TELEPHONE & DATA SYSTEMS INC quarterly report, Q3 FY2023

Business Context and Reporting Period

Telephone and Data Systems, Inc. (TDS) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2023, with comparisons to the same periods in 2022. TDS is a U.S.-only telecommunications company serving approximately 6 million connections through 83%-owned UScellular and wholly owned TDS Telecom.

UScellular: wireless services in 21 states, 4.6 million retail connections and approximately 4,500 associates.
TDS Telecom: broadband, video and voice services in 32 states, 1.2 million connections and approximately 3,600 associates.

Financial Performance and Key Metrics

Metric	Q3 2023	Q3 2022	YTD 2023	YTD 2022
Total operating revenue	$1,278 million	$1,392 million	$3,848 million	$4,056 million
Operating income (loss)	$48 million	$(11) million	$110 million	$147 million
Net income (loss)	$4 million	$(10) million	$16 million	$101 million
Net income (loss) attributable to TDS common shareholders	$(17) million	$(25) million	$(46) million	$35 million
Basic EPS attributable to common shareholders	$(0.16)	$(0.22)	$(0.41)	$0.31
Adjusted EBITDA	$328 million	$271 million	$956 million	$987 million
Capital expenditures	$285 million	$305 million	$906 million	$938 million

Consolidated operating margin was approximately 3.8% in Q3 and 2.9% year to date, compared with a negative margin in Q3 2022 and approximately 3.6% year to date in 2022.
Q3 revenue declined 8%, primarily because of lower UScellular equipment sales and service revenue. Year-to-date revenue declined 5%.
Q3 Adjusted EBITDA increased 21%; year-to-date Adjusted EBITDA decreased 3%.
Interest expense increased to $62 million in Q3 and $178 million year to date, compared with $46 million and $118 million, respectively, primarily because of higher interest rates on variable-rate debt.
The effective tax rate was unusually high at 86.0% in Q3 and 77.4% year to date, reflecting low pretax income and recurring tax adjustments, including state valuation allowances.

Segment Results

UScellular: Q3 revenue declined 11% to $963 million, while operating income improved to $57 million from a $15 million loss. Year-to-date revenue declined 7% to $2.906 billion, and operating income increased 22% to $117 million. Adjusted EBITDA was $263 million in Q3 and $753 million year to date.
UScellular retail connections decreased 3% to 4.621 million. Postpaid handset net losses increased to 38,000 in Q3, although total postpaid churn improved to 1.30% from 1.42%. Postpaid ARPU increased 2% to $51.11.
TDS Telecom: Q3 revenue was unchanged at $256 million, while operating income declined to approximately breakeven from $10 million. Year-to-date revenue was $767 million, essentially flat, while operating income declined 76% to $15 million. Adjusted EBITDA declined 8% year to date to $207 million.
TDS Telecom increased service addresses 11% to 1.6 million and expanded 1 Gigabit-plus availability to 69% of its footprint. Total connections declined 1% to 1.166 million, while broadband connections increased 5%.

Cash Flow, Liquidity and Debt

Year-to-date operating cash flow was $923 million, compared with $901 million in 2022.
Cash paid for property, plant and equipment was $906 million, and cash paid for software licenses was $29 million. Defined free cash flow was negative $12 million, compared with positive $102 million in 2022.
Cash, cash equivalents and restricted cash declined $106 million year to date to $293 million at September 30, 2023; cash and cash equivalents alone were $256 million.
Total long-term debt obligations were $3.934 billion, with approximately 50% fixed-rate and 50% variable-rate debt. Reported long-term debt, net, was $3.840 billion.
TDS had $399 million of available undrawn borrowing capacity. UScellular had $745 million of available capacity after covenant restrictions, including $445 million under its receivables securitization facility.
TDS borrowed $300 million under a new senior secured term loan in September 2023. The loan is secured by, among other assets, approximately 26 million UScellular common shares and certain TDS subsidiary interests.
TDS and UScellular stated that they were in compliance with applicable financial covenants at September 30, 2023. The maximum consolidated leverage ratio was 4.25 to 1.00 through March 2024, declining to 3.75 to 1.00 from April 2025 onward; the minimum interest coverage ratio was 3.00 to 1.00.
TDS paid $114 million of dividends year to date and repurchased 545,990 common shares for $6 million. No common-share repurchases occurred during Q3.

Material Changes Versus the Prior Comparable Period

Consolidated revenue and year-to-date net income declined, but Q3 operating income and net income improved because operating expenses fell faster than revenue.
UScellular benefited from lower equipment costs, system operations expenses, selling and administrative expenses, and depreciation, but faced continuing competitive pricing, promotional pressure, lower connections and declining roaming rates.
TDS Telecom revenue remained flat, but profitability weakened because of higher depreciation, selling and administrative costs, and higher year-to-date service costs associated with network expansion.
Capital expenditures remained substantial, with the mix shifting toward TDS Telecom fiber deployment while UScellular reduced spending year to date.
Interest expense increased materially as variable-rate debt costs rose, and liquidity weakened as free cash flow turned negative.

Guidance, Outlook, Risks and Unusual Items

UScellular expects 2023 capital expenditures of $600 million to $700 million. TDS Telecom expects approximately $550 million for 2023 but stated that future-year capital expenditures may be substantially lower because of liquidity constraints.
TDS Telecom slowed the pace of fiber deployment and expects to reduce or defer future capital spending to lower funding needs.
TDS and UScellular initiated a process to explore strategic alternatives for UScellular. TDS incurred $4 million of third-party review expenses in the first nine months and cannot predict the outcome or financial impact.
UScellular expects inbound roaming revenue to continue declining because of lower roaming rates. Management also expects promotional intensity from national carriers and cable-company mobile virtual network operators to continue.
TDS Telecom accepted 24 of 25 E-ACAM state offers. Beginning in 2024, it expects approximately $90 million annually for 15 years, subject to deploying 100/20 Mbps service to approximately 270,000 locations.
UScellular received full access to its Auction 107 spectrum in Q3. Approximately $105 million of relocation-related invoices were paid in October 2023, with approximately $13 million of estimated payments remaining at September 30.
Material risks include competition and pricing pressure, subscriber losses, declining roaming revenue, high leverage and interest-rate exposure, negative free cash flow, covenant compliance, access to financing, spectrum and regulatory obligations, execution of fiber and 5G deployments, cybersecurity, pending litigation and uncertainty regarding the UScellular strategic review.
Pending legal matters include appeals in False Claims Act litigation related to FCC spectrum auctions and a putative securities class action concerning statements about UScellular business strategies. The filing does not provide a clear estimate of potential losses.

Investor Verification Priorities

Verify the outcome, timing, financing implications and potential valuation effects of the UScellular strategic alternatives process.
Reconcile future capital spending, fiber deployment commitments and E-ACAM obligations with projected operating cash flow and available financing.
Monitor variable-rate debt costs, leverage and interest-coverage covenant headroom as debt maturities approach.
Assess whether UScellular can stabilize retail connections, handset churn, equipment sales and roaming revenue amid continued promotional competition.
Evaluate whether TDS Telecom’s broadband growth and pricing actions can offset declines in voice, video and commercial connections.
Review the pending litigation, Auction 107 relocation obligations and other regulatory contingencies for changes in exposure.
Confirm the sustainability of dividends and share repurchases given negative free cash flow and management’s stated liquidity constraints.