Telephone and Data Systems, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. The filing was signed November 4, 2010. TDS is a diversified telecommunications company operating primarily through 83%-owned U.S. Cellular, wholly owned TDS Telecom and majority-owned Suttle-Straus. Operations covered approximately 6.1 million wireless customers and 1.1 million wireline equivalent access lines in 36 states.
Financial performance and position
| Metric | Three months ended Sept. 30, 2010 | Three months ended Sept. 30, 2009 | Nine months ended Sept. 30, 2010 | Nine months ended Sept. 30, 2009 |
|---|---|---|---|---|
| Operating revenues | $1.266 billion | $1.258 billion | $3.721 billion | $3.758 billion |
| Operating income | $83.2 million | $79.5 million | $271.5 million | $372.8 million |
| Operating margin | 6.6% | 6.3% | 7.3% | 9.9% |
| Net income | $52.6 million | $48.2 million | $167.2 million | $230.4 million |
| Net income attributable to TDS shareholders | $40.6 million | $36.8 million | $129.3 million | $177.2 million |
| Diluted EPS | $0.38 | $0.34 | $1.22 | $1.60 |
For the nine-month period, adjusted OIBDA was $851.2 million versus $940.4 million, and adjusted OIBDA margin was approximately 22.9% versus 25.0%. Net margin was approximately 4.5% versus 6.1%. Third-quarter results improved modestly, but year-to-date profitability declined materially.
- Cash flow: Operating cash flow was $764.8 million, down from $800.0 million. Capital expenditures were $486.1 million, producing reported free cash flow of $278.6 million versus $349.4 million.
- Investing and financing: Investing cash outflow was $905.7 million, including $433.8 million of investments and $486.1 million of capital expenditures. Financing cash outflow was $140.1 million, including $50.5 million of TDS share repurchases, $40.5 million of U.S. Cellular share repurchases and $35.5 million of dividends.
- Liquidity: Cash and cash equivalents were $390.0 million; short-term investments were $389.1 million; long-term investments were $121.4 million. Total cash and investments were approximately $900.5 million. Revolving credit availability was $696.4 million, with no borrowings outstanding.
- Debt: Current and long-term debt totaled approximately $1.494 billion. Public debt included TDS notes of $616.3 million and U.S. Cellular senior notes of $874.0 million. The filing states that debt covenants were satisfied and that near-term principal maturities represented less than 1% of total long-term debt.
- Capital structure: Total assets were $7.694 billion and total equity was $4.486 billion at September 30, 2010. TDS repurchased 1.784 million Special Common Shares year-to-date and 705,000 during the third quarter.
Material changes versus the prior comparable period
- Year-to-date revenue declined 1%, while operating expenses increased 2%, driving a 27% decline in operating income and net income.
- U.S. Cellular revenue decreased 1% to $3.115 billion and operating income fell 37% to $201.0 million. Higher system operations, selling and administrative costs, depreciation and investments in network and support systems outweighed data growth.
- U.S. Cellular service revenue decreased 1%, but data revenue increased 31% to $645.4 million and represented 22% of service revenue. Voice revenue remained under pressure from competition and lower pricing.
- U.S. Cellular had 6.103 million customers, including 5.750 million retail customers. Retail net additions improved to 6,000 from a net loss of 2,000; postpaid churn improved to 1.5% from 1.6%, although postpaid customers declined by 56,000.
- TDS Telecom revenue increased 1% to $596.7 million and operating income increased 11% to $75.0 million. ILEC growth in data services and acquisitions offset declining voice lines and CLEC revenue.
- TDS Telecom equivalent access lines declined 2% to 1.1125 million. ILEC high-speed data customers increased 13%, while CLEC equivalent access lines decreased 7% and residential CLEC lines declined 24%.
- Interest expense decreased $7.4 million year-to-date, primarily due to the December 2009 redemption of U.S. Cellular’s 8.75% senior notes.
- TDS revised comparative prior-period amounts under SAB 108 after identifying errors involving operating revenues and sales-tax liabilities. Management concluded the errors were immaterial to the affected historical periods, but the cumulative correction was significant to certain 2010 interim comparisons.
- Fitch downgraded TDS and U.S. Cellular from BBB+ to BBB during the third quarter; both remained investment grade.
Guidance, outlook, risks and unusual items
- U.S. Cellular 2010 estimates: Service revenue of $3.925–$3.975 billion; adjusted OIBDA of $800–$850 million; operating income of $200–$250 million; approximately $600 million of capital expenditures; and approximately $600 million of depreciation, amortization, accretion and asset-disposal losses. The service-revenue range was narrowed, while other estimates were unchanged.
- TDS Telecom 2010 estimates: ILEC and CLEC revenue of $785–$800 million; adjusted OIBDA of $265–$280 million; operating income of $90–$105 million; approximately $155 million of capital expenditures; and approximately $175 million of depreciation, amortization, accretion and asset-disposal losses. Revenue, adjusted OIBDA and operating-income ranges were raised from the prior estimates.
- U.S. Cellular launched The Belief Project on October 1, 2010, including simplified rate plans, loyalty rewards, overage protection and a phone replacement program. Management expects the initiative to support customer additions, revenue per customer and churn over time.
- U.S. Cellular entered into a B/OSS agreement with Amdocs. Estimated implementation payments are $73 million through 2012, plus $36.4 million of maintenance commitments over seven years beginning in 2013.
- TDS Telecom expects to receive $105.1 million of federal broadband stimulus grants and contribute $30.9 million toward 44 projects.
- Early adoption of ASU 2009-13 began October 1, 2010 in connection with new bundled wireless offerings. Revenue associated with loyalty rewards will generally be deferred until redemption or expiration; management did not expect a significant effect on 2010 or 2011 total retail service revenue.
- Key risks include intense wireless and wireline competition, declining voice and access-line trends, lower roaming revenue following industry consolidation, regulatory and Universal Service Fund changes, FCC spectrum and broadband policy, technology transitions, execution of multi-year systems projects, impairment of licenses or goodwill, economic conditions, financing access, litigation and contingent liabilities.
- The company stated that it had no material off-balance-sheet arrangements and no material change in contractual obligations other than ordinary-course changes and the Amdocs commitments. Legal outcomes could differ materially from recorded accruals.
Important facts investors should verify
- Whether U.S. Cellular’s data growth and The Belief Project can offset continued voice-price pressure, customer losses and declining roaming revenue.
- Progress, total cost and capitalization of the Amdocs B/OSS implementation and related maintenance obligations.
- Actual full-year results relative to the U.S. Cellular and TDS Telecom guidance ranges.
- Effects of the Fitch downgrade on future borrowing costs, refinancing capacity and credit-facility terms.
- Changes in FCC rules, Universal Service Fund support, intercarrier compensation and broadband regulation.
- Whether operating cash flow and liquidity remain sufficient to fund approximately $755 million of guided 2010 segment capital expenditures, acquisitions, debt service, dividends and share repurchases.
- Potential additional effects of the SAB 108 revisions and the company’s controls and financial reporting processes.