Business Context and Reporting Period
Telephone and Data Systems, Inc. (TDS) filed an unaudited Form 10-Q for the three months ended March 31, 2018, compared with the three months ended March 31, 2017. TDS provides wireless services through its 83%-owned U.S. Cellular subsidiary and wireline and cable services through TDS Telecom, serving approximately 6 million connections nationwide.
Effective January 1, 2018, hosted and managed services was moved from TDS Telecom to Corporate, Eliminations and Other; prior periods were recast. TDS also adopted the new revenue recognition standard, ASU 2014-09, using the modified retrospective method.
Financial Results and Key Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Operating revenues | $1,225 million | $1,238 million | (1%) |
| Operating income | $80 million | $81 million | (2%) |
| Income before taxes | $81 million | $77 million | 5% |
| Net income | $57 million | $43 million | 33% |
| Net income attributable to TDS shareholders | $39 million | $37 million | 4% |
| Diluted EPS | $0.34 | $0.33 | 3% |
| Adjusted EBITDA | $340 million | $317 million | 7% |
| Adjusted OIBDA | $296 million | $279 million | 6% |
| Capital expenditures | $115 million | $96 million | 20% |
- Approximate consolidated operating margin was 6.5%, compared with 6.5% in the prior-year quarter; adjusted EBITDA margin was approximately 27.8%, compared with 25.6%.
- Operating cash flow was $214 million, up from $137 million. Free cash flow, defined by TDS as operating cash flow less property, plant and equipment additions, was $83 million versus $10 million.
- Cash and cash equivalents were $779 million at March 31, 2018, compared with $619 million at December 31, 2017. Cash, cash equivalents and restricted cash totaled $783 million.
- Debt consisted of $20 million of current maturities and $2,431 million of long-term debt, or approximately $2.45 billion in total reported debt. No borrowings were outstanding under the revolving credit facilities or U.S. Cellular’s receivables securitization facility at quarter-end.
- Unused revolving credit capacity was $399 million for TDS and $298 million for U.S. Cellular. U.S. Cellular’s receivables securitization facility had $200 million of unused capacity, subject to collateral availability.
Segment Performance
- U.S. Cellular: Revenue increased 1% to $942 million and operating income increased 21% to $65 million. Net income was $55 million, compared with $28 million. Retail connections increased to 5.006 million from 4.935 million, while postpaid churn improved to 1.23% from 1.29%. Postpaid ARPU declined to $44.34 from $45.42, while postpaid ABPU increased to $57.10 from $55.82 due primarily to higher equipment installment plan billings.
- TDS Telecom: Revenue increased 1% to $231 million, while operating income declined 17% to $25 million. Wireline revenue declined 2% to $175 million and operating income declined 6% to $26 million. Cable revenue increased 12% to $55 million, but Cable reported a $1 million operating loss versus $2 million of operating income in the prior-year quarter.
- Wireline and Cable drivers: Wireline broadband speed upgrades and video growth supported residential revenue, but voice and commercial connections declined. Cable connections increased 8%, including a 14% increase in broadband connections, but higher programming costs and depreciation reduced GAAP operating income.
Material Changes Versus the Prior Comparable Period
- The Tax Act reduced the effective tax rate to 29.7% from 44.3%, primarily because the federal corporate tax rate declined from 35% to 21%. The lower tax rate was the principal driver of the increase in consolidated net income.
- U.S. Cellular’s service revenue declined 3%, partly offset by a 14% increase in equipment sales. The equipment loss narrowed to $1 million from $38 million, while selling, general and administrative expense declined 4%.
- TDS Telecom operating expenses increased 4%, largely because of higher video programming costs. TDS Telecom capital expenditures rose 52% to $40 million.
- Consolidated capital expenditures increased to $115 million, including $70 million for U.S. Cellular and $40 million for TDS Telecom.
- Adoption of ASU 2014-09 increased retained earnings by $164 million at January 1, 2018. For Q1 2018, the standard reduced service revenue by $30 million and increased equipment and product sales by $21 million relative to the amounts that would have been reported under prior accounting standards.
- TDS prospectively changed the estimated useful life of Cable video franchise rights from indefinite-lived to 15 years. This increased depreciation, amortization and accretion by $4 million and reduced Q1 net income by $3 million, or $0.03 per share.
- Out-of-period adjustments related to prior-period errors increased net income attributable to noncontrolling interests by $6 million and reduced net income attributable to TDS shareholders by $6 million. Management determined the adjustments were not material to the affected periods.
Guidance, Outlook, Risks and Unusual Items
- Full-year 2018 capital expenditure guidance was $500 million to $550 million for U.S. Cellular and approximately $270 million for TDS Telecom. Planned uses include network capacity, VoLTE deployment, broadband and fiber expansion, A-CAM requirements, IPTV and Cable growth, and platform upgrades.
- Management expects to finance capital expenditures primarily with operating cash flow and existing cash, supplemented if necessary by revolving credit facilities or the receivables securitization facility.
- TDS expects U.S. Cellular’s legacy Federal USF support to continue at the 2017 level through 2018, but cannot predict the timing or outcome of the Mobility Fund Phase II auction or the related phase-down of legacy support.
- The FCC approved an order authorizing more than $360 million of additional A-CAM funding over 10 years; the support remains subject to effectiveness of the order and carrier acceptance procedures.
- TDS states that its credit rating is currently sub-investment grade and warns that financing availability, acquisition activity, spectrum purchases, regulatory support reductions, or weaker operating cash flow could constrain liquidity, capital spending, acquisitions, dividends or repurchases.
- The Department of Justice is investigating U.S. Cellular and TDS under the False Claims Act regarding U.S. Cellular’s participation in FCC spectrum auction 73. TDS and U.S. Cellular believe their arrangements complied with applicable law and FCC rules, but cannot predict the outcome.
- TDS identified competition, customer churn, technology changes, spectrum availability, regulatory support, cybersecurity, indebtedness, impairment risk, acquisitions, litigation and reliance on unconsolidated investments as significant risks.
- TDS reported no material changes to previously disclosed contractual obligations, market-risk information or risk factors, and no material off-balance-sheet arrangements.
Facts an Investor Should Verify
- Reconcile reported year-over-year trends for revenue, margins and EPS after the modified-retrospective adoption of ASU 2014-09.
- Monitor U.S. Cellular postpaid net losses, ARPU, churn, equipment installment receivables and equipment margins.
- Assess whether TDS Telecom can convert Cable connection and broadband growth into positive GAAP operating income while absorbing programming and depreciation costs.
- Compare planned 2018 capital expenditures with operating cash flow, free cash flow and available borrowing capacity.
- Review total debt maturities, sub-investment-grade credit risk and the availability of cash held at U.S. Cellular, which TDS does not directly control absent a U.S. Cellular dividend.
- Track the Mobility Fund II process, legacy Federal USF support, A-CAM funding, spectrum auctions and the unresolved DOJ inquiry.
- Verify the potential effect of final Tax Act adjustments expected by the third quarter of 2018; the filing states those adjustments could be material.