2013 Annual Report www.teldta.com 2013 Annual Report www.teldta.com |
Ensuring a strong financial foundation TDS U.S. Cellular Shares Repurchased (in millions of shares) 8 7 6 5 4 3 2 1 0 07 08 09 10 11 12 13 Capital Allocation Strategy $0.60 $0.50 $0.40 $0.30 $0.20 $0.10 $0.00 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 TDS Annual Dividend Per Share At TDS, we take a balanced approach to capital allocation, investing to build our businesses for the long term, and returning value to our shareholders. Investing for our future Over the next several years, we expect to allocate approximately 75 percent of our available resources to build and strengthen our cable and hosted and managed services businesses through attractive acquisition opportunities. Returning value to our shareholders At the same time, we plan to return approximately 25 percent of our available resources to our shareholders, through cash dividends and share repurchases. We are proud to have increased our annual dividend for 40 consecutive yearsan achievement accomplished by only a handful of companies. Over the past seven years, TDS has repurchased $930 million of TDS and U.S. Cellular shares. 40 years of consecutive dividend increases New $250 million TDS share repurchase program authorized in 2013 Investing for our future Returning value to shareholders |
TELEPHONE AND DATA SYSTEMS 1 To Our Shareholders Total Company Performance For TDS, 2013 was a year of signifi cant strategic action. We divested underperforming wireless markets to focus on stronger markets. We identified cable as an attractive growth area and made our first acquisition, Baja Broadband, to build the business. We united our hosted and managed services businesses under one brand to focus more effectively on attracting midmarket commercial customers. We also took action to return value to TDS and U.S. Cellular shareholders, and to strengthen our financial foundation by monetizing non-strategic assets. TDS mission is to provide outstanding communication services to our customers and meet the needs of our shareholders, our people and our communities. In pursuing this mission, we seek to continuously grow our businesses, create opportunities for our associates and employees, and steadily build value over the long term for our shareholders. While our financial and operating results continue to refl ect the competitive environment and the impact of necessary investments, we believe the actions weve taken to better position our businesses will enable us to improve our performance over time. In addition to the initiatives above, we made progress in a number of important areas: U.S. Cellular continued to increase smartphone penetration and data use through its expanded 4G LTE network, shared data plans, and a competitive portfolio of Android, Apple, and Windows devices. U.S. Cellular further expanded retail distribution through agreements with Sams Club and Amazon, and launched a new billing and operational system that provides an important platform for future growth. Although implementation challenges impacted customer service more than anticipated, we believe the long-term benefits will be substantial. TDS Telecom increased wireline residential average revenue per connection and maintained strong growth in commercial managedIP customers. TDS has invested in substantial initiatives over the past few years to position our businesses to operate more efficiently and compete more effectively. We are confident that the short-term impact to performance is worth the long-term benefits for our businesses and our customers. Thank you to the leadership teams at TDS and each of our businesses for leading us through challenges and opportunities with the highest ethical and professional standards. We appreciate your vision and dedication. TDS Telecom began integrating the Baja Broadband acquisition and implementing strategies to increase residential and commercial penetration in Baja markets. We strengthened our hosted and managed services business with the acquisition of solutions provider MSN Communications, and then united all five HMS businesses under a single brandOneNeck IT Solutions. |
2 TELEPHONE AND DATA SYSTEMS J.D. Power Customer Champion, 2014 Attracting Customers and Building Loyalty Attracting new customers and reducing churn are our highest priorities. We enhanced our value proposition in 2013 by expanding 4G LTE access to nearly 90 percent of our customers, launching Apple devices to strengthen our portfolio, offering shared data plans, and working to provide a seamless and consistently high-quality experience across our sales and service channels. We introduced customizable plans for small and medium businesses, and expanded our distribution to Sams Club and Amazon. We also converted to a new billing and operational support systeman essential platform for delivering services and products more efficiently. During and following the conversion, many of our customers experienced extended reductions in service levels as we worked through implementation issues, and this led to an increase in postpaid churn. These experiences were below our standards, and we provided additional rewards points to postpaid customers in appreciation for their patience and commitment. We launched Apple devices for the fi rst time in November of 2013, and reinstituted contracts for postpaid customers, to help reduce postpaid churn over time. Our strategy is to provide the best customer experiences in the wireless industry, centered around a best-in-class network. A fast and reliable 4G LTE network is the backbone for our competitive data products and services and strong portfolio of Android, Apple, and Windows devices. Our Rewards Programunique in the wireless industrycreates a membership experience for our customers. More than ever, we believe network quality is the most important element of customer satisfaction. U.S. Cellular Value Proposition Data Products & Services Membership Experience Local Market Foc us Competitive devices, plans, and pricing Understanding customer needs in each of our markets Outstanding customer service and Rewards Program Best-in-Class Network |
TELEPHONE AND DATA SYSTEMS 3 Growth in data use is a critical driver of U.S. Cellulars future success. Total data traffic increased 97 percent from 2012 to 2013. Increasing Smartphone Penetration and Monetizing Data Use A best-in-class 4G LTE network is the foundation for competitive data offerings and devices that enable us to maximize and monetize the dramatic growth in data use. By the end of 2013, we offered our strongest-ever portfolio of Android, Apple, and Windows devices, along with attractive shared data plans. Fifty-one percent of postpaid customers were smartphone customers in the fourth quarter, and 80 percent of total devices sold in the quarter were smartphones. We expanded 4G LTE coverage to nearly 90 percent of customers by year end, and 4G LTE devices were 69 percent of devices sold in the fourth quarter. Comprehensive 4G LTE coverage provides signifi cant capacity to promote and monetize smartphone adoption and data use in all of our markets. The recent Federal Communications Commission decision to mandate device interoperability supports our strategy by ensuring that we can continue to offer a greater choice of devices to our customers, and offer nationwide 4G LTE roaming coverage in the future. Highest Network Quality Performance Among Wireless Cell Phone Users in North Central Region - J.D. Power Smartphones as a Percentage of Total Devices Sold 90% 80% 70% 60% 50% 40% 30% 20% 10% 0 63% 62% 66% 80% 65% 69% Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 4G 3G 46% 46% 58% 55% Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Smartphone Customers as a Percentage of Postpaid Customers 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0 42% 43% 46% 51% 47% 42% 15% 21% 29% 4G 3G 33% |
Wireline Residential TDS Telecom is increasing average revenue per residential connection as customers chose faster broadband speeds and higher-tier packages of our IPTV service, TDS TV®. We continued to increase broadband speeds and expand TDS TV availability in our markets, and we marketed high-speed fiber and TDS TV services in new neighborhoods to build momentum prior to buildouts. By the fourth quarter, TDS TV was available in 11 markets, and 13 percent of residential households were passed by facilities that enable TDS TV. Broadband and video service bundles are key to our retention strategy, and by the end of 2013, 73 percent of residential customers had double- or triple-play bundles. We also neared completion of stimulus projects nationwide that will bring broadband access to approximately 27,000 previously underserved households when complete. Commercial Our commercial strategy is to be a trusted partner to our business customers, and our reputation for service quality and reliability enabled us to achieve a 35 percent increase in connections for managedIP, a hosted VoIP voice and data solution. This offset a decline in traditional voice services, which resulted in a slight increase in commercial revenues in 2013. TDS TELECOM Our strategy is to attract customers by providing high-quality, reliable communications services and products. We expanded our business strategically in 2013 by entering the cable sector through the acquisition of Baja Broadband, opening substantial opportunities to leverage our existing products, services, and infrastructure in new markets. We also positioned our hosted and managed services business to offer comprehensive IT solutions through a unified brand and sales force. 4 TELEPHONE AND DATA SYSTEMS Twenty-five percent of customers had access to 25Mbps or faster broadband service at the end of 2013. The average monthly churn rate for customers with three services is very low, at approximately one-half of one percent. 130 120 110 100 90 80 70 60 50 40 30 20 10 0 15 30 54 128 95 managedIP Connections (in thousands) 09 10 11 12 13 |
Suttle-Straus Suttle-Straus, a marketing and graphic communications solutions provider, continued to improve its performance in 2013, expanding its commercial client base and enhancing its bundled packages of marketing services, from creative development through print and distribution. Suttle-Straus also improved margins and increased productivity through continuous improvement initiatives. Airadigm Communications Airadigm Communications, Inc. offers mobile services to customers in Wisconsin. Airadigm operates independently of U.S. Cellular. OTHER TDS SUBSIDIARIES TELEPHONE AND DATA SYSTEMS 5 The high-capacity cable pipeline offers significant growth potential for our residential and commercial data products and services. Recurring hosted and managed services revenues increased 10 percent in 2013. Cable We identified cable broadband as an attractive growth area and entered the sector in 2013 with the acquisition of Baja Broadband, which provides a high-capacity data pipeline to homes and businesses in the southwest U.S. After the acquisition closed in August, we began leveraging our marketing experience and network capabilities to increase residential and commercial penetration in Bajas markets. As we execute on our integration and growth strategies, were identifying operational and infrastructure synergies to increase effi ciency. We plan to continue to build our cable portfolio with acquisitions that offer signifi cant growth potential in complementary markets. Hosted and Managed Services Our strategy is to sell comprehensive IT solutions to mid-market commercial customers. We strengthened our value proposition in 2013 with the acquisition of solutions provider MSN Communications, and then unified our fi ve hosted and managed services businesses under one brandOneNeck IT Solutions. With a comprehensive, unifi ed service portfolio that includes colocation, cloud and hosting solutions, managed services, professional services, ERP application management, and IT hardware, OneNeck is well positioned to be a single, trusted source of end-to-end IT solutions for commercial customers. |
6 TELEPHONE AND DATA SYSTEMS TDS Telecom Were working to attract residential and commercial customers through superior experiences and highquality, reliable services. We plan to bring faster broadband, high-quality video service, and competitive bundles to more residential customers, and increase fiber network coverage for both residential and commercial customers. Well continue to optimize our investment in Baja Broadband and seek additional opportunities to build our cable business through acquisitions. Were focused on developing comprehensive hosted and managed solutions through OneNeck IT Solutions, and increasing recurring revenues from mid-market customers. Our strategic imperative is to increase customer and revenue growth in our businesses by leveraging our improved competitive positioning and allocating our resources effectively to support growth initiatives. U.S. Cellular We plan to attract new customers and build customer loyalty with customer experiences grounded in network quality, competitive data products and services and devices, an innovative Rewards Program that makes customers feel like members, and localized attention to customer needs. Were focused on driving revenues through smartphone penetration and monetized data use, as we continue to expand and enhance 4G LTE access. We will continue to increase operational efficiency. LOOKING FORWARD Thank you to the employees and associates of the TDS companies for their dedication and innovation in providing outstanding services, products, and experiences to our customers. Thank you also to our shareholders and debt holders for your continuing support of our long-term strategies. Sincerely, LeRoy T. Carlson, Jr. Walter C.D. Carlson President and Chief Chairman of the Board Executive Officer |
TELEPHONE AND DATA SYSTEMS, INC.
ANNUAL REPORT TO SHAREHOLDERS FOR THE YEAR ENDED DECEMBER 31, 2013
Pursuant to SEC Rule 14a-3
The following audited financial statements and certain other financial information for the year ended December 31, 2013, represent Telephone and Data Systems' annual report to shareholders as required by the rules and regulations of the Security and Exchange Commission ("SEC").
The following information was filed with the SEC on February 28, 2014 as Exhibit 13 to Telephone and Data Systems' Annual Report on Form 10-K for the year ended December 31, 2013. Such information has not been updated or revised since the date it was originally filed with the SEC. Accordingly, you are encouraged to review such information together with any subsequent information that we have filed with the SEC and other publicly available information.
Telephone and Data Systems, Inc.
Financial Reports Contents
Telephone and Data Systems, Inc.
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 1.1 million wireline and cable connections at December 31, 2013. TDS conducts substantially all of 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 ("HMS"), through its wholly-owned subsidiary, TDS Telecommunications Corporation ("TDS Telecom").
TDS conducts printing and distribution services through its majority-owned subsidiary, Suttle-Straus, Inc. ("Suttle-Straus") and provides wireless services through its wholly-owned subsidiary, Airadigm Communications, Inc. ("Airadigm"), a Wisconsin-based service provider. At this time, Airadigm operates independently from U.S. Cellular. Suttle-Straus and Airadigm's financial results were not significant to TDS' operations for the year ended December 31, 2013 and collectively represent the "Non-Reportable Segment."
The following discussion and analysis should be read in conjunction with TDS' audited consolidated financial statements and the description of TDS' business included in Item 1 of the TDS Annual Report on Form 10-K ("Form 10-K") for the year ended December 31, 2013. The discussion and analysis contained herein refers to consolidated data and results of operations, unless otherwise noted.
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.
Previously, TDS had reported the following reportable segments: U.S. Cellular, TDS Telecom's incumbent local exchange carrier ("ILEC"), its competitive local exchange carrier ("CLEC"), its HMS operations and the Non-Reportable Segment. As a result of recent acquisitions and changes in TDS' strategy, operations and internal reporting, TDS has reevaluated and changed its operating segments during the year ended December 31, 2013, which resulted in the following reportable segments: U.S. Cellular, TDS Telecom's Wireline, Cable and HMS operations, and the Non-Reportable Segment. The Wireline segment consists of the former ILEC and CLEC segments. The Cable segment consists of Baja Broadband, LLC ("Baja"), which was acquired in August 2013. The HMS segment remains unchanged. Periods presented for comparative purposes have been re-presented to conform to this revised presentation.
U.S. Cellular
In its consolidated operating markets, U.S. Cellular serves approximately 4.8 million customers in 23 states. As of December 31, 2013, U.S. Cellular's average penetration rate in its consolidated operating markets was 15.0%. 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 its customers' increased demand for data services. U.S. Cellular anticipates that grouping its operations into market areas will continue to provide it with certain economies in its capital and operating costs.
Financial and operating highlights in 2013 included the following:
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
the "Partnerships") with Cellco Partnership d/b/a Verizon Wireless, which required U.S. Cellular to deconsolidate the Partnerships and thereafter account for them as equity method investments (the "NY1 & NY2 Deconsolidation"). In connection with the deconsolidation, U.S. Cellular recognized a non-cash pre-tax gain of $18.5 million which was recorded in Gain on investments in the Consolidated Statement of Operations. See Note 7Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information regarding this transaction.
The following operating information is presented for Core Markets. As used here, Core Markets is defined as all consolidated markets in which U.S. Cellular currently conducts business and, therefore, excludes the Divestiture Markets and the NY1 & NY2 Deconsolidated Markets. Core Markets as defined also includes any other income or expenses due to U.S. Cellular's direct or indirect ownership interests in other spectrum in the Divestiture Markets which was not included in the Divestiture Transaction and other retained assets from the Divestiture Markets.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
The following financial information is presented for U.S. Cellular consolidated results:
U.S. Cellular anticipates that future results will be affected by the following factors:
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
See "Results of OperationsU.S. Cellular."
TDS Telecom
The Wireline and Cable segments seek to be the preferred telecommunications solutions providers in their chosen markets serving both residential and commercial customers by developing and delivering high-quality products that meet or exceed customers' needs and to outperform the competition by maintaining superior customer service. TDS Telecom provides broadband, voice, and video services to residential customers through value-added bundling of products. The commercial focus is to provide advanced IP-based voice and data services to small to medium sized businesses. The HMS segment provides colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, sales and management of Information Technology ("IT") infrastructure hardware solutions.
On October 4, 2013, TDS acquired 100% of the outstanding shares of MSN Communications, Inc. ("MSN") for $43.6 million in cash. The operations of MSN are included in the HMS segment since the date of acquisition.
On August 1, 2013, TDS Telecom acquired substantially all of the assets of Baja Broadband, LLC ("Baja") for $264.1 million in cash. Baja operates in markets primarily in Colorado, New Mexico, Texas, and Utah. The operations of Baja are included in the Cable segment since the date of acquisition.
TDS Telecom acquired Vital Support Systems, LLC ("Vital") in June 2012 and OneNeck IT Services Corporation ("OneNeck IT Services") in July 2011. The operations of Vital and OneNeck IT Services are included in the HMS segment since their respective dates of acquisition.
All of these acquisitions impact the comparability of TDS Telecom operating results.
Financial and operating highlights in 2013 included the following:
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Management's Discussion and Analysis of Financial Condition and Results of Operations
and software tools that improve management of the network and support sales and customer service processes.
TDS anticipates that TDS Telecom's future results will be affected by the following factors:
See "Results of OperationsTDS Telecom."
Pro Forma Financial Information
Refer to TDS' Form 8-K filed on February 26, 2014 for pro forma financial information related to the Divestiture Transaction and the NY1 & NY2 Deconsolidation for the three and twelve months ended December 31, 2013, as if the transactions had occurred at the beginning of the respective periods. Also refer to TDS' Form 8-K filed on May 3, 2013 for pro forma financial information related to the Divestiture Transaction and the NY1 & NY2 Deconsolidation for the twelve months ended December 31, 2012.
REGULATORY DEVELOPMENTS
FCC Reform Order
In 2011, the FCC released an order ("Reform Order") to: reform its universal service and intercarrier compensation mechanisms; establish a new, broadband-focused support mechanism; and propose further rules to advance reform. Appeals of the Reform Order were consolidated and argued in the U.S. Court of Appeals for the 10th Circuit on November 19, 2013, with a decision anticipated in 2014.
There have been no significant changes to the Reform Order since December 31, 2012 that are expected to adversely affect U.S. Cellular or TDS Telecom. U.S. Cellular and TDS Telecom cannot predict the outcome of the consolidated appeals referred to above or any future rulemaking, reconsideration or legal challenges and, as a consequence, the impacts that such potential developments may have on U.S. Cellular's or TDS Telecom's business, financial condition or results of operations.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
FCC Interoperability Order
On October 25, 2013, the FCC adopted a Report and Order and Order of Proposed Modification confirming a voluntary industry agreement on interoperability in the Lower 700 MHz spectrum band. The FCC's Report and Order lays out a roadmap for the voluntary commitments of AT&T and DISH Network Corporation ("DISH") to become fully binding under a regulatory framework which will require the FCC to take additional actions proposed to be completed by the first quarter of 2014. Pursuant to this voluntary agreement, AT&T will begin incorporating changes in its network and devices that will foster interoperability across all paired spectrum blocks in the Lower 700 MHz Band, collectively comprising "Band 12" under the standards of the 3rd Generation Partnership Project ("3GPP"). AT&T also agreed to support LTE roaming on its networks for carriers with compatible Band 12 devices, consistent with the FCC's rules on roaming. As outlined in its voluntary commitment, AT&T will be implementing the foregoing changes in phases starting with network software enhancement taking place possibly through the third quarter of 2015 with its Band 12 device roll-out to follow. In addition the FCC has adopted changes in its technical rules for certain unpaired spectrum licensed to AT&T and DISH in the Lower 700 MHz band to enhance prospects for Lower 700 MHz interoperability. AT&T's network and devices currently only interoperate across two of the three paired blocks in the Lower 700 MHz band. U.S. Cellular's LTE deployment, carried out in conjunction with its partner, King Street Wireless, utilizes spectrum in all three of these blocks and consequently was not interoperable with the AT&T configuration. U.S. Cellular believes that the FCC action will broaden the ecosystem of devices available to U.S. Cellular's customers over time.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONSCONSOLIDATED
Year Ended December 31,
|
2013 | Increase/ (Decrease) |
Percentage Change |
2012 | Increase/ (Decrease) |
Percentage Change |
2011 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands, except per share amounts) |
||||||||||||||||||||||
Operating revenues |
||||||||||||||||||||||
U.S. Cellular |
$ | 3,918,836 | $ | (533,248 | ) | (12 | )% | $ | 4,452,084 | $ | 108,738 | 3 | % | $ | 4,343,346 | |||||||
TDS Telecom |
947,003 | 92,497 | 11 | % | 854,506 | 39,118 | 5 | % | 815,388 | |||||||||||||
All other(1) |
35,397 | (3,290 | ) | (9 | )% | 38,687 | 16,950 | 78 | % | 21,737 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating revenues |
4,901,236 | (444,041 | ) | (8 | )% | 5,345,277 | 164,806 | 3 | % | 5,180,471 | ||||||||||||
Operating expenses |
||||||||||||||||||||||
U.S. Cellular |
3,771,971 | (523,457 | ) | (12 | )% | 4,295,428 | 232,862 | 6 | % | 4,062,566 | ||||||||||||
TDS Telecom |
902,171 | 88,407 | 11 | % | 813,764 | 97,027 | 14 | % | 716,737 | |||||||||||||
All other(1) |
(8,265 | ) | (60,487 | ) | >(100 | )% | 52,222 | 13,556 | 35 | % | 38,666 | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses |
4,665,877 | (495,537 | ) | (10 | )% | 5,161,414 | 343,445 | 7 | % | 4,817,969 | ||||||||||||
Operating income (loss) |
||||||||||||||||||||||
U.S. Cellular |
146,865 | (9,791 | ) | (6 | )% | 156,656 | (124,124 | ) | (44 | )% | 280,780 | |||||||||||
TDS Telecom |
44,832 | 4,090 | 10 | % | 40,742 | (57,909 | ) | (59 | )% | 98,651 | ||||||||||||
All other(1) |
43,662 | 57,197 | >100 | % | (13,535 | ) | 3,394 | 20 | % | (16,929 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating income |
235,359 | 51,496 | 28 | % | 183,863 | (178,639 | ) | (49 | )% | 362,502 | ||||||||||||
Other income (expenses) |
||||||||||||||||||||||
Equity in earnings of unconsolidated entities |
132,714 | 39,847 | 43 | % | 92,867 | 10,329 | 13 | % | 82,538 | |||||||||||||
Interest and dividend income |
9,092 | (156 | ) | (2 | )% | 9,248 | 103 | 1 | % | 9,145 | ||||||||||||
Gain (loss) on investments |
14,547 | 18,265 | >100 | % | (3,718 | ) | (27,821 | ) | >(100 | )% | 24,103 | |||||||||||
Interest expense |
(98,811 | ) | 12,066 | 14 | % | (86,745 | ) | (31,456 | ) | (27 | )% | (118,201 | ) | |||||||||
Other, net |
(37 | ) | (757 | ) | >(100 | )% | 720 | (2,938 | ) | (80 | )% | 3,658 | ||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total other income (expenses) |
57,505 | 45,133 | >100 | % | 12,372 | 11,129 | >100 | % | 1,243 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Income before income taxes |
292,864 | 96,629 | 49 | % | 196,235 | (167,510 | ) | (46 | )% | 363,745 | ||||||||||||
Income tax expense |
126,043 | 52,461 | 71 | % | 73,582 | (39,921 | ) | (35 | )% | 113,503 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Net income |
166,821 | 44,168 | 36 | % | 122,653 | (127,589 | ) | (51 | )% | 250,242 | ||||||||||||
Less: Net income attributable to noncontrolling interests, net of tax |
24,894 | (15,898 | ) | (39 | )% | 40,792 | (8,884 | ) | (18 | )% | 49,676 | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Net income attributable to TDS shareholders |
141,927 | 60,066 | 73 | % | 81,861 | (118,705 | ) | (59 | )% | 200,566 | ||||||||||||
Preferred dividend requirement |
(49 | ) | (1 | ) | (2 | )% | (50 | ) | | | (50 | ) | ||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Net income available to common shareholders |
$ | 141,878 | $ | 60,067 | 73 | % | $ | 81,811 | $ | (118,705 | ) | (59 | )% | $ | 200,516 | |||||||
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Basic earnings per share attributable to TDS shareholders |
$ | 1.31 | $ | 0.56 | 75 | % | $ | 0.75 | $ | (1.10 | ) | (59 | )% | $ | 1.85 | |||||||
Diluted earnings per share attributable to TDS shareholders |
$ | 1.29 | $ | 0.54 | 72 | % | $ | 0.75 | $ | (1.08 | ) | (59 | )% | $ | 1.83 |
N/MPercentage change not meaningful
Operating Revenues and Expenses
See "Results of OperationsU.S. Cellular" and "Results of OperationsTDS Telecom" below for factors that affected Operating revenues and expenses.
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Equity in earnings of unconsolidated entities
Equity in earnings of unconsolidated entities represents TDS' share of net income from entities in which it has a noncontrolling interest and that are accounted for by the equity method. TDS generally follows the equity method of accounting for unconsolidated entities in which its ownership interest is less than or equal to 50% but equals or exceeds 20% for corporations and 3% for partnerships and limited liability companies, or for unconsolidated entities in which its ownership is greater than 50% but TDS does not have a controlling financial interest.
TDS' investment in the Los Angeles SMSA Limited Partnership ("LA Partnership") contributed $78.4 million, $67.2 million and $55.3 million to Equity in earnings of unconsolidated entities in 2013, 2012 and 2011, respectively. TDS received cash distributions from the LA Partnership of $71.5 million in 2013 and $66.0 million in 2012 and 2011.
On April 3, 2013, TDS deconsolidated the NY1 & NY2 Partnerships and began reporting them as equity method investments in its consolidated financial statements as of that date. In 2013, TDS' investment in the NY1 & NY2 Partnerships contributed $24.7 million to Equity in earnings of unconsolidated entities subsequent to their deconsolidation. No amounts were included in 2012 or 2011 because the NY1 & NY2 Partnerships were consolidated in those years. Distributions from the NY1 & NY2 Partnerships of $29.4 million in 2013, after the deconsolidation on April 1, 2013, are included in Distributions from unconsolidated entities on the Consolidated Statement of Cash Flows.
Gain (loss) on investments
In connection with the deconsolidation of the NY1 & NY2 Partnerships, TDS recognized a non-cash pre-tax gain of $14.5 million which was recorded in Gain (loss) on investments in 2013. See Note 7Investments in Unconsolidated Entities for additional information.
Loss on investment in 2012 includes a provision for loss of $3.7 million related to a note receivable and preferred stock acquired by U.S. Cellular in connection with an acquisition in 1998. Gain on investment in 2011 includes a gain of $12.7 million from TDS' acquisition of 63% of Airadigm in September 2011 and a $13.4 million gain recorded as a result of adjusting the carrying value of a pre-existing noncontrolling interest for which U.S. Cellular purchased the remaining interest in May 2011, as more fully described in Note 5Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements.
Interest expense
Interest expense increased $12.1 million due primarily to the issuance of TDS' 5.875% Senior Notes in November 2012 for $195.0 million. This amount was partially offset by an increase in capitalized interest during 2013. TDS recorded $15.4 million in interest expense to write-off unamortized debt issuance costs related to TDS' $282.5 million, 7.6% Senior Notes, and U.S. Cellular's $330 million, 7.5% Senior Notes, redeemed on May 2, 2011 and June 20, 2011, respectively. The impact of these write-offs in 2011, along with lower effective interest rates on long-term debt and an increase in capitalized interest for multi-year projects during 2012, resulted in the year-over-year decrease of $31.5 million expense from 2011 to 2012.
Income tax expense
The effective tax rates on Income before income taxes and extraordinary items ("pre-tax income") for 2013, 2012 and 2011 were 43.0%, 37.5% and 31.2%, respectively. The following significant discrete and other items impacted income tax expense for these years:
2013Includes tax expense of $14.9 million related to the NY1 & NY2 Deconsolidation and the Divestiture Transaction, and a tax benefit of $5.5 million resulting from statute of limitation expirations.
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
2012Includes tax benefits of $11.3 million resulting from statute of limitation expirations and $6.1 million resulting from corrections relating to prior periods, offset by tax expense of $1.3 million related to state income tax audits and tax expense associated with increases to state deferred tax asset valuation allowances of $5.2 million.
2011Includes a tax benefit of $26.9 million resulting from state tax law changes, a tax benefit of $9.0 million resulting from statute of limitation expirations and tax expense of $6.0 million resulting from correction of partnership tax basis relating to a prior period.
See Note 3Income Taxes in the Notes to Consolidated Financial Statements for further information on the effective tax rate.
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, the noncontrolling shareholders' or partners' share of certain U.S. Cellular subsidiaries' net income or loss and other TDS noncontrolling interests.
Year Ended December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|||||||||
Net income attributable to noncontrolling interest, net of tax U.S. Cellular |
||||||||||
Noncontrolling public shareholders' |
$ | 21,775 | $ | 18,431 | $ | 28,934 | ||||
Noncontrolling shareholders' or partners'(1) |
3,119 | 22,361 | 20,742 | |||||||
| | | | | | | | | | |
|
$ | 24,894 | $ | 40,792 | $ | 49,676 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
9
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONSU.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
Following is a table of summarized operating data for U.S. Cellular's Consolidated Markets. Consolidated Markets herein refers to markets which U.S. Cellular currently consolidates, or previously consolidated in the periods presented, and is not adjusted in prior periods presented for subsequent divestitures or deconsolidations. Unless otherwise noted, figures reported in Results of Operations are representative of consolidated results.
As of or for the Year Ended December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Retail Customers |
||||||||||
Postpaid |
||||||||||
Total at end of period |
4,267,000 | 5,134,000 | 5,302,000 | |||||||
Gross additions |
697,000 | 880,000 | 836,000 | |||||||
Net additions (losses) |
(325,000 | ) | (165,000 | ) | (117,000 | ) | ||||
ARPU(1) |
$ | 54.31 | $ | 54.32 | $ | 52.20 | ||||
Churn rate(2) |
1.8 | % | 1.7 | % | 1.5 | % | ||||
Smartphone penetration(3)(4) |
50.8 | % | 41.8 | % | 30.5 | % | ||||
Prepaid |
||||||||||
Total at end of period |
343,000 | 423,000 | 306,000 | |||||||
Gross additions |
309,000 | 368,000 | 228,000 | |||||||
Net additions (losses) |
(21,000 | ) | 118,000 | (8,000 | ) | |||||
ARPU(1) |
$ | 31.44 | $ | 33.26 | $ | 33.42 | ||||
Churn rate(2) |
7.0 | % | 6.0 | % | 6.6 | % | ||||
Total customers at end of period |
4,774,000 | 5,798,000 | 5,891,000 | |||||||
Billed ARPU(1) |
$ | 50.73 | $ | 50.81 | $ | 48.63 | ||||
Service revenue ARPU(1) |
$ | 57.61 | $ | 58.70 | $ | 56.54 | ||||
Smartphones sold as a percent of total devices sold |
68.4 | % | 55.8 | % | 44.0 | % | ||||
Total Population |
||||||||||
Consolidated markets(5) |
58,013,000 | 93,244,000 | 91,965,000 | |||||||
Consolidated operating markets(5) |
31,759,000 | 46,966,000 | 46,888,000 | |||||||
Market penetration at end of period |
||||||||||
Consolidated markets(6) |
8.2 | % | 6.2 | % | 6.4 | % | ||||
Consolidated operating markets(6) |
15.0 | % | 12.3 | % | 12.6 | % | ||||
Capital expenditures (000s) |
$ | 737,501 | $ | 836,748 | $ | 782,526 | ||||
Total cell sites in service |
6,975 | 8,028 | 7,882 | |||||||
Owned towers in service |
4,448 | 4,408 | 4,311 |
10
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Summary Operating Data for U.S. Cellular Core Markets
Following is a table of summarized operating data for U.S. Cellular's Core Markets (which excludes the Divestiture Markets and NY1 and NY2 markets) as of or for the year ended December 31, 2013 or 2012.
As of or for the Year Ended December 31,
|
2013 | 2012 | |||||
---|---|---|---|---|---|---|---|
Retail Customers |
|||||||
Postpaid |
|||||||
Total at end of period |
4,267,000 | 4,496,000 | |||||
Gross additions |
682,000 | 746,000 | |||||
Net additions (losses) |
(217,000 | ) | (92,000 | ) | |||
ARPU(1) |
$ | 54.23 | $ | 53.65 | |||
Churn rate(2) |
1.7 | % | 1.5 | % | |||
Smartphone penetration(3)(4) |
50.8 | % | 41.1 | % | |||
Prepaid |
|||||||
Total at end of period |
343,000 | 342,000 | |||||
Gross additions |
295,000 | 288,000 | |||||
Net additions (losses) |
2,000 | 124,000 | |||||
ARPU(1) |
$ | 31.45 | $ | 32.98 | |||
Churn rate(2) |
6.7 | % | 5.2 | % | |||
Total customers at end of period |
4,774,000 | 5,022,000 | |||||
Billed ARPU(1) |
$ | 50.82 | $ | 50.54 | |||
Service revenue ARPU(1) |
$ | 57.66 | $ | 58.49 | |||
Smartphones sold as a percent of total devices sold |
68.6 | % | 56.1 | % | |||
Total Population |
|||||||
Consolidated markets(5) |
58,013,000 | 83,384,000 | |||||
Consolidated operating markets(5) |
31,759,000 | 31,445,000 | |||||
Market penetration at end of period |
|||||||
Consolidated markets(6) |
8.2 | % | 6.0 | % | |||
Consolidated operating markets(6) |
15.0 | % | 16.0 | % | |||
Capital expenditures (000s) |
$ | 735,082 | $ | 768,884 | |||
Total cell sites in service |
6,161 | 6,130 | |||||
Owned towers in service |
3,913 | 3,847 |
11
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Components of Operating Income
Year Ended December 31,
|
2013 | Increase/ (Decrease) |
Percentage Change |
2012 | Increase/ (Decrease) |
Percentage Change |
2011 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|||||||||||||||||||||
Retail service |
$ | 3,165,496 | $ | (382,483 | ) | (11)% | $ | 3,547,979 | $ | 61,457 | 2% | $ | 3,486,522 | |||||||||
Inbound roaming |
263,186 | (85,531 | ) | (25)% | 348,717 | 408 | N/M | 348,309 | ||||||||||||||
Other |
166,091 | (36,069 | ) | (18)% | 202,160 | (16,806 | ) | (8)% | 218,966 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Service revenues |
3,594,773 | (504,083 | ) | (12)% | 4,098,856 | 45,059 | 1% | 4,053,797 | ||||||||||||||
Equipment sales |
324,063 | (29,165 | ) | (8)% | 353,228 | 63,679 | 22% | 289,549 | ||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating revenues |
3,918,836 | (533,248 | ) | (12)% | 4,452,084 | 108,738 | 3% | 4,343,346 | ||||||||||||||
System operations (excluding Depreciation, amortization and accretion reported below) |
763,435 |
(183,370 |
) |
(19)% |
946,805 |
17,426 |
2% |
929,379 |
||||||||||||||
Cost of equipment sold |
999,000 | 63,053 | 7% | 935,947 | 144,145 | 18% | 791,802 | |||||||||||||||
Selling, general and administrative |
1,677,395 | (87,538 | ) | (5)% | 1,764,933 | (4,768 | ) | N/M | 1,769,701 | |||||||||||||
Depreciation, amortization and accretion |
803,781 | 195,148 | 32% | 608,633 | 35,076 | 6% | 573,557 | |||||||||||||||
(Gain) loss on asset disposals, net |
30,606 | (12,518 | ) | (69)% | 18,088 | (8,199 | ) | (83)% | 9,889 | |||||||||||||
(Gain) loss on sale of business and other exit costs, net |
(246,767 | ) | 267,789 | >100% | 21,022 | (21,022 | ) | N/M | | |||||||||||||
(Gain) loss on license sales and exchanges |
(255,479 | ) | 255,479 | N/M | | (11,762 | ) | N/M | (11,762 | ) | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses |
3,771,971 | (523,457 | ) | (12)% | 4,295,428 | 232,862 | 6% | 4,062,566 | ||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Operating income |
$ | 146,865 | $ | (9,791 | ) | (6)% | $ | 156,656 | $ | (124,124 | ) | (44)% | $ | 280,780 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
N/MPercentage change not meaningful
Operating Revenues
Service 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, including long-distance roaming ("inbound roaming"); and (iii) amounts received from the Federal USF.
Retail service revenues
Retail service revenues decreased by $382.5 million, or 11%, to $3,165.5 million due primarily to a decrease in U.S. Cellular's average customer base (including the reductions caused by the Divestiture Transaction and NY1 & NY2 Deconsolidation) and a slight decrease in billed ARPU. In 2012, retail service revenues increased by $61.5 million, or 2%, to $3,548.0 million due primarily to the impact of an increase in billed ARPU, partially offset by a decrease in U.S. Cellular's average customer base.
In the fourth quarter of 2013, U.S. Cellular issued loyalty reward points with a value of $43.5 million as a loyalty bonus in recognition of the inconvenience experienced by customers during U.S. Cellular's recent billing system conversion. The value of the loyalty bonus reduced Operating revenues in the Consolidated Statement of Operations and increased Customer deposits and deferred revenues in the Consolidated Balance Sheet.
12
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Billed ARPU of $50.73 in 2013 was relatively flat compared to $50.81 in 2012. The special issuance of loyalty rewards points in the fourth quarter of 2013 negatively impacted billed ARPU by $0.70 in 2013, which was partially offset by an increase in smartphone adoption and corresponding revenues from data products and services. The increase in billed ARPU in 2012 from $48.63 in 2011 also reflects the impact of a larger portion of the customer base using smartphones which drives incremental data access revenue.
U.S. Cellular expects continued pressure on 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.
Inbound roaming revenues
Inbound roaming revenues decreased by $85.5 million, or 25% in 2013 to $263.2 million. The decrease was due primarily to lower rates ($47.9 million) and the impacts of the Divestiture Transaction and NY1 & NY2 Deconsolidation ($37.6 million). Data volume increased year-over year but the impact of this increase was offset by the combined impacts of lower volume for voice and lower rates for both data and voice. The decline in roaming revenues was offset by a decline in roaming expense also due to lower rates. U.S. Cellular expects continued growth in data volume but also expects that the revenue impact of this growth will be offset by the impacts of decreases in data rates and voice volume.
Inbound roaming revenues of $348.7 million were flat in 2012 compared to 2011 as higher data revenues, reflecting significantly higher volumes but lower negotiated rates, were offset by lower voice revenues, reflecting both lower volumes and rates.
Other revenues
Other revenues decreased by $36.1 million, or 18%, in 2013 compared to 2012. In 2012, Other revenues decreased by $16.8 million, or 8%. The decreases in both years are due primarily to decreases in ETC support.
Pursuant to the FCC's Reform Order (See "OverviewFCC Reform Order"), U.S. Cellular's current ETC support is being phased down at the rate of 20% per year beginning July 1, 2012. If the Phase II Mobility Fund is not operational by July 2014, the phase down will halt at that time and U.S. Cellular will continue to receive 60% of its baseline support until the Phase II Mobility Fund is operational.
At this time, U.S. Cellular cannot predict the net effect of the FCC's changes to the USF high cost support program in the Reform Order. Accordingly, U.S. Cellular 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 wireless devices and accessories to agents. All Equipment sales revenues are recorded net of rebates.
U.S. Cellular offers a competitive portfolio 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; in addition, customers on currently offered rate plans receive loyalty reward points that may be used to purchase a new wireless device or accelerate the timing of a customer's eligibility for a wireless device upgrade at promotional pricing. 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.
13
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The decrease in 2013 equipment sales revenues of $29.2 million, or 8%, to $324.1 million was driven primarily by selling fewer devices, partially due to the Divestiture Transaction. Declines in volume were offset by an increase of 12.0% in average revenue per device. The increase in 2012 equipment sales revenues of $63.7 million, or 22%, to $353.2 million was driven primarily by a 17% increase in average revenue per wireless device sold; an increase in equipment activation fees also was a factor. Average revenue per wireless device sold increased in both years due to a continued shift in customer preference to higher priced smartphones.
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.
System operations expenses decreased $183.4 million, or 19%, to $763.4 million in 2013 and increased $17.4 million, or 2%, to $946.8 million in 2012. Key components of the net changes 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
Cost of equipment sold increased $63.1 million, or 7%, in 2013 and $144.1 million, or 18% in 2012. In both years, the increase was driven primarily by an increase in the average cost per wireless device sold (33% in 2013 and 18% in 2012). Average cost per device sold increased due to general customer preference for higher priced 4G LTE smartphones, including the introduction of Apple products in the fourth quarter of 2013. In 2013, total devices sold decreased by 18% partially due to the Divestiture Transaction; in 2012, total devices sold increased by 1%.
14
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
U.S. Cellular's loss on equipment, defined as equipment sales revenues less cost of equipment sold, was $674.9 million, $582.7 million and $502.3 million for 2013, 2012 and 2011, respectively. U.S. Cellular expects loss on equipment to continue to be a significant cost in the foreseeable future as wireless carriers continue to use device pricing as a means of competitive differentiation. In addition, U.S. Cellular expects increasing sales of data centric wireless devices to result in higher equipment subsidies over time; these devices generally have higher purchase costs which cannot be recovered through proportionately higher selling prices to customers under the standard contract/subsidy model the industry has operated with for many years. However, U.S. Cellular is beginning to offer new equipment pricing constructs such as device financing to offset a higher proportion of increasing equipment costs.
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.
Selling, general and administrative expenses decreased by $87.5 million to $1,677.4 million in 2013 and by $4.8 million to $1,764.9 in 2012. Key components of the net changes in Selling, general and administrative expenses were as follows:
2013
2012
Depreciation, amortization and accretion
Depreciation, amortization and accretion expense increased $195.1 million, or 32%, in 2013, and $35.1 million, or 6%, in 2012 due primarily to the acceleration of depreciation, amortization and accretion in the Divestiture Markets. The impact of the acceleration year over year was $158.5 million in 2013. The accelerated depreciation, amortization and accretion in the Divestiture Markets is expected to conclude in the first quarter of 2014.
(Gain) loss on asset disposals, net
(Gain) loss on asset disposals, net was a loss of $30.6 million in 2013 and $18.1 million in 2012 due primarily to losses resulting from the write-off and disposals of certain network assets.
15
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
(Gain) loss on sale of business and other exit costs, net
(Gain) loss on sale of business and other exit costs, net was a gain of $246.8 million in 2013, primarily related to the closing of the Divestiture Transaction. The loss of $21.0 million in 2012 was due primarily to employee severance costs and asset write-offs in the Divestiture Markets, partially offset by a $4.2 million gain resulting from the sale of a wireless market in March 2012.
(Gain) loss on license sales and exchanges
(Gain) loss on license sales and exchanges resulted from the sale of the Mississippi Valley non-operating market license for $308.0 million, which resulted in a pre-tax gain of $250.6 million.
RESULTS OF OPERATIONSTDS TELECOM
TDS conducts its Wireline, Cable and HMS operations through TDS Telecom, a wholly-owned subsidiary. The following table summarizes operating data for Wireline and Cable operations:
As of December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Wireline |
||||||||||
Residential connections |
||||||||||
Voice(1) |
352,100 | 374,700 | 399,300 | |||||||
Broadband(2) |
227,000 | 229,900 | 230,600 | |||||||
IPTV |
13,800 | 7,900 | 4,600 | |||||||
| | | | | | | | | | |
Wireline residential connections |
592,900 | 612,500 | 634,500 | |||||||
| | | | | | | | | | |
| | | | | | | | | | |
Commercial connections |
||||||||||
Voice(1) |
218,400 | 243,100 | 271,700 | |||||||
Broadband(2) |
27,100 | 29,700 | 32,800 | |||||||
managedIP(3) |
127,600 | 94,600 | 53,500 | |||||||
| | | | | | | | | | |
Wireline commercial connections |
373,100 | 367,400 | 358,000 | |||||||
| | | | | | | | | | |
| | | | | | | | | | |
Total Wireline connections |
966,000 | 979,900 | 992,500 | |||||||
| | | | | | | | | | |
| | | | | | | | | | |
Total residential revenue per connection(4) |
$ | 40.53 | $ | 39.65 | $ | 38.86 | ||||
Residential broadband penetration(5) |
66 | % | 63 | % | 60 | % | ||||
Cable |
||||||||||
Cable connections |
||||||||||
Video(6) |
69,200 | |||||||||
Broadband(7) |
61,000 | |||||||||
Voice(7) |
17,200 | |||||||||
| | | | | | | | | | |
Cable connections |
147,400 | |||||||||
| | | | | | | | | | |
| | | | | | | | | | |
Total residential revenue per connection(4) |
$ | 55.43 |
16
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
TDS Telecom Total (Wireline, Cable and HMS Operations)
Components of Operating Income
Year Ended December 31,
|
2013 | Increase/ (Decrease) |
Percentage Change |
2012 | Increase/ (Decrease) |
Percentage Change |
2011 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|
|
|
|
|||||||||||||
Operating revenues |
||||||||||||||||||||
Wireline |
$ | 726,567 | $ | (15,181 | ) | (2)% | $ | 741,748 | $ | (26,460 | ) | (3)% | $ | 768,208 | ||||||
Cable |
35,883 | 35,883 | N/M | | | N/M | | |||||||||||||
HMS |
185,616 | 72,606 | 64% | 113,010 | 65,830 | >100% | 47,180 | |||||||||||||
Intra-company elimination |
(1,063 | ) | (811 | ) | >(100)% | (252 | ) | (252 | ) | N/M | | |||||||||
| | | | | | | | | | | | | | | | | | | | |
TDS Telecom operating revenues |
947,003 | 92,497 | 11% | 854,506 | 39,118 | 5% | 815,388 | |||||||||||||
Operating expenses |
||||||||||||||||||||
Wireline |
661,561 | (21,805 | ) | (3)% | 683,366 | 18,760 | 3% | 664,606 | ||||||||||||
Cable |
35,927 | 35,927 | N/M | | | N/M | | |||||||||||||
HMS |
205,746 | 75,096 | 57% | 130,650 | 78,519 | >100% | 52,131 | |||||||||||||
Intra-company elimination |
(1,063 | ) | (811 | ) | >(100)% | (252 | ) | (252 | ) | N/M | | |||||||||
| | | | | | | | | | | | | | | | | | | | |
TDS Telecom operating expenses |
902,171 | 88,407 | 11% | 813,764 | 97,027 | 14% | 716,737 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
TDS Telecom operating income |
$ | 44,832 | $ | 4,090 | 10% | $ | 40,742 | $ | (57,909 | ) | (59)% | $ | 98,651 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
N/MNot meaningful
17
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Wireline Operations
Components of Operating Income
Year Ended December 31,
|
2013 | Increase/ (Decrease) |
Percentage Change |
2012 | Increase/ (Decrease) |
Percentage Change |
2011 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|
|
|
|
|||||||||||||
Operating revenues |
||||||||||||||||||||
Residential |
$ | 293,217 | $ | (3,375 | ) | (1)% | $ | 296,592 | $ | (5,272 | ) | (2)% | $ | 301,864 | ||||||
Commercial |
232,910 | 2,436 | 1% | 230,474 | (951 | ) | N/M | 231,425 | ||||||||||||
Wholesale |
200,440 | (14,242 | ) | (7)% | 214,682 | (20,237 | ) | (9)% | 234,919 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total operating revenues |
726,567 | (15,181 | ) | (2)% | 741,748 | (26,460 | ) | (3)% | 768,208 | |||||||||||
Operating expenses |
||||||||||||||||||||
Cost of services and products (excluding depreciation, amortization and accretion reported below) |
270,466 | (3,599 | ) | (1)% | 274,065 | (636 | ) | N/M | 274,701 | |||||||||||
Selling, general and administrative expenses |
220,097 | (15,619 | ) | (7)% | 235,716 | 14,602 | 7% | 221,114 | ||||||||||||
Depreciation, amortization and accretion |
170,868 | (1,658 | ) | (1)% | 172,526 | 4,863 | 3% | 167,663 | ||||||||||||
Loss on asset disposals, net |
130 | (890 | ) | (87)% | 1,020 | (108 | ) | (10)% | 1,128 | |||||||||||
Loss on sale of business and other exit costs, net |
| (39 | ) | N/M | 39 | 39 | N/M | | ||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total operating expenses |
661,561 | (21,805 | ) | (3)% | 683,366 | 18,760 | 3% | 664,606 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total operating income |
$ | 65,006 | $ | 6,624 | 11% | $ | 58,382 | $ | (45,220 | ) | (44)% | $ | 103,602 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
N/MNot meaningful
Operating Revenues
Residential revenues consist of voice, data and video services to Wireline's residential customer base.
Residential revenues decreased $3.4 million or 1% to $293.2 million in 2013. A 3% reduction in the number of average residential connections reduced revenues by $7.9 million partially offset by a $5.2 million increase due to growth in average revenue per residential connection of 2%. The growth in average revenue was mainly driven by broadband price increases, growth in customers opting for faster broadband speeds and the growth of customers selecting higher tier IPTV packages.
Residential revenues decreased $5.3 million or 2% to $296.6 million in 2012. Reductions in the number of residential connections of 4% negatively impacted residential revenues by $9.8 million. Customers choosing higher speed data plans primarily drove a 2% increase in average revenue per residential connection in 2012, which increased residential revenues $6.6 million.
Commercial revenues consist of data and voice services and sales and installation of IP-based telecommunications systems to Wireline's commercial customer base.
Commercial revenues increased $2.4 million or 1% to $232.9 million in 2013. A 2% increase in average commercial connections, which was driven by the 49% growth in managedIP as customers converted from traditional voice and data connections, increased revenues by $4.4 million. This increase was partially offset by a 1% decline in average revenue per commercial connection, primarily driven by lower managedIP rates, which decreased revenues $2.7 million.
18
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Commercial revenues decreased $1.0 million to $230.5 million in 2012 due primarily to a $2.5 million decline in business systems sales and charges for directory assistance. A $4.8 million increase in revenue resulting from an increase in commercial connections was partially offset by a $3.2 million decrease in the average revenue per commercial connection primarily driven by lower managedIP rates.
Wholesale revenues consist of compensation from other carriers for utilizing TDS Telecom's network infrastructure and regulatory recoveries.
Wholesale revenues decreased $14.2 million or 7% to $200.4 million in 2013. Network access revenues decreased $6.8 million in 2013 as a result of changes in support mechanisms and in intercarrier compensation resulting from the Reform Order released by the FCC in November 2011. Wholesale revenues also declined $5.3 million due to a 15% reduction in intra-state minutes-of-use.
Wholesale revenues decreased $20.2 million or 9% to $214.7 million in 2012. Wholesale revenues decreased $10.0 million in 2012 as a result of changes in support mechanisms and in intercarrier compensation resulting from the Reform Order. Revenues received through interstate and intrastate regulatory recovery mechanisms also decreased $5.7 million due to changes in eligible expense recovery thresholds and reductions in the pool earnings. Additionally, Wholesale revenues declined $5.1 million due to a 11% decline in intrastate minutes of use.
Operating Expenses
Cost of services and products (excluding Depreciation, amortization and accretion)
Cost of services and products decreased $3.6 million or 1% to $270.5 million in 2013 due primarily to a $5.4 million decrease in cost of goods sold related to long distance services and promotional giveaways. In addition, carrier interconnection charges decreased $2.3 million as a result of lower access charges that became effective related to the Reform Order. Employee expense decreased $1.1 million due to a reduction in employees. Offsetting the decreases were increases in charges related to IPTV expansion.
Cost of services and products of $274.1 million in 2012 were flat compared to 2011. Increases in employee related costs, charges related to IPTV expansion and network maintenance costs were mostly offset by decreased long-distance costs, lower circuit charges, lower purchased network services, and a decrease in reciprocal compensation expense related to the FCC Reform Order which mandated rate reductions that became effective in July of 2012.
Selling, general and administrative expenses
Selling, general and administrative expenses decreased $15.6 million or 7% to $220.1 million in 2013 due primarily to decreases in employee expenses, Federal USF contributions due to lower revenues, bad debts, and property taxes.
Selling, general and administrative expenses increased $14.6 million or 7% to $235.7 million in 2012. Discrete benefits recorded in 2011 including receipt of insurance proceeds, the refund of certain prior year regulatory contributions and the settlement of a legal dispute, which decreased 2011 Selling, general and administrative expenses by $7.7 million. These discrete benefits in 2011 were the primary cause of the overall expense increase from 2011 to 2012. Additionally, higher employee related and contractor costs and Federal USF contributions added to the increase in 2012.
19
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Cable Operations
Components of Operating Income
Year Ended December 31,
|
2013(1) | |||
---|---|---|---|---|
(Dollars in thousands) |
|
|||
Operating revenues |
||||
Residential |
$ | 29,016 | ||
Commercial |
6,867 | |||
| | | | |
Total operating revenues |
35,883 | |||
Operating expenses |
||||
Cost of services and products (excluding depreciation, amortization and accretion reported below) |
17,274 | |||
Selling, general and administrative expenses |
11,054 | |||
Depreciation, amortization and accretion |
7,571 | |||
Loss on asset disposals, net |
28 | |||
| | | | |
Total operating expenses |
35,927 | |||
| | | | |
Total operating income (loss) |
$ | (44 | ) | |
| | | | |
| | | | |
Operating Revenues
Residential revenues consist of video, broadband and voices services to Cable's residential customer base.
Baja had 104,900 residential connections which generated revenues of $29.0 million since the acquisition of Baja on August 1, 2013.
Commercial revenues consist of video, broadband and voice services to Cable's commercial customer base.
Baja had 42,500 commercial connections which generated revenues of $6.9 million since the acquisition of Baja.
Operating Expenses
Cost of services and products (excluding Depreciation, amortization and accretion)
Cost of services and products (excluding Depreciation, amortization and accretion) of $17.3 million were incurred for programming costs and expenses related to the delivery and support of services since the acquisition of Baja.
Selling, general and administrative expenses
Selling, general and administrative expenses of $11.1 million include legal and consulting costs of $2.0 million related to the acquisition.
Depreciation, amortization and accretion expense
Depreciation, amortization and accretion expense of $7.6 million was incurred since the acquisition of Baja. Amortization of the acquired customer list and trade name contributed $3.0 million of expense.
20
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
HMS Operations
Components of Operating Income
Year Ended December 31,
|
2013 | Increase/ (Decrease) |
Percentage Change |
2012 | Increase/ (Decrease) |
Percentage Change |
2011 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|
|
|
|
|||||||||||||||
Operating revenues |
$ | 185,616 | $ | 72,606 | 64 | % | $ | 113,010 | $ | 65,830 | >100 | % | $ | 47,180 | ||||||||
Operating expenses |
||||||||||||||||||||||
Cost of services and products (excluding depreciation, amortization and accretion reported below) |
136,414 | 60,633 | 80 | % | 75,781 | 52,279 | >100 | % | 23,502 | |||||||||||||
Selling, general and administrative expenses |
44,945 | 10,752 | 31 | % | 34,193 | 18,546 | >100 | % | 15,647 | |||||||||||||
Depreciation, amortization and accretion |
24,262 | 3,694 | 18 | % | 20,568 | 7,701 | 60 | % | 12,867 | |||||||||||||
Loss on asset disposals, net |
125 | 17 | 16 | % | 108 | (7 | ) | (6 | )% | 115 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating expenses |
205,746 | 75,096 | 57 | % | 130,650 | 78,519 | >100 | % | 52,131 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
Total operating income (loss) |
$ | (20,130 | ) | $ | (2,490 | ) | (14 | )% | $ | (17,640 | ) | $ | (12,689 | ) | >(100 | )% | $ | (4,951 | ) | |||
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
Operating Revenues
HMS operating revenues consist primarily of colocation, cloud computing and hosted managed services, application management, and sales, installation and management of IT infrastructure hardware solutions.
Operating revenues increased $72.6 million to $185.6 million in 2013. The acquisitions of Vital in June of 2012 and MSN in October of 2013 contributed $64.3 million of incremental revenues. The remaining increase was due to 10% growth in recurring services primarily consisting of colocation, cloud and hosted managed services, and application management.
Operating revenues increased $65.8 million to $113.0 million in 2012. The acquisitions of OneNeck IT Services in June of 2011 and Vital in June of 2012 contributed $64.1 million of incremental revenues.
Operating Expenses
Cost of services and products (excluding Depreciation, amortization and accretion)
Cost of services and products increased $60.6 million to $136.4 million in 2013 and increased $52.3 million to $75.8 million in 2012. Acquisitions increased Cost of services and products $52.8 million and $47.7 million in 2013 and 2012, respectively. Employee related expense also increased in 2013 by $5.7 million in addition to increased data center costs to support revenue growth.
Selling, general and administrative expense
Selling, general and administrative expense increased $10.8 million to $44.9 million in 2013 and increased $18.5 million to $34.2 million in 2012. Acquisitions increased Selling, general and administrative expense $10.6 million and $15.1 million in 2013 and 2012, respectively. Additional expenses were incurred in both 2013 and 2012 as TDS Telecom developed the infrastructure and products and services to support growth of the HMS operations.
21
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Depreciation, amortization and accretion expense
Depreciation, amortization and accretion expense increased $3.7 million to $24.3 million in 2013 and increased $7.7 million to $20.6 million in 2012 due primarily to acquisitions. Customer list and trade name amortization contributed $2.2 million and $4.4 million of the increase in 2013 and 2012, respectively.
Management believes that inflation affects TDS' business to no greater or lesser extent than the general economy.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In general, recently issued accounting pronouncements did not have and are not expected to have a significant effect on TDS' financial condition and results of operations.
See Note 1Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for information on recently issued accounting pronouncements.
TDS operates a capital- and marketing-intensive business. TDS utilizes cash on hand, cash from operating activities, cash proceeds from divestitures and disposition 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, capital expenditures and other factors. The table below and the following discussion in this Financial Resources section summarize TDS' cash flow activities in 2013, 2012 and 2011.
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|||||||
Cash flows from (used in) |
||||||||||
Operating activities |
$ | 494,610 | $ | 1,105,172 | $ | 1,255,711 | ||||
Investing activities |
(260,653 | ) | (998,069 | ) | (866,089 | ) | ||||
Financing activities |
(144,424 | ) | 70,103 | (168,030 | ) | |||||
| | | | | | | | | | |
Net increase in cash and cash equivalents |
$ | 89,533 | $ | 177,206 | $ | 221,592 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
Cash Flows from Operating Activities
Cash flows from operating activities were $494.6 million in 2013 and $1,105.2 million in 2012. Significant items to note are as follows:
22
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
TDS carried back this federal net operating loss to prior tax years and received these refunds in 2012 for carrybacks to 2009 and 2010 tax years.
Cash flows from operating activities were $1,105.2 million in 2012 and $1,255.7 million in 2011. Significant items to note are as follows:
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.
Capital expenditures (i.e., additions to property, plant and equipment and system development expenditures) totaled $909.7 million in 2013, $1,004.6 million in 2012 and $987.2 million in 2011. Cash used for additions to property, plant and equipment is reported in the Consolidated Statement of Cash Flows, and excludes amounts accrued in Accounts receivable and Accounts payable for capital expenditures at December 31 of the current year and includes amounts received and/or paid in the
23
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
current period that were accrued at December 31 of the prior year. Cash used for additions to property, plant and equipment totaled $883.8 million, $995.5 million and $971.8 million in 2013, 2012 and 2011, respectively. These expenditures were made to provide for customer and usage growth (in recent periods, particularly with respect to data usage growth), to upgrade service and to take advantage of service-enhancing and cost-reducing technological developments in order to maintain competitive services.
Cash payments for acquisitions in 2013, 2012 and 2011 were as follows:
Cash Payments for Acquisitions
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|||||||
U.S. Cellular licenses |
$ | 16,540 | $ | 122,690 | $ | 4,406 | ||||
U.S. Cellular business |
| | 19,367 | |||||||
TDS Telecom HMS businesses |
33,961 | 40,692 | 95,865 | |||||||
TDS Telecom cable business |
264,069 | | | |||||||
Non-Reportable Segment(1) |
| | (14,130 | ) | ||||||
| | | | | | | | | | |
Total |
$ | 314,570 | $ | 163,382 | $ | 105,508 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
Cash amounts paid for the acquisitions may differ from the purchase price due to cash acquired in the transactions and the timing of cash payments related to the respective transactions.
Cash Received from Divestitures
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|||||||
U.S. Cellular licenses |
$ | 311,989 | $ | | $ | | ||||
U.S. Cellular businesses |
499,131 | 49,932 | | |||||||
TDS Telecom wireline business |
| 250 | | |||||||
| | | | | | | | | | |
Total |
$ | 811,120 | $ | 50,182 | $ | | ||||
| | | | | | | | | | |
| | | | | | | | | | |
U.S. Cellular received $480.0 million in cash at the close of the Divestiture Transaction in May 2013. In addition, U.S. Cellular received $10.6 million in reimbursements for certain network decommissioning costs, network site lease rent and termination costs, network access termination costs, and employee termination benefits for specified engineering employees (the "Sprint Cost Reimbursement") in 2013.
On October 4, 2013, U.S. Cellular sold the majority of its Mississippi Valley unbuilt license for $308.0 million. This sale resulted in a $250.6 million gain which was recorded in the fourth quarter of 2013.
24
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
On August 14, 2013 U.S. Cellular entered into a definitive agreement to sell the majority of its St. Louis area unbuilt license for $92.3 million. The sale will result in an estimated pre-tax gain of $76.2 million. This transaction is subject to regulatory approval and is expected to close in the first quarter of 2014.
TDS invested $120.0 million and $180.9 million in 2012 and 2011, respectively, in U.S. Treasury Notes and corporate notes with maturities greater than three months from the acquisition date. TDS realized cash proceeds of $115.0 million, $243.4 million and $393.2 million in 2013, 2012 and 2011, respectively, related to the maturities of its investments in U.S. Treasury Notes, corporate notes and certificates of deposit.
Cash Flows from Financing Activities
Cash flows from financing activities include repayments of and proceeds from short-term and 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 November 2012, TDS issued $195.0 million of 5.875% Senior Notes due 2061, and paid related debt issuance costs of $7.1 million.
In September 2011, Airadigm paid $32.7 million to the FCC in satisfaction of amounts due pursuant to Airadigm's plan of reorganization. See Note 5Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements for additional information related to this acquisition.
In May 2011, U.S. Cellular issued $342.0 million of 6.95% Senior Notes due 2060, and paid related debt issuance costs of $11.0 million. The net proceeds from the 6.95% Senior Notes were used primarily to redeem $330.0 million of U.S. Cellular's 7.5% Senior Notes in June 2011. The redemption price of the 7.5% Senior Notes was equal to 100% of the principal amount plus accrued and unpaid interest thereon to the redemption date.
In March 2011, TDS issued $300.0 million of 7% Senior Notes due 2060, and paid related debt issuance costs of $9.7 million. The net proceeds from the 7% Senior Notes were primarily used to redeem $282.5 million of TDS' 7.6% Series A Notes in May 2011. The redemption price of the 7.6% Series A Notes was equal to 100% of the outstanding aggregate principal amount, plus accrued and unpaid interest thereon to the redemption date.
On June 25, 2013, U.S. Cellular paid a special cash dividend of $5.75 per share, for an aggregate amount of $482.3 million, to all holders of U.S. Cellular Common Shares and Series A Common Shares as of June 11, 2013. Of the $482.3 million paid, TDS received $407.1 million while noncontrolling public shareholders received $75.2 million. The cash paid to noncontrolling public shareholders is presented as U.S. Cellular dividends paid to noncontrolling public shareholders on the Consolidated Statement of Cash Flows.
TDS repurchased Common Shares for $9.7 million and $20.0 million in 2013 and 2012, respectively, and Special Common Shares for $21.5 million in 2011. U.S. Cellular repurchased Common Shares for $18.5 million, $20.0 million and $62.3 million in 2013, 2012 and 2011, respectively. See Note 15Common Shareholders' Equity in the Notes to Consolidated Financial Statements for additional information related to these transactions.
Free Cash Flow
The following table presents Free cash flow. Free cash flow is defined as Cash flows from operating activities less Cash used for additions to property, plant and equipment. Free cash flow is a non-GAAP financial measure which TDS believes may be useful to investors and other users of its financial
25
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
information in evaluating the amount of cash generated by business operations, after Cash used for additions to property, plant and equipment.
(Dollars in thousands) |
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities |
$ | 494,610 | $ | 1,105,172 | $ | 1,255,711 | ||||
Cash used for additions to property, plant and equipment |
(883,797 | ) | (995,517 | ) | (971,759 | ) | ||||
| | | | | | | | | | |
Free cash flow |
$ | (389,187 | ) | $ | 109,655 | $ | 283,952 | |||
| | | | | | | | | | |
| | | | | | | | | | |
See Cash flows from Operating Activities and Cash flows from Investing Activities for details on the changes to the components of Free cash flow.
LIQUIDITY AND CAPITAL RESOURCES
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 financing needs for the foreseeable future. In addition, TDS and its subsidiaries may access public and private capital markets to help meet their financing needs.
U.S. Cellular's profitability historically has been lower in the fourth quarter as a result of significant marketing and promotional activity during the holiday season. Changes in these or other economic factors could have a material adverse effect on demand for TDS' products and services and on TDS' financial condition and results of operations.
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 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 capital expenditure, acquisition or share repurchase programs. Such reductions could have a material adverse effect on TDS' business, financial condition or results of operations.
The following table summarizes TDS' and U.S. Cellular's cash and investments as of December 31, 2013.
(Dollars in thousands) |
TDS | U.S. Cellular(1) | |||||
---|---|---|---|---|---|---|---|
Cash and cash equivalents |
$ | 830,014 | $ | 342,065 | |||
Short-term investments |
$ | 50,104 | $ | 50,104 |
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 December 31, 2013, 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.
Short-term and Long-term Investments
Short-term investments consist of U.S. Treasury Notes which are designated as held-to-maturity investments and are recorded at amortized cost in the Consolidated Balance Sheet. For these investments, TDS' objective is to earn a higher rate of return on funds that are not anticipated to be required to meet liquidity needs in the near term, while maintaining a low level of investment risk. See
26
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Note 2Fair Value Measurements in the Notes to Consolidated Financial Statements for additional information on Short-term investments. As of December 31, 2013, TDS does not hold Long-term investments.
Revolving Credit Facilities
TDS and U.S. Cellular have revolving credit facilities available for general corporate purposes.
In connection with U.S. Cellular's revolving credit facility, TDS and U.S. Cellular entered into a subordination agreement dated December 17, 2010 together with the administrative agent for the lenders under U.S. Cellular's revolving credit facility. At December 31, 2013, no U.S. Cellular debt was subordinated pursuant to this subordination agreement.
TDS' and U.S. Cellular's interest cost on their revolving credit facilities is subject to increase if their current credit ratings from nationally recognized credit rating agencies are lowered, and is subject to decrease if the ratings are raised. The credit facilities would not cease to be available nor would the maturity date accelerate solely as a result of a downgrade in TDS' or U.S. Cellular's credit rating. However, a downgrade in TDS' or U.S. Cellular's credit rating could adversely affect their ability to renew the credit facilities or obtain access to other credit facilities in the future.
As of December 31, 2013, TDS' and U.S. Cellular's senior debt credit ratings from nationally recognized credit rating agencies remained at investment grade.
In June 2013, U.S. Cellular provided $17.4 million in letters of credit to the FCC in connection with U.S. Cellular's winning bids in Auction 901. See Note 19Supplemental Cash Flow Disclosures in the Notes to Consolidated Financial Statements for additional information on Auction 901.
The continued availability of the revolving credit facilities requires TDS and U.S. Cellular to comply with certain negative and affirmative covenants, maintain certain financial ratios and make representations regarding certain matters at the time of each borrowing. TDS and U.S. Cellular believe that they were in compliance as of December 31, 2013 with all of the financial covenants and requirements set forth in their revolving credit facilities. TDS also has certain other non-material credit facilities from time to time.
See Note 10Debt in the Notes to Consolidated Financial Statements for additional information regarding the revolving credit facilities.
Long-Term Financing
TDS and its subsidiaries' long-term debt indentures do not contain any provisions resulting in acceleration of the maturities of outstanding debt in the event of a change in TDS' credit rating. However, a downgrade in TDS' credit rating could adversely affect its ability to obtain long-term debt financing in the future. TDS believes that it and its subsidiaries were in compliance as of December 31, 2013 with all financial covenants and other requirements set forth in its long-term debt indentures. TDS and U.S. Cellular have not failed to make nor do they expect to fail to make any scheduled payment of principal or interest under such indentures.
The long-term debt principal payments due for the next four years represent less than 1% of the total long-term debt obligation at December 31, 2013. Refer to Market RiskLong-Term Debt for additional information regarding required principal payments and the weighted average interest rates related to TDS' Long-term debt.
TDS and U.S. Cellular, at their discretion, may from time to time seek to retire or purchase their outstanding debt through cash purchases and/or exchanges for other securities, in open market purchases, privately negotiated transactions, tender offers, exchange offers or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
27
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
TDS and U.S. Cellular each have an effective shelf registration statement on Form S-3 to issue senior or subordinated debt securities. The proceeds from any such issuances may be used for general corporate purposes, including the possible reduction of other long-term debt; in connection with acquisition, construction and development programs; the reduction of short-term debt; for working capital; to provide additional investments in subsidiaries; or the repurchase of shares. The TDS shelf registration permits TDS to issue at any time and from time to time senior or subordinated debt securities in one or more offerings in an indeterminate amount. The U.S. Cellular shelf registration statement permits U.S. Cellular to issue at any time and from time to time senior or subordinated debt securities in one or more offerings up to an aggregate principal amount of $500 million. The ability of TDS or U.S. Cellular to complete an offering pursuant to such shelf registration statements is subject to market conditions and other factors at the time.
See Note 10Debt in the Notes to Consolidated Financial Statements for additional information on Long-term financing.
Capital Expenditures
U.S. Cellular's capital expenditures for 2014 are expected to be approximately $640 million. These expenditures are expected to be for the following general purposes:
TDS Telecom's capital expenditures for 2014 are expected to be approximately $200 million. These expenditures are expected to be for the following general purposes:
TDS plans to finance its capital expenditures program for 2014 using primarily Cash flows from operating activities, and as necessary, existing cash balances and short-term investments.
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.
TDS also 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 5Acquisitions, Divestitures and Exchanges and Note 7Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements for additional information related to significant transactions.
28
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
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 13Variable 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.
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 2013, 2012 and 2011, see Note 15Common Shareholders' Equity 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
At December 31, 2013, the resources required for contractual obligations were as follows:
|
Payments Due by Period | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) |
Total | Less Than 1 Year | 1 - 3 Years | 3 - 5 Years | More Than 5 Years | |||||||||||
Long-term debt obligations(1) |
$ | 1,728.7 | $ | 1.5 | $ | 3.9 | $ | | $ | 1,723.3 | ||||||
Interest payments on long-term debt obligations |
4,336.2 | 116.1 | 232.1 | 231.8 | 3,756.2 | |||||||||||
Operating leases(2) |
1,510.2 | 175.2 | 285.0 | 201.0 | 849.0 | |||||||||||
Capital leases |
8.4 | 0.6 | 1.2 | 1.2 | 5.4 | |||||||||||
Purchase obligations(3)(4) |
1,959.6 | 675.3 | 1,058.7 | 141.3 | 84.3 | |||||||||||
| | | | | | | | | | | | | | | | |
|
$ | 9,543.1 | $ | 968.7 | $ | 1,580.9 | $ | 575.3 | $ | 6,418.2 | ||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
29
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The table above excludes liabilities related to "unrecognized tax benefits" as defined by GAAP because TDS is unable to predict the period of settlement of such liabilities. Such unrecognized tax benefits were $30.4 million at December 31, 2013. See Note 3Income Taxes in the Notes to Consolidated Financial Statements for additional information on unrecognized tax benefits.
Agreements
As previously disclosed, on August 17, 2010, TDS and Amdocs Software Systems Limited ("Amdocs") entered into a Software License and Maintenance Agreement ("SLMA") and a Master Service Agreement ("MSA") (collectively, the "Amdocs Agreements") to develop a Billing and Operational Support System ("B/OSS"). In July 2013, TDS implemented B/OSS, pursuant to an updated Statement of Work dated June 29, 2012. Total payments to Amdocs related to this implementation are estimated to be approximately $183.9 million (subject to certain potential adjustments) over the period from commencement of the SLMA through the first half of 2014. As of December 31, 2013, $136.8 million had been paid to Amdocs.
Apple iPhone Products Purchase Commitment
In March 2013, U.S. Cellular entered into an agreement with Apple to purchase certain minimum quantities of iPhone products over a three-year period beginning in November 2013. The minimum quantity of iPhone products to be purchased during the first contract year is fixed and is subject to adjustment for the second and third contract years based on the percentage growth in smartphone sales in the United States for the immediately preceding calendar year. Based on current forecasts, TDS estimates that the remaining contractual purchase commitment as of December 31, 2013 is approximately $950 million. At this time, TDS expects to meet its contractual commitment with Apple.
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.
Dividends
TDS paid quarterly dividends per outstanding share of $0.1275 in 2013, $0.1225 in 2012 and $0.1175 in 2011. TDS increased the dividend per share to $0.1340 in the first quarter of 2014. The dividends per share amount for 2011 have not been retroactively adjusted to reflect the impact of the Share Consolidation Amendment. See Note 15Common Shareholders' Equity in the Notes to Consolidated Financial Statements for additional information. TDS has no current plans to change its policy of paying dividends.
On June 25, 2013, U.S. Cellular paid a special cash dividend of $5.75 per share, for an aggregate amount of $482.3 million, to all holders of U.S. Cellular Common Shares and Series A Common Shares as of June 11, 2013. Of the $482.3 million paid, TDS received $407.1 million while noncontrolling public shareholders received $75.2 million.
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 1Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements.
Management believes the application of the following critical accounting policies and the estimates required by such application reflect its most significant judgments and estimates used in the preparation of TDS' consolidated financial statements. Management has discussed the development and selection of each of the following accounting policies and related estimates and disclosures with the Audit Committee of TDS' Board of Directors.
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Goodwill, Licenses and Franchise rights
See the Goodwill, Licenses and Franchise rights Impairment Assessment section of Note 1Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for information on Goodwill, Licenses and Franchise rights impairment testing policies and methods. TDS performs annual impairment testing of Goodwill, Licenses and Franchise rights, as required by GAAP, in the fourth quarter of its fiscal year, based on fair values and net carrying values determined as of November 1.
See Note 6Intangible Assets in the Notes to Consolidated Financial Statements for additional information related to Goodwill, Licenses and Franchise rights activity in 2013 and 2012.
GoodwillU.S. Cellular
U.S. Cellular tests Goodwill for impairment at the level of reporting referred to as a reporting unit. For purposes of impairment testing of Goodwill in 2013, U.S. Cellular identified four reporting units based on geographic service areas (all of which are included in TDS' wireless reportable operating segment). For purposes of the impairment testing of Goodwill in 2012, U.S. Cellular identified five reporting units based on geographic service areas. The change in reporting units resulted from the NY1 & NY2 Deconsolidation more fully described in Note 7Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements. There were no changes to U.S. Cellular's overall Goodwill impairment testing methodology between November 1, 2013 and November 1, 2012.
A discounted cash flow approach was used to value each reporting unit, using value drivers and risks specific to the industry and current economic factors. The cash flow estimates incorporated assumptions that market participants would use in their estimates of fair value and may not be indicative of U.S. Cellular specific assumptions. The most significant assumptions made in this process were the revenue growth rate (shown as a ten year compound annual growth rate in the table below), the terminal revenue growth rate, the discount rate and capital expenditures as a percentage of revenue (shown as a simple average in the table below). The averages below are based on ten year projection periods. These assumptions were as follows for November 1, 2013 and 2012:
Key Assumptions
|
November 1, 2013 |
November 1, 2012 |
|||||
---|---|---|---|---|---|---|---|
Revenue growth rate |
2.2 | % | 2.2 | % | |||
Terminal revenue growth rate |
2.0 | % | 2.0 | % | |||
Discount rate |
10.0 | % | 11.0 | % | |||
Capital expenditures as a percentage of revenue |
16.0 | % | 15.2 | % |
The carrying value of each U.S. Cellular reporting unit at TDS as of November 1, 2013 was as follows:
Reporting Unit
|
Carrying Value at TDS(1) |
|||
---|---|---|---|---|
(Dollars in millions) |
|
|||
Central Region |
$ | 2,753 | ||
Mid-Atlantic Region |
836 | |||
New England Region |
269 | |||
Northwest Region |
328 | |||
| | | | |
Total |
$ | 4,186 | ||
| | | | |
| | | | |
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
As of November 1, 2013, the fair values of the reporting units exceeded their respective carrying values by amounts ranging from 18.4% to 33.4%. Therefore, no impairment of Goodwill existed. Given that the fair values of the respective reporting units exceed their respective carrying values, provided all other assumptions remained the same, the discount rate would have to increase to a range of 11.4% to 12.7% to yield estimated fair values of reporting units that equal their respective carrying values at November 1, 2013. Further, assuming all other assumptions remained the same, the terminal growth rate assumptions would need to decrease to amounts ranging from negative 5.3% to negative 1.3% to yield estimates of fair value equal to the carrying values of the respective reporting units at November 1, 2013.
GoodwillTDS Telecom
TDS Telecom has recorded Goodwill as a result of the acquisition of ILEC, HMS and cable companies. For purposes of Goodwill impairment testing, TDS Telecom has three reporting units: ILEC, HMS and Cable.
During the third quarter of 2013, due to continued competitive pressures and negative secular and regulatory trends in the ILEC industry, TDS determined that an interim impairment test of TDS Telecom's ILEC Goodwill was required. TDS performed the Step 1 Goodwill impairment test, as defined by GAAP, as of August 1, 2013, and determined that the fair value of the ILEC reporting unit exceeded its carrying value, and accordingly no Goodwill impairment resulted.
Prior to the third quarter of 2013, HMS was comprised of three reporting units: OneNeck IT Services, TEAM Technologies, LLC/VISI Incorporated ("TEAM/VISI") and Vital. Due to changes in the management of the HMS operations and related changes in internal financial reporting that culminated in the third quarter of 2013, the three separate HMS reporting units were combined into one HMS reporting unit. This change in reporting units required TDS to perform an interim impairment test of the Goodwill in the HMS reporting unit(s) in the third quarter of 2013. TDS performed the Step 1 Goodwill impairment test as of August 1, 2013 for the three historical HMS reporting units of OneNeck IT Services, TEAM/VISI, and Vital and the newly combined HMS reporting unit. In all four of these HMS-related Step 1 Goodwill impairment tests, TDS determined that the fair value of each of the reporting units exceeded its respective carrying value, and accordingly, no Goodwill impairment resulted.
In October 2013, TDS acquired MSN. MSN is included in the HMS reporting unit for purposes of Goodwill impairment testing. However, as MSN was acquired in the fourth quarter, the assumptions discussed below relate solely to the legacy HMS reporting unit. Consistent with fair value principles, as MSN was recently purchased from a third party in an arms-length transaction, management believes that MSN's purchase price of $44 million reflects fair value and carrying value at November 1, 2013. This amount was included in the overall HMS reporting unit fair value and carrying value.
The Cable reporting unit consists of Baja, which was acquired in August 2013. A qualitative assessment, as defined by GAAP, of the reporting unit was completed as of November 1, 2013. The qualitative assessment, which analyzed company, industry and economic trends, concluded that it was more likely than not that the fair value of this reporting unit was at least equal to its carrying value, and accordingly no Goodwill impairment resulted.
The discounted cash flow approach and publicly-traded guideline company method were used to value the ILEC and HMS reporting units. The discounted cash flow approach uses value drivers and risks specific to the industry and current economic factors. The cash flow estimates incorporated assumptions that market participants would use in their estimates of fair value and may not be indicative of TDS Telecom specific assumptions. The most significant assumptions made in this process were the revenue growth rate (shown as a compound annual growth rate in the table below), the terminal revenue growth rate, the discount rate and capital expenditures as a percentage of revenue (shown as a simple average in the table below).
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The publicly-traded guideline company method develops an indication of fair value by calculating average market pricing multiples for selected publicly-traded companies using multiples of: Revenue; Earnings before Interest, Taxes, and Depreciation and Amortization; and Earnings before Interest and Taxes. The developed multiples were applied to applicable financial measures of the respective reporting unit to determine fair value. The discounted cash flow approach and publicly-traded guideline company method were weighted to arrive at the total fair value used for impairment testing.
The following tables represent key assumptions used in estimating the fair value of the ILEC and HMS (excluding MSN, as previously discussed) reporting units as of November 1, 2013 and 2012, the annual impairment testing dates. The ILEC and HMS averages below are based on five and ten year projection periods, respectively. There are uncertainties associated with these key assumptions, and potential events and/or circumstances that could have a negative effect on the key assumptions, which are described below.
The assumptions were as follows for November 1, 2013:
Key Assumptions
|
ILEC | HMS | |||||
---|---|---|---|---|---|---|---|
Revenue growth rate |
(0.5 | )% | 10.8 | % | |||
Terminal revenue growth rate |
0.0 | % | 2.5 | % | |||
Discount rate |
7.5 | % | 12.5 | % | |||
Capital expenditures as a percentage of revenue |
15.0 | % | 11.2 | % |
The assumptions were as follows for November 1, 2012:
Key Assumptions
|
ILEC | HMS | |||||
---|---|---|---|---|---|---|---|
Revenue growth rate |
(0.3 | )% | 6.3-16.3 | % | |||
Terminal revenue growth rate |
0.0 | % | 1.5-3.0 | % | |||
Discount rate |
7.0 | % | 11.0-13.0 | % | |||
Capital expenditures as a percentage of revenue |
15.3 | % | 0.4-21.9 | % |
Revenue growth rates
The negative average expected growth rate for the ILEC reporting unit is due primarily to declines in voice and data market share and declines in regulatory and wholesale revenues.
The mix of products and services in the HMS reporting unit is diverse and offers the following services: colocation, dedicated hosting, hosted application management, cloud computing services and planning, engineering, procurement, installation, and sales and management of IT infrastructure hardware solutions. The following sources were used to generate projected revenues:
There are risks that could negatively impact the projected revenue growth rates, including, but not limited to:
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Discount rates
The discount rate of each reporting unit was computed by calculating the weighted average cost of capital ("WACC") of market participants with businesses reasonably comparable to each respective reporting unit. The following is a summary of the key components of the calculation:
The discount rate is dependent upon the cost of capital of other industry market participants. To the extent that the weighted average cost of capital of industry participants increases, this would decrease the estimated fair value of the reporting units. The weighted average cost of capital may increase if borrowing costs rise, market participants weight more of their capital structure towards equity (vs. debt), or other elements affecting the estimated cost of equity increase.
The WACC calculated for the ILEC reporting unit was lower than the WACC calculated for the HMS reporting unit as a result of the ILEC market participants having capital structures that are more heavily weighted toward debt (vs. higher cost equity) relative to the HMS market participants. ILEC market participants are more mature, capital intensive businesses than the HMS market participants. As a result, ILEC market participants generally have a higher ratio of debt relative to equity in their capital structures as compared to HMS market participants.
Capital expenditures as a percentage of revenue
Capital expenditures for the ILEC reporting unit primarily consist of upgrades to plant and equipment in the IPTV markets, general network support, IT infrastructure and the completion of broadband stimulus projects. To the extent costs associated with these capital expenditures increase at a rate higher than expected and disproportionate to forecasted future revenues, this could negatively impact future cash flows.
Capital expenditures for the HMS reporting unit primarily consist of buildings and improvements related to data center construction and information technology hardware. To the extent building capacity needs increase at a rate higher than expected and disproportionate to forecasted future revenues, this could negatively impact future cash flows. Further, should the cost of IT hardware increase at levels higher than expected, this could also cause future capital expenditures to exceed the amounts forecasted.
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Results
The following represents the carrying values of the reporting units tested for impairment as of November 1, 2013, and the results of the Step 1 Goodwill impairment tests.
Reporting unit
|
Carrying value (in millions) |
Percentage by which the estimated fair value of the reporting unit exceeded its carrying value |
|||||
---|---|---|---|---|---|---|---|
ILEC |
$ | 1,297 | 25.5 | % | |||
HMS |
$ | 223 | 16.7 | % |
As of November 1, 2013, the fair value of the ILEC reporting unit exceeded its carrying value; therefore, no impairment of Goodwill existed. Given that the fair value of the reporting unit exceeded its respective carrying value, provided all other assumptions remained the same, the discount rate would have to increase to 9.7% for the discounted cash flow approach to yield an estimated fair value of the ILEC reporting unit that equals its carrying value at November 1, 2013. Further, provided all other assumptions remained the same, the terminal revenue growth rate assumption would need to decrease to negative 3.0%, for the discounted cash flow approach to yield an estimate of fair value equal to the carrying value of the ILEC reporting unit at November 1, 2013.
As of November 1, 2013 the fair value of the HMS reporting unit exceeded its carrying value; therefore, no impairment of Goodwill existed. Given that the fair value of the reporting unit exceeded its respective carrying value, provided all other assumptions remained the same, the discount rate would have to increase to 13.6% for the discounted cash flow approach to yield estimated fair value of the HMS reporting unit (excluding MSN, as previously discussed) that equals its carrying value at November 1, 2013. Further, provided all other assumptions remained the same, the terminal revenue growth rate assumption would need to decrease to negative 0.2%, for the discounted cash flow approach to yield an estimate of fair value equal to the carrying value of the HMS reporting unit (excluding MSN, as previously discussed) at November 1, 2013.
Licenses
U.S. Cellular tests licenses for impairment at the level of reporting referred to as a unit of accounting. For purposes of its impairment testing of licenses as of November 1, 2013, U.S. Cellular separated its FCC licenses into eleven units of accounting based on geographic service areas. As of November 1, 2012, U.S. Cellular separated its FCC licenses into thirteen units of accounting based on geographic service areas. The change in units of accounting resulted from (i) the Divestiture Transaction and the Mississippi Valley non-operating market license sale, both of which are more fully described in Note 5Acquisitions, Divestitures and Exchanges in the Notes to Consolidated Financial Statements and (ii) the NY1 & NY2 Deconsolidation more fully described in Note 7Investments in Unconsolidated Entities in the Notes to Consolidated Financial Statements. In both 2013 and 2012, seven of the units of accounting represented geographic groupings of licenses which, because they were not being utilized and, therefore, were not expected to generate cash flows from operating activities in the foreseeable future, were considered separate units of accounting for purposes of impairment testing.
35
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Developed operating market licenses ("built licenses")
U.S. Cellular applies the build-out method to estimate the fair values of built licenses. The most significant assumptions applied for purposes of the November 1, 2013 and 2012 licenses impairment assessments were as follows:
Key Assumptions
|
November 1, 2013 |
November 1, 2012 |
|||||
---|---|---|---|---|---|---|---|
Build-out period |
5 years | 7 years | |||||
Discount rate |
8.5 | % | 8.5 | % | |||
Terminal revenue growth rate |
2.0 | % | 2.0 | % | |||
Terminal capital expenditures as a percentage of revenue |
13.6 | % | 13.2 | % | |||
Customer penetration rates |
12.5-16.7 | % | 13.3-17.3 | % |
The shorter build-out period in 2013 reflects a change in management's expectations of the time required to build out the U.S. Cellular network and is based on recent company-specific experience and industry observation.
The discount rate used in the valuation of licenses is less than the discount rate used in the valuation of reporting units for purposes of goodwill impairment testing. The discount rate used for licenses does not include a company-specific risk premium as a wireless license would not be subject to such risk.
The discount rate is the most significant assumption used in the build-out method. The discount rate is estimated based on the overall risk-free interest rate adjusted for industry participant information, such as a typical capital structure (i.e., debt-equity ratio), the after-tax cost of debt and the cost of equity. The cost of equity takes into consideration the average risk specific to individual market participants.
As of November 1, 2013, the fair values of the built licenses units of accounting exceeded their respective carrying values by amounts ranging from 28.0% to 75.9%. Therefore, no impairment of Licenses existed. Given that the fair values of the licenses exceed their respective carrying values, the discount rate would have to increase to a range of 8.9% to 9.5% to yield estimated fair values of licenses in the respective units of accounting that equal their respective carrying values at November 1, 2013. An increase of 50 basis points to the assumed discount rate would cause an impairment of approximately $11 million.
Non-operating market licenses ("unbuilt licenses")
For purposes of performing impairment testing of unbuilt licenses, U.S. Cellular prepares estimates of fair value by reference to prices paid in recent auctions and market transactions where available. If such information is not available, the fair value of the unbuilt licenses is assumed to have changed by the same percentage, and in the same direction, that the fair value of built licenses measured using the build-out method changed during the period. There was no impairment loss recognized related to unbuilt licenses as a result of the November 1, 2013 licenses impairment test.
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Carrying Value of Licenses
The carrying value of licenses at November 1, 2013 was as follows:
Unit of Accounting(1)
|
Carrying Value | |||
---|---|---|---|---|
(Dollars in millions) |
|
|||
U.S. CellularDeveloped Operating markets |
||||
Central Region |
$ | 749 | ||
Mid-Atlantic Region |
235 | |||
New England Region |
107 | |||
Northwest Region |
68 | |||
U.S. CellularNon-operating markets |
||||
New England |
1 | |||
North Northwest |
3 | |||
South Northwest |
2 | |||
North Central |
59 | |||
South Central |
22 | |||
East Central |
107 | |||
Mid-Atlantic |
50 | |||
| | | | |
Total(2) |
$ | 1,403 | ||
| | | | |
TDS Telecom |
3 | |||
Airadigm |
15 | |||
| | | | |
Total(3) |
$ | 1,421 | ||
| | | | |
| | | | |
Franchise rights
TDS Telecom has recorded Franchise rights as a result of the acquisition of a cable business in August 2013. The carrying value of Franchise rights as of December 31, 2013 was $123.7 million. TDS Telecom tests Franchise rights for impairment at a level of reporting referred to as a unit of accounting. For purposes of its impairment testing of Franchise rights in 2013, TDS Telecom identified one unit of accounting: Cable. A qualitative assessment, as defined by GAAP, of the Cable unit of accounting was completed as of November 1, 2013. The qualitative assessment, which analyzed company, industry and economic trends, concluded that it was more likely than not that the fair value of the Franchise rights was at least equal to their carrying value, and accordingly, no Franchise rights impairment resulted.
37
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Income Taxes
The amounts of income tax assets and liabilities, the related income tax provision and the amount of unrecognized tax benefits are critical accounting estimates because such amounts are significant to TDS' financial condition and results of operations.
The preparation of the consolidated financial statements requires TDS to calculate a provision for income taxes. This process involves estimating the actual current income tax liability together with assessing temporary differences resulting from the different treatment of items for tax purposes. These temporary differences result in deferred income tax assets and liabilities, which are included in TDS' Consolidated Balance Sheet. TDS must then assess the likelihood that deferred income tax assets will be realized based on future taxable income and, to the extent management believes that realization is not likely, establish a valuation allowance. Management's judgment is required in determining the provision for income taxes, deferred income tax assets and liabilities and any valuation allowance that is established for deferred income tax assets.
TDS recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution.
See Note 3Income Taxes in the Notes to Consolidated Financial Statements for details regarding TDS' income tax provision, deferred income taxes and liabilities, valuation allowances and unrecognized tax benefits, including information regarding estimates that impact income taxes.
Loyalty Reward Program
See the Revenue RecognitionU.S. Cellular section of Note 1Summary of Significant Accounting Policies and Recent Accounting Pronouncements in the Notes to Consolidated Financial Statements for a description of this program and the related accounting.
TDS follows the deferred revenue method of accounting for its loyalty reward program. Under this method, revenue allocated to loyalty reward points is deferred. Revenue is recognized at the time of customer redemption or when such points have been depleted via an account maintenance charge. TDS periodically reviews and revises the redemption and depletion rates as appropriate based on history and related future expectations. As of December 31, 2013, TDS estimated loyalty reward points breakage based on actuarial estimates and recorded a $7.4 million change in estimate, which reduced Customer deposits and deferred revenues in the Consolidated Balance Sheet and increased Operating revenues in the Consolidated Statement of Operations.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Note 20Certain Relationships and Related Transactions in the Notes to Consolidated Financial Statements.
38
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
SAFE HARBOR CAUTIONARY STATEMENT
This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Annual Report contain statements that are not based on historical facts, including the words "believes," "anticipates," "intends," "expects" and similar words. These statements constitute and represent "forward-looking statements" as this term is defined in the Private Securities Litigation Reform Act of 1995. 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, but are not limited to, the following risks:
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Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
40
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
See "Risk Factors" in TDS' Annual Report on Form 10-K for the year ended December 31, 2013 for a further discussion of these risks. TDS undertakes no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Readers should evaluate any statements in light of these important factors.
41
Telephone and Data Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Long-Term Debt
As of December 31, 2013, the majority of TDS' long-term debt was in the form of fixed-rate notes with maturities ranging up to 48 years. Fluctuations in market interest rates can lead to significant fluctuations in the fair value of these fixed-rate notes.
The following table presents the scheduled principal payments on long-term debt and capital lease obligations, and the related weighted average interest rates by maturity dates at December 31, 2013:
|
Principal Payments Due by Period | ||||||
---|---|---|---|---|---|---|---|
(Dollars in millions) |
Long-Term Debt Obligations(1) |
Weighted-Avg. Interest Rates on Long-Term Debt Obligations(2) |
|||||
2014 |
$ | 1.6 | 4.8 | % | |||
2015 |
1.3 | 2.7 | % | ||||
2016 |
3.1 | 4.8 | % | ||||
2017 |
0.2 | 9.1 | % | ||||
2018 |
0.2 | 9.2 | % | ||||
After 5 years |
1,726.9 | 6.7 | % | ||||
| | | | | | | |
Total |
$ | 1,733.3 | 6.7 | % | |||
| | | | | | | |
| | | | | | | |
Fair Value of Long-Term Debt
At December 31, 2013 and 2012, the estimated fair value of long-term debt obligations, excluding capital lease obligations and the current portion of such long-term debt, was $1,560.6 million and $1,827.6 million, respectively. The fair value of long-term debt, excluding capital lease obligations and the current portion of such 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 at December 31, 2013 and 2012 and discounted cash flow analysis for U.S. Cellular's 6.7% Senior Notes and the remaining debt at December 31, 2013 and 2012.
Other Market Risk Sensitive Instruments
The substantial majority of TDS' other market risk sensitive instruments (as defined in item 305 of SEC Regulation S-K) are short-term, including Cash and cash equivalents and Short-term investments. The fair value of such instruments is less sensitive to market fluctuations than longer term instruments. Accordingly, TDS believes that a significant change in interest rates would not have a material effect on such other market risk sensitive instruments.
42
Telephone and Data Systems, Inc.
Consolidated Statement of Operations
Year Ended December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars and shares in thousands, except per share amounts) |
|
|
|
|||||||
Operating revenues |
$ | 4,901,236 | $ | 5,345,277 | $ | 5,180,471 | ||||
Operating expenses |
||||||||||
Cost of services and products (excluding Depreciation, amortization and accretion expense reported below) |
2,225,316 | 2,272,570 | 2,050,644 | |||||||
Selling, general and administrative |
1,947,778 | 2,033,901 | 2,002,359 | |||||||
Depreciation, amortization and accretion |
1,018,077 | 813,626 | 765,776 | |||||||
Loss on impairment of assets |
| 515 | | |||||||
(Gain) loss on asset disposals, net |
30,841 | 19,741 | 10,952 | |||||||
(Gain) loss on sale of business and other exit costs, net |
(300,656 | ) | 21,061 | | ||||||
(Gain) loss on license sales and exchanges |
(255,479 | ) | | (11,762 | ) | |||||
| | | | | | | | | | |
Total operating expenses |
4,665,877 | 5,161,414 | 4,817,969 | |||||||
| | | | | | | | | | |
Operating income |
235,359 | 183,863 | 362,502 | |||||||
Investment and other income (expense) |
||||||||||
Equity in earnings of unconsolidated entities |
132,714 | 92,867 | 82,538 | |||||||
Interest and dividend income |
9,092 | 9,248 | 9,145 | |||||||
Gain (loss) on investments |
14,547 | (3,718 | ) | 24,103 | ||||||
Interest expense |
(98,811 | ) | (86,745 | ) | (118,201 | ) | ||||
Other, net |
(37 | ) | 720 | 3,658 | ||||||
| | | | | | | | | | |
Total investment and other income (expense) |
57,505 | 12,372 | 1,243 | |||||||
| | | | | | | | | | |
Income before income taxes |
292,864 | 196,235 | 363,745 | |||||||
Income tax expense |
126,043 | 73,582 | 113,503 | |||||||
| | | | | | | | | | |
Net income |
166,821 | 122,653 | 250,242 | |||||||
Less: Net income attributable to noncontrolling interests, net of tax |
24,894 | 40,792 | 49,676 | |||||||
| | | | | | | | | | |
Net income attributable to TDS shareholders |
141,927 | 81,861 | 200,566 | |||||||
TDS Preferred dividend requirement |
(49 | ) | (50 | ) | (50 | ) | ||||
| | | | | | | | | | |
Net income available to common shareholders |
$ | 141,878 | $ | 81,811 | $ | 200,516 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
Basic weighted average shares outstanding |
108,490 | 108,671 | 108,562 | |||||||
Basic earnings per share attributable to TDS shareholders |
$ | 1.31 | $ | 0.75 | $ | 1.85 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
Diluted weighted average shares outstanding |
109,132 | 108,937 | 109,098 | |||||||
Diluted earnings per share attributable to TDS shareholders |
$ | 1.29 | $ | 0.75 | $ | 1.83 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
Dividends per share to TDS shareholders |
$ | 0.51 | $ | 0.49 | $ | 0.47 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
43
Telephone and Data Systems, Inc.
Consolidated Statement of Comprehensive Income
Year Ended December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|||||||
Net income |
$ | 166,821 | $ | 122,653 | $ | 250,242 | ||||
Net change in accumulated other comprehensive income |
||||||||||
Change in net unrealized gain on equity investments |
51 | 49 | 138 | |||||||
Change in foreign currency translation adjustment |
(34 | ) | 4 | | ||||||
Change related to retirement plan |
||||||||||
Amounts included in net periodic benefit cost for the period |
||||||||||
Net actuarial gains (losses) |
13,345 | 90 | (9,625 | ) | ||||||
Amortization of prior service cost |
(3,605 | ) | (3,735 | ) | (3,815 | ) | ||||
Amortization of unrecognized net loss |
2,452 | 2,517 | 1,934 | |||||||
| | | | | | | | | | |
|
12,192 | (1,128 | ) | (11,506 | ) | |||||
Change in deferred income taxes |
(4,646 | ) | 1,797 | 5,722 | ||||||
| | | | | | | | | | |
Change related to retirement plan, net of tax |
7,546 | 669 | (5,784 | ) | ||||||
| | | | | | | | | | |
Net change in accumulated other comprehensive income |
7,563 | 722 | (5,646 | ) | ||||||
| | | | | | | | | | |
Comprehensive income |
174,384 | 123,375 | 244,596 | |||||||
Less: Comprehensive income attributable to noncontrolling interest |
24,894 | 40,792 | 49,676 | |||||||
| | | | | | | | | | |
Comprehensive income attributable to TDS shareholders |
$ | 149,490 | $ | 82,583 | $ | 194,920 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
44
Telephone and Data Systems, Inc.
Consolidated Statement of Cash Flows
Year Ended December 31,
|
2013 | 2012 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|
|||||||
Cash flows from operating activities |
||||||||||
Net income |
$ | 166,821 | $ | 122,653 | $ | 250,242 | ||||
Add (deduct) adjustments to reconcile net income to net cash flows from |
||||||||||
Depreciation, amortization and accretion |
1,018,077 | 813,626 | 765,776 | |||||||
Bad debts expense |
105,629 | 74,695 | 68,611 | |||||||
Stock-based compensation expense |
30,338 | 41,871 | 36,837 | |||||||
Deferred income taxes, net |
(67,150 | ) | 58,785 | 202,547 | ||||||
Equity in earnings of unconsolidated entities |
(132,714 | ) | (92,867 | ) | (82,538 | ) | ||||
Distributions from unconsolidated entities |
127,929 | 84,884 | 92,231 | |||||||
Loss on impairment of assets |
| 515 | | |||||||
(Gain) loss on asset disposals, net |
30,841 | 19,741 | 10,952 | |||||||
(Gain) loss on sale of business and other exit costs, net |
(300,656 | ) | 21,061 | | ||||||
(Gain) loss on license sales and exchanges |
(255,479 | ) | | (11,762 | ) | |||||
(Gain) loss on investments |
(14,547 | ) | 3,718 | (24,103 | ) | |||||
Noncash interest expense |
2,463 | (572 | ) | 18,849 | ||||||
Other operating activities |
612 | 1,393 | 1,067 | |||||||
Changes in assets and liabilities from operations |
||||||||||
Accounts receivable |
(294,320 | ) | (81,107 | ) | (95,426 | ) | ||||
Inventory |
(83,536 | ) | (29,917 | ) | (13,382 | ) | ||||
Accounts payable |
86,028 | (12,332 | ) | 29,291 | ||||||
Customer deposits and deferred revenues |
66,460 | 32,981 | 35,457 | |||||||
Accrued taxes |
17,388 | 77,458 | (27,871 | ) | ||||||
Accrued interest |
380 | (891 | ) | 3,351 | ||||||
Other assets and liabilities |
(9,954 | ) | (30,523 | ) | (4,418 | ) | ||||
| | | | | | | | | | |
|
494,610 | 1,105,172 | 1,255,711 | |||||||
| | | | | | | | | | |
Cash flows from investing activities |
||||||||||
Cash used for additions to property, plant and equipment |
(883,797 | ) | (995,517 | ) | (971,759 | ) | ||||
Cash paid for acquisitions and licenses |
(314,570 | ) | (163,382 | ) | (105,508 | ) | ||||
Cash received from divestitures |
811,120 | 50,182 | | |||||||
Cash paid for investments |
| (120,000 | ) | (180,920 | ) | |||||
Cash received for investments |
115,000 | 243,444 | 393,246 | |||||||
Other investing activities |
11,594 | (12,796 | ) | (1,148 | ) | |||||
| | | | | | | | | | |
|
(260,653 | ) | (998,069 | ) | (866,089 | ) | ||||
| | | | | | | | | | |
Cash flows from financing activities |
||||||||||
Repayment of short-term debt |
| | (32,671 | ) | ||||||
Repayment of long-term debt |
(1,581 | ) | (2,566 | ) | (614,639 | ) | ||||
Issuance of long-term debt |
37 | 195,358 | 643,700 | |||||||
TDS Common Shares and Special Common Shares reissued for benefit plans, net of tax payments |
9,654 | (1,119 | ) | 32 | ||||||
U.S. Cellular Common Shares reissued for benefit plans, net of tax payments |
5,784 | (2,205 | ) | 1,935 | ||||||
Repurchase of TDS Common and Special Common Shares |
(9,692 | ) | (20,026 | ) | (21,500 | ) | ||||
Repurchase of U.S. Cellular Common Shares |
(18,544 | ) | (20,045 | ) | (62,294 | ) | ||||
Dividends paid to TDS shareholders |
(55,293 | ) | (53,165 | ) | (48,670 | ) | ||||
U.S. Cellular dividends paid to noncontrolling public shareholders |
(75,235 | ) | | | ||||||
Payment of debt issuance costs |
(23 | ) | (8,242 | ) | (21,657 | ) | ||||
Distributions to noncontrolling interests |
(3,766 | ) | (20,856 | ) | (16,236 | ) | ||||
Payments to acquire additional interest in subsidiaries |
(4,505 | ) | (3,167 | ) | | |||||
Other financing activities |
8,740 | 6,136 | 3,970 | |||||||
| | | | | | | | | | |
|
(144,424 | ) | 70,103 | (168,030 | ) | |||||
| | | | | | | | | | |
Net increase in cash and cash equivalents |
89,533 | 177,206 | 221,592 | |||||||
Cash and cash equivalents |
||||||||||
Beginning of period |
740,481 | 563,275 | 341,683 | |||||||
| | | | | | | | | | |
End of period |
$ | 830,014 | $ | 740,481 | $ | 563,275 | ||||
| | | | | | | | | | |
| | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
45
Telephone and Data Systems, Inc.
Consolidated Balance SheetAssets
December 31,
|
2013 | 2012 | |||||
---|---|---|---|---|---|---|---|
(Dollars in thousands) |
|
|
|||||
Current assets |
|||||||
Cash and cash equivalents |
$ | 830,014 | $ | 740,481 | |||
Short-term investments |
50,104 | 115,700 | |||||
Accounts receivable |