UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-14157
TELEPHONE AND DATA SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware
36-2669023
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
30 North LaSalle Street, Suite 4000, Chicago, Illinois 60602
(Address of principal executive offices) (Zip code)
Registrant’s telephone number, including area code: (312) 630-1900
Indicate by check mark
Yes
No
• whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
• whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
• whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
• whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Outstanding at September 30, 2015
Common Shares, $0.01 par value
101,556,713 Shares
Series A Common Shares, $0.01 par value
7,204,168 Shares
Telephone and Data Systems, Inc.
Quarterly Report on Form 10-Q
For the Quarterly Period Ended September 30, 2015
Index
Page No.
Part I.
Financial Information
Item 1.
Financial Statements (Unaudited)
1
Consolidated Statement of Operations
Three and Nine Months Ended September 30, 2015 and 2014
Consolidated Statement of Comprehensive Income (Loss)
2
Consolidated Statement of Cash Flows
3
Nine Months Ended September 30, 2015 and 2014
Consolidated Balance Sheet
4
September 30, 2015 and December 31, 2014
Consolidated Statement of Changes in Equity
6
Notes to Consolidated Financial Statements
8
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
23
Overview
Regulatory Matters
26
Results of Operations — Consolidated
27
Results of Operations — U.S. Cellular
29
Results of Operations — TDS Telecom
33
Three Months Ended September 30, 2015 and 2014
38
40
42
Recent Accounting Pronouncements
45
Liquidity and Capital Resources
Application of Critical Accounting Policies and Estimates
50
Safe Harbor Cautionary Statement
51
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
53
Item 4.
Controls and Procedures
Part II.
Other Information
Legal Proceedings
54
Item1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.
55
Item 6.
Exhibits
56
Signatures
Table of Contents
Part I. Financial Information
Item 1. Financial Statements
(Unaudited)
Three Months Ended
Nine Months Ended
September 30,
(Dollars and shares in thousands, except per share amounts)
2015
2014
Operating revenues
Service
$
1,137,767
1,081,472
3,281,508
3,233,893
Equipment and product sales
236,031
198,551
620,278
478,484
Total operating revenues
1,373,798
1,280,023
3,901,786
3,712,377
Operating expenses
Cost of services (excluding Depreciation,
amortization and accretion reported below)
303,091
297,183
896,890
859,629
Cost of equipment and products
337,051
349,209
907,482
968,867
Selling, general and administrative
449,084
465,014
1,322,554
1,399,585
Depreciation, amortization and accretion
210,764
205,529
628,443
635,015
Loss on impairment of assets
–
84,000
(Gain) loss on asset disposals, net
4,919
9,293
15,048
19,626
(Gain) loss on sale of business and other exit costs, net
(559)
(4,790)
(129,931)
(9,079)
(Gain) loss on license sales and exchanges, net
(23,986)
(146,884)
(91,446)
Total operating expenses
1,280,364
1,405,438
3,493,602
3,866,197
Operating income (loss)
93,434
(125,415)
408,184
(153,820)
Investment and other income (expense)
Equity in earnings of unconsolidated entities
39,770
36,081
109,823
108,198
Interest and dividend income
9,617
4,526
28,119
9,763
Interest expense
(35,043)
(27,170)
(102,792)
(83,775)
Other, net
(56)
69
142
279
Total investment and other income
14,288
13,506
35,292
34,465
Income (loss) before income taxes
107,722
(111,909)
443,476
(119,355)
Income tax expense
45,327
9,290
178,780
7,276
Net income (loss)
62,395
(121,199)
264,696
(126,631)
Less: Net income (loss) attributable to noncontrolling
interests, net of tax
11,312
(5,169)
44,827
(6,817)
Net income (loss) attributable to TDS shareholders
51,083
(116,030)
219,869
(119,814)
TDS Preferred dividend requirement
(12)
(37)
Net income (loss) available to common shareholders
51,071
(116,042)
219,832
(119,851)
Basic weighted average shares outstanding
108,848
108,252
108,503
108,650
Basic earnings (loss) per share attributable to TDS
shareholders
0.47
(1.07)
2.03
(1.10)
Diluted weighted average shares outstanding
110,214
109,737
Diluted earnings (loss) per share attributable to TDS
0.46
1.99
Dividends per share to TDS shareholders
0.141
0.134
0.423
0.402
The accompanying notes are an integral part of these consolidated financial statements.
(Dollars in thousands)
Net change in accumulated other
comprehensive income (loss)
Change in net unrealized gain (loss) on equity
investments
(353)
341
Change in foreign currency translation adjustment
20
17
Change related to retirement plan
Amounts included in net periodic benefit cost for
the period
Change in prior service cost
(8,263)
(911)
(9,967)
(2,733)
Change in unrecognized net loss
(1,124)
322
(994)
966
(9,387)
(589)
(10,961)
(1,767)
Changes in deferred income taxes
3,550
224
4,158
671
Change related to retirement plan, net of tax
(5,837)
(365)
(6,803)
(1,096)
Net change in accumulated other comprehensive
(5,814)
(327)
(7,136)
(738)
income (loss)
Comprehensive income (loss)
56,581
(121,526)
257,560
(127,369)
Less: Comprehensive income (loss) attributable to
noncontrolling interest
Comprehensive income (loss) attributable to
45,269
(116,357)
212,733
(120,552)
TDS shareholders
Cash flows from operating activities
Add (deduct) adjustments to reconcile net income (loss) to cash flows
from operating activities
Bad debts expense
83,368
79,218
Stock-based compensation expense
28,961
25,715
Deferred income taxes, net
(39,516)
(33,242)
(109,823)
(108,198)
Distributions from unconsolidated entities
45,047
74,864
Noncash interest expense
2,058
1,584
Other operating activities
(701)
13
Changes in assets and liabilities from operations
Accounts receivable
(93,540)
70,653
Equipment installment plans receivable
(95,799)
(131,520)
Inventory
89,821
52,078
Accounts payable
125,123
11,034
Customer deposits and deferred revenues
(49,970)
28,684
Accrued taxes
211,803
14,307
Accrued interest
10,798
9,105
Other assets and liabilities
(112,084)
(109,569)
726,918
496,211
Cash flows from investing activities
Cash used for additions to property, plant and equipment
(558,112)
(553,718)
Cash paid for acquisitions and licenses
(286,710)
(284,089)
Cash received from divestitures and exchanges
324,772
151,369
Cash received for investments
10,000
Other investing activities
6,338
5,598
(513,712)
(670,840)
Cash flows from financing activities
Issuance of long-term debt
225,000
Repayment of long-term debt
(615)
(819)
TDS Common Shares reissued for benefit plans, net of tax payments
11,409
486
U.S. Cellular Common Shares reissued for benefit plans, net of tax payments
(868)
1,150
Repurchase of TDS Common Shares
(31,293)
Repurchase of U.S. Cellular Common Shares
(4,070)
(14,698)
Dividends paid to TDS shareholders
(45,859)
(43,575)
Payment of debt issuance costs
(3,101)
(1,019)
Distributions to noncontrolling interests
(6,097)
(439)
Other financing activities
4,519
7,889
180,318
(82,318)
Net increase (decrease) in cash and cash equivalents
393,524
(256,947)
Cash and cash equivalents
Beginning of period
471,901
830,014
End of period
865,425
573,067
Consolidated Balance Sheet — Assets
December 31,
Current assets
Due from customers and agents, less allowances of $45,565 and $41,431, respectively
672,845
548,537
Other, less allowances of $1,268 and $1,141, respectively
102,684
135,144
Inventory, net
183,884
273,707
Net deferred income tax asset
98,343
107,686
Prepaid expenses
119,453
86,506
Income taxes receivable
113,708
Other current assets
30,425
29,766
2,073,059
1,766,955
Assets held for sale
9,018
103,343
Investments
Licenses
1,844,197
1,453,574
Goodwill
765,773
771,352
Franchise rights
244,300
Other intangible assets, net of accumulated amortization of $143,286 and $133,823,
respectively
50,923
64,499
Investments in unconsolidated entities
386,153
321,729
Other investments
445
508
3,291,791
2,855,962
Property, plant and equipment
In service and under construction
11,307,122
11,194,044
Less: Accumulated depreciation
7,600,435
7,347,919
3,706,687
3,846,125
Other assets and deferred charges
236,803
334,554
Total assets
9,317,358
8,906,939
Consolidated Balance Sheet — Liabilities and Equity
(Dollars and shares in thousands)
Current liabilities
Current portion of long-term debt
9,102
808
433,620
387,125
274,293
324,318
18,714
7,919
143,082
46,734
Accrued compensation
98,134
114,549
Other current liabilities
105,625
181,803
1,082,570
1,063,256
Liabilities held for sale
687
21,643
Deferred liabilities and credits
Net deferred income tax liability
888,499
941,519
Other deferred liabilities and credits
431,874
430,774
Long-term debt
2,209,992
1,993,586
Commitments and contingencies
Noncontrolling interests with redemption features
910
Equity
TDS shareholders’ equity
Series A Common and Common Shares
Authorized 290,000 shares (25,000 Series A Common and 265,000 Common Shares)
Issued 132,774 shares (7,204 Series A Common and 125,570 Common Shares) and 132,749 shares (7,179 Series A Common and 125,570 Common Shares), respectively
Outstanding 108,760 shares (7,204 Series A Common and 101,556 Common Shares) and 107,899 shares (7,179 Series A Common and 100,720 Common Shares), respectively
Par Value ($.01 per share) $1,327 ($72 Series A Common and $1,255 Common Shares)
1,327
Capital in excess of par value
2,353,054
2,336,511
Treasury shares at cost:
24,014 and 24,850 Common Shares, respectively
(731,224)
(748,199)
Accumulated other comprehensive income (loss)
(684)
6,452
Retained earnings
2,503,825
2,330,187
Total TDS shareholders' equity
4,126,298
3,926,278
Preferred shares
824
Noncontrolling interests
575,704
527,909
Total equity
4,702,826
4,455,011
Total liabilities and equity
TDS Shareholders
Series A
Accumulated
Common and
Capital in
other
Total TDS
Common
excess of
Treasury
comprehensive
Retained
shareholders'
Preferred
Noncontrolling
Total
shares
par value
earnings
equity
interests
December 31, 2014
Add (Deduct)
Net income attributable to
Net income attributable
to noncontrolling interests
classified as equity
39,407
Net unrealized loss
on equity investments
Change in foreign currency
translation adjustment
Change related to retirement
plan
TDS Common and Series A
Common share dividends
(45,822)
TDS Preferred dividend
requirement
Dividend reinvestment plan
2,321
6,315
8,636
Incentive and compensation
plans
1,361
10,660
(372)
11,649
Adjust investment in
subsidiaries for repurchases,
issuances and other compensation
1,889
8,825
10,714
Stock-based compensation
awards
11,122
Tax windfall (shortfall) from
stock awards
(150)
Distributions to
noncontrolling interests
(437)
September 30, 2015
December 31, 2013
2,308,807
(721,354)
(569)
2,529,626
4,117,837
551,436
4,670,097
Net loss attributable to
Net loss attributable
(7,209)
Net unrealized gain
(43,538)
Repurchase of Common shares
(31,794)
2,119
5,268
7,387
(303)
1,220
917
9,831
(9,004)
827
9,821
(601)
(517)
September 30, 2014
2,329,674
(746,660)
(1,307)
2,366,237
3,949,271
534,706
4,484,801
1. Basis of Presentation
The accounting policies of Telephone and Data Systems, Inc. (“TDS”) conform to accounting principles generally accepted in the United States of America (“GAAP”) as set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). The consolidated financial statements include the accounts of TDS and subsidiaries in which it has a controlling financial interest, including TDS’ 84%-owned wireless telephone subsidiary, United States Cellular Corporation (“U.S. Cellular”) and TDS’ wholly-owned subsidiary, TDS Telecommunications Corporation (“TDS Telecom”). In addition, the consolidated financial statements include certain entities in which TDS has a variable interest that require consolidation under GAAP. All material intercompany accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the 2015 presentation.
The unaudited consolidated financial statements included herein have been prepared by TDS pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, TDS believes that the disclosures included herein are adequate to make the information presented not misleading. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in TDS’ Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2014.
TDS’ business segments reflected in this Quarterly Report on Form 10-Q for the period ended September 30, 2015 are U.S. Cellular, TDS Telecom’s Wireline, Cable, and Hosted and Managed Services (“HMS”) operations. TDS’ non-reportable other business activities are presented as “Corporate, Eliminations and Other”, which includes the operations of TDS’ wholly-owned subsidiaries Suttle-Straus, Inc. (“Suttle-Straus”) and Airadigm Communications, Inc. (“Airadigm”). Suttle-Straus and Airadigm’s financial results were not significant to TDS’ operations. All of TDS’ segments operate only in the United States, except for HMS, which includes an insignificant foreign operation. See Note 13 — Business Segment Information for summary financial information on each business segment.
The accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring items, unless otherwise disclosed) necessary for a fair statement of the financial position as of September 30, 2015 and December 31, 2014, and the results of operations and changes in comprehensive income for the three and nine months ended September 30, 2015 and 2014 and cash flows and changes in equity for the nine months ended September 30, 2015 and 2014. These results are not necessarily indicative of the results to be expected for the full year.
Recently Issued Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 outlines a single comprehensive model to use in accounting for revenue arising from contracts with customers. In August 2015, the FASB issued Accounting Standards Update 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, requiring the adoption of ASU 2014-09 on January 1, 2018. Early adoption as of January 1, 2017 is permitted; however, TDS does not intend to adopt early. TDS is evaluating the effects that adoption of ASU 2014-09 will have on its financial position, results of operations, and disclosures.
In August 2014, the FASB issued Accounting Standards Update 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires TDS to assess its ability to continue as a going concern each interim and annual reporting period and provide certain disclosures if there is substantial doubt about the entity’s ability to continue as a going concern, including management’s plan to alleviate the substantial doubt. TDS is required to adopt the provisions of ASU 2014-15 for the annual period ending December 31, 2016, but early adoption is permitted. The adoption of ASU 2014-15 will not impact TDS’ financial position or results of operations but may impact future disclosures.
In February 2015, the FASB issued Accounting Standards Update 2015-02, Consolidation: Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 simplifies consolidation accounting by reducing the number of consolidation models. Additionally, ASU 2015-02 changes certain criteria for identifying variable interest entities. TDS is required to adopt the provisions of ASU 2015-02 effective January 1, 2016. Early adoption is permitted. TDS expects that certain consolidated subsidiaries that are not defined as variable interest entities under current accounting guidance will be defined as variable interest entities under the provisions of ASU 2015-02. However, TDS does not expect the adoption of ASU 2015-02 to change the group of entities which TDS is required to consolidate in its financial statements. Accordingly, TDS does not expect the adoption of ASU 2015-02 to impact its financial position or results of operations. However, additional disclosures are expected.
In April 2015, the FASB issued Accounting Standards Update 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which requires certain debt issuance costs to be presented in the balance sheet as an offset to the related debt obligation. TDS is required to apply the provisions of this update effective January 1, 2016 on a retrospective basis. Early adoption is permitted. In August 2015, the FASB issued Accounting Standards Update 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, excluding debt issuance costs related to line-of-credit arrangements from the scope of ASU 2015-03. As of September 30, 2015, TDS had $54.7 million in debt issuance costs classified as Other assets and deferred charges that, upon adoption of ASU 2015-03, would be reclassified as an offset to Long-term debt.
In July 2015, the FASB issued Accounting Standards Update 2015-11, Inventory: Simplifying the Measurement of Inventory (“ASU 2015-11”), which requires inventory to be measured at the lower of cost or net realizable value. TDS is required to adopt ASU 2015-11 on January 1, 2017. Early adoption is permitted. TDS is evaluating the effects that adoption of ASU 2015-11 will have on its financial position and results of operations.
In September 2015, the FASB issued Accounting Standards Update 2015-16, Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments (“ASU 2015-16”). ASU 2015-16 simplifies how adjustments are made to provisional amounts recognized in a business combination during the measurement period. TDS is required to adopt ASU 2015-16 on January 1, 2016. TDS is evaluating the effects that adoption of ASU 2015-16 will have on its financial position, results of operations, and disclosures.
Amounts Collected from Customers and Remitted to Governmental Authorities
TDS records amounts collected from customers and remitted to governmental authorities net within a tax liability account if the tax is assessed upon the customer and TDS merely acts as an agent in collecting the tax on behalf of the imposing governmental authority. If the tax is assessed upon TDS, then amounts collected from customers as recovery of the tax are recorded in Service revenues and amounts remitted to governmental authorities are recorded in Selling, general and administrative expenses in the Consolidated Statement of Operations. The amounts recorded gross in revenues that are billed to customers and remitted to governmental authorities totaled $23.8 million and $75.4 million for the three and nine months ended September 30, 2015, respectively, and $26.4 million and $86.5 million for the three and nine months ended September 30, 2014, respectively.
2. Fair Value Measurements
As of September 30, 2015 and December 31, 2014, TDS did not have any financial or nonfinancial assets or liabilities that were required to be recorded at fair value in its Consolidated Balance Sheet in accordance with GAAP.
The provisions of GAAP establish a fair value hierarchy that contains three levels for inputs used in fair value measurements. Level 1 inputs include quoted market prices for identical assets or liabilities in active markets. Level 2 inputs include quoted market prices for similar assets and liabilities in active markets or quoted market prices for identical assets and liabilities in inactive markets. Level 3 inputs are unobservable. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. A financial instrument’s level within the fair value hierarchy is not representative of its expected performance or its overall risk profile and, therefore, Level 3 assets are not necessarily higher risk than Level 2 or Level 1 assets.
TDS has applied the provisions of fair value accounting for purposes of computing the fair value of financial instruments for disclosure purposes as displayed below.
Level within the Fair Value Hierarchy
Book Value
Fair Value
Retail
1,453,250
1,460,294
1,414,105
Institutional
532,940
489,373
532,722
513,647
Other
220,922
221,538
4,749
4,675
The fair value of Cash and cash equivalents approximates the book value due to the short-term nature of these financial instruments. Long-term debt excludes capital lease obligations and the current portion of Long-term debt. The fair value of “Retail” Long-term debt was estimated using market prices for TDS’ 7.0% Senior Notes, 6.875% Senior Notes, 6.625% Senior Notes and 5.875% Senior Notes, and U.S. Cellular’s 6.95% Senior Notes and 7.25% Senior Notes. TDS’ “Institutional” debt
consists of U.S. Cellular’s 6.7% Senior Notes which are traded over the counter. TDS’ “Other” debt consists of a senior term loan credit facility and other borrowings with financial institutions. TDS estimated the fair value of its Institutional and Other debt through a discounted cash flow analysis using the interest rates or estimated yield to maturity for each borrowing, which ranged from 0.00% to 7.73% and 0.00% to 7.25% at September 30, 2015 and December 31, 2014, respectively.
3. Equipment Installment Plans
TDS offers customers the option to purchase certain devices under an equipment installment contract over a period of up to 24 months. Under certain equipment installment plans, the customer has the right to upgrade to a new device after a specified period of time and have the remaining unpaid equipment installment contract balance waived, subject to certain conditions, including trading in the original device in good working condition and signing a new equipment installment contract. TDS values this trade-in right as a guarantee liability. The guarantee liability is initially measured at fair value and is determined based on assumptions including the probability and timing of the customer upgrading to a new device and the fair value of the device being traded-in at the time of trade-in. As of September 30, 2015 and December 31, 2014, the guarantee liability related to these plans was $91.3 million and $57.5 million, respectively, and is reflected in Customer deposits and deferred revenues in the Consolidated Balance Sheet.
TDS equipment installment plans do not provide for explicit interest charges. For equipment installment plans with a duration of greater than twelve months, TDS imputes interest.
The following table summarizes unbilled equipment installment plan receivables as of September 30, 2015 and December 31, 2014. Such amounts are included in the Consolidated Balance Sheet as Accounts receivable – customers and agents (short-term portion) and Other assets and deferred charges (long-term portion).
Short-term portion of unbilled equipment installment plan receivables, gross
245,218
127,400
Short-term portion of unbilled deferred interest
(18,504)
(16,365)
Short-term portion of unbilled allowance for credit losses
(9,326)
(3,686)
Short-term portion of unbilled equipment installment plan receivables, net
217,388
107,349
Long-term portion of unbilled equipment installment plan receivables, gross
66,512
89,435
Long-term portion of unbilled deferred interest
(2,791)
Long-term portion of unbilled allowance for credit losses
(4,740)
(6,065)
Long-term portion of unbilled equipment installment plan receivables, net
60,953
80,579
TDS assesses the collectability of equipment installment plan receivables based on historical payment experience, account aging and other qualitative factors. To mitigate credit risk, TDS requires certain customers who desire to purchase equipment under an installment plan to make a down payment.
TDS recorded out-of-period adjustments during the nine months ended September 30, 2015 due to errors related to equipment installment plan transactions that were attributable to 2014. TDS has determined that these adjustments were not material to the prior quarterly or annual periods, and also were not material to the current period or anticipated full year 2015 results. These equipment installment plan adjustments had the impact of reducing Equipment and product sales revenues by $6.2 million and Income before income taxes by $5.8 million for the nine months ended September 30, 2015. These adjustments were made in the first six months of 2015.
4. Income Taxes
TDS’ overall effective tax rate on Income (loss) before income taxes for the three and nine months ended September 30, 2015 were 42.1% and 40.3%, respectively.
The effective tax rates for the three and nine months ended September 30, 2014 were negative and not meaningful due to the impact of several items on tax expense, including:
5. Earnings Per Share
Basic earnings (loss) per share attributable to TDS shareholders is computed by dividing Net income (loss) available to common shareholders of TDS by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share attributable to TDS shareholders is computed by dividing Net income (loss) available to common shareholders of TDS by the weighted average number of common shares outstanding during the period adjusted to include the effects of potentially dilutive securities. Potentially dilutive securities primarily include incremental shares issuable upon exercise of outstanding stock options and the vesting of restricted stock units.
The amounts used in computing earnings (loss) per common share and the effects of potentially dilutive securities on the weighted average number of common shares were as follows:
Basic earnings (loss) per share attributable to TDS shareholders:
Net income (loss) available to common shareholders of
TDS used in basic earnings (loss) per share
Adjustments to compute diluted earnings (loss):
Noncontrolling interest adjustment
(384)
(1,540)
Preferred dividend adjustment
12
37
Net income (loss) attributable to common shareholders of
TDS used in diluted earnings (loss) per share
50,699
218,329
Weighted average number of shares used in basic
earnings (loss) per share:
Common Shares
101,652
101,067
101,315
101,474
Series A Common Shares
7,196
7,185
7,188
7,176
Effects of dilutive securities:
Stock options
818
778
Restricted stock units
498
406
Weighted average number of shares used in diluted
earnings (loss) per share
Certain Common Shares issuable upon the exercise of stock options, vesting of restricted stock units or conversion of preferred shares were not included in average diluted shares outstanding for the calculation of Diluted earnings (loss) per share attributable to TDS shareholders because their effects were antidilutive. The number of such Common Shares excluded, if any, is shown in the table below.
(Shares in thousands)
4,687
9,207
4,438
8,922
992
191
823
52
6. Acquisitions, Divestitures and Exchanges
Divestiture Transaction
On May 16, 2013, pursuant to a Purchase and Sale Agreement, U.S. Cellular sold customers and certain PCS spectrum licenses to subsidiaries of Sprint Corp. fka Sprint Nextel Corporation (“Sprint”) in U.S. Cellular’s Chicago, central Illinois, St. Louis and certain Indiana/Michigan/Ohio markets (“Divestiture Markets”) in consideration for $480 million in cash. The Purchase and Sale Agreement also contemplated certain other agreements, together with the Purchase and Sale Agreement collectively referred to as the “Divestiture Transaction.”
These agreements require Sprint to reimburse U.S. Cellular up to $200 million (the “Sprint Cost Reimbursement”) for certain network decommissioning costs, network site lease rent and termination costs, network access termination costs, and employee termination benefits for specified engineering employees. As of September 30, 2015, U.S. Cellular had received a cumulative total of $109.3 million pursuant to the Sprint Cost Reimbursement. For the nine months ended September 30, 2015 and 2014, $27.6 million and $52.0 million, respectively, of the Sprint Cost Reimbursement had been received and recorded in Cash received from divestitures and exchanges in the Consolidated Statement of Cash Flows.
For the nine months ended September 30, 2015 and 2014, as a result of the Divestiture Transaction, U.S. Cellular recognized gains of $6.2 million and $28.1 million, respectively, in (Gain) loss on sale of business and other exit costs, net. For the three months ended September 30, 2015 and 2014, U.S. Cellular recognized gains of $0.3 million and $10.4 million, respectively.
Other Acquisitions, Divestitures and Exchanges
7. Intangible Assets
Changes in Licenses at TDS for the nine months ended September 30, 2015 are presented below. There were no significant changes to Franchise rights, Goodwill or Other intangible assets during the nine months ended September 30, 2015.
Balance December 31, 2014
Acquisitions (1)
345,656
Exchanges (2)
43,485
1,482
Balance September 30, 2015
(1)
Amount includes payments totaling $338.3 million made by Advantage Spectrum to the FCC for licenses in which it was the provisional winning bidder in Auction 97. See Note 6 — Acquisitions, Divestitures and Exchanges, and Note 10 — Variable Interest Entities for further information.
(2)
Amount represents licenses received in the March 2015 PCS license exchange. See Note 6 — Acquisitions, Divestitures and Exchanges for further information. Licenses disposed of in this exchange and the exchange that closed in July 2015 were previously removed from the Licenses balance and reflected in Assets held for sale in the Consolidated Balance Sheet as of December 31, 2014.
8. Investments in Unconsolidated Entities
Investments in unconsolidated entities consist of amounts invested in wireless and wireline entities in which TDS holds a noncontrolling interest. These investments are accounted for using either the equity or cost method.
The following table, which is based on information provided in part by third parties, summarizes the combined results of operations of TDS’ equity method investments.
Three Months Ended September 30,
Nine Months Ended September 30,
Revenues
1,738,488
1,649,160
5,199,305
4,876,269
1,267,820
1,230,366
3,840,462
3,554,598
Operating income
470,668
418,794
1,358,843
1,321,671
Other income (loss), net
(10,236)
4,752
(16,744)
7,178
Net income
460,432
423,546
1,342,099
1,328,849
9. Debt
In January 2015, U.S. Cellular entered into a senior term loan credit facility. In July 2015, U.S. Cellular borrowed the full amount of $225 million available under this facility in two separate draws at an overall interest rate of 2.88%. The interest rate on outstanding borrowings will be reset at three and six month intervals at a rate of LIBOR plus 250 basis points. This credit facility provides for the draws to be continued on a long-term basis under terms that are readily determinable. U.S. Cellular has the ability and intent to carry the debt for the duration of the agreement. Principal reductions will be due and payable in quarterly installments of $2.8 million beginning in March 2016 through December 2021, and the remaining unpaid balance will be due and payable in January 2022. These funds will be used for general corporate purposes, including working capital, spectrum purchases and capital expenditures.
10. Variable Interest Entities
TDS consolidates variable interest entities (“VIEs”) in which it has a controlling financial interest and is the primary beneficiary. A controlling financial interest will have both of the following characteristics: (a) the power to direct the VIE activities that most significantly impact economic performance and (b) the obligation to absorb VIE losses and the right to receive benefits that are significant to the VIE. TDS reviews these criteria initially at the time it enters into agreements and subsequently when reconsideration events occur.
Consolidated VIEs
As of September 30, 2015, TDS holds a variable interest in and consolidates the following VIEs:
The power to direct the activities that most significantly impact the economic performance of Advantage Spectrum, Aquinas Wireless and King Street Wireless (collectively, the “limited partnerships”) is shared. Specifically, the general partner of these VIEs has the exclusive right to manage, operate and control the limited partnerships and make all decisions to carry on the business of the partnerships; however, the general partner of each partnership needs the consent of the limited partner, a TDS subsidiary, to sell or lease certain licenses, to make certain large expenditures, admit other partners or liquidate the limited partnerships. Although the power to direct the activities of the VIEs is shared, TDS has a disproportionate level of exposure to the variability associated with the economic performance of the VIEs, indicating that TDS is the primary beneficiary of the VIEs. Accordingly, these VIEs are consolidated.
The following table presents the classification of the consolidated VIEs’ assets and liabilities in TDS’ Consolidated Balance Sheet.
Assets
1,681
2,588
175
278
Licenses (1)
648,661
312,977
Property, plant and equipment, net
8,635
10,671
324
60,059
659,476
386,573
Liabilities
110
494
622
Total liabilities
495
732
At September 30, 2015, includes payments totaling $338.3 million made by Advantage Spectrum to the FCC as described below.
Other Related Matters
In March 2015, King Street Wireless made a $60.0 million distribution to its investors. Of this distribution, $6.0 million was provided to King Street Wireless, Inc. and $54.0 million was provided to U.S. Cellular.
FCC Auction 97 ended in January 2015. TDS participated in Auction 97 indirectly through its interest in Advantage Spectrum. A subsidiary of U.S. Cellular is a limited partner in Advantage Spectrum. Advantage Spectrum qualified as a “designated entity,” and thereby was eligible for bid credits with respect to spectrum purchased in Auction 97. Advantage Spectrum was the winning bidder for 124 licenses for an aggregate bid of $338.3 million, after its designated entity discount of 25%. This amount is classified as Licenses in TDS’ Consolidated Balance Sheet. Advantage Spectrum’s bid amount, less the initial deposit of $60.0 million paid in 2014, plus certain other charges totaling $2.3 million, were paid to the FCC in March 2015. To help fund this payment, U.S. Cellular made loans and capital contributions to Advantage Spectrum and Frequency Advantage totaling $280.6 million during the nine months ended September 30, 2015. There were no capital contributions, loans or advances made to TDS’ VIEs during the nine months ended September 30, 2014.
Advantage Spectrum, Aquinas Wireless and King Street Wireless were formed to participate in FCC auctions of wireless spectrum and to fund, establish, and provide wireless service with respect to any FCC licenses won in the auctions. As such, these entities have risks similar to those described in the “Risk Factors” in TDS’ Form 10-K for the year ended December 31, 2014.
TDS may agree to make additional capital contributions and/or advances to Advantage Spectrum, Aquinas Wireless or King Street Wireless and/or to their general partners to provide additional funding for the development of licenses granted in various auctions. TDS may finance such amounts with a combination of cash on hand, borrowings under its revolving credit agreement and/or other long-term debt. There is no assurance that TDS will be able to obtain additional financing on commercially reasonable terms or at all to provide such financial support.
During the three and nine-months ended September 30, 2015, TDS recorded out-of-period adjustments attributable to the third quarter of 2013 through the second quarter of 2015 related to an agreement with King Street Wireless. TDS has determined that these adjustments were not material to the prior quarterly or annual periods, and also were not material to the current period or anticipated full year 2015 results. As a result of these out-of-period adjustments, for the three and nine months ended September 30, 2015, Net income decreased by $3.2 million and $2.8 million, and Net income attributable to TDS shareholders decreased by $3.8 million and $3.3 million, respectively.
11. Noncontrolling Interests
The following schedule discloses the effects of Net income (loss) attributable to TDS shareholders and changes in TDS’ ownership interest in U.S. Cellular on TDS’ equity:
Transfer (to) from the noncontrolling interests
Change in TDS' Capital in excess of par value from
U.S. Cellular's issuance of U.S. Cellular shares
(13,768)
(11,042)
U.S. Cellular's repurchases of U.S. Cellular shares
951
858
Purchase of ownership in subsidiaries from noncontrolling interests
240
7,484
Net transfers (to) from noncontrolling interests
(12,577)
(2,700)
Change from net income (loss) attributable to TDS and
transfers (to) from noncontrolling interests
207,292
(122,514)
12. Common Share Repurchases
On August 2, 2013, the Board of Directors of TDS authorized a $250 million stock repurchase program for the purchase of TDS Common Shares from time to time pursuant to open market purchases, block transactions, private purchases or otherwise, depending on market conditions. This authorization does not have an expiration date.
On November 17, 2009, the Board of Directors of U.S. Cellular authorized the repurchase of up to 1,300,000 Common Shares on an annual basis beginning in 2009 and continuing each year thereafter, on a cumulative basis. These purchases will be made pursuant to open market purchases, block purchases, private purchases or otherwise, depending on market conditions. This authorization does not have an expiration date.
Share repurchases made under these authorizations were as follows:
Number of
Average Cost
Shares
Per Share
Amount
(Dollar amounts and shares in thousands, except per share data)
TDS Common Shares
U.S. Cellular Common Shares
154
34.85
5,362
1,230
25.85
31,794
384
39.37
15,124
13. Business Segment Information
U.S. Cellular and TDS Telecom are billed for all services they receive from TDS, consisting primarily of information processing, accounting and finance, and general management services. Such billings are based on expenses specifically identified to U.S. Cellular and TDS Telecom and on allocations of common expenses. Management believes the method used to allocate common expenses is reasonable and that all expenses and costs applicable to U.S. Cellular and TDS Telecom are reflected in the accompanying business segment information on a basis that is representative of what they would have been if U.S. Cellular and TDS Telecom operated on a stand-alone basis.
Financial data for TDS’ reportable segments for the three and nine month periods ended, or as of September 30, 2015 and 2014, is as follows. See Note 1 — Basis of Presentation for additional information.
TDS Telecom
Three Months Ended or as of September 30, 2015
U.S. Cellular
Wireline
Cable
HMS
TDS Telecom Eliminations
TDS Telecom Total
Corporate, Eliminations and Other
Services
895,960
174,579
43,741
30,428
(1,184)
247,564
(5,757)
172,946
477
119
51,214
51,810
11,275
1,068,906
175,056
43,860
81,642
299,374
5,518
Cost of services (excluding Depreciation, amortization
and accretion expense reported below)
198,982
63,696
19,545
21,163
(1,125)
103,279
830
287,256
515
25
43,081
43,621
6,174
374,585
50,062
14,346
12,446
(59)
76,795
(2,296)
152,369
41,228
8,530
6,790
56,548
1,847
2,618
1,845
425
22
2,292
9
(643)
(105)
189
77,725
17,815
989
(1,860)
16,944
(1,235)
39,674
94
9,299
624
10
640
(322)
(21,121)
193
109
(565)
(263)
(13,659)
78
(48)
(79)
(127)
(7)
105,655
18,586
1,108
(2,498)
17,196
(15,129)
Income tax expense (benefit) (1)
40,634
8,278
(3,585)
65,021
8,918
(11,544)
Add back:
21,121
(193)
(109)
565
263
13,659
35,043
Adjusted EBITDA (2)
257,134
61,361
9,954
4,879
76,194
575
333,903
347,709
3,806
34,638
6,938,384
1,322,359
571,836
299,101
2,193,296
185,678
Capital expenditures
134,816
38,354
13,023
5,090
56,467
2,425
193,708
Three Months Ended or as of September 30, 2014
851,063
177,650
28,519
27,806
(980)
232,995
(2,586)
149,356
39,737
40,162
9,033
1,000,419
178,075
67,543
273,157
6,447
199,750
64,072
12,651
19,442
(926)
95,239
2,194
307,862
829
33,819
34,648
6,699
397,545
46,627
9,948
12,724
(54)
69,245
(1,776)
148,952
41,358
6,171
6,726
54,255
2,322
7,947
743
626
1,367
(21)
(10,283)
(2,201)
7,694
(51,354)
26,647
(877)
(89,166)
(63,396)
(10,665)
35,971
108
3,572
569
(23)
545
409
(13,514)
598
32
(343)
287
(13,943)
95
71
(86)
(15)
(11)
(25,230)
27,887
(846)
(89,618)
(62,577)
(24,102)
(1,459)
(2,937)
13,686
(23,771)
(59,640)
(37,788)
13,514
(598)
(32)
343
(287)
13,943
27,170
134,900
67,189
5,919
1,449
74,557
(164)
209,293
296,900
3,804
34,744
335,448
6,257,075
1,385,524
543,731
255,519
2,184,774
198,699
8,640,548
142,452
34,243
7,598
9,800
51,641
1,132
195,225
Nine Months Ended or as of September 30, 2015
2,548,544
525,683
131,767
88,311
(3,222)
742,539
(9,575)
461,274
1,478
277
129,878
131,633
27,371
3,009,818
527,161
132,044
218,189
874,172
17,796
585,935
188,727
59,342
63,145
(3,011)
308,203
2,752
779,228
1,675
100
108,777
110,552
17,702
1,106,524
144,931
40,735
36,105
(211)
221,560
(5,530)
450,035
124,440
26,109
19,798
170,347
8,061
12,268
3,373
(561)
2,791
(113,825)
(3,159)
(12,947)
336,537
67,174
6,319
(9,615)
63,878
7,769
109,729
15
79
25,834
1,726
1,778
507
(61,239)
784
352
(1,550)
(414)
(41,139)
274
(81)
(65)
(143)
11
411,135
69,618
6,697
(11,201)
65,114
(32,773)
161,214
27,083
(9,517)
249,921
38,031
(23,256)
61,239
(784)
(352)
1,550
414
41,139
102,792
673,968
193,488
31,893
10,126
235,507
3,469
912,944
334,942
90,517
36,575
19,341
146,433
5,570
486,945
Nine Months Ended or as of September 30, 2014
2,548,149
534,880
73,506
82,757
(1,959)
689,184
(3,440)
335,854
1,409
115,830
117,239
25,391
2,884,003
536,289
198,587
806,423
21,951
567,488
192,777
35,000
57,689
(1,820)
283,646
8,495
850,314
1,793
98,161
99,954
18,599
1,197,361
140,855
22,611
39,935
(139)
203,262
(1,038)
465,042
125,921
15,089
20,195
161,205
8,768
16,774
1,502
1,116
76
2,694
158
(27,694)
20,816
(93,836)
75,642
(310)
(101,469)
(26,137)
(33,847)
106,166
2,026
6,029
1,744
19
1,764
1,970
(42,712)
1,939
67
(1,203)
803
(41,866)
281
(78)
93
(17)
(24,072)
79,253
(242)
(102,560)
(23,549)
(71,734)
746
12,571
(6,041)
(24,818)
(36,120)
(65,693)
42,712
(1,939)
(67)
1,203
(803)
41,866
83,775
381,316
202,536
15,896
2,914
221,346
(126)
602,536
375,960
84,511
20,998
23,179
128,688
3,856
508,504
Income tax expense (benefit) is not provided at the individual segment level for Wireline, Cable and HMS. TDS calculates income tax expense for “TDS Telecom Total”.
Adjusted earnings before interest, taxes, depreciation, amortization and accretion (“Adjusted EBITDA”) is a segment measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segments and assessing their performance. Adjusted EBITDA is defined as net income, adjusted for the items set forth in the reconciliation above. Adjusted EBITDA excludes these items in order to show operating results on a more comparable basis from period to period. From time to time, TDS may also exclude other items from Adjusted EBITDA if such items help reflect operating results on a more comparable basis. TDS does not intend to imply that any of such items that are excluded are non-recurring, infrequent or unusual; such items may occur in the future. TDS believes Adjusted EBITDA is a useful measure of TDS’ operating results before significant recurring non-cash charges, discrete gains and losses, and other items as indicated above.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Telephone and Data Systems, Inc. (“TDS”) is a diversified telecommunications company providing high-quality telecommunications services to approximately 4.8 million wireless customers and 1.2 million wireline and cable connections at September 30, 2015. TDS conducts its wireless operations through its 84%‑owned subsidiary, United States Cellular Corporation (“U.S. Cellular”). TDS provides wireline services, cable services and hosted and managed services through its wholly-owned subsidiary, TDS Telecommunications Corporation (“TDS Telecom”).
The following discussion and analysis should be read in conjunction with TDS’ interim unaudited consolidated financial statements and notes included in Item 1 above, and with the description of TDS’ business, its audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in TDS’ Annual Report on Form 10-K (“Form 10-K”) for the year ended December 31, 2014.
OVERVIEW
The following is a summary of certain selected information contained in the comprehensive Management’s Discussion and Analysis of Financial Condition and Results of Operations that follows. The overview does not contain all of the information that may be important. You should carefully read the entire Management’s Discussion and Analysis of Financial Condition and Results of Operations and not rely solely on the overview.
The following provides historical and forward-looking information and analysis about TDS’ existing business segments. TDS’ business segments reflected in this Form 10-Q for the quarter ended September 30, 2015 are U.S. Cellular, TDS Telecom’s Wireline, Cable, and Hosted and Managed Services (“HMS”) operations. TDS operations also include the wholly-owned subsidiaries Suttle-Straus, Inc. (“Suttle-Straus”) and Airadigm Communications, Inc. (“Airadigm”). Suttle-Straus and Airadigm’s financial results were not significant to TDS’ operations. All of TDS’ segments operate only in the United States, except for HMS, which includes an insignificant foreign operation. See Note 13 — Business Segment Information for summary financial information on each business segment.
In its consolidated operating markets, U.S. Cellular serves approximately 4.8 million customers in 23 states. As of September 30, 2015, U.S. Cellular’s average penetration rate in its consolidated operating markets was 15%. U.S. Cellular operates on a customer satisfaction strategy, striving to meet or exceed customer needs by providing a comprehensive range of wireless products and services, excellent customer support, and a high-quality network. U.S. Cellular’s business development strategy is to obtain interests in and access to wireless licenses in its current operating markets and in areas that are adjacent to or in close proximity to its other wireless licenses, thereby building contiguous operating market areas with strong spectrum positions. U.S. Cellular believes that the acquisition of additional licenses within its current operating markets will enhance its network capacity to meet customers’ network performance expectations. In addition, U.S. Cellular anticipates that grouping its operations into market areas will continue to provide it with certain economies of scale in its capital and operating costs.
Financial and operating highlights for the nine months ended September 30, 2015 included matters discussed in the notes to the financial statements and the following:
U.S. Cellular anticipates that its future results may be affected by the following factors:
See Results of Operations—U.S. Cellular.
TDS Telecom provides wireline and cable broadband, video and voice services to approximately 1.2 million connections in 35 states. The overall strategy for the wireline and cable businesses is to own the best pipe in the market in order to capitalize on data growth and the need for higher broadband speeds. In addition, TDS Telecom provides a wide range of Information Technology (“IT”) services including colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, sales and management of IT infrastructure hardware solutions.
TDS Telecom’s wireline and cable strategy is to focus on broadband offerings and be the preferred communications solutions provider in its markets for both residential and commercial customers by developing and delivering high-quality broadband, video and voice products and services that meet or exceed customers’ needs, and to outperform the competition by delivering superior customer service. The company is leveraging existing processes, procedures, shared support teams, commercial expertise, and customer service focus in providing services to Wireline and Cable customers.
Through its hosted and managed services business, OneNeck IT Solutions, TDS Telecom aims to grow recurring revenues from mid-market businesses by leveraging core competencies in network management, IT, customer service and reliability to take advantage of the growing IT outsourcing marketplace.
On September 1, 2014, TDS acquired substantially all of the assets of a group of companies operating as BendBroadband. This acquisition impacts the comparability of TDS Telecom’s operating results.
TDS Telecom’s financial results for the nine months ended September 30, 2015 included the following:
TDS anticipates that TDS Telecom’s future results will be affected by the following factors:
See Results of Operations—TDS Telecom.
REGULATORY MATTERS
The discussion below includes updates related to recent regulatory developments. These updates should be read in conjunction with the disclosures previously provided under “Regulatory Matters” in TDS’ Form 10-K for the year ended December 31, 2014.
FCC Net Neutrality Order
In February 2015, the FCC adopted an Open Internet Order relating to new net neutrality rules. The rules became effective in June 2015. The order reclassified high-speed, or broadband, internet access service as a “telecommunication service, ” making it subject to common carrier regulation under Title II of the Communications Act of 1934. The order applies equally to fixed and wireless broadband internet service providers and thus applies to internet broadband services provided by telephone, cable and wireless providers.
The rules prohibit (i) blocking (broadband providers may not block access to legal content, applications, services, or non-harmful devices); (ii) throttling (broadband providers may not impair or degrade lawful Internet traffic on the basis of content, applications, services, or non-harmful devices); and (iii) paid prioritization (broadband providers may not favor some lawful internet traffic over other lawful traffic in exchange for consideration, i.e., internet “fast lanes” are prohibited). Also, internet service providers may not prioritize content and services of their affiliates. In addition, the FCC has now asserted jurisdiction over internet traffic exchange, so interconnection arrangements will now be subject to a statutory requirement that all charges, practices, classifications, and regulations for and in connection with interconnection must be just and reasonable. The rules also include a general conduct standard that will be applied on a case-by-case basis to address questionable practices as they occur that unreasonably interfere with or unreasonably disadvantage lawful content, applications, services, or devices to be used by end users (individuals or entities that use a broadband internet access service), or made available by edge providers (individuals or entities that provide any content, application, or service over the internet, and any individual or entity that provides a device used for accessing any content, application, or service over the internet). Although broadband internet access providers will be allowed to engage in reasonable network management practices, it is uncertain what practices will be permitted by the FCC. The order also expands the FCC’s current internet transparency rules.
All of these requirements will be subject to FCC enforcement and potential third-party claims for damages or equitable relief. Under Title II, the FCC will have broad regulatory authority over internet services and internet service providers. Although the FCC indicated that it will forbear from a number of utility-style regulations, such as rate regulation, tariffs, and unbundling requirements, the FCC could determine to apply such regulations and requirements in the future. Also, it is uncertain if internet services may be subject to the Federal Universal Service Fund (“USF”) contributions or taxation in the future as a result of the reclassification under Title II. Lawsuits have been filed challenging the net neutrality rules and the FCC’s decision to reclassify broadband internet access service under Title II. TDS cannot predict the outcome of these proceedings or the impact on its business.
Changes to FCC’s Designated Entity Rules
TDS participated in prior FCC spectrum auctions through limited partnerships that qualified as “designated entities” under FCC rules and, as such were eligible for bid credit discounts of 25% with respect to licenses won in the auctions. In July 2015, the FCC adopted a Report and Order that amended the FCC’s designated entity rules. The amended rules include caps on bid credits that designated entities may receive in future auctions and modify the attribution rules. The amended rules also restrict certain joint bidding agreements but permit certain other arrangements involving more than one party. Additionally, the amended rules make certain other changes to the FCC’s competitive bidding rules. TDS is evaluating how these amended rules may impact future FCC spectrum auctions and its potential participation through a designated entity.
FCC Auction 1000
The FCC has scheduled an auction of 600 MHz spectrum licenses, referred to as Auction 1000. Auction 1000 involves: (1) a “reverse auction” in which broadcast television licensees submit bids to voluntarily relinquish spectrum usage rights in exchange for payments; (2) a “repacking” of the broadcast television bands in order to free up certain broadcast spectrum for other uses; and (3) a “forward auction” of licenses for spectrum cleared through this process. Interested broadcasters must file their applications by December 18, 2015 and forward auction bidders must file applications by January 28, 2016. TDS evaluates opportunities to acquire additional spectrum in FCC auctions and may participate in the forward auction as a bidder or member of a bidding group. If TDS participates in the forward auction, information relating to this will be disclosed at a later time, subject to FCC rules. In such event, applicable FCC anti-collusion rules will place certain restrictions on public disclosures and business communications with other companies relating to TDS’ participation, commencing on the application deadline of January 28, 2016 until the down payment deadline for Auction 1000, which will be ten business days after release of the FCC’s Channel Reassignment Public Notice. These anti-collusion rules, which could last six months or more, may restrict the conduct of certain TDS activities with other applicants in Auction 1000 as well as with nationwide providers of wireless services which are not applicants in Auction 1000. The restrictions could have an adverse effect on TDS’ business, financial condition or results of operations.
Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014
RESULTS OF OPERATIONS — CONSOLIDATED
Percentage
Change
(Dollars in thousands, except per share amounts)
125,815
4%
67,749
8%
All other (1)
(4,155)
(19)%
189,409
5%
2,673,281
2,977,839
(304,558)
(10)%
810,294
832,560
(22,266)
(3)%
All other (1) (2)
10,027
55,798
(45,771)
(82)%
(372,595)
430,373
>100%
90,015
41,616
Total operating income (loss)
562,004
1,625
2%
18,356
(19,017)
(23)%
(137)
(49)%
Total investment and other income (expense)
562,831
171,504
391,327
Less: Net income (loss) attributable to
noncontrolling interests, net of tax
51,644
339,683
Preferred dividend requirement
-
Consists of corporate and other operations and intercompany eliminations.
Compared to U.S. Cellular, TDS recognized an incremental gain of $11.9 million on the Tower Sale in the nine months ended September 30, 2015 as a result of a lower basis in the assets disposed. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information. In 2014, TDS recognized expenses of $20.8 million related to exit and disposal activities due to a License Purchase and Customer Recommendation Agreement between U.S. Cellular and Airadigm.
Operating revenues and expenses
See Results of Operations — U.S. Cellular and Results of Operations — TDS Telecom below for factors that affected consolidated Operating revenues and expenses.
TDS’ investment in the Los Angeles SMSA Limited Partnership (“LA Partnership”) through U.S. Cellular contributed $58.1 million and $57.8 million to Equity in earnings of unconsolidated entities in 2015 and 2014, respectively.
Interest and dividend income increased due to imputed interest income recognized on equipment installment plans of $23.8 million and $3.4 million in 2015 and 2014, respectively. See Note 3 — Equipment Installment Plans in the Notes to the Consolidated Financial Statements for additional information.
The increase in interest expense was due primarily to U.S. Cellular’s issuance of $275 million of 7.25% Senior Notes in December 2014 and the $225 million Term Loan in July 2015.
See Note 4 — Income Taxes in the Notes to Consolidated Financial Statements for additional discussion of the overall effective tax rate on Income (loss) before income taxes.
Net income attributable to noncontrolling interests, net of tax
Net income attributable to noncontrolling interests, net of tax includes the noncontrolling public shareholders’ share of U.S. Cellular’s net income and the noncontrolling shareholders’ or partners’ share of certain TDS or U.S. Cellular subsidiaries’ net income.
Net income (loss) attributable to noncontrolling interests, net of tax
U.S. Cellular noncontrolling public shareholders’
38,506
(3,454)
Noncontrolling shareholders’ or partners’
6,321
(3,363)
RESULTS OF OPERATIONS — U.S. CELLULAR
TDS provides wireless telephone service through U.S. Cellular, an 84%-owned subsidiary. U.S. Cellular owns, manages and invests in wireless markets throughout the United States.
Summary Operating Data for U.S. Cellular Consolidated Markets
As of or for Nine Months Ended September 30,
Retail Customers
Postpaid
Total at end of period
4,341,000
4,200,000
Gross additions
591,000
638,000
Net additions (losses)
43,000
(67,000)
ARPU(1)
55.54
56.87
ARPA(2)
138.55
132.19
Churn rate(3)
1.4%
1.9%
Smartphone penetration(4)
72%
62%
Prepaid
380,000
350,000
209,000
214,000
Net additions
32,000
7,000
35.88
33.59
5.4%
6.6%
Total customers at end of period
4,807,000
4,674,000
Billed ARPU(1)
53.00
53.47
Service revenue ARPU(1)
59.29
60.43
Smartphones sold as a percent of total handsets sold
87%
79%
Total Population
Consolidated markets(5)(7)
50,313,000
60,136,000
Consolidated operating markets(5)(7)
31,814,000
31,729,000
Market penetration at end of period
Consolidated markets(6)
10%
Consolidated operating markets(6)
15%
Capital expenditures (000s)
Total cell sites in service
6,246
6,209
Owned towers in service
3,957
4,487
Average Revenue per User (“ARPU”) metrics are calculated by dividing a revenue base by an average number of customers by the number of months in the period. These revenue bases and customer populations are shown below:
a.
Postpaid ARPU consists of total postpaid service revenues and postpaid customers.
b.
Prepaid ARPU consists of total prepaid service revenues and prepaid customers.
c.
Billed ARPU consists of total postpaid, prepaid and reseller service revenues and postpaid, prepaid and reseller customers.
d.
Service revenue ARPU consists of total postpaid, prepaid and reseller service revenues, inbound roaming and other service revenues and postpaid, prepaid and reseller customers.
Average Revenue per Account (“ARPA”) metric is calculated by dividing total postpaid service revenues by the average number of postpaid accounts by the number of months in the period.
(3)
Churn metrics represent the percentage of the postpaid or prepaid customers that disconnect service each month. These metrics represent the average monthly postpaid or prepaid churn rate for each respective period.
(4)
Smartphones represent wireless devices which run on an Android, Apple, BlackBerry or Windows Mobile operating system, excluding connected devices. Smartphone penetration is calculated by dividing postpaid smartphone customers by total postpaid handset customers.
(5)
During the third quarter of 2015, U.S. Cellular reassessed population statistics with respect to markets which U.S. Cellular consolidates and revised its calculations to more accurately accumulate such population statistics. As a result, prior period population data and corresponding market penetration ratios were revised for markets that U.S. Cellular currently consolidates, or previously consolidated in the periods presented. The decrease in the population of Consolidated markets is due primarily to the license exchange transactions of certain non-operating licenses in North Carolina in December 2014 and Illinois and Indiana in March 2015. Total Population is used only to calculate market penetration of consolidated markets and consolidated operating markets, respectively. See footnote (6) below.
(6)
Market penetration is calculated by dividing the number of wireless customers at the end of the period by the total population of consolidated markets and consolidated operating markets, respectively, as estimated by Claritas.
As licenses awarded in Auction 97 have not yet been granted, population statistics related to such licenses have not been included in the population data.
Components of Operating Income (Loss)
Retail service
2,278,049
2,254,716
23,333
1%
Inbound roaming
148,542
174,283
(25,741)
(15)%
121,953
119,150
2,803
Service revenues
395
Equipment sales
125,420
37%
System operations (excluding Depreciation, amortization
and accretion reported below)
18,447
3%
Cost of equipment sold
(71,086)
(8)%
(90,837)
(15,007)
(4,506)
(27)%
(86,131)
>(100)%
(55,438)
(61)%
Operating Revenues
Service revenues consist primarily of: (i) charges for access, airtime, roaming, recovery of regulatory costs and value added services, including data products and services, provided to U.S. Cellular’s retail customers and to end users through third party resellers (“retail service”); (ii) charges to other wireless carriers whose customers use U.S. Cellular’s wireless systems when roaming; and (iii) amounts received from the Federal Universal Service Fund (“USF”), tower rental revenue, and revenue from spectrum leases.
Retail service revenues
Retail service revenues increased due primarily to the growth in U.S. Cellular’s average customer base, offset by a decrease in billed ARPU, net of the impact of revenues recognized from expired rewards points.
Billed ARPU decreased to $53.00 in 2015 from $53.47 in 2014, reflecting a decrease in postpaid ARPU of $1.33 due primarily to discounts on shared data plans provided to customers on equipment installment plans and those providing their own device at the time of activation or renewal, partially offset by the growth in customers, increased adoption of shared data plans and the $1.50 postpaid ARPU impact of the revenue recognized from expired rewards points.
U.S. Cellular expects continued pressure on retail service revenues in the foreseeable future due to industry competition for customers and related effects on pricing of service plan offerings offset to some degree by continued adoption of smartphones and data usage. Beginning in the second quarter of 2014, U.S. Cellular expanded its offerings of equipment installment plans. To the extent that customers adopt these plans, U.S. Cellular expects an increase in equipment sales revenues. However, certain of the equipment installment plans provide the customer with a reduction in the monthly access charge for the device; thus, to the extent that existing customers adopt such plans, U.S. Cellular expects a reduction in retail service revenues and ARPU.
Inbound roaming revenues
Inbound roaming revenues decreased due primarily to lower rates for both voice and data traffic and lower volumes for voice traffic.
Other revenues
Other revenues increased due primarily to increases in revenues from spectrum leases and mobile applications.
Revenues representing amounts received from the Federal USF in 2015 were $69.1 million, which remained flat year over year. Pursuant to the FCC's Reform Order (“Reform Order”), U.S. Cellular’s current Federal USF support is being phased down at the rate of 20% per year beginning July 1, 2012. The Phase II Mobility Fund was not operational as of July 2014 and therefore, as provided by the Reform Order, the phase down was suspended at 60% of the baseline amount. U.S. Cellular will continue to receive USF support at the 60% level until the FCC takes further action. At this time, U.S. Cellular cannot predict what changes that the FCC might make to the USF high cost support program and, accordingly, cannot predict whether such changes will have a material adverse effect on U.S. Cellular’s business, financial condition or results of operations.
Equipment sales revenues
Equipment sales revenues include revenues from sales of wireless devices and related accessories to both new and existing customers, as well as revenues from sales of devices to agents. U.S. Cellular offers a competitive line of quality wireless devices to both new and existing customers. U.S. Cellular's customer acquisition and retention efforts include offering new wireless devices to customers at discounted prices. U.S. Cellular also continues to sell wireless devices to agents including national retailers; this practice enables U.S. Cellular to provide better control over the quality of wireless devices sold to its customers, establish roaming preferences and earn quantity discounts from wireless device manufacturers which are passed along to agents and other retailers.
Equipment sales revenues increased due primarily to an increase in average revenue per device sold (including the impact of sales under equipment installment plans and a mix shift to smartphones and connected devices) and an increase in sales of accessories, partially offset by a decrease in total devices sold of 9%. Equipment sales revenues in 2015 include $226.1 million related to equipment installment plan sales compared to $111.8 million in 2014. See Note 3 — Equipment Installment Plans in the Notes to Consolidated Financial Statements for additional information.
Operating Expenses
System operations expenses (excluding Depreciation, amortization and accretion)
System operations expenses (excluding Depreciation, amortization, and accretion) include charges from telecommunications service providers for U.S. Cellular’s customers’ use of their facilities, costs related to local interconnection to the wireline network, charges for cell site rent and maintenance of U.S. Cellular’s network, long-distance charges, outbound roaming expenses and payments to third‑party data product and platform developers.
Key components of the net change in System operations expenses were as follows:
U.S. Cellular expects system operations expenses to increase in the future to support the continued growth in cell sites and other network facilities as it continues to add capacity, enhance quality and deploy new technologies as well as to support increases in total customer usage, particularly data usage. However, these increases are expected to be offset to some extent by cost savings generated by shifting data traffic to the 4G LTE network from the 3G network.
Cost of equipment sold decreased due primarily to a 9% reduction in the total number of devices sold and a slight decrease in the average cost per device sold due to lower costs from original equipment manufacturers, partially offset by higher sales of accessories. Cost of equipment sold in 2015 includes $300.7 million related to equipment installment plan sales compared to $160.9 million in 2014.
U.S. Cellular's loss on equipment, defined as equipment sales revenues less cost of equipment sold, was $318.0 million and $514.5 million for 2015 and 2014, respectively. The $196.5 million decrease in loss on equipment was driven by a reduction in the total number of devices sold and a higher mix of equipment installment plan sales which have a lower loss per device. During the nine months ended September 30, 2015 and 2014, 43% and 20% of total devices sold to postpaid customers were made under equipment installment plans, respectively. In addition, lower handset sales contributed to the decline in loss on equipment.
U.S. Cellular expects loss on equipment to continue to be a significant cost in the foreseeable future as iconic data-centric wireless devices continue to increase in cost and wireless carriers continue to experience competitive pricing pressures. However, U.S. Cellular expects sales of devices under equipment installment plans will offset loss on equipment to some degree.
Selling, general and administrative expenses
Selling, general and administrative expenses include salaries, commissions and expenses of field sales and retail personnel and facilities; telesales department salaries and expenses; agent commissions and related expenses; corporate marketing and merchandise management; and advertising expenses. Selling, general and administrative expenses also include bad debts expense, costs of operating customer care centers and corporate expenses.
Key components of the net change in Selling, general and administrative expenses were as follows:
Depreciation, amortization and accretion expenses
Depreciation, amortization and accretion decreased due primarily to the cessation of depreciation related to the Divestiture Transaction and by certain assets becoming fully depreciated, partially offset by an increase in amortization expense related to billing system updates. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.
(Gain) loss on asset disposals, net was a loss in both 2015 and 2014 due primarily to write-offs and disposals of certain network assets.
The net gain in 2015 was due primarily to a $107.7 million gain recognized from the Tower Sale. The net gain in 2014 resulted from the continuing impact of the Divestiture Transaction. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.
The net gain in 2015 was due primarily to the license exchange of certain of U.S. Cellular’s PCS licenses for certain other PCS licenses and cash in March 2015. The net gain in 2014 resulted from the sale of the St. Louis area non-operating market license and the license exchange in Milwaukee. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.
RESULTS OF OPERATIONS — TDS TELECOM
TDS Telecom provides broadband, video and voice telecommunications services in its Wireline and Cable segments, and provides hosted and managed services in its HMS segment.
On September 1, 2014, TDS acquired substantially all of the assets of BendBroadband, a full-service cable communications company. As part of the agreement, TDS also acquired a cable advertising and broadcast business and a Tier III data center providing colocation and managed services. The operations of the cable and cable advertising and broadcast businesses are included in the Cable segment. The operations of the data center are included in the HMS segment. This acquisition impacts the comparability of TDS Telecom’s operating results.
The following table summarizes customer connections for TDS Telecom’s Wireline and Cable operations:
As of or for the Nine Months Ended September 30,
Residential connections
Voice (1)
325,900
340,300
(14,400)
Broadband (2)
231,600
IPTV (3)
30,300
20,700
9,600
Wireline residential connections
587,800
592,600
(4,800)
Total residential revenue per connection (4)
42.42
41.10
1.32
Commercial connections
176,700
199,300
(22,600)
23,000
25,300
(2,300)
managedIP (5)
145,900
137,700
8,200
Wireline commercial connections
345,600
362,300
(16,700)
Total Wireline connections
933,400
954,900
(21,500)
Cable connections
Video (6)
108,300
109,100
(800)
Broadband (7)
114,600
106,400
Voice (7)
54,000
41,800
12,200
276,900
257,300
19,600
The individual circuit connecting customers to TDS Telecom’s central office facilities.
The number of customers provided high-capacity data circuits via various technologies, including DSL and dedicated internet circuit technologies.
The number of customers provided video services using IP networking technology.
Total residential revenue per connection is calculated by dividing the average residential revenue for the period by the average number of residential connections for the period.
The number of telephone handsets, data lines and IP trunks providing communications using IP networking technology.
Generally, a home or business receiving video programming counts as one video connection. In counting bulk residential or commercial connections, such as an apartment building or a hotel, connections are counted based on the number of units/rooms within the building receiving service.
Broadband and voice connections reflect billable number of lines into a building for high speed data and voice services, respectively.
(9,128)
(2)%
58,538
80%
19,602
Intra-company elimination
(1,263)
(64)%
459,987
460,647
(660)
125,725
73,816
51,909
70%
227,804
300,056
(72,252)
(24)%
The Wireline business has continued to experience secular declines in its legacy revenues which have not been offset by new product revenues. Increases in Cable and HMS revenues due to acquisitions and organic growth have contributed to overall growth in revenues. In 2014, an $84.0 million impairment loss on the carrying value of the HMS goodwill was recognized.
Wireline Operations
Components of Operating Income
Residential
224,470
219,766
4,704
Commercial
166,197
172,631
(6,434)
(4)%
Wholesale
135,016
142,483
(7,467)
(5)%
Total service revenues
(9,197)
(4,050)
(118)
(7)%
4,076
(1,481)
(1)%
1,871
(Gain) loss on sale of business and other exit
costs, net
(958)
(44)%
Total operating income
(8,468)
(11)%
Residential revenues, which consist of broadband, video, and voice services, increased in 2015 as growth in data and IPTV more than offset the decline in legacy voice services. A 3% increase in average revenue per residential connection driven by price increases for broadband and video services, growth in customers opting for faster broadband speeds and growth in customers selecting higher tier IPTV packages increased revenues $3.3 million. IPTV average connections grew 56% increasing revenues $6.9 million, while legacy voice connections declined by 4% decreasing revenues by $3.8 million.
Commercial revenues, which consist of broadband and voice services and sales and installation of IP-based telecommunication systems, decreased in 2015. Declining legacy voice and data connections reduced revenues $10.7 million, while 8% growth in average managedIP connections increased commercial revenue $4.5 million.
Wholesale revenues, which represent compensation from other carriers for utilizing TDS Telecom’s network infrastructure and federal and state regulatory recoveries, decreased in 2015 due primarily to a $2.6 million reduction in revenues received through inter-state and intra-state regulatory mechanisms and $1.1 million due to a 10% reduction in intra-state minutes-of-use.
Cost of services decreased in 2015 due primarily to $9.6 million in reduced costs of provisioning circuits, purchasing unbundled network elements and providing long-distance services, offset by $5.5 million in increased charges related to the growth in IPTV.
Selling, general and administrative expense increased in 2015 due to $2.3 million of employee-related expenses and a $1.9 million increase in Federal Universal Service Fund contribution expense.
The divestiture of certain wireline companies resulted in a Gain on sale of business and other exit costs, net in 2015 and 2014.
Cable Operations
104,847
59,396
45,451
77%
26,920
14,110
12,810
91%
58,261
N/M
24,342
18,124
11,020
73%
(1,677)
6,629
N/M - Not Meaningful
Changes in operating revenues and operating expenses in 2015 are due primarily to acquisitions. Acquisitions contributed $55.5 million to operating revenues. The remaining increase is due primarily to an increase in residential connections. Acquisitions contributed $43.8 million to operating expenses. The remaining increase is due to higher advertising, plant maintenance and programming content costs.
HMS Operations
5,554
7%
14,048
12%
5,456
9%
10,616
11%
(3,830)
(397)
(84,000)
(97)
91,854
Growth in recurring services and increases in professional services and maintenance resulted in an increase in Service revenues in 2015. Equipment and product sales revenues from sales of IT infrastructure hardware solutions increased in 2015 due to higher spending by existing customers. There was a corresponding increase in Cost of equipment and products and Cost of services needed to support revenue growth.
As a result of interim testing performed during the third quarter of 2014, TDS determined the carrying value of the HMS goodwill exceeded the implied fair value of goodwill. As a result, an $84.0 million impairment loss was recognized.
Three Months Ended September 30, 2015 Compared to Three Months Ended September 30, 2014
68,487
26,217
(929)
(14)%
93,775
991,181
1,051,773
(60,592)
(6)%
282,430
336,553
(54,123)
(16)%
6,753
17,112
(10,359)
(125,074)
(9)%
129,079
80,340
9,430
88%
218,849
3,689
5,091
(7,873)
(29)%
(125)
782
6%
219,631
36,037
183,594
16,481
167,113
In 2014, TDS recognized expenses of $7.7 million related to exit and disposal activities due to a License Purchase and Customer Recommendation Agreement between U.S. Cellular and Airadigm.
Operating Revenues and Expenses
See Results of Operations — U.S. Cellular and Results of Operations — TDS Telecom below for factors that affected consolidated Operating Revenues and Expenses.
TDS’ investment in the Los Angeles SMSA Limited Partnership (“LA Partnership”) through U.S. Cellular contributed $18.8 million and $18.2 million to Equity in earnings of unconsolidated entities in 2015 and 2014, respectively.
Interest and dividend income increased due to imputed interest income recognized on equipment installment plans of $9.0 million and $2.7 million in 2015 and 2014, respectively. See Note 3 — Equipment Installment Plans in the Notes to the Consolidated Financial Statements for additional information.
10,191
(3,524)
1,121
(1,645)
796,821
743,798
53,023
59,169
66,577
(7,408)
39,970
40,688
(718)
44,897
23,590
16%
(768)
(20,606)
(22,960)
3,417
(5,329)
(67)%
9,640
94%
N/M - Not meaningful
Retail service revenues increased due primarily to the growth in U.S. Cellular’s average customer base and an increase in billed ARPU, including the impact of revenue recognized from expired rewards points.
Billed ARPU increased to $55.42 in 2015 from $53.24 in 2014, reflecting an increase in postpaid ARPU of $1.75 to $58.12 due to increased adoption of shared data plans and the $4.48 postpaid ARPU impact of the expired rewards points, partially offset by discounts on shared data plans provided to customers on equipment installment plans and those providing their own device at the time of activation or renewal.
Inbound roaming revenues decreased due primarily to lower rates for both voice and data and a decline in voice volume.
Other revenues decreased due primarily to a decrease in tower rent revenue due to the Tower Sale, partially offset by increases in revenue from spectrum leases and mobile applications. Revenues representing amounts received from the Federal USF in 2015 were $23.0 million, which remained flat year over year.
Equipment sales revenues increased due primarily to an increase in average revenue per device sold (including the impact of sales under equipment installment plans and a mix shift to smartphones and connected devices) and an increase in sales of accessories, partially offset by a decrease in total devices sold of 3%. Equipment sales revenues in 2015 include $89.2 million related to equipment installment plan sales compared to $78.2 million in 2014. See Note 3 — Equipment Installment Plans in the Notes to Consolidated Financial Statements for additional information.
Cost of equipment sold decreased due primarily to a 3% decrease in the total number of devices sold and a decrease in the average cost per device sold due to lower costs from original equipment manufacturers, slightly offset by higher sales of accessories. Cost of equipment sold in 2015 includes $109.3 million related to equipment installment plan sales compared to $113.5 million in 2014.
U.S. Cellular's loss on equipment, defined as equipment sales revenues less cost of equipment sold, was $114.3 million and $158.5 million for 2015 and 2014, respectively. The $44.2 million decrease in loss on equipment was driven by higher equipment installment plan sales which have a lower loss per device. In addition, lower handset sales contributed to the decline in loss on equipment.
The net gains in 2015 and in 2014 were due primarily to the continuing impact of the Divestiture Transaction. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.
The net gain in 2015 was due primarily to the license exchange of certain of U.S. Cellular’s PCS and AWS licenses for certain other PCS and AWS licenses and cash. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information.
RESULTS OF OPERATIONS – TDS TELECOM
(3,019)
15,341
54%
14,099
21%
(204)
(21)%
157,241
151,428
5,813
42,871
29,396
13,475
46%
83,502
156,709
(73,207)
(47)%
75,508
73,901
1,607
55,039
57,179
(2,140)
44,032
46,570
(2,538)
(3,071)
(376)
(314)
(38)%
3,435
(130)
1,102
2,096
95%
(8,832)
(33)%
Residential revenues increased in 2015 as growth in data and IPTV more than offset the decline in legacy voice services. IPTV average connections grew 48% increasing revenues $2.3 million, while legacy voice connections declined by 3% decreasing revenues by $1.1 million. A 3% increase in average revenue per residential connection increased revenues $1.2 million.
Commercial revenues decreased in 2015 as declining legacy voice and data connections reduced revenues $3.4 million, while 7% growth in average managedIP connections increased commercial revenues $1.3 million.
Cost of services decreased in 2015 due primarily to $3.1 million in reduced costs of provisioning circuits, purchasing unbundled network elements and providing long-distance services, offset by $1.8 million in increased charges related to the growth in IPTV.
Selling, general and administrative expense increased in 2015 due to an increase in Federal Universal Service Fund contribution expense. Increases in employee related expenses, bad debts and property taxes made up the majority of the remaining increase.
34,888
22,921
11,967
52%
8,853
3,255
58%
15,222
53%
6,894
4,398
44%
2,359
38%
(201)
(32)%
1,866
Changes in operating revenues and operating expenses in 2015 are due primarily to acquisitions. Acquisitions contributed $14.2 million to operating revenues. The remaining increase is due primarily to an increase in residential connections. Acquisitions contributed $11.5 million to operating expenses. The remaining increase is due to higher advertising, plant maintenance and programming content costs.
2,622
11,477
29%
1,721
9,262
27%
(278)
64
24
87,306
98%
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 — Basis of Presentation in the Notes to Consolidated Financial Statements for information on recent accounting pronouncements.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
TDS operates a capital- and marketing-intensive business. TDS utilizes cash on hand, cash from operating activities, cash proceeds from divestitures and dispositions of investments, short-term credit facilities and long-term debt financing to fund its acquisitions (including licenses), construction costs, operating expenses and share repurchases. Cash flows may fluctuate from quarter to quarter and year to year due to seasonality, the timing of acquisitions and divestitures, capital expenditures and other factors. The table below and the following discussion summarize TDS' cash flow activities for the nine months ended September 30, 2015 and 2014.
Cash flows from (used in):
Operating activities
Investing activities
Financing activities
Cash Flows from Operating Activities
An increase in cash flows from operating activities was due primarily to improved net income and working capital factors. Future cash flows from operating activities may be impacted by distributions from investments in unconsolidated entities. Distributions from unconsolidated entities in 2015 and 2014 were $45.0 million and $74.9 million, respectively. U.S. Cellular holds a 5.5% ownership interest in the LA Partnership. U.S. Cellular has been informed by the general partner of the LA Partnership that, in connection with the acquisition of a spectrum license covering the LA Partnership’s market in FCC Auction 97, the LA Partnership will not make a cash distribution in 2015. Notwithstanding the lack of a cash distribution, U.S. Cellular will be obligated to make tax payments on its share of any taxable income reported by the LA Partnership in 2015 and beyond. U.S. Cellular currently expects that it might receive a cash distribution in the latter half of 2016, although the amount of any such distribution is uncertain. During the nine months ended September 30, 2014 and the twelve months ended December 31, 2014, U.S. Cellular received cash distributions of $35.8 million and $60.5 million, respectively, from the LA Partnership.
TDS’ future federal income tax liabilities associated with the benefits realized in prior periods from bonus depreciation are accrued as a component of Net deferred income tax liability (noncurrent) in the Consolidated Balance Sheet. Currently, there is no federal bonus depreciation deduction allowed for 2015 and future periods. Therefore, depending on TDS’ future pretax income levels, TDS’ federal income tax payments could increase in 2015 and remain at a higher level for several years as the amount of TDS’ federal tax depreciation deductions decrease. This expectation of potentially higher federal income tax payments in 2015 and subsequent years assumes that federal bonus depreciation provisions are not enacted in 2015 or future periods. To the extent further federal bonus depreciation provisions are enacted, this expectation would change and may have an impact on the overall level of operating cash flows in the future.
Cash Flows from Investing Activities
TDS makes substantial investments to acquire wireless licenses and properties and to construct and upgrade telecommunications networks and facilities as a basis for creating long-term value for shareholders. In recent years, rapid changes in technology and new opportunities have required substantial investments in potentially revenue‑enhancing and cost-reducing upgrades to TDS’ networks.
Cash used for additions to property, plant and equipment totaled $558.1 million in 2015 and $553.7 million in 2014, and is reported in the Consolidated Statement of Cash Flows.
Capital expenditures (i.e., additions to property, plant and equipment and system development expenditures), which include the effects of accruals and capitalized interest, in the nine months ended September 30, 2015 and 2014 were as follows:
TDS Telecom total
Corporate and Other
See Capital Expenditures below for additional information on Capital expenditures.
During 2015, a $278.3 million payment was made by Advantage Spectrum L.P. to the FCC for licenses for which it was the provisional winning bidder. See Note 6 — Acquisitions, Divestitures and Exchanges and Note 10 — Variable Interest Entities in the Notes to Consolidated Financial Statements for additional information.
Cash received from Divestitures and Exchanges, which is a component of cash flows from investing activities in the Consolidated Statement of Cash Flows, is shown below.
U.S. Cellular licenses
145,000
91,789
U.S. Cellular businesses (1)
169,352
52,012
TDS Telecom wireline businesses
10,400
7,568
Amount includes cash proceeds received from the sale of 359 towers and reimbursements related to the Divestiture Transaction.
See Note 6— Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to these divestitures.
Cash Flows from Financing Activities
Cash flows from financing activities include proceeds from and repayments of long-term debt, dividends to shareholders, distributions to noncontrolling interests, cash used to repurchase Common Shares and cash proceeds from reissuance of Common Shares pursuant to stock-based compensation plans. In July 2015, U.S. Cellular borrowed $225 million on its Term Loan. See Financing section below for additional discussion.
Adjusted Free Cash Flow
The following table presents Adjusted free cash flow. Adjusted free cash flow is defined as Cash flows from operating activities (which includes cash outflows related to the Sprint decommissioning), as adjusted for cash proceeds from the Sprint Cost Reimbursement (which are included in Cash flows from investing activities in the Consolidated Statement of Cash Flows), less Cash used for additions to property, plant and equipment. Adjusted free cash flow is a non-GAAP financial measure which TDS believes may be useful to investors and other users of its financial information in evaluating the amount of cash generated by business operations (including cash proceeds from the Sprint Cost Reimbursement), after Cash used for additions to property, plant and equipment.
Add: Sprint Cost Reimbursement (1)
27,596
Less: Cash used for additions to property, plant and equipment
558,112
553,718
Adjusted free cash flow
196,402
(5,495)
See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to the Sprint Cost Reimbursement.
See Cash Flows from Operating Activities and Cash Flows from Investing Activities for additional information related to the components of Adjusted free cash flow.
LIQUIDITY
TDS believes that existing cash and investment balances, funds available under its revolving credit facilities, and expected cash flows from operating and investing activities provide substantial liquidity and financial flexibility for TDS to meet its normal day-to-day operating needs and debt service requirements. However, these resources may not be adequate to fund all future expenditures that the companies could potentially elect to make such as acquisitions of spectrum licenses in FCC auctions and other acquisition, construction and development programs. It may be necessary from time to time to increase the size of the existing revolving credit facilities, to put in place new credit facilities, or to obtain other forms of financing in order to fund these potential expenditures. To the extent that sufficient funds are not available to TDS or its subsidiaries on terms or at prices acceptable to TDS, it could require TDS to reduce its acquisition, capital expenditure, business development and share repurchase programs.
TDS cannot provide assurances that circumstances that could have a material adverse effect on its liquidity or capital resources will not occur. Economic conditions, changes in financial markets, TDS financial performance and/or prospects or other factors could restrict TDS’ liquidity and availability of financing on terms and prices acceptable to TDS, which could require TDS to reduce its acquisition, capital expenditure, business development and share repurchase programs. Such reductions could have a material adverse effect on TDS’ business, financial condition or results of operations.
Cash and Cash Equivalents
Cash and cash equivalents include cash and short-term, highly liquid investments with original maturities of three months or less. The primary objective of TDS’ Cash and cash equivalents investment activities is to preserve principal. At September 30, 2015, the majority of TDS’ Cash and cash equivalents was held in bank deposit accounts and in money market funds that invest exclusively in U.S. Treasury Notes or in repurchase agreements fully collateralized by such obligations. TDS monitors the financial viability of the money market funds and direct investments in which it invests and believes that the credit risk associated with these investments is low.
Financing
As of September 30, 2015, TDS and U.S. Cellular’s unused capacity under their revolving credit facilities was $399.4 million and $282.5 million, respectively. These credit facilities mature in December 2017. In July 2015, U.S. Cellular borrowed $225 million on the Term Loan. TDS and U.S. Cellular believe they were in compliance with all of the financial covenants and requirements set forth in their revolving credit facilities and Term Loan as of September 30, 2015.
TDS and U.S. Cellular have in place effective shelf registration statements on Form S-3 to issue senior or subordinated debt securities.
The proceeds from any of the aforementioned financing facilities are available for general corporate purposes, including spectrum purchases and capital expenditures.
The long-term debt payments due for the remainder of 2015 and the next four years represent less than 3% of TDS’ total long-term debt obligation.
Capital Expenditures
U.S. Cellular’s capital expenditures for 2015 are expected to be approximately $600 million. These expenditures are expected to be for the following general purposes:
TDS Telecom’s capital expenditures for 2015 are expected to be $220 million. These expenditures are expected to be for the following general purposes:
TDS plans to finance its capital expenditures program for 2015 using primarily Cash flows from operating activities and, as necessary, existing cash balances and borrowings under its revolving credit agreements and/or other long-term debt.
Acquisitions, Divestitures and Exchanges
TDS assesses its business interests on an ongoing basis with a goal of improving the competitiveness of its operations and maximizing its long-term return on investment. As part of this strategy, TDS reviews attractive opportunities to acquire additional wireless operating markets and wireless spectrum; and telecommunications, cable, HMS or other possible businesses. In addition, TDS may seek to divest outright or include in exchanges for other interests those interests that are not strategic to its long-term success. As a result, TDS may be engaged from time to time in negotiations relating to the acquisition, divestiture or exchange of companies, properties, wireless spectrum and other possible businesses. In general, TDS may not disclose such transactions until there is a definitive agreement. See Note 6 — Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to significant transactions, including expected pre-tax cash proceeds from such transactions in 2015.
Variable Interest Entities
TDS consolidates certain entities because they are “variable interest entities” under accounting principles generally accepted in the United States of America (“GAAP”). See Note 10 — Variable Interest Entities in the Notes to Consolidated Financial Statements for additional information related to these variable interest entities. TDS may elect to make additional capital contributions and/or advances to these variable interest entities in future periods in order to fund their operations.
U.S. Cellular currently provides 4G LTE service in conjunction with King Street Wireless L.P. Aquinas Wireless L.P. has not yet developed long-term business plans. Advantage Spectrum L.P. will develop its long-term business plans after it is granted licenses by the FCC. These licenses have not yet been granted.
Common Share Repurchase Programs
In the past year, TDS and U.S. Cellular have repurchased and expect to continue to repurchase their Common Shares, in each case subject to any available repurchase program. For additional information related to the current TDS and U.S. Cellular repurchase authorizations and repurchases made during 2015 and 2014, see Note 12 — Common Share Repurchases in the Notes to Consolidated Financial Statements and Part II, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Contractual and Other Obligations
There were no material changes outside the ordinary course of business between December 31, 2014 and September 30, 2015 to the Contractual and Other Obligations disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in TDS’ Form 10-K for the year ended December 31, 2014, except for U.S. Cellular’s borrowing of $225 million under the Term Loan in July 2015. See Note 9 — Debt in the Notes to Consolidated Financial Statements for additional information.
Off-Balance Sheet Arrangements
TDS had no transactions, agreements or other contractual arrangements with unconsolidated entities involving “off-balance sheet arrangements,” as defined by SEC rules, that had or are reasonably likely to have a material current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
TDS prepares its consolidated financial statements in accordance with GAAP. TDS’ significant accounting policies are discussed in detail in Note 1 — Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements and TDS’ Application of Critical Accounting Policies and Estimates is discussed in detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are included in TDS’ Form 10-K for the year ended December 31, 2014. There were no material changes to TDS’ application of critical accounting policies and estimates during the nine months ended September 30, 2015.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR CAUTIONARY STATEMENT
This Form 10-Q, including exhibits, contains statements that are not based on historical facts and represent forward-looking statements, as this term is defined in the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, that address activities, events or developments that TDS intends, expects, projects, believes, estimates, plans or anticipates will or may occur in the future are forward-looking statements. The words “believes,” “anticipates,” “estimates,” “expects,” “plans,” “intends,” “projects” and similar expressions are intended to identify these forward-looking statements, but are not the exclusive means of identifying them. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, events or developments to be significantly different from any future results, events or developments expressed or implied by such forward-looking statements. Such risks, uncertainties and other factors include those set forth below, as more fully described under “Risk Factors” in TDS’ Form 10-K for the year ended December 31, 2014. However, such factors are not necessarily all of the important factors that could cause actual results, performance or achievements to differ materially from those expressed in, or implied by, the forward-looking statements contained in this document. Other unknown or unpredictable factors also could have material adverse effects on future results, performance or achievements. TDS undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. You should carefully consider the Risk Factors in TDS’ Form 10-K for the year ended December 31, 2014, the following factors and other information contained in, or incorporated by reference into, this Form 10-Q to understand the material risks relating to TDS’ business.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
MARKET RISK
Refer to the disclosure under Market Risk in TDS’ Form 10-K for the year ended December 31, 2014 for additional information, including information regarding required principal payments and the weighted average interest rates related to TDS’ Long-term debt. There have been no material changes to such information since December 31, 2014, except for U.S. Cellular’s borrowing of $225 million under the Term Loan in July 2015.
See Note 2 — Fair Value Measurements in the Notes to Consolidated Financial Statements for additional information related to the fair value of TDS’ Long-term debt as of September 30, 2015.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
TDS maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in its reports filed or submitted under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and that such information is accumulated and communicated to TDS’ management, including its principal executive officer and principal financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
As required by SEC Rule 13a-15(b), TDS carried out an evaluation, under the supervision and with the participation of management, including its principal executive officer and principal financial officer, of the effectiveness of the design and operation of TDS’ disclosure controls and procedures as of the end of the period covered by this Quarterly Report. Based on this evaluation, TDS’ principal executive officer and principal financial officer concluded that TDS' disclosure controls and procedures were effective as of September 30, 2015, at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
Internal controls over financial reporting continue to be updated as necessary to accommodate modifications to our business processes and accounting procedures. As previously disclosed in TDS’ Form 10-K for the year ended December 31, 2014, U.S. Cellular entered into certain arrangements in the latter part of the fourth quarter of 2014 pursuant to which U.S. Cellular now outsources certain support functions for its Billing and Operational Support System (“B/OSS”) to a third-party vendor. In accordance with this change and effective January 1, 2015, U.S. Cellular is placing reliance on certain third-party controls with respect to the B/OSS environment. There have been no other changes in internal controls over financial reporting that have occurred during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, TDS’ internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings.
Refer to the disclosure under Legal Proceedings in TDS’ Form 10-K for the year ended December 31, 2014. There have been no material changes to such information since December 31, 2014.
Item 1A. Risk Factors.
In addition to the information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in TDS’ Annual Report on Form 10-K for the year ended December 31, 2014, which could materially affect TDS’ business, financial condition or future results. The risks described in this Form 10-Q and the Form 10-K for the year ended December 31, 2014, may not be the only risks that could affect TDS. Additional unidentified or unrecognized risks and uncertainties could materially adversely affect TDS’ business, financial condition and/or operating results. Subject to the foregoing, TDS has not identified for disclosure any material changes to the risk factors as previously disclosed in TDS’ Annual Report on Form 10-K for the year ended December 31, 2014.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On August 2, 2013, the Board of Directors of TDS authorized a $250 million stock repurchase program for TDS Common Shares. Depending on market conditions, such shares may be repurchased in compliance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended ("Exchange Act"), pursuant to Rule 10b5-1 under the Exchange Act, or pursuant to accelerated share repurchase arrangements, prepaid share repurchases, private transactions or as otherwise authorized. This authorization does not have an expiration date.
The maximum dollar value of shares that may yet be purchased under the program was $201.2 million as of September 30, 2015. There were no purchases made by or on behalf of TDS, and no open market purchases made by any “affiliated purchaser” (as defined by the SEC) of TDS, of TDS Common Shares during the quarter covered by this Form 10-Q.
The following is additional information with respect to the Common Share authorization:
Item 5. Other Information.
Neither TDS nor U.S. Cellular borrowed or repaid any cash amounts under their revolving credit facilities in the third quarter of 2015 or through the filing date of this Form 10-Q, and had no cash borrowings outstanding under their revolving credit facilities as of September 30, 2015 or as of the filing date of this Form 10-Q.
A description of TDS’ revolving credit facility is included in TDS’ Current Report on Form 8-K dated December 17, 2010, as such description is amended by Item 1.01 in TDS’ Current Report on Form 8-K dated July 24, 2014, and is incorporated by reference herein.
A description of U.S. Cellular’s revolving credit facility is included in U.S. Cellular’s Current Report on Form 8-K dated December 17, 2010, as such description is amended by Item 1.01 in U.S. Cellular’s Current Report on Form 8-K dated July 24, 2014, and is incorporated by reference herein.
The following briefly describes amendments to TDS’ Bylaws effective August 19, 2015 that made changes to TDS’ shareholder nomination procedures:
The foregoing description is qualified by reference to the copy of the amended Bylaws attached as Exhibit 3.1 to TDS’ Current Report on Form 8-K dated August 19, 2015 and filed August 25, 2015.
Item 6. Exhibits.
Exhibit 3.1— Restated Bylaws of TDS effective August 19, 2015, are hereby incorporated by reference to Exhibit 3.1 to TDS’ Current Report on Form 8-K dated August 19, 2015.
Exhibit 4.1 — Restated Bylaws of TDS are hereby incorporated by reference to Exhibit 3.1 above.
Exhibit 4.2 — Term Loan Credit Agreement dated as of January 21, 2015 between U.S. Cellular and CoBank ACB, including exhibits, is hereby incorporated by reference to Exhibit 4.1 to U.S. Cellular’s Current Report on Form 8-K dated January 21, 2015.
Exhibit 10.1 — Form of TDS 2011 Long-Term Incentive Plan Stock Option Award Agreement, is hereby incorporated by reference to Exhibit 10.1 to TDS’ Current Report on Form 8-K dated May 1, 2015.
Exhibit 10.2 — Form of TDS 2011 Long-Term Incentive Plan Stock Restricted Stock Unit Award Agreement, is hereby incorporated by reference to Exhibit 10.2 to TDS’ Current Report on Form 8-K dated May 1, 2015.
Exhibit 10.3 — Form of U.S. Cellular 2013 Long-Term Incentive Plan Stock Option Award Agreement for the President and Chief Executive Officer of U.S. Cellular, is hereby incorporated by reference to Exhibit 10.3 to U.S. Cellular’s Current Report on Form 8-K dated February 26, 2015.
Exhibit 10.4 — Form of U.S. Cellular 2013 Long-Term Incentive Plan Stock Restricted Stock Unit Award Agreement for the President and Chief Executive Officer of U.S. Cellular, is hereby incorporated by reference to Exhibit 10.4 to U.S. Cellular’s Current Report on Form 8-K dated February 26, 2015.
Exhibit 10.5 — TDS 2015 Officer Bonus Program, is hereby incorporated by reference to Exhibit 10.1 to TDS’ Current Report on Form 8-K dated August 7, 2015.
Exhibit 11 — Statement regarding computation of per share earnings is included herein as Note 5 — Earnings Per Share in the Notes to Consolidated Financial Statements.
Exhibit 12 — Statement regarding computation of ratio of earnings to fixed charges.
Exhibit 31.1 — Principal executive officer certification pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
Exhibit 31.2 — Principal financial officer certification pursuant to Rule 13a-14 of the Securities Exchange Act of 1934.
Exhibit 32.1 — Principal executive officer certification pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
Exhibit 32.2 — Principal financial officer certification pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
Exhibit 101.INS — XBRL Instance Document
Exhibit 101.SCH — XBRL Taxonomy Extension Schema Document
Exhibit 101.PRE — XBRL Taxonomy Presentation Linkbase Document
Exhibit 101.CAL — XBRL Taxonomy Calculation Linkbase Document
Exhibit 101.LAB — XBRL Taxonomy Label Linkbase Document
Exhibit 101.DEF — XBRL Taxonomy Extension Definition Linkbase Document
The foregoing exhibits include only the exhibits that relate specifically to this Form 10-Q or that supplement the exhibits identified in TDS’ Form 10-K for the year ended December 31, 2014. Reference is made to TDS’ Form 10-K for the year ended December 31, 2014 for a complete list of exhibits, which are incorporated herein except to the extent supplemented or superseded above.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date:
October 30, 2015
/s/ LeRoy T. Carlson, Jr.
LeRoy T. Carlson, Jr.,
President and Chief Executive Officer
(principal executive officer)
/s/ Douglas D. Shuma
Douglas D. Shuma,
Senior Vice President - Finance and Chief Accounting Officer
(principal financial officer and principal accounting officer)
/s/ Douglas W. Chambers
Douglas W. Chambers,
Vice President and Controller