Telephone and Data Systems, Inc. — Q1 2011 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 31, 2011, compared with the three months ended March 31, 2010. TDS operates primarily through 83%-owned U.S. Cellular, its wireless business, and wholly owned TDS Telecom, its wireline business. The company served approximately 6.0 million wireless customers and 1.1 million wireline equivalent access lines at March 31, 2011.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Operating revenues | $1,258.7 million | $1,222.4 million | +3% |
| Operating income | $87.2 million | $102.0 million | -15% |
| Operating margin | 6.9% | 8.3% | Down 1.4 points |
| Net income | $52.2 million | $62.3 million | -16% |
| Net income attributable to TDS shareholders | $41.6 million | $48.4 million | -14% |
| Diluted EPS | $0.40 | $0.45 | Down $0.05 |
| Adjusted OIBDA | $280.8 million | $296.8 million | -5% |
| Cash flow from operating activities | $261.8 million | $210.7 million | +$51.1 million |
| Capital expenditures | $127.5 million | $146.6 million | -13% |
| Free cash flow | $134.3 million | $64.0 million | +$70.3 million |
Adjusted OIBDA margin was approximately 22.3%, compared with 24.3% in the prior-year quarter. The effective tax rate declined to 35.6% from 37.9%, helped by a $1.7 million favorable change in estimates for certain state tax contingencies and other discrete benefits.
U.S. Cellular revenue increased 3% to $1,057.1 million, but operating income fell 27% to $57.0 million. Service revenue rose 2% to $985.1 million, while equipment sales increased 22%; equipment losses increased to $122.4 million from $102.3 million. TDS Telecom revenue rose 2% to $198.9 million and operating income increased 24% to $32.2 million.
Liquidity, debt and balance sheet
- Cash and cash equivalents were $592.0 million at March 31, 2011, compared with $368.1 million at December 31, 2010.
- Short-term and long-term investments totaled $381.1 million, producing total unrestricted cash and investments of $973.1 million. Restricted cash of $282.5 million was set aside for debt redemption.
- Total debt was approximately $1.80 billion, consisting of $284.2 million of current debt and $1.52 billion of long-term debt. The increase in current debt primarily reflected the planned redemption of the 7.6% Series A notes.
- TDS issued $300 million of 7% senior notes due 2060 in March 2011 and paid $9.8 million of related issuance costs. The proceeds were used substantially to redeem the $282.5 million of 7.6% Series A notes on May 2, 2011.
- TDS and U.S. Cellular had no revolving-credit borrowings outstanding and had approximately $699.6 million of combined availability, net of letters of credit.
- Management stated that available cash, investments, operating cash flow and external financing capacity were sufficient for anticipated needs. Credit ratings were investment grade and debt covenants were reported to be satisfied.
Material changes versus the prior comparable period
- Revenue growth did not translate into profit growth because U.S. Cellular experienced higher network, equipment, selling and administrative costs.
- U.S. Cellular’s total customers declined to 6.033 million from 6.147 million; retail customer net losses were 31,000 versus net additions of 24,000. Postpaid churn remained 1.4%.
- Smartphone penetration increased to 20.2% from 8.9%, and smartphones represented 42.5% of devices sold versus 16.6%. This supported higher equipment revenue but increased device subsidies and equipment losses.
- U.S. Cellular’s inbound roaming revenue increased 24%, and ETC revenue increased to $41.8 million from $34.8 million.
- TDS Telecom equivalent access lines decreased 3% to 1.096 million. ILEC data revenue increased 28%, while voice and network access revenues declined.
- TDS Telecom operating expenses decreased 2%, aided by lower network costs and discrete benefits including insurance proceeds, a regulatory contribution refund and settlement of a legal dispute.
- Equity in earnings of unconsolidated entities declined 22% to $19.4 million, including lower contribution from the Los Angeles SMSA Limited Partnership.
- Share repurchases totaled $11.6 million for TDS Special Common Shares and $17.4 million for U.S. Cellular shares. The quarterly dividend increased to $0.1175 per share from $0.1125.
Guidance, outlook, risks and unusual items
Management provided segment guidance but no consolidated TDS guidance. U.S. Cellular’s 2011 estimates were unchanged for service revenue of $4.0–$4.1 billion, adjusted OIBDA of $775–$875 million and operating income of $185–$285 million. U.S. Cellular capital expenditures were increased to $750–$800 million from approximately $650 million, reflecting planned LTE deployment and network investments.
TDS Telecom’s 2011 estimates were unchanged for ILEC and CLEC revenue of $780–$810 million, adjusted OIBDA of $260–$290 million, operating income of $75–$105 million and capital expenditures of $175–$200 million. Guidance excludes $105.1 million of federal Broadband Stimulus grants awarded for projects scheduled through 2013.
- Key operating risks include intense wireless and wireline competition, customer losses, pricing pressure, prepaid growth, device availability, roaming changes, and rapid technology changes including LTE, VoIP and WiMax.
- Future results depend on data-service growth, customer retention, network capacity, LTE deployment, business-support-system investments and the ability to control equipment subsidies and operating costs.
- Regulatory uncertainty includes FCC rulemaking, mandatory data-roaming requirements, Universal Service Fund funding and intercarrier compensation.
- TDS expects a federal net operating loss in 2011 from bonus depreciation and recorded a $21.7 million deferred tax asset related to an estimated federal tax-loss carryback. Federal tax payments may increase substantially beginning in 2013 if further bonus depreciation is not enacted.
- Legal proceedings and unasserted claims accrued were $6.7 million at March 31, 2011. The company stated that excess contingent losses were not expected to be material, although ultimate outcomes could differ from recorded amounts.
- The filing identifies potential future funding obligations for consolidated wireless-spectrum variable interest entities; TDS had contributed or advanced $568.8 million to these entities as of March 31, 2011.
- The quarter included a $7.2 million write-off of debt issuance costs related to the redeemed Series A notes, recognized as interest expense in May 2011 rather than in the quarter ended March 31, 2011.
Investor verification points
- Verify the May 2, 2011 redemption of the $282.5 million 7.6% Series A notes and the resulting effect on interest expense and debt maturity.
- Assess whether U.S. Cellular’s customer losses, higher smartphone adoption and equipment subsidies support or undermine the full-year adjusted OIBDA guidance.
- Compare actual LTE capital spending with the revised $750–$800 million U.S. Cellular capital expenditure forecast.
- Monitor wireless roaming, ETC and Universal Service Fund revenues, which materially influenced Q1 revenue growth.
- Evaluate the sustainability of TDS Telecom’s improvement given continuing access-line declines and regulatory uncertainty.
- Review future federal tax cash payments as bonus depreciation benefits reverse.
- Reconcile non-GAAP adjusted OIBDA and free cash flow to GAAP operating income and operating cash flow, and review the company’s stated risks concerning impairments, litigation, VIE funding and access to capital.