Telephone and Data Systems, Inc. — 2015 First-Quarter Form 10-Q
Business context and reporting period
Unaudited results for the three months ended March 31, 2015, compared with the three months ended March 31, 2014. TDS operates through 84%-owned U.S. Cellular and wholly owned TDS Telecom, which includes Wireline, Cable, and Hosted and Managed Services. TDS served approximately 4.8 million wireless customers and 1.2 million wireline and cable connections at quarter-end.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total operating revenues | $1.252 billion | $1.196 billion | +5% |
| Operating income | $282.6 million | $20.7 million | +$261.9 million |
| Operating margin | 22.6% | 1.7% | +20.9 points |
| Net income | $175.8 million | $20.3 million | +$155.5 million |
| Net income attributable to TDS shareholders | $145.7 million | $18.3 million | +$127.5 million |
| Net income available to common shareholders | $145.7 million | $18.2 million | +$127.5 million |
| Diluted EPS | $1.33 | $0.16 | +$1.17 |
| Adjusted EBITDA | $290.9 million | $189.7 million | +53% |
| Cash flow from operating activities | $355.3 million | $104.9 million | +$250.4 million |
| Adjusted free cash flow | $204.6 million | $(34.7) million | +$239.3 million |
| Cash and cash equivalents at March 31 | $635.1 million | $872.9 million | Prior-year comparison |
| Long-term debt at March 31 | $1.993 billion | Not provided for the comparable date in the filing excerpt |
Net margin was approximately 14.0% in Q1 2015 versus 1.7% in Q1 2014. The effective tax rate increased to 39.8% from 36.5%. TDS received a $99.7 million federal income tax refund during the quarter related to a 2014 net operating loss and recovery of estimated taxes.
Material changes versus the prior comparable period
- U.S. Cellular revenue increased 4% to $965.2 million. Equipment sales rose 90% to $137.0 million, primarily from equipment installment plans, while service revenue declined 3% to $828.2 million.
- U.S. Cellular retail customer net additions improved to 21,000 from a net loss of 80,000. Postpaid churn improved to 1.5% from 2.3%, while billed ARPU declined to $52.29 from $53.93.
- U.S. Cellular operating income increased to $250.3 million from $7.8 million. Excluding gains, underlying operating income improved by $106.5 million, driven by lower equipment losses, selling, general and administrative expense, and depreciation.
- TDS Telecom revenue increased 7% to $280.0 million and operating income increased 18% to $21.2 million. The September 2014 BendBroadband acquisition contributed materially to the year-over-year increase, particularly in Cable.
- Wireline revenue declined 1%, reflecting lower commercial and wholesale revenue and declining legacy voice connections, partly offset by broadband and IPTV growth. Cable revenue increased 94%, primarily due to acquisitions. HMS revenue declined 3%.
- Operating cash flow increased substantially because of working-capital changes, the $99.7 million tax refund, and higher accrued taxes. Inventory reductions also contributed, while increased equipment-installment-plan receivables partially offset inflows.
- Cash used in investing activities increased to $170.3 million, including $280.7 million for acquisitions and licenses and $166.5 million for property, plant and equipment. Cash received from divestitures and exchanges was $274.1 million.
Guidance, outlook, risks and unusual items
- Management expects 2015 capital expenditures of approximately $600 million for U.S. Cellular and $220 million for TDS Telecom, primarily for network capacity, 4G LTE deployment, infrastructure, fiber, data centers, and operating systems.
- U.S. Cellular acquired 124 AWS-3 licenses through Advantage Spectrum for an aggregate winning bid of $338.3 million and funded approximately $280.6 million of loans and contributions to related variable interest entities during the quarter.
- A March 2015 PCS license exchange generated a $125.2 million gain. The January 2015 sale of 359 towers generated a $119.6 million gain. These and other divestiture and license gains materially inflated reported operating income.
- U.S. Cellular discontinued its loyalty rewards program effective September 1, 2015. Approximately $95.4 million of related deferred revenue was outstanding at March 31, 2015 and may be recognized as revenue when unredeemed points expire; the filing states that the impact on redemptions and future results cannot be predicted.
- Equipment installment plans create exposure to customer upgrade behavior, device trade-in values, credit losses, and reduced monthly service charges. The related guarantee liability was $67.8 million at March 31, 2015.
- Key risks include intense wireless and broadband competition, declining roaming revenue, pricing pressure, spectrum availability and auction commitments, network and billing-system performance, regulatory uncertainty, the FCC net-neutrality order, technology changes, acquisitions and integration, cybersecurity, financing access, and potential impairment of licenses, goodwill, or other assets.
- TDS reported $399.4 million of unused capacity under its revolving facility and U.S. Cellular reported $282.5 million of unused revolving capacity, plus $225.0 million of unused term-loan capacity. Neither company had borrowings under these facilities at March 31, 2015. Management stated that liquidity was sufficient for normal operating needs but might not fund all potential spectrum, acquisition, construction, and development programs.
- No material changes to contractual obligations, legal proceedings, market-risk disclosures, or previously disclosed risk factors were reported. Disclosure controls were deemed effective, although U.S. Cellular began relying on certain third-party controls after outsourcing B/OSS support functions.
Most important facts for investors to verify
- Separate recurring operating performance from the $234.4 million of combined U.S. Cellular gains on license exchanges and business or tower sales.
- Assess whether customer additions, churn improvement, smartphone penetration, and equipment-installment-plan adoption can offset declining service ARPU and roaming revenue.
- Review the cash-flow benefit from the $99.7 million tax refund, accrued taxes, inventory reduction, and divestiture reimbursements for sustainability.
- Monitor the cash requirements and operating risks associated with the $338.3 million AWS-3 spectrum commitment and consolidated variable interest entities.
- Evaluate the effect of the loyalty-rewards program termination and recognition of up to $95.4 million of deferred revenue.
- Compare actual 2015 capital spending and financing needs with the stated $820 million capital-expenditure plan and available credit capacity.