Telephone and Data Systems, Inc. — Q1 2019 Form 10-Q Summary
Business Context and Reporting Period
TDS is a diversified U.S. telecommunications company serving approximately 6 million connections through its 82%-owned U.S. Cellular wireless subsidiary and wholly owned TDS Telecom Wireline and Cable businesses. The filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Operating revenues | $1,257 million | $1,225 million | +3% |
| Operating income | $94 million | $80 million | +18% |
| Income before taxes | $104 million | $81 million | +29% |
| Net income | $70 million | $57 million | +24% |
| Net income attributable to TDS shareholders | $59 million | $39 million | +53% |
| Diluted EPS | $0.50 | $0.34 | +$0.16 |
| Adjusted EBITDA | $365 million | $340 million | +7% |
| Capital expenditures | $147 million | $115 million | +28% |
| Cash flow from operations | $327 million | $214 million | +53% |
| Free cash flow | $172 million | $83 million | +107% |
Calculated margins were approximately 7.5% for operating income, 5.6% for consolidated net income, 4.7% for net income attributable to TDS shareholders, and 29.0% for Adjusted EBITDA. The effective tax rate increased to 32.6% from 29.7%, primarily because Q1 2018 included a discrete tax benefit related to the Tax Act.
Segment Performance and Material Changes
- U.S. Cellular: Revenue increased 3% to $966 million. Operating income declined 1% to $64 million, while net income increased 6% to $58 million and Adjusted EBITDA increased 8% to $281 million. Results benefited from higher-priced service plans and increased device protection revenue, partially offset by higher equipment costs, depreciation, and network investment.
- U.S. Cellular had 4.943 million retail connections at March 31, 2019, down from 5.006 million a year earlier. Postpaid gross additions increased 6%, postpaid net losses improved to 32,000 from 37,000, and total postpaid churn increased to 1.26% from 1.23%.
- TDS Telecom: Revenue was essentially flat at $230 million, but operating income increased 47% to $37 million and net income increased 47% to $31 million. The improvement primarily reflected a gain on the sale of Wireline fiber assets and lower employee-related expenses.
- Wireline: Revenue declined 3% to $171 million as commercial, wholesale, and legacy voice revenues decreased. Operating income increased 31% to $34 million, primarily because of the asset-disposal gain and lower expenses. Broadband and video connections grew, while voice connections declined.
- Cable: Revenue increased 8% to $60 million, connections increased 6%, and operating income improved to $2 million from a $1 million loss. Broadband connections increased 9%, supporting higher revenue and Adjusted EBITDA of $20 million versus $16 million.
Cash, Debt, Liquidity, and Capital Allocation
- Cash and cash equivalents were $959 million at March 31, 2019, compared with $921 million at December 31, 2018. Cash, cash equivalents, and restricted cash totaled $966 million.
- Long-term debt, net, was $2.414 billion, with a current portion of $21 million. TDS reported no cash borrowings under its revolving credit agreements or U.S. Cellular’s receivables securitization agreement.
- Unused revolving credit capacity was $400 million for TDS and $298 million for U.S. Cellular. U.S. Cellular also had $200 million of unused receivables-securitization capacity, subject to collateral availability.
- Debt payments due during the remainder of 2019 and the next four years totaled $204 million. TDS disclosed that its credit rating was sub-investment grade.
- Operating lease adoption under ASC 842 added $965 million of operating lease right-of-use assets and $1.039 billion of operating lease liabilities to the March 31, 2019 balance sheet.
- TDS paid $19 million in dividends during the quarter. No TDS share repurchases occurred; $199 million remained available under the repurchase authorization.
Guidance, Outlook, Risks, and Unusual Items
- 2019 capital expenditures were expected to be $625 million to $725 million for U.S. Cellular and $300 million to $350 million for TDS Telecom. Planned investments include 5G and VoLTE deployment, network capacity, fiber expansion, A-CAM obligations, broadband upgrades, and the TDS TV+ video platform.
- TDS accepted an additional A-CAM offer providing $198 million of additional funding and increasing annual support to approximately $82 million through 2028, subject to additional broadband buildout obligations.
- Subsequent to March 31, 2019, TDS committed to purchase spectrum licenses for $120 million, subject to regulatory approval. Separately, the notes state that total 2019 spectrum commitments were $249 million, of which $135 million had been paid by March 31.
- Operating cash flow benefited from improved working-capital timing and was partly offset by $155 million of property and equipment additions and $135 million of advance spectrum payments.
- The Department of Justice is investigating U.S. Cellular and TDS participation in certain FCC spectrum auctions under the False Claims Act. Management believes the arrangements complied with applicable law and FCC rules, but the outcome cannot be predicted.
- Key risks include intense competition, customer churn, technology deployment and 5G execution, spectrum availability and costs, regulatory support, sub-investment-grade credit, substantial indebtedness, access to financing, cybersecurity, litigation, and possible impairment of licenses, goodwill, or other assets.
- The filing disclosed no material changes to previously reported risk factors and no material off-balance-sheet arrangements. Disclosure controls were assessed as effective.
Important Facts for Investors to Verify
- Reconcile reported GAAP earnings with non-GAAP Adjusted EBITDA and free cash flow, particularly the impact of asset-sale gains, license gains, and other adjustments.
- Monitor U.S. Cellular’s connection trends, churn, pricing, equipment margins, roaming economics, and the return on 5G and VoLTE investments.
- Verify the timing, regulatory approval, and funding requirements for the $120 million post-quarter spectrum commitment and the broader $249 million 2019 spectrum commitment.
- Assess whether projected 2019 capital expenditures can be funded through operating cash flow and existing liquidity without increasing leverage.
- Evaluate the impact of the DOJ False Claims Act inquiry, including potential penalties, repayments, restrictions, or other remedies.
- Consider the effect of ASC 842 lease liabilities and the company’s sub-investment-grade credit rating on leverage, liquidity, and future financing costs.