Telephone and Data Systems, Inc. — Q2 2012 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and six months ended June 30, 2012, filed August 3, 2012. TDS is a diversified telecommunications company with approximately 5.8 million wireless customers through 84%-owned U.S. Cellular and approximately 1.0 million wireline customer connections through TDS Telecom. TDS also operates hosted and managed services, printing and distribution, and Airadigm wireless operations.
The reportable segments are U.S. Cellular, TDS Telecom ILEC, CLEC, HMS and a non-reportable segment. Prior periods were re-presented for the revised segment structure.
Financial metrics
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Operating revenues | $1.323 billion | $1.280 billion | $2.629 billion | $2.538 billion |
| Operating income | $91.1 million | $127.4 million | $184.7 million | $216.2 million |
| Operating margin | 6.9% | 10.0% | 7.0% | 8.5% |
| Net income | $55.9 million | $109.7 million | $123.5 million | $164.0 million |
| Net income attributable to TDS shareholders | $42.3 million | $92.0 million | $94.6 million | $135.5 million |
| Diluted EPS | $0.39 | $0.84 | $0.86 | $1.23 |
| Adjusted OIBDA | Not separately provided | Not separately provided | $582.1 million | $604.5 million |
| Cash flow from operating activities | Not separately provided | Not separately provided | $506.9 million | $562.2 million |
| Free cash flow | Not separately provided | Not separately provided | $5.7 million | $211.4 million |
Six-month revenue increased 4%, but operating income declined 15% and net income attributable to TDS shareholders declined 30%. The six-month effective tax rate increased to 33.8% from 20.3%; second-quarter rates were 39.0% and 9.5%, respectively. Prior-year tax benefits from state law changes and expired statutes of limitation reduced 2011 tax expense by $30.8 million for the first six months.
At June 30, 2012, TDS had $613.8 million of cash and cash equivalents, $150.9 million of short-term investments and $55.5 million of long-term investments. Long-term debt was $1.530 billion, with total debt including current maturities of approximately $1.531 billion. Revolving credit availability was $399.8 million for TDS and $299.8 million for U.S. Cellular; neither facility had borrowings outstanding. Management stated that liquidity was sufficient for foreseeable contractual, operating and capital requirements.
Material changes versus the prior comparable period
- Second-quarter revenue rose 3%, but operating income fell 28% and diluted EPS fell 54%, primarily reflecting higher operating costs, a $17.1 million unfavorable investment comparison and higher income taxes.
- For the first six months, U.S. Cellular revenue increased 3% to $2.197 billion and operating income increased 4% to $169.4 million. Service revenue benefited from data and inbound roaming growth, while customer losses and higher network, roaming and equipment costs remained pressures.
- U.S. Cellular had 5.799 million total customers, down from 5.968 million, and a 1.6% postpaid churn rate versus 1.4%. Smartphone penetration increased to 36.8% from 23.1%, and 4G LTE coverage reached approximately 30% of customers.
- TDS Telecom revenue increased 4% to $412.6 million, mainly from OneNeck and Vital HMS acquisitions. Operating income declined 58% to $24.4 million as acquisition-related costs and unfavorable prior-year comparisons outweighed growth.
- Six-month capital expenditures increased to $452.4 million from $338.7 million, including $384.5 million at U.S. Cellular. Cash used for property, plant and equipment was $501.2 million, reducing free cash flow to $5.7 million.
- TDS acquired Vital Support Systems for approximately $46.1 million, including $45.0 million of cash consideration plus preliminary working-capital adjustments. U.S. Cellular also acquired licenses and sold a wireless market for $49.8 million, recording a $4.2 million gain.
- A sustained decrease in TDS’s stock price triggered interim impairment testing. TDS recorded a $0.5 million impairment of Airadigm goodwill; no impairment was recorded for U.S. Cellular or TDS Telecom goodwill or licenses.
- The January 2012 share consolidation reclassified Special Common Shares into Common Shares and increased Common and Series A Common Shares by a factor of 1.087. Comparative share and EPS amounts were retroactively restated.
Guidance, outlook, risks and unusual items
U.S. Cellular maintained its 2012 estimates: service revenues of $4.050–$4.150 billion, operating income of $200–$300 million, adjusted OIBDA of $800–$900 million and capital expenditures of approximately $850 million. TDS Telecom revised its estimates to revenue of $850–$880 million, operating income of $50–$70 million, adjusted OIBDA of $245–$265 million and capital expenditures of $170–$190 million.
- U.S. Cellular expects continued competitive pressure, customer churn, lower pricing, declining voice revenue, higher data and smartphone costs, and continued investment in LTE and network capacity.
- U.S. Cellular’s 2012 Universal Service Fund support is scheduled to decline by 20% beginning in July 2012, with an estimated 2012 reduction of approximately $16 million. The potential offset from the Connect America Fund or Mobility Fund remains uncertain.
- TDS Telecom faces declining physical access lines, competition from wireless, cable and VoIP providers, regulatory uncertainty and reductions in intercarrier compensation and other recovery mechanisms.
- U.S. Cellular agreed to acquire seven 700 MHz licenses for $57.7 million and four licenses for $34.0 million, subject to FCC approval and expected third- and fourth-quarter 2012 closings.
- U.S. Cellular’s Amdocs billing and operational support system implementation is expected to continue through 2013. Estimated payments are approximately $148.5 million, of which $67.4 million had been paid by June 30, 2012.
- Additional commitments included $161.3 million of increased future tower lease payments and $135.4 million of increased purchase obligations, primarily related to LTE deployment.
- TDS had accrued $2.1 million for legal proceedings and unasserted claims. An FCC Office of Inspector General subpoena concerning Universal Service Fund support remained unresolved; TDS had provided the requested information and could not predict further action.
- Management identified no material changes to previously disclosed risk factors and concluded disclosure controls were effective as of June 30, 2012.
Important facts for investors to verify
- Whether U.S. Cellular can reverse customer losses and improve postpaid churn while expanding smartphones, prepaid offerings and LTE.
- The effect of Universal Service Fund phase-downs, intercarrier compensation reform and future FCC funding decisions.
- Whether the large LTE, network, billing-system and TDS Telecom investment programs generate the projected revenue and cost benefits.
- The sustainability of very low free cash flow after capital expenditures and the effect of higher expected federal tax payments.
- Whether goodwill and wireless license fair values remain above carrying values; the filing notes that further market or operating deterioration could result in material impairment charges.
- Completion, cost and timing of the Amdocs B/OSS project and pending FCC approvals for spectrum and related transactions.
- The impact of the disclosed cash-flow and asset-retirement obligation revisions to prior-period information when comparing reported results.