T-Mobile US, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Financial amounts are in U.S. dollars; dollar figures below are in millions unless stated otherwise.
Business context and reporting period
T-Mobile provides wireless services and sells or leases devices and accessories. It reported one operating segment. The quarter’s results reflect continued customer growth, network investment and the January 2018 adoption of the new revenue recognition standard. Comparative 2017 figures were not restated for that standard.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $10,571 (+4%) | $10,213 | $21,026 (+6%) | $19,826 |
| Service revenue | $7,931 (+7%) | $7,445 | $15,737 (+7%) | $14,774 |
| Equipment revenue | $2,325 (-7%) | $2,506 | $4,678 (+3%) | $4,549 |
| Operating income | $1,450 (+2%) | $1,416 | $2,732 (+11%) | $2,453 |
| Net income | $782 (+35%) | $581 | $1,453 (+14%) | $1,279 |
| Diluted EPS | $0.92 | $0.67 | $1.69 | $1.47 |
| Adjusted EBITDA (non-GAAP) | $3,233 (+7%) | $3,012 | $6,189 (+9%) | $5,680 |
| Operating cash flow | $1,261 (+14%) | $1,106 | $2,031 (+18%) | $1,714 |
| Free cash flow (non-GAAP) | $774 (+61%) | $482 | $1,442 (+116%) | $667 |
Q2 Adjusted EBITDA margin was 41% of service revenue, up 100 basis points year over year; the six-month margin was 39%, also up 100 basis points. Management-defined net income margin was 10% in Q2 versus 8% a year earlier, and 9% for both six-month periods.
At June 30, cash and cash equivalents were $215, total assets were $69,692 and stockholders’ equity was $23,390. Total debt was $27,970, excluding tower obligations of $2,574; $26,646 was classified as long-term debt. Current assets of $7,091 compared with current liabilities of $9,281. Net cash used in investing activities was $306 in Q2 and $768 for the first half, including property and equipment purchases of $1,629 and $2,995, respectively. Financing activities used $3,267 in Q2 and $2,267 in the first half.
Free cash flow is a non-GAAP measure defined here as operating cash flow less property and equipment purchases, plus proceeds related to securitization beneficial interests, less debt prepayment or extinguishment payments. The company reported $2,618 of such proceeds in the first half. Adoption of a cash-flow accounting standard reclassified these proceeds from operating to investing activities, and debt-extinguishment payments from operating to financing activities; comparisons should account for the retrospective reclassification.
Material changes versus comparable periods
- Service revenue growth was driven primarily by a larger branded customer base, including postpaid growth, connected devices and MetroPCS; management also cited record-low churn. Q2 branded postpaid phone ARPU declined 1% to $46.52, while branded postpaid ABPU declined 3% to $58.37.
- Equipment revenue fell 7% in Q2, reflecting fewer purchased leased devices, lower lease revenue and fewer devices sold, partly offset by higher average device revenue and returned-handset liquidation proceeds. First-half equipment revenue increased 3%.
- SG&A rose 9% in Q2 and 8% for the first half; depreciation and amortization increased 8% and 4%, respectively, amid network expansion and billing-system implementation. Operating income growth was therefore slower than revenue growth in Q2.
- Reported Q2 operating income included an $84 benefit from adopting the new revenue standard; the first-half benefit was $179. The corresponding net-income benefits were $62 and $133. The standard also increased reported equipment revenue by $96 in Q2 and $173 in the first half, mainly because certain dealer commissions moved from a reduction of equipment revenue to SG&A. The filing’s prior-standard comparison shows Q2 total revenue $96 lower and first-half revenue $143 lower.
- Interest expense declined 26% in both reported comparison periods, mainly reflecting debt redemptions and refinancing. The first-half effective tax comparison was affected by a $281 state-tax valuation-allowance benefit recorded in the 2017 period.
- Customer counts at June 30 were 40.1 million branded postpaid, 21.0 million branded prepaid and 14.6 million wholesale, totaling 75.6 million. Total customers increased 9% year over year.
Outlook, management commentary, risks and unusual items
- Management expected full-year 2018 branded postpaid phone ARPU to be generally stable versus 2017, excluding the new revenue standard’s impact. It expected cash purchases of property and equipment, excluding capitalized interest, at the high end of a $4.9–$5.3 billion range, including 5G deployment.
- The proposed all-stock Sprint merger, announced April 29, 2018, provides for 0.10256 T-Mobile shares per Sprint share and was expected to close in the first half of 2019, subject to regulatory and other conditions. Management cited the potential for a nationwide 5G network and broader competition; those benefits are prospective and not assured.
- Merger-related risks include regulatory delay, conditions or denial; integration and synergy execution; business disruption and employee or customer retention; financing availability and cost; and substantially higher leverage. The company disclosed $30 billion of remaining committed transaction financing, conditional on closing and other requirements. It estimated combined-company debt of approximately $75–$77 billion after the transactions, excluding tower obligations. Under certain circumstances related to minimum closing credit ratings, T-Mobile could owe Sprint $600 million if it terminates the agreement.
- T-Mobile incurred $41 million of Sprint-transaction costs in the first half. If the merger closes, additional consent payments disclosed but not accrued at June 30 include up to $20 million to Deutsche Telekom and up to $95 million to third-party noteholders. If the agreement terminates, potential reimbursement obligations to Sprint may also arise.
- Hurricane-related Puerto Rico costs were $36 million in the first half, offset by $70 million of insurance reimbursements received in 2018; management expected further reimbursement. Litigation and regulatory matters were described as ordinary-course matters, with no individually or collectively material accrual, although an unfavorable outcome could materially affect a particular period’s results or cash flows.
- The 2018 revenue-standard adoption produced a $213 million cumulative increase to opening accumulated deficit as adjusted (reducing the deficit), and capitalized contract costs and promotional contract assets affect the timing of reported results. Adoption of the new lease standard was planned for January 1, 2019 and expected to materially increase recognized right-of-use assets and lease liabilities.
- The additional $7.5 billion share-repurchase authorization was contingent on termination of the Sprint agreement and abandonment of the transaction. The earlier $1.5 billion program was completed; $1.1 billion of shares were repurchased in the first half.
Key facts for investors to verify
- How much of reported revenue, operating income, EBITDA and EPS growth reflects the new revenue standard rather than underlying operating performance.
- Whether operating cash generation and free cash flow remain robust after considering capital spending, securitization proceeds and the unusually low $215 million cash balance.
- Debt maturities, interest costs, covenants and related-party financing exposure, including the expected leverage and financing terms if the Sprint merger closes.
- Progress on Sprint regulatory approvals, transaction conditions, integration planning, expected synergies and potential termination or consent-payment obligations.
- Whether network investment and 5G deployment meet the stated capital-spending outlook while customer growth, churn and ARPU trends remain consistent with management’s expectations.