Business Context and Reporting Period
Telephone and Data Systems, Inc. (TDS) filed this unaudited Form 10-Q for the three months ended March 31, 2017, compared with the three months ended March 31, 2016. TDS is a diversified U.S. telecommunications company serving approximately 6 million customers through 83%-owned U.S. Cellular and wholly owned TDS Telecom, which includes Wireline, Cable and Hosted and Managed Services (HMS).
Financial Performance and Key Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total operating revenues | $1,238 million | $1,254 million | Down 1% |
| Operating income | $82 million | $26 million | Up more than 100% |
| Income before taxes | $77 million | $23 million | Up more than 100% |
| Net income | $43 million | $10 million | Up more than 100% |
| Net income attributable to TDS shareholders | $37 million | $8 million | Up more than 100% |
| Diluted EPS | $0.33 | $0.07 | Up $0.26 |
| Adjusted EBITDA | $317 million | $282 million | Up 12% |
| Net cash provided by operating activities | $137 million | $246 million | Down $109 million |
| Free cash flow | $10 million | $87 million | Down $77 million |
| Capital expenditures | $96 million | $125 million | Down 23% |
Calculated consolidated operating margin was approximately 6.6% in Q1 2017 versus 2.1% in Q1 2016. Net margin was approximately 3.5% versus 0.8%. The improvement in operating income was driven primarily by lower U.S. Cellular expenses, including a $17 million gain on a license exchange, and improved TDS Telecom results.
- U.S. Cellular revenue was $936 million, down 3%; operating income was $54 million versus $10 million; adjusted EBITDA was $229 million versus $206 million.
- U.S. Cellular ended the quarter with approximately 4.94 million retail connections, including 4.46 million postpaid and 0.48 million prepaid connections. Postpaid net additions were a loss of 27,000 versus additions of 45,000 in the prior-year quarter.
- U.S. Cellular postpaid ARPU declined to $45.42 from $48.13, while postpaid ABPA increased to $149.78 from $145.99 as equipment installment plan billings grew.
- TDS Telecom revenue increased 6% to $299 million and operating income increased 70% to $29 million. Adjusted EBITDA increased to $86 million from $76 million.
- Wireline revenue increased 3% to $179 million and operating income increased 41% to $29 million. Cable revenue increased 10% to $49 million, with operating income of $2 million. HMS revenue increased 11% to $71 million, but remained at an operating loss of $2 million.
- Cash and cash equivalents were $896 million at March 31, 2017, versus $900 million at December 31, 2016.
- Total long-term debt, including the current portion, was approximately $2.44 billion. TDS reported $399 million of unused revolving capacity and U.S. Cellular reported $298 million; neither entity had borrowings outstanding under those facilities at March 31, 2017.
- TDS paid $17 million in dividends during the quarter. The quarterly dividend was $0.155 per share, compared with $0.148 in Q1 2016. No share repurchases were made in Q1 2017.
Material Changes Versus the Prior Comparable Period
- Revenue declined modestly because of lower U.S. Cellular retail service, inbound roaming and equipment sales revenue. Industry-wide wireless price competition and plan discounts pressured service revenue.
- Operating expenses declined 6%, primarily due to lower equipment costs, advertising and commissions, together with the $17 million license-exchange gain.
- U.S. Cellular profitability improved despite lower revenue, but customer acquisition weakened materially, reflected in lower gross additions and negative postpaid net additions.
- TDS Telecom growth was led by A-CAM support revenue, broadband and IPTV growth, Cable broadband connections, pricing actions and HMS equipment sales.
- Operating cash flow and free cash flow fell substantially. Working capital absorbed cash, including a $44 million increase in equipment installment plan receivables and a $75 million decrease in accounts payable.
- Effective January 1, 2017, TDS reclassified equipment installment plan interest income from interest and dividend income to service revenue. Prior periods were recast; the change did not affect income before taxes, net income or EPS.
Guidance, Outlook, Risks and Unusual Items
- TDS expects 2017 capital expenditures of approximately $500 million for U.S. Cellular and approximately $225 million for TDS Telecom. Planned spending includes network expansion, VoLTE deployment, broadband upgrades and infrastructure improvements.
- Management expects negative free cash flow for 2017, but believes cash balances, revolving credit availability and expected operating and investing cash flows will fund normal operations and debt service for the coming year.
- In April 2017, U.S. Cellular was announced as the winning bidder for 188 600 MHz spectrum licenses for $329 million. After a $143 million upfront payment made in 2016, $186 million remained payable in May 2017.
- U.S. Cellular completed the second closing of a license exchange in Q1 2017, receiving $15 million in cash and recording a $17 million gain.
- The FCC adopted an order concerning the Mobility Fund 2 and potential resumption of the phase-down of legacy Federal USF support. U.S. Cellular expects legacy support to remain at current levels during 2017, but cannot predict the auction timing or longer-term impact.
- Key risks include intense wireless and broadband competition, declining wireless pricing and roaming rates, customer churn, spectrum requirements, equipment installment plan credit and churn exposure, substantial capital needs, sub-investment-grade credit ratings, regulatory support reductions, technology deployment risks, cybersecurity and access to financing.
- TDS reported no material changes to previously disclosed legal proceedings, contractual obligations, market-risk disclosures or risk factors, and no material off-balance-sheet arrangements.
Most Important Facts for Investors to Verify
- Whether U.S. Cellular can stabilize postpaid gross additions and reverse the 27,000 postpaid connection loss while maintaining churn.
- The sustainability of the Q1 operating-income improvement after excluding the $17 million license-exchange gain.
- The effect of continued price competition on U.S. Cellular ARPU, service revenue and margins.
- Cash generation relative to the planned $725 million of 2017 capital expenditures and the $186 million spectrum payment due in May 2017.
- Growth and profitability of TDS Telecom, particularly A-CAM support, broadband and IPTV growth, and HMS recurring service revenue.
- Credit losses, bad-debt expense and working-capital requirements associated with expanding equipment installment plan receivables.
- The timing and financial impact of Mobility Fund 2, legacy Federal USF phase-downs and other FCC regulatory changes.
- The company’s ability to maintain dividends and fund operations given expected negative 2017 free cash flow and sub-investment-grade credit ratings.