ARRAY DIGITAL INFRASTRUCTURE, INC. quarterly report, Q1 FY2016

Business context and reporting period

Entity mismatch: The supplied 10-Q is for United States Cellular Corporation (U.S. Cellular), not ARRAY DIGITAL INFRASTRUCTURE, INC. This summary therefore describes U.S. Cellular’s unaudited quarter ended March 31, 2016, compared with the quarter ended March 31, 2015.

U.S. Cellular, an 84%-owned subsidiary of Telephone and Data Systems, Inc., operates wireless markets in 23 states and reported approximately 4.9 million customers.

Financial and operating metrics

Operating margin was approximately negative 0.1% in Q1 2016 versus 25.9% in Q1 2015; the prior-year result included substantial gains on tower and spectrum transactions. Adjusted EBITDA margin was approximately 21.5% versus 21.7%.

At March 31, 2016, cash and cash equivalents were $772 million, total current assets $1.708 billion and current liabilities $723 million. Long-term debt was $1.626 billion, plus $11 million current portion; cash less reported debt was approximately $135 million net cash. The revolving credit facility had $282 million of unused capacity, no cash borrowings outstanding, and matures in December 2017. Total assets were $7.057 billion.

Postpaid net additions increased to 45,000 from 9,000; postpaid churn improved to 1.28% from 1.48%. End-of-period postpaid customers rose to 4.454 million from 4.307 million. Smartphone penetration reached 75% of postpaid handset customers, versus 67% a year earlier.

Material changes versus prior period

• Revenue was nearly flat overall, as an 8% decline in service revenue was largely offset by 45% growth in equipment sales. Service revenue fell amid price competition, discounts and lower inbound roaming rates; equipment sales benefited from installment plans and higher device sales.
• Operating results fell sharply because Q1 2015 included net gains of $111 million on a business sale and $123 million on license sales and exchanges; neither gain recurred in Q1 2016. Adjusted EBITDA was comparatively stable, down 2%.
• Interest expense increased to $28 million from $20 million, primarily reflecting debt issued and term-loan borrowing in 2015. The Q1 2016 effective tax rate was 53.1%, versus 39.5%, with discrete tax adjustments having a disproportionate effect at the lower pretax income level.
• Operating cash flow and free cash flow declined. Management attributed working-capital pressure in part to a $41 million increase in equipment installment plan receivables; Q1 2015 cash flow benefited from larger working-capital inflows.

Outlook, commentary and risks

• Management expected approximately $500 million of 2016 capital expenditures, primarily for network capacity and coverage, VoLTE deployment, retail stores and systems. It expected negative free cash flow for 2016, citing installment-plan receivables growth and capital spending.
• Management’s strategy emphasized customer growth, smartphone adoption, data monetization, network investment and business/government connected solutions. VoLTE field trials were completed in Q1; deployment work was expected to continue through 2016. LTE reached 99% of postpaid customers and 98% of cell sites.
• Management said liquidity was expected to cover normal operating needs and debt service for the coming year, but identified risks from financing access and credit ratings, spectrum purchases, possible reduced distributions from the LA Partnership, regulatory-support changes, and lower future asset-sale proceeds. The company reported a sub-investment-grade credit rating.
• U.S. Cellular participated in the FCC’s 600 MHz Auction 1000. Any winning bids could require substantial payments; auction anti-collusion restrictions could constrain certain business communications and activities. Multiple spectrum purchase and exchange agreements were expected to close in 2016, subject to approvals and other conditions; exchange closings could produce gains.
• Other cited risks included intense competition, price pressure and churn, spectrum availability, network investment and technology execution, device installment-plan credit and cash-flow risks, cybersecurity, litigation and regulatory uncertainty. Management reported no material change in previously disclosed risk factors or legal proceedings.
• The filing states adoption of the new lease standard in 2019 is expected to substantially increase reported assets and liabilities. Other accounting standards were still under evaluation.

Important facts for investors to verify

• Confirm the issuer: this filing is U.S. Cellular’s, not ARRAY DIGITAL INFRASTRUCTURE, INC.’s.
• Review the drivers and persistence of declining service revenue, postpaid ARPU/ARPA, and equipment installment-plan receivables and related credit exposure.
• Assess the 2016 capital-spending plan, management’s negative-free-cash-flow expectation, and available liquidity, including facility capacity and debt maturities.
• Check closing, regulatory approval, cash consideration and gain recognition for the pending spectrum purchases and exchanges, and track Auction 1000 commitments.
• Interpret Q1 comparisons in light of the large prior-year asset-sale and license-exchange gains; distinguish GAAP results from non-GAAP Adjusted EBITDA and free cash flow.