Telephone and Data Systems, Inc. — Q3 2016 Form 10-Q Summary
Business Context and Reporting Period
Unaudited results cover the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods. TDS is a diversified U.S. telecommunications company serving approximately 6 million customers through 83%-owned U.S. Cellular and wholly owned TDS Telecom, which includes Wireline, Cable and Hosted and Managed Services (HMS).
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Operating revenues | $1.301 billion | $1.374 billion | $3.826 billion | $3.902 billion |
| Operating income | $20 million | $93 million | $76 million | $408 million |
| Net income | $16 million | $62 million | $58 million | $265 million |
| Net income attributable to TDS shareholders | $13 million | $51 million | $49 million | $220 million |
| Diluted EPS | $0.11 | $0.46 | $0.44 | $1.99 |
| Adjusted EBITDA | $287 million | $334 million | $869 million | $912 million |
| Cash flows from operating activities | Not separately provided | Not separately provided | $638 million | $727 million |
| Capital expenditures | $145 million | $194 million | $412 million | $487 million |
| Free cash flow | Not separately provided | Not separately provided | $212 million | $169 million |
Consolidated operating margin was approximately 1.5% in Q3 2016 versus 6.8% in Q3 2015, and approximately 2.0% for the first nine months versus 10.5% in the prior-year period. Net margin was approximately 1.2% in Q3 and 1.5% year to date.
- Cash and cash equivalents were $985 million at September 30, 2016, unchanged from December 31, 2015.
- Total long-term debt, including current maturities, was approximately $2.448 billion at September 30, 2016, compared with $2.454 billion at year-end 2015.
- TDS had $399 million available under its $400 million revolving facility; U.S. Cellular had $284 million available under its $300 million facility. Neither facility had outstanding borrowings other than letters of credit.
- 2016 capital expenditure expectations were approximately $500 million for U.S. Cellular and $180 million for TDS Telecom.
Material Changes Versus the Prior Comparable Period
- Revenue declined 5% in Q3 and 2% year to date. The primary factor was the absence of $58 million of revenue recognized in Q3 2015 from expired loyalty rewards points.
- U.S. Cellular revenue declined 6% in Q3 and 2% year to date. Service revenue fell 14% and 10%, respectively, while equipment sales increased 38% and 42% as customers increasingly adopted equipment installment plans.
- U.S. Cellular operating income fell 88% in Q3 and 92% year to date. The 2015 nine-month period benefited from a $108 million tower-sale gain and significantly greater gains on license and business transactions.
- U.S. Cellular operating trends improved operationally: year-to-date postpaid net additions increased to 75,000 from 43,000, postpaid churn decreased to 1.27% from 1.41%, and retail connections increased to 4.964 million from 4.721 million.
- TDS Telecom revenue declined 4% in Q3 and 1% year to date, while operating income declined 32% and 17%, respectively. Cable revenue increased, but HMS equipment revenue declined and Wireline revenue was broadly flat.
- Operating cash flow declined $89 million year to date, primarily reflecting lower earnings and a $160 million increase in equipment installment plan receivables. Lower capital expenditures helped increase free cash flow to $212 million from $169 million.
- Interest expense increased to $127 million year to date from $103 million, primarily due to U.S. Cellular debt issued in November 2015 and its senior term-loan borrowing.
Guidance, Outlook, Risks and Unusual Items
- Management expects minimal free cash flow in 2016 because of rising equipment installment plan receivables and significant capital expenditures.
- U.S. Cellular expects system operating expenses to rise as it expands network capacity and deploys new technologies, partially offset by anticipated 4G LTE efficiencies. A multi-year commercial VoLTE rollout is planned beginning in early 2017.
- U.S. Cellular paid $143 million to the FCC for initial eligibility in the 600 MHz Auction 1002. Additional payments could be substantial if it wins licenses; the deposit could be partially or fully refunded if it does not.
- U.S. Cellular completed license exchanges and purchases that generated $16 million of gains and $15 million of cash proceeds through September 30. Additional transactions and gains were expected in the fourth quarter.
- TDS Telecom elected the FCC’s A-CAM support path. The offer described $82 million of annual support for ten years in exchange for broadband build-out obligations covering approximately 159,600 homes, but the FCC indicated that elected support exceeded available funding and the final funding level remained uncertain.
- Q3 included a $13 million U.S. Cellular expense related to terminating a naming-rights agreement. TDS also recorded immaterial out-of-period adjustments related to equipment installment plans and prior Wireline depreciation.
- Principal risks include intense competition, price pressure and churn, roaming and regulatory-support reductions, spectrum availability and auction costs, equipment-installment credit and collection risk, substantial indebtedness, sub-investment-grade credit ratings, technology execution, cybersecurity, litigation and access to capital.
- The filing states that there were no material changes to previously reported legal proceedings, market-risk information or risk factors, and no material off-balance-sheet arrangements.
Most Important Facts to Verify
- Reconcile the sharp decline in reported earnings with the nonrecurring 2015 rewards-points, tower-sale and license-sale gains.
- Monitor U.S. Cellular’s postpaid additions, churn, ARPU/ABPU trends and the effect of the transition to equipment installment plans on cash flow, receivables and credit losses.
- Verify the final outcome and funding level of the FCC’s A-CAM program, including required broadband capital commitments.
- Track Auction 1002 results, potential spectrum payments and the timing and gains from pending license exchanges.
- Review debt maturities, covenant compliance, credit ratings and the availability of the revolving facilities.
- Assess whether projected 2016 capital expenditures and equipment installment plan receivable growth are consistent with the company’s minimal-free-cash-flow outlook.