Business Context and Reporting Period
Telephone and Data Systems, Inc. (TDS) filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. TDS operates primarily through 84%-owned U.S. Cellular, which provides wireless services, and wholly owned TDS Telecom, which provides wireline, cable and hosted and managed services. TDS served approximately 4.9 million wireless customers and 1.1 million wireline and cable connections at quarter-end.
TDS revised its reportable segments to U.S. Cellular, TDS Telecom Wireline, Cable and HMS, and a Non-Reportable Segment. Prior periods were re-presented. All dollar amounts below are approximate unless otherwise stated.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | First nine months 2013 | First nine months 2012 |
|---|---|---|---|---|
| Operating revenues | $1,181.0 million | $1,370.1 million | $3,717.7 million | $3,999.1 million |
| Operating income (loss) | $(33.1) million | $55.5 million | $256.3 million | $240.2 million |
| Net income (loss) | $(11.1) million | $40.2 million | $174.3 million | $163.7 million |
| Net income (loss) attributable to TDS shareholders | $(9.5) million | $29.1 million | $148.0 million | $123.7 million |
| Diluted earnings (loss) per share | $(0.09) | $0.26 | $1.35 | $1.13 |
| Cash flow from operating activities | Not provided for quarter | Not provided for quarter | $437.9 million | $760.5 million |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $637.4 million | $697.0 million |
| Free cash flow | Not provided for quarter | Not provided for quarter | $(193.5) million | $29.6 million |
Consolidated operating margin was approximately negative 2.8% in Q3 2013 versus 4.1% in Q3 2012, and approximately 6.9% for the first nine months of 2013 versus 6.0% in the comparable 2012 period. The nine-month improvement was substantially affected by the U.S. Cellular divestiture gain and other unusual items.
- U.S. Cellular nine-month revenue declined 10% to $3.016 billion and operating income declined 18% to $177.4 million. Retail service revenue fell 8%, inbound roaming revenue fell 26%, and equipment losses increased to $405.7 million from $379.8 million.
- U.S. Cellular had 4.875 million customers at September 30, 2013, including 4.343 million postpaid and 370,000 prepaid customers. Core-market retail customers experienced a net loss of 118,000 during the period. Billed ARPU increased to $50.98 from $50.48, while service revenue ARPU declined to $57.83 from $58.76.
- TDS Telecom nine-month revenue increased 7% to $675.1 million, while operating income declined 6% to $32.5 million. Wireline revenue declined 2%, HMS revenue increased 50%, and Cable contributed $14.4 million of revenue following the Baja acquisition.
- Cash and cash equivalents were $711.1 million at September 30, 2013, compared with $740.5 million at December 31, 2012. Short-term and long-term investments totaled approximately $85.3 million.
- Current and long-term debt totaled approximately $1.723 billion, including $1.806 million of current maturities and $1.721 billion of long-term debt. TDS and U.S. Cellular had no revolving-credit borrowings outstanding; available capacity was approximately $399.7 million for TDS and $282.4 million for U.S. Cellular.
- Total assets were $8.700 billion and total equity was $4.672 billion at September 30, 2013.
Material Changes Versus the Prior Comparable Period
- U.S. Cellular completed the sale of customers and certain spectrum in Chicago, central Illinois, St. Louis and specified Indiana, Michigan and Ohio markets to Sprint on May 16, 2013 for $480 million in cash. TDS recognized a $297.6 million net gain on sale of business and other exit costs for the first nine months.
- U.S. Cellular deconsolidated the NY1 and NY2 partnerships effective April 3, 2013 and began accounting for them under the equity method. TDS recognized a $14.5 million non-cash pre-tax investment gain and increased equity earnings from unconsolidated entities.
- TDS acquired substantially all of Baja Broadband’s assets on August 1, 2013 for $264.1 million after the preliminary working-capital adjustment. Baja added approximately 146,900 cable connections and generated $14.4 million of revenue during the period after acquisition.
- U.S. Cellular completed migration to a new billing and operational support system. Billing delays increased accounts receivable and reduced operating cash flow; system outages and response-time problems also affected customer service and sales operations.
- Depreciation, amortization and accretion increased 27% to $751.6 million for the first nine months, including $134.0 million of accelerated expense associated with the divestiture markets.
- TDS authorized a new $250 million common-share repurchase program on August 2, 2013 and repurchased 204,548 shares for $5.8 million during the third quarter.
- Quarterly results deteriorated materially: U.S. Cellular posted a $43.2 million operating loss versus $48.1 million of operating income in Q3 2012, while consolidated net loss attributable to TDS shareholders was $9.5 million versus net income of $29.1 million.
Guidance, Outlook, Risks and Unusual Items
Management’s current full-year 2013 estimates were approximately $4.555 billion to $4.645 billion of adjusted operating revenue, $830 million to $960 million of adjusted income before income taxes, and $910 million of capital expenditures. U.S. Cellular’s adjusted revenue estimate was reduced to $3.590 billion to $3.640 billion; its adjusted income-before-tax and $735 million capital-expenditure estimates were unchanged. TDS Telecom’s adjusted revenue estimate increased to $920 million to $960 million, while its adjusted income-before-tax estimate remained $230 million to $260 million and capital-expenditure estimate remained $165 million.
- Guidance excludes reported gains on the divestiture, investment gains and actual or expected spectrum-license gains. Adjusted measures are non-GAAP and are not substitutes for GAAP results.
- On October 4, 2013, U.S. Cellular sold its majority Mississippi Valley unbuilt license for $308 million, expected to produce a $252.2 million gain and $96.0 million current tax expense in Q4 2013. A proposed $92.3 million sale of a St. Louis unbuilt license was subject to regulatory approval and expected to close by year-end.
- On October 4, 2013, TDS acquired MSN Communications for $40 million in cash; MSN will be included in TDS Telecom HMS.
- U.S. Cellular committed to purchase an estimated $1.2 billion of Apple iPhone products over three years beginning November 2013. Management expected higher equipment subsidies and capital requirements from Apple products.
- U.S. Cellular’s principal operating risks include customer losses, higher churn, pricing pressure, declining roaming and Universal Service Fund revenues, device subsidies, LTE investment requirements, spectrum and regulatory uncertainty, and billing-system execution.
- TDS Telecom faces declining wireline voice connections, competition from wireless, cable and VoIP providers, regulatory and Universal Service Fund changes, and integration and operating risks from Baja and other acquisitions.
- Legal proceedings and unasserted claims were accrued at $1.7 million. The filing states that potential excess losses were not expected to be material, although outcomes could differ from accrued amounts.
- Total payments under the Amdocs billing-system agreements were estimated at $183.5 million through the first half of 2014; $133.3 million had been paid by September 30, 2013.
- Management reported effective disclosure controls as of September 30, 2013 and no material change in internal control over financial reporting other than the billing-system migration.
Facts Investors Should Verify
- Whether U.S. Cellular’s billing-system delays, customer-service disruptions and higher accounts receivable lead to increased bad debts, churn or additional operating costs.
- The timing and final gain, tax expense and cash proceeds from the Mississippi Valley and proposed St. Louis spectrum-license transactions.
- Progress toward the 2013 adjusted revenue, adjusted pretax income and capital-expenditure ranges, with particular attention to the effect of non-GAAP exclusions.
- U.S. Cellular customer trends, postpaid and prepaid churn, smartphone penetration, equipment subsidies and roaming revenue.
- Integration, retention and profitability performance of Baja and MSN within TDS Telecom.
- Free cash flow conversion after capital expenditures, the effect of the special U.S. Cellular dividend, and the funding of acquisitions, network deployment and share repurchases.
- Compliance with debt covenants, availability of revolving facilities, and the impact of regulatory changes affecting Universal Service Fund support, intercarrier compensation and LTE roaming.