Array Digital Infrastructure, Inc. (AD) Earnings Call Transcript & Summary

Good afternoon. For those joining us on the line, I'm Mike Rollins, covering the Communications Services and Infrastructure categories for Citi Research. We also have disclosures available at the registration desk. I'd like to welcome back the teams from TDS and U.S. Cellular. We have joining us today Ken Meyers, President and CEO of U.S. Cellular. He also serves on the Boards of TDS and U.S. Cellular. We also have joining us Michael Irizarry, CTO of U.S. Cellular; Jane McCahon, Senior Vice President, Corporate Relations and the Corporate Secretary of TDS; as well as Michelle Brukwicki, Vice President of Financial Strategy and Planning for TDS. Thank you all for joining us today.

Thanks for having us, Mike.

We do have microphones around the room. So if anyone has questions at any time, please push your button. It will turn red, and we'll get you involved in the conversation. And with that, if I'll just turn it over to the team and ask you about your strategic and your operating priorities for the coming year.

Okay. So let me -- I'll start with that at U.S. Cellular. And this year, meaning 2019, we started modernizing our network in preparation for some 5G rollout in 2020. Mike can talk all about that. I hope you got a lot of questions for him about that. But in 2020, we will actually launch 5G on low band spectrum in 2 of our market areas, Wisconsin and Iowa. We'll then start our next phase of that modernization work for a 2021 launch in other markets. At the same time, on the network side, we will be completing the last phase of our Voice over LTE rollout in some of our final markets. And if things work out on schedule, by the end of '20, we'll have some of the millimeter wave spectrum that we acquired in auctions last year that we'll be turning on judiciously in a few cell sites. So a lot about the network this year, and we're doing all that to continue to improve the customer experience as these devices draw more and more demand. You are continuing to invest in providing higher speed, more capacity to continue to improve that network experience. And that's kind of been core to our strategy from day 1, is maintaining a real focus on that customer network experience. And nothing we're doing is going to stop that. At the same time, probably not as much going on right now from the consumer growth standpoint. What we're actually seeing is people stepping back a little bit. You have $1,000 phones. Is there really a demand for the incremental difference? What's this 5G? Do I need to -- should I be waiting for it? So not as much going on there. What we are doing is continue to push fixed wireless into some of our rural areas. When I talk of fixed wireless, I'm talking about the end of the line. I'm not talking about millimeter wave in Downtown Chicago. I'm talking about 4G, LTE, where the competition is DSL or satellite-type services. Continuing to migrate our customers into higher revenue packages, that means more unlimited. Well, I've never been a big fan of unlimited for the disconnect with revenue and the investment required in this industry. Nonetheless, it's a way, at least midterm, to continue to increase average revenue per customer and augmenting that with other services, particularly device protection, things like that, that just add a little bit to ARPU. Finally, I'd say the other area of investment, the investment in time, is really our B2B channel is working with midsized cities and towns around what's the potential, whether you call it 5G, whether you call it Smart City. Quite frankly, we've been amazed at the interest in smaller communities, trying to figure out how can we improve the services that we are offering, the quality of life or our costs to our citizens by understanding the capability of these services. And we -- it's going to be a long lead time sales cycle, but I'm really pretty excited by just the level of interest that we're seeing out of these smaller towns. So that's really where our focus is going to be next year.

And for TDS Telecom, we're going to continue our strategy of providing high-quality broadband services to our customers, while bundling that broadband with video and invoice products. TDS Telecom is made up of -- is it on now? Okay. TDS Telecom is made up of 2 business segments. The first one is our wireline, which is our legacy ILEC and CLEC, and that's where we're doing some fiber. And the second segment is cable. I'll start with our wireline business. And the couple of top strategic priorities there are to continue expanding our fiber deployment, both in our existing territory, which we've been doing for many years, and we're going to continue doing that. But the new part of that program is that we're also starting to take fiber into out-of-territory markets as a growth vehicle and to really meet the needs of those communities. In addition, we're going to continue executing on our broadband build-outs that we're doing under certain federal and state broadband programs. On our cable side of our business, we're going to continue increasing our broadband penetration in all of our markets for both our residential and our commercial customers. Almost all of our service addresses currently have DOCSIS 3.0 technology, and we are investing in DOCSIS 3.1 in our largest markets in order to increase speeds there for our customers as well. And on the cable front, we do continue to look for acquisition opportunities. That's an important part of our growth strategy for that business. And in fact, we just closed on our most recent cable acquisition called Continuum, which serves customers just north of Charlotte, North Carolina. And in both businesses, we continue to invest in our video product. So broadband is our leading product, but we do still think that video is an important part of our bundle of packages that we offer to our customers. And so we're investing in a cloud TV platform that we call TDS TV+, and that's showing our commitment to that part of our product portfolio. So all really great things going on at TDS Telecom that we're excited to continue into 2020.

So if I think about the history of the industry and the way that TDS was divided between having the telecom business and a separate wireless business, it's because the products were viewed separately. The build-outs were viewed separately. But as we look at the industry now, one of the key ingredients to 5G, for example, is a lot of fiber. And so how does this change at all the way TDS and U.S. Cellular might work together or certain investments might shift between businesses? Because you could go to a market, to your point about expanding fiber out of market, but then that could also fuel small cells and wireless. And how do you look at those opportunities given the common ownership and what both companies are trying to accomplish on the broadband front?

And so we look at them and leverage the opportunities where they exist. But where they exist isn't large enough today to really make it a core part of the discussion in this room, right? And so when we think about that, we absolutely use fiber that TDS has in markets where we both operate. Similarly, should -- we've had this discussion in the past about content and the importance of content. And from what we've seen with our customers so far, there are so many different roads to content that having to deliver it is our road. We don't have to own it, okay? The broadband that we have, the fixed wireless today is really broadband only. However, if I need to go to the content route, the assets that we have in TDS Telecom around TV would be a very fast and easy way to market for me to go there. I just don't need it. So there are places where we can leverage, and we are leveraging, but they just aren't -- because of the difference in footprints, they just aren't big enough right now to really make it a core part of the discussion.

Right. And so, Mike, as we think about those new markets that we might be going to, Ken is right. Whether U.S. Cellular is there or not is not a critical part of that decision-making process. If they're there, then that's great. But from a TDS Telecom perspective, we do recognize that fiber is going to be needed by whatever carriers might be there. So we do look at commercial opportunities there, including what might be needed to help support the 5G rollout.

If I could push the conversation for a moment back on the 5G front, over to Michael. There's a question over the applicability of millimeter wave spectrum in suburban and rural markets. And now that you own some millimeter wave spectrum, and you probably had some chance to test it and get a feel for it, you mentioned that -- or Ken mentioned there's going to be some deployments maybe later this year. Like what are you seeing in terms of the propagation and what you can do, whether it's mobile or fixed wireless broadband with that in your markets?

Yes. We've been testing millimeter wave, both 28 and -- 28 gigahertz for a while in different types of environments, rural, suburban and urban. And it certainly doesn't propagate as far as lower band frequencies. But what we've found is you get really great coverage the higher you mount the radios up on the towers. And we've seen up to 2 kilometers of very usable signal strength to deliver improved speeds across the existing network. So when we think about our deployments, as Ken mentioned earlier, we would look to leverage the towers we have in these markets to increase the speed of our networks by mounting a millimeter wave higher up on a tower. And we're working with the different infrastructure vendors to make sure that it supports those ranges.

Now would this be for mobile? Or would this also be for fixed wireless broadband?

It would be for both.

And when you look at fixed wireless broadband, is it important for the antenna to sit outside the premise or the house? Or can you get in-building, in-window regardless of the materials being used?

Yes, that's a great question, Mike. So millimeter wave really does not propagate well through buildings. There are variances depending on the construction. But in general, it just doesn't propagate well. So if you plan on using millimeter wave to enhance coverage in the building, you really need an external antenna. Frankly though, external antenna benefits low band and mid-band for fixed wireless. And we've seen doubling of speeds and capacity with our LTE fixed wireless access by using an external antenna. So that's something that we try to really push forward with the vendors that are supplying CP equipment.

So given the emerging opportunities for 5G, fixed wireless broadband, millimeter wave, do you have a business case to look at the expansion of the revenue opportunity for U.S. Cellular in your markets to be more of a home broadband provider? And how significant could this be for the company from both an investment and revenue perspective if you look at this over the next 3 to 5 years?

I'm not ready just to size it yet. We need actual in-market experience with the devices. We just haven't seen a sufficient supply of customer-premise equipment yet. But our whole investment in millimeter is heavily driven by what we see as the fixed wireless opportunity. In midsized and rural communities, that is not based on what we do in Milwaukee, but more on what we do in the suburban and rural areas.

And when you look at your markets, this is just to reframe the competitive landscape more broadly today, is cable having an impact on your mobile business today? Have the recent changes by Verizon's promotions and the insertion of Disney+ have had any impact on your business?

The market's competitive. It's always been competitive, and it gets increasingly competitive every year. The content piece has not had a meaningful impact on us. Most customers have had a wireless device so long, they're getting -- they've been getting their content. They can get content. In fact, I'm amazed at the amount of sharing of content that goes on, so that hasn't been an issue. What we did see though is, again, the consumer isn't as compelled right now with the difference in devices to boy, I've got to have it. There's a little bit of hesitancy waiting to understand what's the next device. I think the concern -- there's been a lot of talk of GE in 5G devices next year from a couple of big companies, is it going to make -- is that going to become the super cycle or whatever. Well, the issue is whether the networks are going to be ready for it. I mean nothing is going to be more disappointing to a customer than to spend a lot of money on a new super device that only works once in a while, right? And it's going to become the carrier's problem. Because they're going to say wait a minute, your network isn't working. Well, my network is working just the way it always worked. You will add something that doesn't exist yet, right? So I'm a little worried that we're getting too far in front of ourselves on consumer expectations right now. So saw some softness there. And I said before, where we've felt maybe the competitive impact has been the bundling of cable on our low-end customers. Customers that are only using a gig or less, and they're getting a $15 offering from a cable company on a bundled offering. Well, $15 doesn't do anything for me. There's no economics in that. So I'm not about to change pricing for it. But what we've seen -- some of our low-end customers that were impacted more. I'd say that's probably the biggest competitive impact. Yes, Verizon changed prices, but it didn't have a big impact on us because we moved, what, 10 days later? So it has an impact on the business long term if you're pricing that way. But competitively, we didn't have an issue in the quarter.

And so you did change up some of the promotions. Were there any positive benefits that came from that as well in terms of driving more customer interest or being able to expand the kind of verticals that you've been able to attract into the company?

Well, we've been -- we -- this year, looking back over the whole year, we've done a nice job of growing average revenue per customer. All the promotions are based upon people moving up the ladder in terms of different services and price points. The inclusion of device protection, there's a nice margin. And similarly, this year, we did a very nice job of growing roaming revenue, while at the same time driving down roaming expenses. That's a combination of the fact that we've got agreements for Voice over LTE roaming with each of the 4 major carriers all up and running now. So we've expanded the volume across the network to more than offset the price declines that were built in there that are holding down our expense growth. So if I look at total systems operations costs, which include the cost of running our network as well as roaming, I think, what, the network demand is up like almost 40% year-over-year, but actual expenses net are up 4% or 5%, so it's been a very nice balance on the roaming side. It's been a nice contributor to the year.

And going back to the point that you were making on cable with them picking off the low-end customers, is the low-hanging fruit for them off a tree? Or is this something where it's just going to drag on for a period of time?

I'd say I hope the biggest impact's behind us. But I don't have numbers yet in front of me to measure it.

Do you have a prediction of what's going to happen with the proposed merger between T-Mobile and Sprint?

With all the experts in this room, I'm hoping someone is going to tell me what the line is. I haven't been down to the casino yet, but is there a line there?

Haven't checked.

More importantly, what's the over and under on when we get an answer, or at least the final answer.

So does that -- do you look at that transaction, whether it happens or doesn't happen, as a -- one way or the other, a significant impact on your operations and your competitive environment?

I think there are clearly significant impacts longer term in the industry level depending on how it happens, right? I mean there -- what happens to that spectrum, okay? And depending upon what happens with that deal, how does that impact the C-band auction, whatever that happens, I think are 2 of the bigger potential questions for the industry. When we talked about how we're starting to judiciously build out some millimeter, quite frankly, I'm doing that because that's the spectrum we have. I think I can't wait for 3 years to find out when we get -- if and when we get mid-band, right? All other things being equal, I'd like to have mid-band, I'd like to have it today, okay? And we were -- we thought that the industry was moving one way, and all of a sudden, that didn't work out that way. And so now there's uncertainty about when we're going to see C-band. And when we see it, we're still going to have a couple of years to clear it. So there's some time to market issues, competitive issues that will get tied up with either that deal going forward and one company getting mid-band or everybody waiting a few more years for it. So I think there are some big issues related to that. In terms of how it impacts us specifically one way or another, I don't worry about it in the sense that in -- whether it be Cedar Rapids or Omaha or Madison or Green Bay, they're both -- both Sprint and T-Mobile are there, okay? So there are very few places until I get to the very edge of my footprint that they aren't. So we compete with them today, and I'll be competing with them tomorrow. Our job is to continue to focus on the needs of our customers and make sure that we can meet them.

Is the competitive environment shifting for T-Mobile at all with the 600 megahertz deployment by them, where I think you have the A band 700, where you operate and so this now gives them low band in your markets potentially?

I haven't seen it yet. They're just -- just turning on. We haven't seen it. We're doing the same thing in terms of using 600 to roll out 5G.

And when -- maybe back to Michael for a question. When do you turn on dynamic spectrum sharing where you could advertise a 5G footprint across your footprint?

Yes. We don't have to use it because, as Ken said, we're deploying on 600, and that's not shared with LTE. We've been using 800 and 700 for our LTE network. So our current plan of record has no dependency on spectrum sharing capability. But we will deploy it as we start to further move to 5G. But we don't need it unlike some of the other carriers that don't have clean spectrum to deploy 5G in low band.

And maybe just moving back over to the TDS Telecom side, what are you seeing in terms of the take-ups? As you're building out into these new fiber markets, what kind of market share are you achieving?

Yes. So let me just give a little overview of the fiber program. So we've been building fiber for several years in our existing markets. And we developed a competency and a process around that. And a couple of years ago, we decided to try to increase our growth potential with fiber by going in markets outside of our existing territory. And so we did that with our first trial market, and that's in Sun Prairie, Wisconsin, the suburb of Madison, in the Dane County area. So we're calling this our Southern Wisconsin cluster. So that market has now been in operations for a couple of years. And what we're seeing there is, as of the end of third quarter, we had broadband penetration of about 50%. And that translates into a market share of over 50%. It's about 55% in the areas that we serve. So those results were beating our expectations for what we thought we would achieve. And we're very pleased with that, and that's giving us the confidence to continue with the strategy into other markets. And so what we're doing now is adding a few more markets in the Southern Wisconsin cluster. A few of those markets are in different stages of development, and they'll add a little over 20,000 service addresses by the time we're done in that cluster. And so far, what we're seeing from the initial installation and presell results is that they're tracking very similarly to what we saw in Sun Prairie. And then beyond that, we've decided to move beyond Southern Wisconsin, and we've got a new cluster that we're starting in Mid-Central Wisconsin, in the Stevens Point and the Wausau areas. And then all the way out into Coeur d'Alene, Idaho, Coeur d'Alene and 3 surrounding communities there. And so far, the presales results that we're seeing in those clusters are also very pleasing, and we're optimistic.

When you think about the amount of money you could spend on mid-band spectrum and pushing 5G more aggressively doing fixed wireless broadband, would that be a sizable-enough expense where you might want to find some alternative funding mechanisms, like monetizing your towers?

Boy, you do that nicely. Potentially. I mean I say, potentially. I don't know what the C-band opportunity is going to look like, how many people are going to show up, what prices are going to look like and how much spectrum is going to be available. Having said that, as we think about the balance sheet right now, between our cash balances and current existing facilities such as an EIP receivable line that's sitting there unused, I think we've got sufficient flexibility. And what we've said is those towers are strategic. I've talked about how we're going back up to the top of the tower with equipment again, okay, that had -- we sold those, and someone else was sitting there. We'd have to be putting up other towers instead of being able to use the resources we have today. Also have said that those strategic assets could be used for another strategic asset. Spectrum is a strategic asset. It's one of the few that I can think of that as we look forward, that I could say, yes, I'm trading one strategic asset for another. But that auction is so undefined right now and so uncertain in terms of what it looks like. I have no commitment, but that would be a strategic asset.

You entered in, I believe, a new partnering arrangement over the last year to help sell colocation on the towers. Has that borne any fruit?

Yes, but they are small little fruits. I mean, again, even when we are leasing space out, okay, it is leasing it subject to our needs or potential needs of the engineering organization. So the objective is not to sit there and take a $65 million current rental revenue stream and double it to $130 million, but put the billions of dollars we've got in the network at risk, okay? And so it is still a business that is subject to the needs of the bigger business.

And a few years ago, you were selling down some of the non-core spectrum. Is there still non-core spectrum sitting on the books?

We do have the economics related to some spectrum that a partner of ours has that they may decide to look at what their holdings are and how they decide to deploy that, that may flow through to us, a direct ownership. We do not have much non-core spectrum at this point in time. But we do have an economic interest in a -- on some that when that partner decides what to do, would flow through us.

Is that referring to designated entities in the past?

Yes.

And then has there been any progress in terms of finding creative structures for some of the investment stakes you hold in Los Angeles and some of the other cellular markets that are operated by the national carriers?

There hasn't been anything that changes the 3 major pieces of the dynamics around that. And so the answer is, we own 5.5% of Verizon's L.A. It's generating free cash flow to us of $90 million between all of them?

Well, between all of them, over $100 million.

Over $100 million, okay. And that's been an annuity for many, many years. The dynamics that kind of -- that impact that is there's one natural buyer for those, okay? So when you have a one-buyer market, that affects pricing on one side. On the other side, the tax bases are extraordinarily low. And so while we may have had conversations at various times, we still look at what's the kind of cash-on-cash return. And we know what that annuity has delivered over years. And if we can get sufficient value for that annuity, it's not strategic, okay? But if at prices that are not approaching what the value of that annuity is, we're happy to take the $100 million share.

Operationally, what -- on the wireless side, what are the opportunities for cost-cutting and cost efficiencies to try to break the margins?

We've been really successful on that, now completing our third year. And by our totals close to $250 million to $300 million of costs that come out. At the same time, we're still putting up more cell sites, and we're still hitting 40% year-over-year increases in demand. But we have seen some meaningful improvement in margins. Even though revenue has been relatively flat, the system -- the network group is one that has really shown some real aggressive work using artificial intelligence and other things to take costs out of the business there. Customer service has actually reduced the size of its, I'll call it, footprint in terms of investment level every year now for the last 4 years. And there's more to go. I mean the reality of unlimited is a lot fewer customer questions around bills when it's the exact same amount every month no matter what I do, right? And so that starts to change it. And so there's more work to be done on the cost side, but I'm really impressed with how much success the company has had over the last 3 years going after it.

Once T-Mobile-Sprint gets resolved one way or the other, if there is an opportunity to have a closer partnership with a national carrier that could potentially give you some scale of operations or marketing and help improve the margins, but the company would still operate its business, is that a strategic interest to TDS and U.S. Cellular? Or is there a focus on just retaining full control over the future operating destiny of the company?

Well, the way you described the first part of it doesn't necessarily suggest that you can't have that control, right? And so I think anything that could improve our competitive position or our economics are something that we're always interested in, subject to not giving up the control. And I don't know that they are -- you can't do both, right?

So it's something that would be considered at some point.

I think so.

And as you look at -- on the wireless side, what's really driving maybe the margin differences? How much of it is cost of service in gross margin versus how much is it in the SG&A load of the business?

I'd say that more of it is in the SG&A side than it is in the gross margin side. And that's a combination of what's in the system's ops expenses, right, is pretty linear, okay? Everybody -- if you've got 50 cell sites, your 50 cell sites aren't going to cost a lot more or less to operate than my 50 cell sites, okay? The cost of the rent isn't going to be that much different. The cost of maintenance, the cost of support from your third-party vendors doesn't. On the other side, though, take billing, okay? A billing system that we have to build and implement isn't going to cost that much differently whether I'm using it for 5 million customers or whether I'm using it for 25 million customers, right? So more of the opportunity sits, I would say, on the SG&A side than on the systems ops side.

And if you were to look out over a 3- to 5-year period on the current revenue base that you have -- service revenue base that you have, where can margins get to?

How many years have you been asking me that question? How many years you've been doing this?

2 or more.

Actually, if we think back where we started this discussion, we were 17%, 18%, 19%. We're now mid-20s. Still got to grow, okay? The question of -- is really going to be driven by what happened -- if you think about the current revenue base, what happens on the demand capacity side, right? If you have 4G, a few of 4K video going over your network, and you suddenly need 3 and 4x the capacity at the same revenue that you used in your example, right, that's just driving expenses on the network side for no additional revenue. And so as we look at how do we manage the network experience to make sure that we're giving the customer a great experience, but one that's also affordable that therein lies one of the big challenges to the business and the industry going forward, which is why that spectrum is so important. Though it's important, but it's not free, right? And so while it may not wind up showing itself in that margin, okay, it's sitting on the balance sheet, and that needs return to.

And then just finally, as you look forward, are there any other factors or themes that you think investors should keep in mind that could influence the performance of TDS or U.S. Cellular over the coming 12 months?

I'd say that the potential challenge to your question is -- the question was framed as what changes over the next 10 to 12 months, right? And TDS and the family behind it has a very long outlook to this business, to the opportunities that are in front of it. And so whether it be the fiber investments that we're making in telecom or the spectrum investments we make at U.S. Cellular, we don't think of quarters. We take a much longer look at this business and the industry that we're in.

Any issues that you're seeing from the economy in terms of the way your customers are behaving?

Not right now. Not right now. I mean the challenge, in fact, for us is we've got some markets, I think Iowa was an example, where the unemployment rate is so, so low that you're really dealing with, okay, I've got stores I need to staff, and unemployment is approaching 1% in places. Up in Maine, especially during the summer months when everybody goes to work on the fishing boats, it's hard to get employees at this level of employment. The economy itself has been doing pretty well in our markets.

Thank you for your time today. Thanks.

Thank you.

Thank you.