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, 2014. TDS operates primarily through 84%-owned U.S. Cellular, serving approximately 4.7 million wireless customers, and wholly owned TDS Telecom, which provides wireline, cable, broadband and hosted and managed services to approximately 1.1 million connections.
Financial Performance and Position
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Total operating revenues | $1,236.4 million, versus $1,228.2 million | $2,432.4 million, versus $2,536.7 million |
| Operating income (loss) | $(49.1) million, versus $282.2 million | $(28.4) million, versus $289.4 million |
| Operating margin | (4.0%), versus 23.0% | (1.2%), versus 11.4% |
| Net income (loss) attributable to TDS shareholders | $(22.0) million, versus $156.1 million | $(3.8) million, versus $157.5 million |
| Diluted earnings per share | $(0.20), versus $1.42 | $(0.04), versus $1.44 |
| Cash flow from operating activities | Not separately reported | $315.6 million, versus $521.5 million |
| Adjusted free cash flow | Not separately reported | $9.9 million, versus $137.2 million |
Six-month capital expenditures were $313.3 million on an accrual basis and cash payments for property, plant and equipment were $339.9 million. Cash and cash equivalents increased to $874.9 million at June 30, 2014 from $830.0 million at December 31, 2013; short-term investments were $40.0 million.
Total debt was approximately $1.72 billion, consisting of $0.9 million of current debt and $1.72 billion of long-term debt as reported on the balance sheet. TDS and U.S. Cellular had no borrowings under their revolving credit facilities, with $399.7 million and $282.5 million available, respectively. The actual consolidated leverage ratio for the twelve months ended June 30, 2014 was 2.36 to 1.00.
Current assets were $1.98 billion and current liabilities were $1.07 billion, implying current coverage of approximately 1.85 times. Total assets were $8.71 billion and total equity was $4.63 billion.
Material Changes Versus the Prior Comparable Period
- Consolidated six-month revenue declined 4%, primarily because U.S. Cellular revenue fell 9% following the divestiture of certain markets and the deconsolidation of the NY1 and NY2 partnerships. TDS Telecom revenue increased 21%, primarily from the Baja and MSN acquisitions.
- U.S. Cellular operating income declined to a $42.5 million loss from income of $220.6 million. Excluding license-sale gains and divestiture-related items, the filing attributes the decline primarily to lower service revenue and higher equipment subsidies.
- U.S. Cellular retail service revenue decreased 10% to $1.51 billion, while equipment revenue increased 10% to $186.5 million. Customers declined to 4.653 million from 4.968 million; postpaid churn increased to 2.0% from 1.6% in the Core Markets.
- U.S. Cellular billed ARPU increased to $53.62 from $50.97, service-revenue ARPU increased to $60.23 from $57.52, and smartphone penetration increased to 55% from 46%. However, equipment cost increased 18% to $542.5 million.
- TDS Telecom operating income increased 83% to $37.3 million. Wireline operating income increased 70% to $49.0 million, while HMS remained loss-making at $(12.3) million as acquisition-driven revenue growth was offset by related costs. Cable contributed $0.6 million of operating income for the six-month period.
- Operating cash flow declined $205.9 million, reflecting lower earnings excluding prior-year gains, payment timing for accounts payable and device purchases, and other operating changes. The decline was partly offset by lower inventory and receivables.
Guidance, Outlook, Risks and Unusual Items
- Expected 2014 capital expenditures are approximately $640 million for U.S. Cellular and $200 million for TDS Telecom, primarily for network capacity, 4G LTE deployment, infrastructure, fiber, data centers and systems.
- TDS agreed to acquire substantially all assets of BendBroadband for approximately $261 million in cash, subject to regulatory approvals and other conditions. Closing was expected in the third quarter of 2014; the transaction would use cash and affect liquidity.
- U.S. Cellular expanded equipment installment plans in the second quarter. The plans may increase equipment revenue but reduce service revenue and ARPU, and may increase churn, credit losses, bad-debt expense and cash-flow risk.
- U.S. Cellular recognized $75.8 million from the sale of most of its St. Louis area non-operating spectrum license and $15.7 million from a Milwaukee spectrum exchange in the first quarter. These gains materially affected six-month results.
- U.S. Cellular received $34.1 million of Sprint cost reimbursements during the first six months. Up to $200 million may be reimbursed under the divestiture agreements, with recognition extending through 2015.
- U.S. Cellular agreed to acquire Airadigm spectrum licenses and tower assets for $91.5 million. The transaction was expected to close in the third quarter of 2014, with projected Airadigm exit and disposal charges of $19 million to $35 million; $13.1 million had been recognized by June 30.
- Credit-rating downgrades in April and July 2014 placed TDS and U.S. Cellular at sub-investment-grade ratings with two agencies and increased revolving-facility commitment fees by 0.075% and borrowing rates by 0.25%. The facilities remained available and no rating-triggered acceleration applied.
- Key risks include intense wireless and telecommunications competition, customer losses, billing-system issues, equipment subsidies, installment-plan credit exposure, spectrum availability and auction costs, regulatory and Universal Service Fund changes, acquisition integration, liquidity and credit-market conditions, and potential asset impairments.
- The filing reports no material changes to previously disclosed legal proceedings, contractual obligations or off-balance-sheet arrangements. Disclosure controls were effective as of June 30, 2014.
Investor Verification Checklist
- Verify the sustainability of U.S. Cellular customer trends, churn, ARPU growth and the effect of equipment installment plans on service revenue, margins and bad debts.
- Reconcile reported operating results excluding the St. Louis license sale, Milwaukee license exchange, Sprint divestiture items, Airadigm exit costs and other unusual gains or charges.
- Confirm the timing, funding, regulatory approval and integration progress of the BendBroadband and Airadigm transactions.
- Monitor operating cash flow, adjusted free cash flow, capital expenditures and cash funding needs relative to the 2014 capital program.
- Review debt maturities, leverage-covenant headroom, credit ratings and the effect of higher borrowing costs on liquidity.
- Assess whether TDS Telecom acquisition-driven growth, Wireline cost reductions and HMS expansion offset continued declines in legacy voice and wholesale revenue.