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, 2019, compared with the corresponding 2018 periods. TDS is a U.S.-only diversified telecommunications company serving approximately 6 million connections through 82%-owned U.S. Cellular and wholly owned TDS Telecom, which comprises Wireline and Cable operations.
Financial Performance and Key Metrics
| Metric | Q2 2019 | Q2 2018 | YTD 2019 | YTD 2018 |
|---|---|---|---|---|
| Total operating revenues | $1,261 million | $1,255 million | $2,518 million | $2,480 million |
| Operating income | $48 million | $61 million | $142 million | $141 million |
| Net income | $39 million | $44 million | $109 million | $101 million |
| Net income attributable to TDS shareholders | $33 million | $33 million | $92 million | $72 million |
| Diluted EPS | $0.28 | $0.29 | $0.78 | $0.63 |
| Adjusted EBITDA | $337 million | $319 million | $701 million | $659 million |
| Capital expenditures | $264 million | $138 million | $411 million | $253 million |
Q2 operating margin was approximately 3.8%, compared with 4.9% in the prior-year quarter; YTD operating margin was approximately 5.6%, compared with 5.7%. Q2 net margin was approximately 3.1%, versus 3.5% in 2018; YTD net margin was approximately 4.3%, versus 4.1%.
- U.S. Cellular: Q2 revenue was $973 million, essentially flat year over year, while operating income declined 45% to $30 million. Service revenue increased 2%, but equipment sales declined 7%. Adjusted EBITDA rose 3% to $257 million. Retail connections totaled 4.914 million, down from 4.995 million, and postpaid churn increased to 1.23% from 1.19%.
- TDS Telecom: Q2 revenue increased 1% to $233 million and operating income increased 60% to $29 million. Adjusted EBITDA increased 9% to $82 million. Wireline revenue declined 1%, while Cable revenue increased 9%.
- Cash flow: YTD operating cash flow was $592 million, up from $463 million. Capital expenditures consumed $393 million, producing reported free cash flow of $199 million versus $188 million in 2018. Cash flows used in investing activities were $616 million, including $255 million for wireless spectrum licenses.
- Liquidity and debt: Cash and cash equivalents were $834 million at June 30, 2019, compared with $921 million at December 31, 2018. Long-term debt, net, was $2.409 billion, with $21 million of current maturities. TDS and U.S. Cellular had no revolving-credit borrowings outstanding and unused revolving capacity of $400 million and $298 million, respectively. U.S. Cellular also had $200 million of unused receivables-securitization capacity, subject to collateral availability.
Material Changes Versus the Prior Comparable Period
- Consolidated YTD revenue increased 2%, while YTD net income attributable to TDS shareholders increased 28%, primarily reflecting higher revenues and lower noncontrolling interests; 2018 included a $6 million out-of-period adjustment related to noncontrolling interests.
- U.S. Cellular profitability was pressured by higher depreciation from network assets and accelerated depreciation related to technology changes, as well as higher system operations costs. Prior-year results benefited from $11 million of Q2 license-exchange gains.
- U.S. Cellular’s postpaid gross additions and connections declined amid aggressive industry handset promotions; churn increased, particularly for handsets and connected wearables. Postpaid ARPU increased to $45.90 from $44.74.
- TDS Telecom operating income improved because of lower employee-related costs, asset-disposal gains, broadband and video growth, pricing, and higher A-CAM support. Wireline commercial revenues and voice connections continued to decline.
- Capital spending increased substantially, driven by U.S. Cellular network modernization and 5G deployment and by TDS Telecom fiber investment.
- TDS adopted ASC 842 lease accounting on January 1, 2019. At June 30, operating lease right-of-use assets were $963 million and operating lease liabilities totaled $1.039 billion; prior periods were not recast.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expects 2019 U.S. Cellular capital expenditures of $625 million to $725 million and TDS Telecom capital expenditures of $300 million to $350 million. Planned investment includes 5G, VoLTE, network capacity, fiber deployment, broadband upgrades and the TDS TV+ video platform.
- U.S. Cellular was the provisional winning bidder for 690 spectrum licenses in the 28 GHz and 24 GHz FCC auctions for an aggregate purchase price of $256 million, substantially paid during the first half of 2019. Licenses were expected to be granted during 2019.
- TDS Telecom accepted revised A-CAM support providing up to $198 million of additional funding, increasing annual support to approximately $82 million excluding transitional amounts through 2028, with additional broadband deployment obligations.
- TDS stated that its credit rating was sub-investment grade and cautioned that liquidity could be affected by spectrum purchases, acquisitions, lower regulatory support, reduced distributions from the Los Angeles SMSA Partnership, weaker operating cash flow or limited capital-market access.
- The Department of Justice is investigating U.S. Cellular and TDS under the False Claims Act regarding U.S. Cellular’s participation in certain FCC spectrum auctions. The companies believe their arrangements complied with applicable law and FCC rules, but cannot predict the outcome.
- The FCC’s USTelecom forbearance proceedings could increase prices paid by TDS Telecom’s CLEC operations for facilities obtained from other incumbent carriers. The filing did not identify material changes to previously disclosed risk factors.
- TDS had no material off-balance-sheet arrangements and no material changes outside the ordinary course to contractual obligations. No TDS common shares were repurchased during the quarter or first six months; $199 million remained available under the repurchase program.
Important Facts for Investors to Verify
- Whether U.S. Cellular can stabilize retail connections and churn while funding 5G and network modernization.
- The timing, final cost and operating benefits of the 28 GHz and 24 GHz spectrum licenses, and any future participation in FCC Auction 103.
- Whether projected 2019 capital expenditures can be funded primarily from operating cash flow and existing liquidity without increased borrowing.
- The sustainability of TDS Telecom’s A-CAM support, related broadband buildout obligations and the impact of declining voice and commercial connections.
- The potential financial, regulatory and reputational consequences of the DOJ False Claims Act inquiry.
- The effect of sub-investment-grade credit ratings, debt maturities, lease obligations and potential changes in access to financing.
- The comparability of non-GAAP Adjusted EBITDA and free cash flow with GAAP measures, including the effects of depreciation, license gains and spectrum spending.