United States Cellular Corporation — Q1 2013 Form 10-Q
Entity note: The filing identifies the registrant as United States Cellular Corporation, not Array Digital Infrastructure, Inc. The filing covers the unaudited quarter ended March 31, 2013; comparisons are with Q1 2012 unless noted.
Business context
U.S. Cellular, an 85%-owned subsidiary of Telephone and Data Systems, Inc., reported 5.736 million customers across markets in 26 states. It was preparing to sell customers and certain spectrum in Chicago, central Illinois, St. Louis and parts of Indiana, Michigan and Ohio to Sprint. The FCC approved the transaction in March; closing was expected in Q2 2013.
Key financial metrics
| Metric | Q1 2013 | Q1 2012 / comparison |
|---|---|---|
| Total operating revenue | $1,081.7 million | $1,092.1 million, down 1% |
| Service revenue | $996.3 million | $1,023.8 million, down 3% |
| Operating income | $1.5 million | $85.2 million, down 98% |
| Net income attributable to U.S. Cellular shareholders | $4.9 million; diluted EPS $0.06 | $62.5 million; diluted EPS $0.73 |
| Cash from operating activities | $223.6 million | $257.0 million |
| Capital expenditures | $118.4 million of additions; $151.0 million cash paid for property and equipment | $201.3 million of additions; $209.2 million cash paid |
| Free cash flow (company-defined, non-GAAP) | $72.6 million | $47.8 million |
| Cash and short-term investments | $530.3 million | At March 31, 2013 |
| Long-term debt | $879.0 million | At March 31, 2013; current portion was $0.1 million |
Operating margin was approximately 0.1%, versus 7.8% in Q1 2012, calculated from reported operating income and revenue. The company had no revolving-credit borrowings and reported $299.8 million available under its $300 million facility. Liquidity also included $40.1 million of long-term investments.
Material changes and operating trends
- Operating income fell mainly because of lower service revenue, higher equipment costs, and divestiture-related accelerated depreciation and exit costs. The divestiture reduced Q1 operating income by $45.1 million.
- Service revenue declined $27.5 million: retail service revenue fell 1%, inbound roaming revenue fell 18%, and other revenue fell 16%, including lower eligible telecommunications carrier support.
- Equipment sales rose 25%, but equipment costs rose 29%; the reported equipment loss widened to $156.3 million from $118.7 million.
- Retail customers had net losses of 51,000, versus 34,000 a year earlier. Postpaid net losses worsened to 74,000 from 38,000; prepaid net additions increased to 23,000 from 4,000. Postpaid churn rose to 1.7% from 1.6%.
- Smartphone adoption increased: 43.5% of postpaid customers had smartphones, versus 34.4%; smartphones were 61.7% of devices sold, versus 54.1%.
- Cash from operations declined partly because Q1 2012 included $58.1 million of federal tax refunds. Lower capital spending helped lift company-defined free cash flow despite lower operating cash flow.
Outlook, management commentary and notable items
- Revised 2013 consolidated estimates, assuming the Sprint transaction closes in Q2: service revenue of $3.620–$3.740 billion; adjusted income before taxes of $595–$715 million; and capital expenditures of approximately $735 million. Adjusted income before taxes is a non-GAAP measure; the company estimated GAAP income before taxes at a loss of $245–$125 million, reflecting, among other items, expected divestiture-related depreciation.
- The company expected approximately $185 million of incremental accelerated depreciation, amortization and accretion in the Divestiture Markets during 2013. Estimates depend on transaction timing and other assumptions and are not guarantees of results.
- The Sprint agreement provides for $480 million cash consideration, subject to adjustments, and up to $200 million of cost reimbursement. U.S. Cellular expected to provide transition services for up to 24 months after closing.
- U.S. Cellular agreed to purchase an estimated $1.2 billion of Apple iPhone products over three years, beginning later in 2013. Management cited device costs, network investment and competition as factors affecting future performance.
- Expected 2013 capital expenditures were directed toward network capacity and 4G LTE, retail facilities, and customer and billing systems. The B/OSS project was expected to be completed by year-end 2013; estimated total payments to Amdocs were approximately $179 million, of which $114 million had been paid by March 31.
- On April 3, 2013, an agreement with Verizon Wireless required U.S. Cellular to deconsolidate two partnerships and account for them as equity-method investments. The company expected a non-cash pretax gain of $16–$32 million in Q2.
- Legal proceedings were accrued at $1.7 million; the company stated it did not believe possible losses above accruals would be material. It also disclosed an estimated $167.9 million settlement value for certain mandatorily redeemable noncontrolling interests, based on subjective assumptions; it had no plans for early liquidation.
Important facts for investors to verify
- Whether and when the Sprint divestiture closed, final consideration and reimbursements, transition costs, and realized operating impact.
- Whether customer losses and roaming-revenue declines continued, and whether higher smartphone adoption improved service revenue enough to offset device subsidies and churn.
- Actual 2013 results against guidance, particularly adjusted versus GAAP pretax results and the substantial expected accelerated depreciation.
- The economics and cash-flow implications of the $1.2 billion Apple purchase commitment and the planned network and billing-system investments.
- Debt, liquidity, and any funding needs for capital expenditures or spectrum interests; the filing reported investment-grade senior debt ratings and compliance with facility covenants.