Telephone and Data Systems, Inc. — Q1 2014 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2014, compared with the three months ended March 31, 2013. TDS is a diversified telecommunications company operating primarily through 84%-owned U.S. Cellular and wholly owned TDS Telecom. At March 31, 2014, TDS served approximately 4.7 million wireless customers and 1.1 million wireline and cable connections.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total operating revenues | $1.196 billion | $1.309 billion | Down 9% |
| Operating income | $20.7 million | $7.2 million | Up $13.5 million |
| Operating margin | 1.7% | 0.5% | Improved |
| Income before taxes | $32.0 million | $11.2 million | Up $20.8 million |
| Net income | $20.3 million | $7.0 million | Up $13.3 million |
| Net income available to common shareholders | $18.2 million | $1.4 million | Up $16.8 million |
| Diluted EPS | $0.16 | $0.01 | Up $0.15 |
| Cash flow from operating activities | $104.9 million | $246.4 million | Down $141.4 million |
| Capital expenditures | $122.6 million | $150.1 million | Down $27.5 million |
| Free cash flow | $(46.0) million | $70.0 million | Down $116.0 million |
Operating results benefited from a $91.4 million net gain on license sales and exchanges, including a $75.8 million gain from the sale of a St. Louis-area license and a $15.7 million gain from a Milwaukee spectrum exchange. TDS also recorded a $6.9 million net gain related to the Sprint divestiture transaction. Excluding these items, underlying operating performance was materially weaker, particularly at U.S. Cellular.
Cash and cash equivalents increased to $872.9 million from $830.0 million at December 31, 2013. Short-term investments were $40.1 million. Current liabilities were $1.025 billion, long-term debt was $1.720 billion, and current debt was $1.4 million. Total debt was approximately $1.721 billion, excluding any capital lease obligations not separately quantified in the supplied balance sheet. TDS had no revolving-credit borrowings outstanding; available capacity was $399.7 million for TDS and $282.4 million for U.S. Cellular.
The effective tax rate was 36.5%, compared with 37.4% in the prior-year quarter. The quarterly dividend was $0.1340 per share, compared with $0.1275 in Q1 2013.
Material changes versus the prior comparable period
- Consolidated revenue declined 9%, primarily because U.S. Cellular revenue fell 14%. U.S. Cellular revenue was affected by the prior-year divestiture of markets to Sprint and the deconsolidation of the NY1 and NY2 partnerships.
- U.S. Cellular operating revenue decreased to $925.8 million from $1.082 billion. Retail service revenue fell 13% to $764.8 million, while equipment revenue declined 15% to $72.2 million.
- U.S. Cellular operating income increased to $7.8 million from $1.5 million, largely because of license-sale gains. Excluding license gains, operating income declined as lower service revenue and higher equipment subsidies outweighed expense reductions.
- U.S. Cellular’s consolidated customer count was 4.684 million, down from 5.736 million, while Core Market retail customers declined by 321,000 year over year. Core Market retail net losses were 80,000, including 93,000 postpaid losses.
- U.S. Cellular’s postpaid churn increased to 2.3% from 1.6%; prepaid churn increased to 6.9% from 5.6%. Billed ARPU increased to $53.93 from $50.93, and smartphone penetration increased to 53.1% from 43.5%.
- TDS Telecom revenue increased 21% to $262.4 million and operating income increased to $18.0 million from $7.9 million. The increase primarily reflected the Baja Broadband and MSN acquisitions.
- TDS Telecom Wireline revenue declined 2% to $177.5 million, although Wireline operating income increased 84% to $23.1 million due mainly to lower expenses. Cable contributed $22.5 million of revenue and $0.7 million of operating income in its first reported comparable period following the Baja acquisition.
- Operating cash flow declined substantially because of lower earnings excluding gains, payment timing for accounts payable, and higher income tax payments. Accounts receivable balances improved as billing-system-related receivables declined toward more normal levels.
- Cash used for investing activities improved to $44.5 million from $184.1 million, primarily because of $103.0 million of divestiture proceeds. Financing cash outflows were $17.6 million, including $14.6 million of dividends and $5.3 million of share repurchases.
Guidance, outlook, risks and unusual items
- Expected 2014 capital expenditures are approximately $640 million for U.S. Cellular and $200 million for TDS Telecom. Management expects to fund capital expenditures primarily with operating cash flow, existing cash and short-term investments.
- TDS entered into an agreement on May 1, 2014 to acquire substantially all assets of BendBroadband for $261 million in cash, subject to adjustments and regulatory conditions. Closing was expected in Q3 2014. The transaction is expected to reduce available liquidity and increase integration and execution requirements.
- U.S. Cellular expanded equipment installment-plan offerings beginning in Q2 2014. Management expects these plans to reduce service revenue and reported ARPU while increasing equipment revenue and potentially mitigating equipment losses.
- U.S. Cellular’s billing and operational support system continued to present risks after intermittent outages and delayed response times contributed to customer losses, higher churn and potential bad-debt exposure. Management reported that response times had improved but warned that future problems could materially affect results and cash flows.
- Key wireless risks include intense competition, pricing pressure, equipment subsidies, declining roaming and government support revenue, spectrum availability, network investment requirements, technology changes and the ability to negotiate favorable LTE roaming agreements.
- TDS Telecom faces competition from wireless, cable and internet-based technologies, continued declines in legacy voice connections, regulatory changes affecting Universal Service Fund and intercarrier compensation, and integration risks from Baja, MSN and the proposed BendBroadband acquisition.
- April 2014 credit-rating downgrades affected TDS and U.S. Cellular, although the filing states that the downgrades did not increase revolving-facility interest costs, terminate facility availability or accelerate maturities. A further downgrade could restrict future financing access.
- The filing reports no material changes to legal proceedings or previously disclosed risk factors, no material off-balance-sheet arrangements, and effective disclosure controls as of March 31, 2014.
Most important facts for investors to verify
- Reconcile reported earnings with the $91.4 million license-sale and exchange gain and the $6.9 million Sprint-related gain.
- Assess whether U.S. Cellular can stabilize postpaid churn, customer losses and billing-system performance while managing equipment subsidies.
- Monitor operating cash flow and free cash flow, which turned negative after capital expenditures despite reported net income.
- Evaluate funding, regulatory approval, integration and liquidity effects of the proposed $261 million BendBroadband acquisition.
- Review the $1.721 billion debt balance, credit-rating changes, covenant compliance and future refinancing access.
- Track 2014 capital expenditures against the approximately $840 million plan and assess whether operating cash flow can fund the program.
- Confirm the effect of Baja and MSN acquisitions on TDS Telecom’s revenue growth, margins and cash generation.