TELEPHONE & DATA SYSTEMS INC annual report, FY2016

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Telephone and Data Systems, Inc. — FY2016 Form 10-K Summary

Business context and reporting period

TDS filed its annual report for the fiscal year ended December 31, 2016. TDS is a diversified U.S. telecommunications company operating through majority-owned U.S. Cellular and wholly owned TDS Telecom. Its principal segments are wireless, Wireline, Cable, and Hosted and Managed Services, with additional operations through Suttle-Straus.

  • Approximately 5.0 million wireless customers and 1.2 million wireline and cable connections at year-end.
  • TDS owned 83% of U.S. Cellular’s combined outstanding shares and controlled 96% of its combined voting power.
  • U.S. Cellular operated in 23 states; TDS Telecom operated in 34 states.
  • The filing text provided does not include the consolidated TDS income statement, balance sheet, or cash flow statement; those financial statements were incorporated by reference from the 2016 Annual Report to Shareholders.

Financial metrics, liquidity, and capital structure

  • TDS paid quarterly dividends of $0.148 per share in 2016, compared with $0.141 in 2015 and $0.134 in 2014. The quarterly dividend was increased to $0.155 in the first quarter of 2017, and management stated that it had no current plans to change its dividend policy.
  • No TDS Common Shares were repurchased during the fourth quarter of 2016. The remaining authorization under the $250 million repurchase program was $198.7 million at December 31, 2016.
  • Net property, plant and equipment totaled $3.555 billion across U.S. Cellular, Wireline, Cable, HMS, Corporate, and Suttle-Straus at year-end, based on the segment amounts disclosed in the filing.
  • The company had publicly traded senior notes with coupon rates ranging from 5.875% to 7.000% and maturities from 2045 through 2061. U.S. Cellular also had senior notes with maturities from 2033 through 2064. The filing text does not provide total consolidated debt or year-end cash and liquidity balances.
  • Management stated that TDS had recently been rated below investment grade and currently expected negative free cash flow in 2017, defined as operating cash flow less capital expenditures.
  • As supplemental information, the Los Angeles SMSA partnership, in which U.S. Cellular held a 5.5% interest, reported 2016 revenue of $5.185 billion, operating income of $1.285 billion, net income of $1.279 billion, and operating cash flow of $1.594 billion. These figures are partnership-level results and are not TDS consolidated results.

Material changes versus the prior comparable period

  • Beginning in September 2016, new postpaid handset sales to retail consumers were made exclusively through equipment installment plans; business and government customers could continue using either installment plans or service contracts.
  • U.S. Cellular continued expanding 4G LTE capabilities and planned a multiyear Voice over LTE rollout, with an initial market deployment expected in early 2017.
  • TDS Telecom completed an analog reclamation project in its Cable operations, converting analog markets to all-digital video and freeing spectrum for higher broadband speeds.
  • Wireline recognized $175 million of wholesale revenue in 2016, including $67 million from federal regulatory support programs. Regulatory changes are expected to affect future wholesale revenue.
  • In January 2017, TDS Telecom accepted an Alternative Connect America Cost Model offer providing $75 million of annual federal support for ten years, subject to broadband build-out obligations and potentially significant capital expenditures.
  • U.S. Cellular was qualified to participate directly in the FCC’s 600 MHz Auction 1002 and would not receive the designated-entity bidding discount.

Guidance, outlook, management commentary, risks, and unusual items

  • Management’s current forecasts indicated that TDS and U.S. Cellular would not earn returns on capital above their respective costs of capital in the foreseeable future.
  • Management expected negative free cash flow in 2017 and warned that reduced operating cash flow, capital requirements, spectrum purchases, acquisitions, lower regulatory support, or reduced distributions from investments could pressure liquidity.
  • Key operating risks include aggressive wireless pricing and promotions, customer churn, competition from larger national carriers, cable and wireless substitution for Wireline services, declining intercarrier compensation, programming costs, and limited scale.
  • U.S. Cellular depends on roaming agreements and adequate spectrum. Changes in roaming economics, carrier consolidation, spectrum availability, or the outcome and cost of FCC auctions could materially affect results.
  • Regulatory support is material: U.S. Cellular received $92 million of high-cost support in 2016 and TDS Telecom received $67 million under federal regulatory support programs. Future support levels remain uncertain.
  • TDS has significant indebtedness and credit-facility financial covenants. A covenant breach could trigger defaults, cross-defaults, acceleration, termination of facilities, or reduced financial flexibility.
  • Other material risks include cyberattacks, network outages, technology obsolescence, device purchase commitments, impairment of goodwill, licenses or other assets, litigation, regulatory proceedings, and acquisition or integration risks.
  • The company reported effective disclosure controls and effective internal control over financial reporting as of December 31, 2016. No material changes in internal control were reported during the fourth quarter.

Most important facts for investors to verify

  • Retrieve the incorporated 2016 Annual Report to verify consolidated revenue, net income, EBITDA or operating income, margins, operating cash flow, capital expenditures, cash, debt, liquidity, and segment results.
  • Assess the magnitude and timing of expected 2017 negative free cash flow and its effect on dividends, repurchases, acquisitions, spectrum purchases, and debt service.
  • Review debt balances, maturities, interest expense, credit ratings, revolver availability, and compliance with TDS and U.S. Cellular financial covenants.
  • Evaluate the sustainability of U.S. Cellular’s $92 million of high-cost support and TDS Telecom’s $67 million of federal support, including the impact of Mobility Fund II and A-CAM build-out requirements.
  • Monitor wireless customer additions, churn, service revenue, device economics, roaming revenue and expense, and the transition to installment billing.
  • Review the results and financial commitments associated with FCC Auction 1002 and the planned VoLTE deployment.
  • Examine the incorporated notes for acquisitions, divestitures, impairments, legal contingencies, commitments, related-party transactions, and the company’s below-investment-grade credit profile.