Telephone and Data Systems, Inc. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2017, filed November 8, 2017. TDS is a diversified U.S. telecommunications company serving approximately 6 million connections through 83%-owned U.S. Cellular and wholly owned TDS Telecom, which includes Wireline, Cable and Hosted and Managed Services (HMS).
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | First nine months 2017 | First nine months 2016 |
|---|---|---|---|---|
| Operating revenues | $1,251 million | $1,314 million | $3,736 million | $3,863 million |
| Operating income (loss) | $(232) million | $33 million | $(122) million | $113 million |
| Net income (loss) | $(231) million | $16 million | $(176) million | $58 million |
| Net income (loss) attributable to TDS shareholders | $(181) million | $13 million | $(134) million | $49 million |
| Diluted EPS | $(1.64) | $0.11 | $(1.21) | $0.44 |
| Adjusted EBITDA | $283 million | $287 million | $881 million | $869 million |
| Adjusted OIBDA | $244 million | $248 million | $768 million | $752 million |
| Capital expenditures | $172 million | $145 million | $402 million | $412 million |
Q3 operating margin was approximately negative 18.5%, compared with approximately 2.5% in the prior-year quarter, primarily because of goodwill impairment charges. Excluding the impairment and other specified adjustments, Adjusted EBITDA was broadly stable.
- Goodwill impairment: TDS recorded a $262 million consolidated non-cash charge, consisting of $227 million for U.S. Cellular and $35 million for HMS. The estimated after-tax and noncontrolling-interest impact on TDS shareholders was $190 million.
- U.S. Cellular: Revenue declined 6% in Q3 and 4% year to date to $963 million and $2.862 billion, respectively. Q3 operating loss was $360 million, including the $370 million U.S. Cellular-level goodwill impairment. Postpaid connections increased to 4.513 million and prepaid connections to 515,000 at September 30, 2017. Postpaid churn improved to 1.16% from 1.34%, while postpaid ARPU declined to $43.41 from $47.08.
- TDS Telecom: Revenue was $285 million in Q3 and $865 million year to date, down 1% and flat, respectively. Q3 operating loss was $13 million, including the HMS impairment. Wireline and Cable improved, while HMS revenue declined 18% in Q3 and 16% year to date.
- Cash flow: Nine-month operating cash flow was $621 million, versus $638 million in 2016. Capital spending paid in cash was $398 million, producing reported non-GAAP free cash flow of $223 million, versus $212 million in 2016.
- Liquidity and debt: Cash and equivalents were $784 million at September 30, 2017, down from $900 million at December 31, 2016. Short-term investments were $100 million. Debt comprised $20 million of current maturities and $2.443 billion of long-term debt. Available unused revolving credit capacity was $399 million at TDS and $298 million at U.S. Cellular; neither entity had borrowings outstanding under those facilities.
Material changes versus the prior comparable period
- Revenue declined because of lower U.S. Cellular retail service, inbound roaming and equipment sales revenue, reflecting industry price competition, lower roaming rates and fewer devices sold.
- U.S. Cellular’s postpaid net additions improved to 35,000 in Q3 from a loss of 6,000, driven by higher handset additions and lower handset churn. Year-to-date postpaid net additions fell to 31,000 from 75,000, primarily because of weaker connected-device activity.
- Wireline revenue increased 2% in Q3 and 3% year to date, supported by broadband, IPTV and A-CAM support revenue. Cable revenue increased 12% and 11%, respectively, supported by broadband connection growth and pricing.
- HMS revenue fell to $56 million in Q3 from $68 million and to $178 million year to date from $212 million. HMS adjusted EBITDA declined to $1 million in Q3 and $6 million year to date.
- U.S. Cellular won 188 FCC 600 MHz licenses for $329 million and paid the remaining $186 million during the second quarter. Licenses increased to $2.234 billion at September 30, 2017.
- TDS changed the classification of equipment installment-plan interest income from interest and dividend income to service revenue effective January 1, 2017; prior periods were recast. The change did not affect income before taxes, net income or EPS.
Guidance, outlook, commentary and risks
- Management expected approximately $500 million of full-year 2017 U.S. Cellular capital expenditures and approximately $225 million of TDS Telecom capital expenditures, including A-CAM spending.
- TDS expected negative free cash flow for full-year 2017, but stated that existing cash and investments, available credit facilities and expected operating and investing cash flows should meet normal operating needs and debt service for the coming year.
- U.S. Cellular continued deploying VoLTE, expanding network capacity and preparing additional commercial launches, with further launches expected in early 2018.
- Management cited intensified wireless competition, unlimited-data pricing, declining service revenue and revised long-range forecasts as triggers for the U.S. Cellular impairment. HMS cited slower service-revenue growth and a shift toward lower-margin revenue streams.
- Federal USF support remained at current levels for the remainder of 2017, but the timing and outcome of the FCC Mobility Fund Phase II auction and any related legacy-support phase-down were uncertain.
- Principal risks include intense competition and pricing pressure, customer churn, spectrum and network investment requirements, regulatory changes, impairment of goodwill or licenses, equipment-installment-plan credit and cash-flow exposure, access to financing, cyber and technology risks, and reliance on unconsolidated investments and regulatory support.
Important facts for investors to verify
- Assess whether U.S. Cellular can stabilize service revenue, ARPU and connected-device churn amid industry-wide pricing pressure.
- Review the assumptions supporting the U.S. Cellular and HMS goodwill impairment tests, including revenue growth and discount rates, and monitor future impairment risk.
- Verify the sustainability of dividends given expected negative 2017 free cash flow, reduced cash balances and TDS’s sub-investment-grade credit rating.
- Track FCC Mobility Fund Phase II timing, auction results and potential reductions in legacy USF support.
- Evaluate capital allocation for the $329 million spectrum purchase, planned network spending and the potential securitization of equipment installment-plan receivables.
- Reconcile reported GAAP results with management’s non-GAAP Adjusted EBITDA, Adjusted OIBDA and free cash flow measures.