Telephone and Data Systems, Inc. — Form 10-Q Summary
Business context and reporting period
TDS is a diversified U.S. telecommunications company serving approximately 6 million connections. Its principal businesses are U.S. Cellular, an 82%-owned wireless subsidiary, and TDS Telecom, comprising Wireline and Cable operations. The unaudited filing covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Operating revenues | $1,263 million | $1,261 million | $2,524 million | $2,518 million |
| Operating income | $78 million | $48 million | $151 million | $142 million |
| Net income | $78 million | $39 million | $161 million | $109 million |
| Net income attributable to TDS shareholders | $65 million | $33 million | $135 million | $92 million |
| Diluted EPS | $0.56 | $0.28 | $1.15 | $0.78 |
| Adjusted EBITDA | $364 million | $337 million | $726 million | $701 million |
| Adjusted OIBDA | $318 million | $287 million | $629 million | $598 million |
| Capital expenditures | $247 million | $264 million | $539 million | $411 million |
Q2 operating margin was approximately 6.2%, compared with 3.8% in the prior-year quarter. Six-month operating margin was approximately 6.0%, compared with 5.6% in 2019. The improvement in net income was substantially aided by lower income tax expense under the CARES Act: the effective tax rate declined to 9.6% from 28.8% in Q2 and to 6.9% from 31.3% year to date.
- U.S. Cellular: Q2 revenue was $973 million, unchanged year over year; operating income increased to $53 million from $30 million. Six-month revenue was $1,937 million, compared with $1,939 million, while operating income rose to $104 million from $95 million. Retail connections declined to 4.868 million from 4.914 million. Postpaid churn improved to 0.89% from 1.23%, and postpaid ARPU increased 1% in Q2 and 2% year to date.
- TDS Telecom: Q2 revenue increased 3% to $241 million; operating income increased 6% to $31 million. Six-month revenue increased 4% to $481 million, while operating income declined 10% to $59 million. Cable revenue benefited from the Continuum acquisition and broadband growth; Wireline revenue declined modestly.
- Cash flow: Six-month cash flow from operations was $806 million, compared with $592 million. Cash paid for property, plant and equipment was $610 million, producing reported free cash flow of $196 million versus $199 million in 2019. Cash, cash equivalents and restricted cash increased $112 million to $586 million at June 30, 2020; cash and cash equivalents alone were $565 million.
- Debt and liquidity: Long-term debt, net, was $2.487 billion, compared with $2.316 billion at December 31, 2019. TDS had $399 million of unused capacity under its $400 million revolving facility, and U.S. Cellular had $298 million available under its $300 million facility. U.S. Cellular also had $75 million of unused receivables-securitization capacity, subject to collateral requirements.
Material changes versus the prior comparable period
- Consolidated revenue was essentially flat, but operating income increased 63% in Q2 and 6% year to date, primarily from lower operating expenses and improved U.S. Cellular results.
- Adjusted EBITDA increased 8% in Q2 and 4% year to date. U.S. Cellular expense reductions, including lower selling, general and administrative costs and lower equipment costs, were key contributors.
- U.S. Cellular’s retail subscriber base decreased approximately 1%, but lower churn and reduced non-pay defections temporarily supported net additions. The company expects non-pay defections to increase after the FCC Keep Americans Connected Pledge expired on June 30, 2020.
- TDS Telecom revenue growth reflected the December 2019 Continuum cable acquisition, broadband and video growth, and pricing. Wireline commercial and wholesale revenue declined, while Cable operating income increased substantially from a low base.
- Capital expenditures increased 31% year to date, driven primarily by U.S. Cellular network investments and TDS Telecom fiber deployment. TDS also acquired $147 million of wireless licenses, including the $146 million Auction 103 purchase price.
Guidance, outlook, risks and unusual items
- For full-year 2020, U.S. Cellular expects capital expenditures of $850 million to $950 million; TDS Telecom expects $300 million to $350 million. TDS expects to fund investment primarily with operating cash flow, existing cash and, if needed, additional debt financing.
- Management expects continued investment in VoLTE, 5G, network capacity, fiber expansion, broadband speeds and the TDS TV+ platform. U.S. Cellular had launched 5G in Iowa and Wisconsin and expected additional deployments during 2020.
- COVID-19 reduced service revenue, equipment sales, retail activity and certain customer additions, while also reducing churn and increasing demand for remote-connectivity products. Management stated that the ultimate effects on operations, cash flows and financial position could be material but remain uncertain.
- The CARES Act generated significant tax benefits and is expected to produce a cash tax refund in 2021. This benefit is a major driver of the period’s earnings increase and unusually low effective tax rate.
- TDS’ credit rating was sub-investment grade. Management identified risks related to capital-market access, indebtedness, competition, spectrum availability and costs, regulatory support, technology deployment, supply-chain and contractor disruptions, impairment, cybersecurity and COVID-19.
- Private plaintiffs continue False Claims Act litigation concerning U.S. Cellular’s participation in prior FCC spectrum auctions. The Department of Justice declined to intervene; TDS cannot predict the outcome.
- U.S. Cellular qualified to bid in Auction 105, and TDS and U.S. Cellular may participate in future spectrum and broadband-support auctions, potentially requiring significant capital.
Investor verification checklist
- Verify whether post-pandemic non-pay defections and customer churn increased after expiration of the FCC pledge.
- Separate recurring operating improvement from the temporary CARES Act tax benefit when assessing earnings quality.
- Track U.S. Cellular capital expenditures, 5G deployment returns and spectrum-auction commitments against cash flow and debt capacity.
- Assess whether TDS Telecom’s broadband and Cable growth offsets Wireline commercial, wholesale and legacy voice declines.
- Reconcile reported free cash flow with capital expenditures, spectrum purchases, dividends, share repurchases and additional borrowing.
- Review the status and potential exposure from the False Claims Act proceedings and other regulatory matters.