Business Context and Reporting Period
Telephone and Data Systems, Inc. (TDS) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. TDS operates primarily through 84%-owned U.S. Cellular and wholly owned TDS Telecom. U.S. Cellular served approximately 4.8 million wireless customers, while TDS Telecom provided wireline, cable and hosted and managed services to approximately 1.2 million connections.
TDS’s reportable operations were U.S. Cellular and TDS Telecom’s Wireline, Cable and Hosted and Managed Services businesses. The filing was signed July 31, 2015.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2015 | Three Months Ended June 30, 2014 | Six Months Ended June 30, 2015 | Six Months Ended June 30, 2014 |
|---|---|---|---|---|
| Total operating revenues | $1.276 billion | $1.236 billion | $2.528 billion | $2.432 billion |
| Operating income (loss) | $32.1 million | $(49.1) million | $314.8 million | $(28.4) million |
| Net income (loss) | $26.5 million | $(25.7) million | $202.3 million | $(5.4) million |
| Net income (loss) available to common shareholders | $23.0 million | $(22.1) million | $168.8 million | $(3.8) million |
| Diluted earnings (loss) per share | $0.21 | $(0.20) | $1.53 | $(0.04) |
| Operating margin | 2.5% | (4.0)% | 12.5% | (1.2)% |
Six-month operating revenues increased 4%, driven by U.S. Cellular revenue growth of 3% and TDS Telecom growth of 8%. The six-month operating margin improvement was substantially influenced by gains on license exchanges and business disposals, including a $122.9 million net gain on license sales and exchanges and a $129.4 million net gain on business sales and exit costs.
Six-month cash flow from operating activities was $538.4 million, compared with $315.6 million in the prior-year period. Cash used for property, plant and equipment was $359.5 million, cash paid for acquisitions and licenses was $280.7 million, and cash received from divestitures and exchanges was $291.9 million. Adjusted free cash flow, as defined by TDS, was $202.1 million versus $9.9 million in 2014.
Cash and cash equivalents were $631.5 million at June 30, 2015, compared with $471.9 million at December 31, 2014. Long-term debt was $1.993 billion, plus $0.7 million of current debt. TDS reported $399.4 million of unused revolving capacity and U.S. Cellular reported $282.5 million of unused revolving capacity, with both facilities maturing in December 2017.
Dividends paid to TDS shareholders were $30.5 million during the first six months. The quarterly dividend was $0.141 per share, compared with $0.134 in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- U.S. Cellular operating revenues rose 3% to $1.941 billion for the first six months. Equipment sales increased 55% to $288.3 million, largely from equipment installment plans, while service revenues declined 3% to $1.653 billion.
- U.S. Cellular operating income improved to $258.8 million from a $42.5 million loss. Excluding license and business-disposal gains, management attributed improvement to lower equipment losses, selling, general and administrative expenses, and depreciation, partially offset by lower service revenue and higher network operating costs.
- U.S. Cellular retail customer net additions were 46,000 versus a net loss of 110,000 in 2014. Postpaid churn improved to 1.4% from 2.0%, although billed ARPU declined to $51.80 from $53.62.
- TDS Telecom revenue increased 8% to $574.8 million and operating income increased 26% to $46.9 million. Growth reflected the BendBroadband acquisition, cable expansion and organic HMS growth, partly offset by Wireline declines.
- Wireline connections declined by 23,800 year over year, while cable connections increased by 122,200, primarily reflecting the BendBroadband acquisition. HMS operating losses improved to $7.8 million from $12.3 million.
- U.S. Cellular’s March 2015 PCS license exchange generated a $125.2 million gain and $117.0 million of cash. Advantage Spectrum paid $338.3 million for 124 AWS-3 licenses after its designated-entity discount; the licenses were expected to be granted later in 2015.
- U.S. Cellular completed the sale of 359 towers in January 2015 and recognized a $119.6 million gain. TDS also received $23.2 million of Sprint cost reimbursements during the first six months.
- Equipment installment plan receivables and related customer upgrade guarantee liabilities increased. The guarantee liability was $80.2 million at June 30, 2015, compared with $57.5 million at year-end 2014.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2015 capital expenditures of approximately $600 million for U.S. Cellular and $220 million for TDS Telecom. Reported first-half capital expenditures were $293.2 million, excluding license acquisitions.
- In July 2015, U.S. Cellular borrowed $225 million under its term loan facility. Quarterly principal payments of $2.8 million were scheduled to begin in March 2016, with the remaining balance due in January 2022.
- Management expects continued competitive pressure on wireless service pricing and ARPU, ongoing roaming-rate pressure, continued equipment losses, and increased network and data-usage costs.
- Equipment installment plans create uncertainty regarding customer upgrades, device trade-in values, credit losses and the timing of revenue recognition. The filing records out-of-period adjustments that reduced second-quarter equipment revenue by $5.7 million and pretax income by $5.3 million; six-month reductions were $6.2 million and $5.8 million, respectively. TDS stated the adjustments were not material to prior or current periods.
- U.S. Cellular’s loyalty rewards program was scheduled to end September 1, 2015. Unredeemed points would expire and related deferred revenue could be recognized, but management could not predict the impact. The deferred revenue balance was $81.1 million at June 30, 2015.
- U.S. Cellular expected no cash distribution from its 5.5%-owned Los Angeles SMSA Limited Partnership in 2015, although it might receive an uncertain distribution in the latter half of 2016 while still incurring tax obligations on its share of taxable income.
- New FCC net-neutrality rules became effective in June 2015 and reclassified broadband internet access as a Title II telecommunications service. Litigation and uncertainty regarding implementation, interconnection, Universal Service Fund contributions and future regulation could affect results.
- Principal risks include intense wireless, wireline, cable and IT-services competition; spectrum availability and auction requirements; regulatory changes; execution of acquisitions and divestitures; network and billing-system reliability; cybersecurity; technology changes; financing access; litigation; and potential impairment of licenses, goodwill or other assets.
- TDS stated that no material changes had occurred to previously disclosed legal proceedings or risk factors, and that disclosure controls were effective as of June 30, 2015.
Important Facts for Investors to Verify
- Separate recurring operating performance from the material 2015 gains on spectrum exchanges, tower sales and other divestitures.
- Assess whether U.S. Cellular’s improved customer additions and churn offset declining ARPU, roaming revenue and competitive pricing pressure.
- Monitor equipment installment plan receivables, upgrade guarantees, trade-in assumptions, credit losses and related revenue adjustments.
- Verify the timing and terms of the $225 million U.S. Cellular term-loan borrowing and its effect on consolidated leverage and interest expense.
- Evaluate the cash requirements and potential returns from spectrum acquisitions, network investment and FCC license development.
- Track the effects of the BendBroadband acquisition and the continuing decline in Wireline connections on TDS Telecom’s organic growth and margins.
- Review the effect of net-neutrality litigation, Universal Service Fund changes, spectrum-auction rules and other FCC proceedings.
- Confirm the sustainability of cash flow and dividends after considering taxes on divestiture gains, capital expenditures, license purchases and the uncertain Los Angeles SMSA distribution.