Telephone and Data Systems, Inc. — Q3 2018 Form 10-Q Summary
Business context and reporting period
TDS is a diversified U.S. telecommunications company serving approximately 6 million connections. Its principal businesses are 82%-owned U.S. Cellular, providing wireless services, and wholly owned TDS Telecom, comprising Wireline and Cable operations. This Form 10-Q covers the three and nine months ended September 30, 2018, compared with the comparable 2017 periods. Effective January 1, 2018, hosted and managed services was reclassified from TDS Telecom to Corporate, Eliminations and Other; prior periods were recast.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | YTD 2018 | YTD 2017 |
|---|---|---|---|---|
| Total operating revenues | $1,297 million | $1,251 million | $3,777 million | $3,736 million |
| Operating income (loss) | $51 million | $(233) million | $192 million | $(125) million |
| Net income (loss) | $53 million | $(231) million | $155 million | $(176) million |
| Net income (loss) attributable to TDS shareholders | $46 million | $(181) million | $119 million | $(134) million |
| Diluted EPS | $0.41 | $(1.64) | $1.04 | $(1.21) |
| Adjusted EBITDA | $321 million | $283 million | $979 million | $881 million |
| Capital expenditures | $177 million | $172 million | $430 million | $402 million |
- Reported operating margin was approximately 3.9% in Q3 and 5.1% year to date, versus negative margins in the 2017 comparable periods. Net margin attributable to TDS shareholders was approximately 3.5% in Q3 and 3.1% year to date.
- U.S. Cellular revenue increased 4% in Q3 and 2% year to date. Adjusted EBITDA increased 19% in both periods to $243 million and $750 million, respectively. U.S. Cellular operating income was $34 million in Q3 and $155 million year to date, compared with losses in 2017.
- TDS Telecom revenue increased 2% in Q3 and 1% year to date. Wireline revenue declined 1% and 2%, respectively, while Cable revenue increased 11% and 12%. TDS Telecom operating income was $28 million in Q3 and $71 million year to date.
- U.S. Cellular ended the quarter with 4.994 million retail connections, down from 5.028 million a year earlier. Postpaid connections declined to 4.466 million, while prepaid connections increased to 528,000. Postpaid churn rose to 1.29% from 1.16%.
- U.S. Cellular postpaid ARPU increased to $45.31 in Q3 from $43.41; postpaid ABPU increased to $59.41 from $54.71. These metrics benefited from higher-priced plans, device protection revenue and increased equipment-installment billings.
- Cash flows from operating activities were $812 million year to date, compared with $621 million in 2017. Free cash flow, a non-GAAP measure, was $365 million versus $223 million.
- Cash and cash equivalents were $1.062 billion at September 30, 2018, compared with $619 million at December 31, 2017. Gross long-term debt, including current maturities, was approximately $2.442 billion.
- TDS reported $2.422 billion of long-term debt, net, and $20 million of current debt. TDS had $399 million of unused capacity under its revolving credit facility and U.S. Cellular had $298 million; neither facility had cash borrowings outstanding.
Material changes versus the prior comparable period
- Results improved substantially because the third quarter of 2017 included $370 million of U.S. Cellular goodwill impairment, $227 million of TDS-level impairment related to the U.S. Cellular reporting unit and $35 million of HMS impairment. No goodwill impairment was recorded in Q3 2018.
- Consolidated adjusted EBITDA increased 13% in Q3 and 11% year to date, primarily reflecting higher U.S. Cellular revenue and operating performance.
- U.S. Cellular service revenue increased 3% in Q3, including a 35% increase in inbound roaming revenue, while equipment sales increased 7%. Higher roaming, network maintenance and cell-site costs partially offset revenue gains.
- Wireline results reflected broadband and video growth, pricing increases and A-CAM support, but commercial and legacy voice connections declined. Cable revenue growth was offset by higher programming, operating and depreciation expenses.
- TDS adopted the new revenue recognition standard, ASU 2014-09, using the modified retrospective method. Retained earnings increased by $163 million at January 1, 2018. The standard changed the timing and classification of wireless equipment and service revenue and increased contract-related assets and liabilities.
- TDS prospectively changed the estimated useful life of Cable video franchise rights from indefinite to 15 years. This increased depreciation by $13 million and reduced year-to-date net income by $10 million, or $0.09 basic EPS and $0.08 diluted EPS.
Guidance, outlook, commentary and risks
- Management expected 2018 capital expenditures of approximately $500 million for U.S. Cellular and $250 million for TDS Telecom. Planned spending supports network capacity, VoLTE, fiber and broadband expansion, A-CAM obligations, Cloud TV and information technology.
- TDS expected 2019 capital expenditures to increase relative to 2018, primarily because of continued fiber investment and U.S. Cellular network-capacity and 5G deployment investments. U.S. Cellular planned a 5G trial beginning in the fourth quarter of 2018.
- U.S. Cellular applied to participate in the FCC’s 28 GHz and 24 GHz spectrum auctions. The company may require additional capital for spectrum, acquisitions, network investment and other strategic purposes.
- Legacy Federal USF support remains subject to the FCC Mobility Fund Phase II process. TDS could not predict the timing of the auction, the resulting phase-down of legacy support or whether new support would offset the reduction.
- TDS stated that existing cash, investments, revolving credit facilities, receivables securitization capacity and expected cash flows should provide sufficient liquidity for normal operations and debt service for the coming year. However, TDS’s credit rating was sub-investment grade, and management warned that access to financing could be constrained.
- The Department of Justice is investigating U.S. Cellular and TDS under the False Claims Act concerning participation in certain FCC spectrum auctions. The companies are cooperating and believe their arrangements complied with applicable law, but cannot predict the outcome.
- Principal risks include intense competition, customer churn, technology and 5G execution, spectrum availability and costs, declining regulatory support, indebtedness, credit-market access, equipment-plan credit losses, potential asset impairments, cybersecurity incidents, litigation and regulatory changes.
- No material changes to previously disclosed risk factors were identified, and no material off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Reconcile reported 2018 results with 2017 results given the ASU 2014-09 revenue-recognition transition and the large 2017 goodwill impairments.
- Monitor U.S. Cellular postpaid connection trends, churn, equipment-installment receivables and credit-loss allowances.
- Assess whether projected 2018 and 2019 network, fiber, Cloud TV, VoLTE and 5G investments generate sufficient returns and free cash flow.
- Review total debt maturities, the sub-investment-grade credit rating and the availability of TDS, U.S. Cellular and receivables-securitization financing.
- Track the FCC Mobility Fund Phase II process, A-CAM obligations and spectrum auction participation and spending.
- Follow the DOJ False Claims Act inquiry and assess potential financial, regulatory or reputational consequences.
- Confirm the effect of the Cable franchise-rights useful-life change and future impairment testing.