Telephone and Data Systems, Inc. — 2013 Q2 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2013, with comparisons to the same 2012 periods. TDS is a diversified telecommunications company operating primarily through 84%-owned U.S. Cellular, wholly owned TDS Telecom, and smaller non-reportable businesses. At June 30, 2013, the company served approximately 5.0 million wireless customers and 1.0 million wireline customer connections.
Key financial metrics
| Metric | Three months ended June 30, 2013 | Three months ended June 30, 2012 | Six months ended June 30, 2013 | Six months ended June 30, 2012 |
|---|---|---|---|---|
| Operating revenues | $1.228 billion | $1.323 billion | $2.537 billion | $2.629 billion |
| Operating income | $282.2 million | $91.1 million | $289.4 million | $184.7 million |
| Operating margin | 23.0% | 6.9% | 11.4% | 7.0% |
| Net income | $178.4 million | $55.9 million | $185.4 million | $123.5 million |
| Net income available to common shareholders | $156.1 million | $42.3 million | $157.5 million | $94.6 million |
| Diluted EPS | $1.42 | $0.39 | $1.44 | $0.86 |
| Operating cash flow | Not separately provided | Not separately provided | $521.5 million | $506.9 million |
| Free cash flow | Not separately provided | Not separately provided | $137.2 million | $5.7 million |
- Cash and cash equivalents increased to $1.246 billion at June 30, 2013 from $740.5 million at December 31, 2012. Short-term investments were $110.4 million and long-term investments were $40.1 million.
- Total debt was approximately $1.723 billion, consisting of $1.899 million of current maturities and $1.721 billion of long-term debt. No amounts were drawn under the TDS or U.S. Cellular revolving credit facilities; $399.8 million and $282.4 million, respectively, remained available.
- Capital expenditures were $384.3 million on a cash basis and $356.2 million on an additions basis for the six months, compared with $501.2 million and $452.4 million, respectively, in 2012.
- Dividends per TDS share were $0.1275 for the quarter and $0.2550 for the first six months, compared with $0.1225 and $0.2450 in the comparable 2012 periods.
Material changes versus the prior comparable period
- Six-month operating revenue declined 4%, primarily because U.S. Cellular revenue fell 5%; TDS Telecom revenue increased 7%.
- U.S. Cellular operating income increased 30% to $220.6 million for the six months, principally because of the 2013 divestiture gain and lower operating expenses. Service revenue declined 7% to $1.907 billion, while equipment sales revenue increased 19% to $169.6 million.
- U.S. Cellular’s total customers declined to 4.968 million from 5.799 million, reflecting the sale of markets to Sprint and the NY1 and NY2 deconsolidation. In the comparable core markets, retail customer net losses increased to 47,000 from 22,000; postpaid churn rose to 1.6% from 1.4%.
- Smartphone penetration improved: smartphones represented 63.7% of devices sold versus 53.0% in 2012, and postpaid smartphone penetration reached 45.5% versus 36.8%. However, equipment loss increased to $289.2 million from $235.8 million.
- TDS Telecom revenue rose $27.9 million to $440.5 million, largely from the Vital Support Systems acquisition and growth in Hosted and Managed Services. Operating income declined 17% to $20.3 million as expenses grew faster than revenue. Wireline customer connections decreased by 12,100 to 975,400.
- Equity earnings from unconsolidated entities increased 29% to $62.7 million. The effective tax rate increased to 42.5% from 33.8% for the six months, primarily due to tax effects of the NY1 and NY2 deconsolidation and favorable 2012 tax items.
Guidance, outlook, risks and unusual items
- Current 2013 estimates include U.S. Cellular adjusted operating revenue of $3.615–$3.715 billion, adjusted income before taxes of $600–$700 million, and capital expenditures of approximately $735 million.
- TDS Telecom estimates include adjusted operating revenue of $890–$930 million, adjusted income before taxes of $230–$260 million, and capital expenditures of approximately $165 million. Consolidated TDS estimates are adjusted operating revenue of $4.550–$4.690 billion and adjusted income before taxes of $830–$960 million.
- Guidance excludes reported gains on the divestiture and NY1/NY2 deconsolidation and expected gains from pending spectrum sales. The guidance is non-GAAP and is subject to competition, customer trends, regulatory developments, acquisition and integration risks, and changing technology costs.
- On May 16, 2013, U.S. Cellular sold customers and certain spectrum in Chicago, central Illinois, St. Louis and certain Indiana/Michigan/Ohio markets to Sprint for $480.0 million. TDS recognized a net operating gain of approximately $296.1 million for the six months, including a $266.4 million U.S. Cellular pre-tax gain and an incremental $53.5 million TDS gain from lower asset basis. Related transition, severance, contract termination and accelerated depreciation costs remain possible.
- On April 3, 2013, NY1 and NY2 were deconsolidated and accounted for under the equity method. TDS recognized a $14.5 million non-cash pre-tax investment gain.
- U.S. Cellular paid a $482.3 million special dividend, of which TDS received $407.1 million and external shareholders received $75.2 million. TDS accrued a $128.9 million current tax liability related to the divestiture, expected to be paid in the third quarter.
- U.S. Cellular agreed to purchase approximately $1.2 billion of Apple iPhone products over three years beginning later in 2013. The company expects higher customer acquisition potential but also higher equipment subsidies and network investment.
- U.S. Cellular agreed to sell a Mississippi Valley unbuilt license for $308.0 million, subject to regulatory approval, with an estimated gain of $252.2 million. A St. Louis unbuilt license was also approved for sale.
- After quarter-end, on August 1, 2013, TDS acquired substantially all assets of Baja Broadband for $267.5 million in cash, subject to a working capital adjustment.
- Key risks include intense wireless and wireline competition, customer losses and churn, declining roaming and regulatory-support revenue, equipment subsidies, spectrum and network requirements, FCC and Universal Service Fund reforms, technology deployment, acquisitions and divestitures, potential impairments of licenses and goodwill, supplier and system implementation risks, litigation, and access to financing.
- U.S. Cellular’s B/OSS migration was underway and expected to be completed in the third quarter of 2013. Management reported effective disclosure controls as of June 30, 2013.
Most important facts for investors to verify
- Whether the apparent earnings improvement is sustainable after removing the Sprint divestiture gain, NY1/NY2 deconsolidation gain, accelerated depreciation and other unusual items.
- The effect of continued U.S. Cellular customer losses, higher churn, lower roaming revenue and increasing smartphone equipment subsidies.
- Execution and profitability of the Apple iPhone launch, B/OSS migration and 4G LTE network expansion.
- Regulatory approval, timing, proceeds and tax effects of the pending spectrum license sales.
- Integration, financing and operating performance of Baja Broadband following the August 1 acquisition.
- Compliance with debt covenants and the availability of the $399.8 million TDS and $282.4 million U.S. Cellular revolving credit facilities.
- Progress toward TDS Telecom revenue growth and whether HMS expansion can offset declining ILEC, CLEC and wholesale trends.