Business Context and Reporting Period
Telephone and Data Systems, Inc. (TDS) filed this unaudited Form 10-Q for the three months ended March 31, 2020, compared with the first quarter of 2019. TDS provides wireless services through its 83%-owned United States Cellular subsidiary and wireline and cable services through TDS Telecom. The businesses serve approximately 6 million connections across the United States.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Operating revenues | $1,261 million | $1,257 million | Flat |
| Operating income | $72 million | $94 million | Down 23% |
| Operating margin | 5.7% | 7.5% | Down 1.8 percentage points |
| Income before taxes | $86 million | $104 million | Down 17% |
| Net income | $83 million | $70 million | Up 18% |
| Net income attributable to TDS shareholders | $69 million | $59 million | Up 17% |
| Diluted EPS | $0.59 | $0.50 | Up 18% |
| Adjusted EBITDA | $362 million | $365 million | Down 1% |
| Capital expenditures | $292 million | $147 million | Up 99% |
| Cash flow from operating activities | $367 million | $327 million | Up 12% |
| Free cash flow | $(10) million | $172 million | Down $182 million |
Net income increased despite lower operating income primarily because the CARES Act reduced income tax expense. The effective tax rate declined to 4.2% from 32.6% in the prior-year quarter. Adjusted OIBDA was $311 million versus $312 million.
Segment Performance
- U.S. Cellular: Revenue was $963 million, unchanged year over year. Service revenue increased 3% to $762 million, while equipment sales declined 10% to $201 million. Operating income fell 22% to $50 million, while net income increased 24% to $72 million, primarily reflecting the tax benefit and lower equipment costs. Adjusted EBITDA was $281 million, unchanged.
- TDS Telecom: Revenue increased 4% to $240 million, driven by broadband and video growth and the Continuum cable acquisition. Operating income declined 23% to $28 million as expenses rose 10%. Adjusted EBITDA declined 2% to $82 million.
- Wireline: Revenue declined 1% to $169 million and operating income declined 32% to $23 million. Broadband connections grew 3% and video connections grew 9%, offset by a 4% decline in voice connections and a 10% decline in commercial connections.
- Cable: Revenue increased 19% to $71 million, primarily due to the Continuum acquisition and broadband growth. Operating income increased to $5 million from $2 million, and Adjusted EBITDA increased 22% to $25 million.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $421 million at March 31, 2020, compared with $465 million at December 31, 2019. Cash, cash equivalents and restricted cash totaled $434 million at quarter-end.
- Operating cash flow of $367 million was more than offset by $377 million of property, plant and equipment additions and $26 million of license payments, resulting in free cash flow of negative $10 million.
- Total reported debt was approximately $2.4 billion, consisting of $8 million of current debt and $2.365 billion of long-term debt, net.
- TDS entered into a new $400 million unsecured revolving credit facility and U.S. Cellular entered into a new $300 million facility. At March 31, 2020, unused capacity was $399 million and $298 million, respectively, with no cash borrowings outstanding under the revolvers other than letters of credit.
- TDS borrowed $50 million under its senior term loan in March 2020. U.S. Cellular subsequently borrowed $125 million under its receivables securitization facility in April 2020.
- TDS stated that existing cash, available credit and expected operating and investing cash flows should provide sufficient liquidity for normal operating needs and debt service over the coming year, but noted that its credit rating is sub-investment grade.
Material Changes Versus the Prior Comparable Period
- Revenue was broadly stable, but operating income fell because operating expenses increased 2% while revenue was flat. Depreciation, amortization and accretion increased to $235 million from $227 million.
- U.S. Cellular retail connections declined to 4.853 million from 4.943 million. Postpaid net losses improved to 26,000 from 32,000, but postpaid handset gross additions declined 12%.
- COVID-19 reduced subscriber gross additions, device and accessory sales, roaming activity and collections, while reducing customer churn. Bad-debt expense increased, including from participation in the FCC Keep Americans Connected Pledge.
- Capital expenditures increased substantially as TDS accelerated wireless network, VoLTE and 5G investments and continued fiber deployment. U.S. Cellular capital expenditures were $236 million versus $102 million; TDS Telecom capital expenditures were $54 million versus $42 million.
- TDS adopted the expected credit loss standard on January 1, 2020; the adoption had no impact on beginning retained earnings.
- TDS acquired substantially all assets of Continuum on December 31, 2019, contributing to Cable revenue and connection growth in the current quarter.
Guidance, Outlook, Risks and Unusual Items
- 2020 capital expenditure guidance was $850 million to $950 million for U.S. Cellular and $300 million to $350 million for TDS Telecom.
- Planned investments include 5G and VoLTE deployment, wireless network capacity, fiber expansion, broadband upgrades and the TDS TV+ video platform.
- U.S. Cellular was the provisional winning bidder for 237 Auction 103 spectrum licenses for $146 million. It paid $24 million in the first quarter and substantially all of the remainder in April; licenses were expected to be granted during 2020.
- COVID-19 may materially affect revenue, bad debts, customer additions, supply chains, construction schedules, cash flows and financial position. TDS and its subsidiaries extended their FCC Keep Americans Connected commitments through June 30, 2020.
- The CARES Act produced a significant tax benefit in the quarter and was expected to generate additional 2020 tax benefits and a cash refund in 2021.
- TDS disclosed a False Claims Act proceeding concerning U.S. Cellular’s participation in prior FCC spectrum auctions. TDS and U.S. Cellular believe the arrangements complied with applicable law and FCC rules, but cannot predict the outcome.
- Other principal risks include intense competition, sub-investment-grade credit, substantial capital requirements and indebtedness, access to financing, spectrum availability, regulatory support, technology changes, construction execution, cyberattacks and COVID-19-related economic disruption.
Investor Verification Checklist
- Verify the sustainability of earnings growth excluding the CARES Act tax benefit.
- Monitor COVID-19 effects on bad debts, churn, gross additions, equipment sales, roaming and service revenues.
- Assess whether the elevated capital expenditure program can be funded while maintaining dividends and debt service.
- Review the terms, covenants and future maturities of TDS and U.S. Cellular debt, including the April 2020 $125 million securitization borrowing.
- Track execution and returns from 5G, VoLTE, fiber deployment and the Auction 103 spectrum investment.
- Evaluate the legal and regulatory exposure associated with the False Claims Act proceedings, FCC support programs and spectrum auctions.