Telephone and Data Systems, Inc. — Q3 2012 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and nine months ended September 30, 2012, filed November 7, 2012. TDS is a diversified telecommunications company, primarily comprising 84%-owned U.S. Cellular, wholly owned TDS Telecom, and smaller printing, wireless and corporate operations. At September 30, 2012, TDS reported approximately 5.8 million wireless customers and 1.0 million wireline customer connections. Reportable segments were U.S. Cellular, ILEC, CLEC, Hosted and Managed Services, and a non-reportable segment.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Operating revenues | $1.370 billion | $1.325 billion | $3.999 billion | $3.864 billion |
| Operating income | $55.5 million | $126.9 million | $240.2 million | $343.2 million |
| Operating margin | 4.1% | 9.6% | 6.0% | 8.9% |
| Net income | $40.2 million | $88.2 million | $163.7 million | $252.3 million |
| Net income attributable to TDS shareholders | $29.1 million | $71.3 million | $123.7 million | $206.8 million |
| Diluted EPS | $0.27 | $0.65 | $1.13 | $1.89 |
| Adjusted OIBDA | Not separately provided in the filing excerpt | Not separately provided in the filing excerpt | $845.5 million | $912.1 million |
| Cash flow from operating activities | Not provided for the quarter | Not provided for the quarter | $760.5 million | $939.2 million |
| Free cash flow | Not provided for the quarter | Not provided for the quarter | $29.6 million | $337.4 million |
Nine-month revenue increased 4%, but operating income declined 30% and net income attributable to TDS shareholders declined 40%. The nine-month operating cash flow conversion was pressured by lower operating results, inventory investment and accounts-payable timing. Capital expenditures were $697.0 million, including $583.6 million for U.S. Cellular and $122.1 million for TDS Telecom; cash paid for property, plant and equipment was $730.9 million.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $589.3 million at September 30, 2012, compared with $563.3 million at December 31, 2011.
- Short-term and long-term investments totaled $190.7 million.
- Revolving credit availability was $399.8 million at TDS and $299.8 million at U.S. Cellular; neither facility had borrowings outstanding.
- Current debt was $1.3 million and long-term debt was $1.529 billion. Aggregate principal amounts of senior notes totaled approximately $1.527 billion.
- Total assets were $8.391 billion and total equity was $4.763 billion at September 30, 2012.
- Management stated that cash, investments, operating cash flow and external financing sources were sufficient for anticipated obligations and expenditures. Investment-grade credit ratings and covenant compliance were maintained.
Material changes versus the prior comparable period
- Q3 operating revenue increased 3%, while operating expenses increased 10%, reducing operating income 56% and net income attributable to TDS shareholders 59%.
- U.S. Cellular revenue increased 3% in Q3 and 3% for the nine months, but operating income decreased 53% in Q3 and 18% for the nine months. Higher smartphone subsidies, network and LTE costs, asset write-offs and lower universal-service support were significant pressures.
- U.S. Cellular had 5.808 million total customers at September 30, down from 5.932 million a year earlier. Retail customer net losses improved to 43,000 from 112,000, while smartphone penetration increased to 38.6% from 26.2% and service revenue per customer increased to $58.93 from $56.02.
- TDS Telecom revenue increased 4% for the nine months, primarily from HMS acquisitions, but operating income declined 58% because operating expenses increased 14%. ILEC and CLEC revenues declined 4% each, while HMS revenue increased to $76.9 million from $29.9 million.
- Free cash flow fell to $29.6 million from $337.4 million, reflecting higher capital expenditures and lower operating cash flow.
- Interest expense decreased to $68.1 million from $94.2 million, while 2011 included significant investment gains that did not recur in 2012.
- TDS changed its reportable segment presentation in 2012 and re-presented prior periods. The company also revised certain 2011 cash-flow classifications for immaterial errors.
Guidance, outlook, risks and unusual items
- U.S. Cellular’s full-year 2012 estimates, before the Sprint transaction, were service revenue of $4.075–$4.125 billion, operating income of $200–$250 million, adjusted OIBDA of $800–$850 million and capital expenditures of approximately $850 million. The company expected $30–$60 million of incremental fourth-quarter costs related to the Sprint transaction.
- TDS Telecom’s full-year estimates were revenue of $850–$860 million, operating income of $40–$50 million, adjusted OIBDA of $235–$245 million and capital expenditures of $175–$190 million.
- On November 6, 2012, U.S. Cellular agreed to transfer approximately 585,000 customers and certain spectrum in specified Mid-Central markets to Sprint for $480 million in cash, subject to approvals and other conditions. Closing was expected by mid-2013.
- The Sprint transaction was expected to generate $275–$350 million of net cash proceeds after anticipated costs and taxes, but also to produce employee, contract termination, accelerated depreciation, asset write-down and other operating charges. TDS estimated total transaction-related operating impacts, including proceeds and costs, over the signing-to-transition period.
- Management expected to review goodwill and intangible assets for impairment in the fourth quarter of 2012 and could not predict the outcome. At June 30, 2012, $0.5 million of Airadigm goodwill had been impaired; certain license balances had less than 10% headroom over carrying value.
- U.S. Cellular won up to $40.1 million in FCC Mobility Fund Phase I support, subject to coverage milestones and related obligations. Universal-service support was being reduced by 20% beginning in July 2012, with an estimated 2012 reduction of approximately $16 million.
- U.S. Cellular’s Amdocs billing and operational support system was expected to require total payments of approximately $152.1 million through the second half of 2013; $77.6 million had been paid by September 30, 2012.
- Legal proceedings and unasserted claims accrued were $2.3 million. TDS also continued to face uncertainty from an FCC subpoena concerning Federal Universal Service Fund support, although no further FCC communication had been received after the requested information was provided.
- Primary ongoing risks include wireless and wireline competition, customer churn, device subsidies, roaming revenue pressure, LTE and systems implementation costs, FCC reforms to universal-service and intercarrier compensation, spectrum requirements, impairment risk, economic conditions and access to financing.
Most important facts for investors to verify
- Whether the Sprint transaction received regulatory approval, closed on schedule and produced the projected proceeds, exit costs and impairment charges.
- Actual fourth-quarter 2012 U.S. Cellular transaction-related costs versus the $30–$60 million estimate.
- U.S. Cellular’s customer trends, postpaid churn, smartphone adoption, equipment subsidies and adjusted OIBDA relative to guidance.
- The outcome of fourth-quarter goodwill and license impairment testing, particularly for assets with limited valuation headroom.
- The effect of FCC universal-service and intercarrier-compensation reforms on U.S. Cellular and TDS Telecom revenue.
- Whether operating cash flow and free cash flow recover after the elevated LTE, network, systems and broadband capital program.
- Future federal tax payments, which management expected to increase substantially beginning in 2013 as accelerated tax depreciation benefits decline.