Telephone and Data Systems, Inc. — Q1 2016 Form 10-Q
Business context and reporting period
TDS is a diversified U.S. telecommunications company serving approximately 6 million customers. Its principal businesses are 84%-owned U.S. Cellular wireless operations and wholly owned TDS Telecom operations, comprising Wireline, Cable and Hosted and Managed Services (HMS). The filing covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015. Results are unaudited and are not necessarily indicative of full-year performance.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total operating revenues | $1,243 million | $1,252 million | Down 1% |
| Operating income | $15 million | $283 million | Down 95% |
| Operating margin | 1.2% | 22.6% | Down 21.4 percentage points |
| Net income | $10 million | $176 million | Down 94% |
| Net income attributable to TDS shareholders | $8 million | $146 million | Down 94% |
| Diluted EPS | $0.07 | $1.33 | Down $1.26 |
| Adjusted EBITDA | $282 million | $291 million | Down 3% |
| Cash flows from operating activities | $246 million | $355 million | Down 31% |
| Capital expenditures | $125 million | $105 million | Up 19% |
| Free cash flow | $87 million | $189 million | Down 54% |
Service revenue declined to $1,000 million from $1,073 million, while equipment and product sales increased to $243 million from $179 million, primarily reflecting greater equipment-installment-plan activity. The implied net margin was 0.8% in Q1 2016 versus 14.1% in Q1 2015.
At March 31, 2016, cash and cash equivalents were $1,054 million, up from $985 million at December 31, 2015. Total debt was approximately $2,451 million, including $14 million of current maturities and $2,437 million of long-term debt. Unused revolving credit capacity was $399 million for TDS and $282 million for U.S. Cellular; neither entity had revolving-facility borrowings outstanding. TDS reported compliance with applicable financial covenants.
Material changes versus the prior comparable period
- Operating income fell primarily because Q1 2015 included $124 million of gains from the sale of a business and other exit activities and $123 million of gains from license sales and exchanges. No comparable gains were recorded in Q1 2016.
- U.S. Cellular revenue declined 1% to $958 million and operating income decreased to a $1 million loss from $250 million of income. Service revenue fell 8% because of price competition and lower roaming rates, while equipment sales rose 45%.
- U.S. Cellular adjusted EBITDA decreased 2% to $206 million. Postpaid net additions improved to 45,000 from 9,000, churn declined to 1.28% from 1.48%, and postpaid customers increased to 4.454 million from 4.307 million.
- U.S. Cellular’s postpaid smartphone penetration increased to 75% from 67%; however, price competition, shared-plan discounts and connected-device additions reduced postpaid ARPU.
- TDS Telecom revenue was essentially flat at $281 million, while operating income decreased 21% to $17 million and adjusted EBITDA decreased 4% to $76 million. Wireline revenue declined 2%, Cable revenue increased 3%, and HMS revenue increased 5%.
- Operating cash flow decreased partly because equipment-installment-plan receivables used $41 million of cash and because Q1 2016 benefited from a $63 million federal tax refund. Cash flows from operations exceeded capital expenditures by $87 million, but management expects negative free cash flow for 2016.
Guidance, outlook, commentary, risks and unusual items
- Management expects 2016 U.S. Cellular capital expenditures of approximately $500 million and TDS Telecom capital expenditures of approximately $180 million, principally for network capacity, LTE and VoLTE deployment, fiber expansion, Cable upgrades and HMS infrastructure.
- TDS expects negative free cash flow in 2016 because of anticipated growth in equipment-installment-plan receivables combined with significant capital expenditures.
- U.S. Cellular completed VoLTE field trials in Q1 2016 and expects deployment-related efforts to continue during 2016. Its LTE network reached 99% of postpaid customers and 98% of cell sites.
- U.S. Cellular entered agreements involving spectrum transfers and approximately $29 million of net cash consideration. The transactions require regulatory approval and are expected to close in 2016; gains are expected upon closing. Separately, spectrum purchase agreements with an aggregate price of $54 million remained outstanding.
- U.S. Cellular participated in FCC Auction 1000 for 600 MHz spectrum. Potential payments could be substantial, and FCC anti-collusion rules may restrict certain communications and business activities.
- U.S. Cellular’s $338 million of Auction 97 license payments remained pending before the FCC, and TDS consolidates related variable-interest entities. Consolidated VIE assets totaled $804 million, including $649 million of licenses, while VIE liabilities totaled $33 million at March 31, 2016.
- Key risks include intense wireless competition and pricing pressure, customer churn, spectrum availability and auction obligations, regulatory support reductions, high capital needs, equipment-installment-plan credit and upgrade risks, access to financing, cybersecurity, technology execution, impairment of licenses or goodwill, litigation and investments in entities TDS does not control.
- Management disclosed that TDS’s credit rating had declined to sub-investment grade and that future liquidity could be affected by weaker operating results, reduced asset-sale proceeds, lower regulatory support or limited access to financing.
- The effective tax rate was 55.7% versus 39.8% in the prior-year quarter, primarily because discrete tax adjustments had a disproportionate effect on relatively low pretax income.
- TDS adopted new variable-interest-entity consolidation guidance on January 1, 2016; the adoption did not change the entities consolidated or affect financial position or results of operations.
Most important facts for an investor to verify
- Whether U.S. Cellular can sustain improved postpaid additions and lower churn while offsetting continuing service-price pressure and declining ARPU.
- The timing, regulatory approvals and expected gains from the spectrum exchanges, and the final cost and funding requirements associated with FCC Auction 1000.
- The effect of growing equipment-installment-plan receivables, upgrade guarantees and credit losses on working capital and future free cash flow.
- Whether planned 2016 capital expenditures can be funded without materially increasing debt or reducing dividends and share repurchases.
- The availability and terms of revolving credit facilities and other financing, particularly given TDS’s sub-investment-grade credit rating.
- The status of pending FCC license grants and the potential exposure associated with consolidated variable-interest entities.