulatory support, roaming revenue declines, capital-market access, leverage, supply-chain and construction delays, cybersecurity, impairments and litigation.
Investor verification points
- Verify the sustainability of the 2020 earnings improvement after excluding CARES Act tax benefits and considering expected COVID-19-related customer payment issues.
- Reconcile operating cash flow and free cash flow with the substantially higher capital-spending program and planned spectrum purchases.
- Monitor leverage, interest costs, covenant compliance and availability under TDS and UScellular credit facilities, including the October 2020 securitization amendment.
- Assess whether UScellular can offset declining roaming revenue through postpaid growth, connected devices, 5G, home internet and business services.
- Evaluate execution and returns on UScellular 5G/VoLTE investments and TDS Telecom fiber and broadband expansion.
- Track the outcome and potential exposure from the False Claims Act litigation and future FCC spectrum and broadband funding proceedings.
- Confirm that reported non-GAAP Adjusted EBITDA and free cash flow are not being used as substitutes for GAAP earnings, operating cash flow or liquidity analysis.