Telephone and Data Systems, Inc. — Form 10-Q Summary
Business context and reporting period
TDS is a diversified telecommunications company operating through approximately 84%-owned U.S. Cellular and wholly owned TDS Telecom. At September 30, 2015, the company served approximately 4.8 million wireless customers and 1.2 million wireline and cable connections. TDS Telecom includes Wireline, Cable, and Hosted and Managed Services operations. This unaudited report covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Financial performance and key metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total operating revenues | $1.374 billion, up 7% | $3.902 billion, up 5% |
| Operating income | $93.4 million, versus $(125.4) million | $408.2 million, versus $(153.8) million |
| Net income | $62.4 million, versus $(121.2) million | $264.7 million, versus $(126.6) million |
| Net income attributable to TDS shareholders | $51.1 million, versus $(116.0) million | $219.9 million, versus $(119.8) million |
| Diluted earnings per share | $0.46, versus $(1.07) | $1.99, versus $(1.10) |
| Cash flow from operating activities | Not provided for the quarter | $726.9 million, versus $496.2 million |
| Adjusted free cash flow | Not provided for the quarter | $196.4 million, versus $(5.5) million |
Consolidated operating margin was approximately 6.8% for the third quarter and 10.5% for the nine-month period, compared with negative margins in the 2014 comparable periods. Net margin attributable to TDS common shareholders was approximately 3.7% for the third quarter and 5.6% for the nine-month period.
- U.S. Cellular generated nine-month revenue of $3.010 billion, up 4%, and operating income of $336.5 million, compared with an operating loss of $93.8 million in 2014.
- TDS Telecom generated nine-month revenue of $874.2 million, up 8%, and operating income of $63.9 million, compared with an operating loss of $26.1 million in 2014.
- U.S. Cellular ended the period with 4.807 million customers. Retail net additions were 75,000, compared with net losses of 60,000 in 2014. Postpaid churn improved to 1.4% from 1.9%, and prepaid churn improved to 5.4% from 6.6%.
- U.S. Cellular’s nine-month service revenue ARPU declined to $59.29 from $60.43, while billed ARPU declined to $53.00 from $53.47. Smartphone penetration increased to 72% from 62%.
- TDS Telecom’s Wireline connections declined to 933,400 from 954,900, while Cable connections increased to 276,900 from 257,300.
- Capital expenditures were $486.9 million for the first nine months, including $334.9 million for U.S. Cellular and $146.4 million for TDS Telecom.
Cash, debt and liquidity
- Cash and cash equivalents were $865.4 million at September 30, 2015, up from $471.9 million at December 31, 2014.
- Total debt consisted of $2.210 billion of long-term debt and $9.1 million of current maturities, compared with $1.994 billion of long-term debt and $0.8 million of current maturities at year-end 2014.
- U.S. Cellular borrowed $225 million under a senior term loan in July 2015 at an initial overall interest rate of 2.88%. Principal installments begin in March 2016, with the remaining balance due in January 2022.
- Unused revolving credit capacity was $399.4 million for TDS and $282.5 million for U.S. Cellular. Both revolving facilities mature in December 2017. Management stated that the applicable financial covenants were satisfied at September 30, 2015.
- Cash used for investing activities was $513.7 million, including $558.1 million of property, plant and equipment additions, $286.7 million for acquisitions and licenses, and $324.8 million of proceeds from divestitures and exchanges.
- Cash provided by financing activities was $180.3 million, principally reflecting the $225 million term-loan borrowing, partially offset by dividends and debt issuance costs.
Material changes versus the prior comparable period
- Results improved substantially because 2014 included an $84.0 million noncash goodwill impairment charge related to Hosted and Managed Services. No comparable impairment was recorded in 2015.
- U.S. Cellular benefited from a $107.7 million gain on the Tower Sale and a $146.9 million net gain on license sales and exchanges for the nine-month period. The 2015 period also included a $125.2 million gain from a March PCS license exchange.
- U.S. Cellular’s equipment sales increased 37% for the nine-month period, partly because equipment installment plan sales rose to $226.1 million from $111.8 million. The related loss on equipment declined to $318.0 million from $514.5 million.
- U.S. Cellular recognized $58.2 million of deferred revenue from unredeemed loyalty rewards points that expired when the rewards program was discontinued on September 1, 2015.
- TDS Telecom revenue growth reflected the September 2014 BendBroadband acquisition, which contributed approximately $57.2 million of nine-month revenue. Cable revenue increased 80%, while Wireline revenue declined 2% due to legacy voice and data declines.
- Interest expense increased to $102.8 million from $83.8 million, primarily because of U.S. Cellular’s $275 million of 7.25% senior notes issued in December 2014 and the $225 million term loan issued in July 2015.
Guidance, outlook, risks and unusual items
- Management expected 2015 capital expenditures of approximately $600 million for U.S. Cellular and $220 million for TDS Telecom, funded primarily through operating cash flow, cash balances, and borrowings if needed.
- U.S. Cellular expects ongoing competitive pressure on service pricing and ARPU, continued equipment-related losses, rising data usage and network costs, and the need for additional spectrum and network investment.
- Equipment installment plans create exposure to customer upgrade behavior, device trade-in timing and values, credit losses, and the associated guarantee liability. The guarantee liability was $91.3 million at September 30, 2015, compared with $57.5 million at year-end 2014.
- TDS Telecom faces secular declines in legacy Wireline voice connections, competition from wireless, cable, satellite and VoIP providers, higher video content costs, and regulatory uncertainty involving broadband and the Universal Service Fund.
- The FCC’s 2015 Open Internet Order subjected broadband internet access to Title II regulation. Litigation and future FCC actions could affect operations, costs and compliance requirements.
- Advantage Spectrum was the provisional winning bidder for 124 AWS-3 licenses at an aggregate discounted bid of $338.3 million. The licenses had not yet been granted by the FCC at the filing date, creating execution and funding risks.
- TDS may need additional financing or capital contributions for spectrum, acquisitions and network development. Management noted that future financing may not be available on acceptable terms.
- The filing disclosed out-of-period adjustments related to equipment installment plan transactions and a King Street Wireless agreement. Management concluded the adjustments were not material to prior periods, the current period, or anticipated full-year 2015 results.
- U.S. Cellular’s 5.5% investment in the Los Angeles SMSA Limited Partnership was not expected to make a cash distribution in 2015, although a possible distribution in the latter half of 2016 remained uncertain. U.S. Cellular remains obligated for taxes on its share of taxable income.
- No material changes to previously disclosed legal proceedings or risk factors were reported. Disclosure controls were assessed as effective as of September 30, 2015.
Important facts for investors to verify
- How much of the 2015 earnings and operating cash flow improvement is attributable to nonrecurring tower, license and loyalty-rewards items rather than recurring operations.
- The sustainability of U.S. Cellular’s customer additions, churn improvement, ARPU trends and reduced equipment losses as competition and installment-plan adoption continue.
- The collectability and future economics of equipment installment plan receivables, including the $91.3 million trade-in guarantee liability.
- The status, funding requirements and regulatory approval of the 124 Auction 97 spectrum licenses.
- Progress against the approximately $820 million 2015 capital-expenditure plan and the effect of the new term loan on interest expense and leverage.
- The impact of FCC net-neutrality proceedings, Universal Service Fund changes and other regulatory developments.
- Whether TDS Telecom can offset Wireline connection declines through Cable, broadband, IPTV, managedIP and Hosted and Managed Services growth.