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

Good afternoon, everybody. I'm Ric Prentiss. Welcome to the Raymond James Institutional Investor Conference. I'm the Head of Telecom Services Research. We've got a great lineup, mix of tower, wireless, satellite and data center companies here in sunny Orlando. We pioneered the modified fireside chat format a few years ago in our group. . We'll start with a few minutes for prepared remarks. We'll then have an extended fireside or poolside chat, I guess, what we say in here. And then somebody actually thought I was serious about that when I sent it out to the company management. And then we'll hit on all the topical or tropical items, save time at the end for the Q&A and then down to the breakout session. I do have 2 rules for my room. First, we're going to call it the virus, or COVID-19, not coronavirus, because I really do feel sorry that 38% of the U.S. population apparently thinks you can contract coronavirus from drinking cerveza. Seriously, that is not a joke. And so I feel sorry for the Corona folks, so we're going to call it COVID-19 or the virus. And that with 5G, as we talk about 5G, we've got the business cases, not use cases because I don't care if you use it, I want you to pay for it. So with that as a setup, we've got Ken Meyers, the CEO of U.S. Cellular; and Jane McCahon from TDS, sitting in for Vicki, who couldn't make it. So we'll start with a few minutes. Jane, you're up first.

Yes.

All right. Thanks for coming.

Thank you. So good morning -- good afternoon, I guess, everyone, and thanks again, Ric, for having us. We always come down here for some really interesting one-on-ones and a great session with you and your team. A quick overview of TDS. For those of you who don't know us very well, we have -- we're going to talk to you today about our 2 primary business units: U.S. Cellular and TDS Telecom. At TDS, our mission statement really reflects our multi-stakeholder focus. It is to provide outstanding communication services to our customers and meet the needs of our shareholders, our people and our communities. We're a controlled company with a focus on long-term value creation. We maintain financial flexibility through a strong balance sheet and conservative financing strategies. And in terms of dividend policy, we just announced our 46th consecutive year of dividend increases. And so now I'd like to turn it over to Ken Meyers to talk about U.S. Cellular.

And then I got 2 more chances at it. Thanks, Jane, thanks, Ric. Starting with a little bit about U.S. Cellular. Regional telephone company, regional wireless company, been in the business since the very, very founding of the wireless industry. And depending upon how Ric gives me credit, I could be pretty soon the fourth largest wireless company. I have been working hard on that. Been 5 for a long time, get to move up a little bit. Last year result, 1% increase in revenue, a 5% increase in operating cash flow -- or I'm sorry, adjusted OIBDA is the correct term I'm supposed to use. Importantly though, that line equity earnings and unconsolidated subsidiaries. The company owns investment interest in markets that are managed by others, 5.5% of L.A., 14% of Oklahoma City. That returned $166 million last year. And that number, that's an income statement number, that's operating income though, that's after depreciation and amortization of those investments as opposed to the cash flow number. So that's, in fact, a richer number. If we think about this year, what's important? Where are we going? One of the things that we started late last year, we call it brand refresh. The company is extraordinarily well known within the segment that it serves. And we're actually moving the company a little bit younger, moving to what we call the influencers of the industry, a large effort around continuing to drive customer engagement. One of the investments is into personalization and even more closer to the customers and understanding what they need and how best to position with them. Given our size and where we're at and the investments that are in front of us, growing revenue is absolutely critical for us this year. And while you've seen a lot of kind of, call it, stabilization in the customer base itself in the business, some of the things that we're doing is continuing to move our customers from smartphone to feature phone -- I'm sorry, feature phones to smartphones. We actually still have hundreds of thousands, almost 400,000, I believe, customers that are still on feature phones. And that's one opportunity. Two, smartphones. Smartphone is about 43% of our customer base today at -- those 43% are on unlimited. And it's another area of growth for us. Also, last year, we completed a multiyear project to reposition our company in terms of roaming and now serve every one of the other carriers. And the result of that is we're actually seeing traffic and roaming revenue increase the same time roaming costs have come down extraordinarily nicely this year. One of the things that we have spent almost 20 years right now is building the culture within the company, which is extraordinarily customer-focused, very, very high level of customer engagement and leveraging that in order to better meet the needs of our customers in our local markets. 3 years ago, we started down on a project around costs. And over the last 3 years, we've taken about $500 million out of the business in various areas, and next year is another year in that road. And finally, and probably the biggest change over the last 2 years, has been the increased investment in the network. A couple of things going on there. One, year-over-year demand on the network is up 40%, obviously, the usage per customer going up. Second, we are modernizing the network, putting out LTEA, LTE technology version A, which dramatically increases the speed for the customers. We're starting to roll out 5G right now. In fact, we just placed our first 5G interaction between a mayor of a relatively mid-sized town in Wisconsin we're seeing and some students in the local school. And we will continue using a low-band license for the first rollout of 5G and hopefully if supply chains and contract negotiation and everything else plays out the way we're hoping, we'll start with some millimeter investments before the end of the year. This year's guidance, a small increase in revenue from what we see right now, mainly in the -- our average revenue per customer; continue cost management to drive some increase in operating cash flow; and a meaningful increase right now as we continue to complete our VoLTE rollout of 4G technology and start down the 5G path. So a more meaningful increase in capital expenditures this year.

Okay. I'd like to talk to you a little bit about TDS Telecom. So unlike many of our other wireless companies -- unlike other wireline companies, we have been investing in our network for many years, really transforming TDS Telecom into a premier broadband company. Some of the things we've done is to deploy fiber to the home. We now reached 30% of our service addresses with fiber to the home. We've tested and launched an out-of-territory fiber deployment program to bring fiber to new well-selected towns in the U.S. We've secured A-CAM and state broadband funding to address rural customer needs, and we have acquired cable companies, driving revenue and margin expansion there. And as a result, as you can see, we now have a strong company with much more certain revenues, positioned to grow well into the future. A quick look at 2019 results. Revenue from growth initiatives, fiber and cable, offset declines in our legacy business revenues in voice and commercial. Cash expenses were flat as we successfully redeployed resources into growth initiatives, holding EBITDA stable, and CapEx reflects the increase in our fiber deployment strategies. But as we look to 2020, we really think about our priorities in 3 buckets: network, products and people. And broadband is our primary product. And we'll be focusing this year on the execution mostly of our out-of-territory fiber program, where we're rapidly scaling up the operations in new markets. We're going to continue to strengthen our cable operations and focus on the integration of the Continuum acquisition we closed at year-end. And this year, we'll -- by year-end, we expect to meet our first A-CAM milestone. We also work on innovating what we sell and how we sell it. And this year, we're particularly pleased, we just launched our TDS TV+ product, which is the next-generation cloud-based TV service. A particularly critical component of our success this year and well into the future will be our ability to identify markets where we believe our formula will win. We've built a very sophisticated model that uses the criteria on the slide here to prioritize the most attractive markets for us to enter. And finally, our long-term strength is our ability to operate lean, allowing us to redeploy resources from the legacy parts of our business into our growth initiatives. Our guidance for 2020 looks for revenue growth from our fiber programs that will more than offset any declines in the legacy business. For adjusted EBITDA, contributions from broadband and video growth, along with cost reductions, will continue to help offset pressures from legacy wireline losses as well as extra costs associated with those fiber expansion. And capital, as you can see, looks to remain relatively flat, but very importantly, we expect to spend about $150 million on our fiber deployments, which is 50% more than we did last year. So getting focus over to growth capital. We believe this positions TDS Telecom well for continued success.

Great. With that, I'll turn it over to the fireside portion.

Oh, not the pool portion?

Yes, the pool portion. It was your -- when somebody said, "How can we webcast from the pool if we're doing poolside chats?"

And did you have an answer for them?

I did. It's Ric-diculous to think that I would do that. So I trademarked it. Yes.

Let's start, Ken, with U.S. Cellular side of things. 5G. What does it mean to you? And how should the investor world think about when it becomes meaningful?

What does it mean for? I think there are some really exciting opportunities 5G-related, but I think, particularly wireless broadband and some of the things we're seeing in the business and government account area. Early -- and the broadband is later this year to early next year. The business and government is probably early next year to late next year. Both of them, you've got to have network in place, and it's a long lead time sales cycle on the government side. From a consumer standpoint, I don't know that 5G has a dramatic effect today on what the consumer gets or needs. I'm sure there'll be a lot of marketing around it, but I don't know that it really changes their experience much today.

And there's been a big debate of will it drive "a super cycle" in the handsets, that will all the advertising by different carriers and maybe device manufacturer-supported efforts create an impetus to have a super cycled upgrade? Will it increase the switching pool? Your thoughts.

I think it eventually will. And I -- but I hope it's not this year, because I think the big mistake would be for the industry to overpromise and under-deliver. And so you'll always have the early adopter that wants the latest and the greatest. The fact of the matter is that I don't think from the consumer experience that what happens on this size of device is going to change meaningfully at all from a consumer standpoint. Talk about next year, late next year perhaps when networks are much more pervasive and maybe there's something that can better take advantage of it, but I'm concerned that we'd do it too soon.

And a lot of people have talked also about network slicing. It's a confusing term. Is that something more business-oriented? And is that something that could be monetized?

Well, if it can't be monetized, I'm really not interested in it. It's -- definitely, it's a business term. It's -- I'm not an engineer, and he's asking me a question like this. But fundamentally, what it means is you'll be able to take part of your network and dedicate it to an individual customer and whatever it is their need is and do it in a way that you can monetize it. And that could be, based upon work we did with Bell Labs a year ago, where some of the value really gets unlocked in this technology.

We get the question also a lot of well, if 5G is here, what happens to 3G and 4G?

It stays around for some time. It's amazing how -- I talked about it before. I still have hundreds of thousands of people that have feature phones in them, okay? People that have got the phone, they're comfortable with it, they like it. And the last thing you want to do is turn off the network at them. And there were discussions 2 and 3 years ago that said CDMA will be gone right now, and it's not. And it's at least 2 years out, just based upon commitments we've made with each other at the carrier level, so it's got years you have in front of it. 3G and CDMA, still a couple of years. And 4G is going to be there for as long as we keep doing this, right? I mean this is a base business -- base technology upon which 5G is actually built off of. And so they will interact for 5, 10 years, at least from everything I see.

Makes sense. So it also allows the capital to be kind of feathered in over a period of time. The capital was a bit of a surprise, I think, in your guidance to investors. Talk a little bit about how you guys looked at coming up with the guidance, what the gating factor is to hitting the high, the low or below the low end.

Yes. So you talked about feathering in capital, and it's something that from a managerial standpoint, I believe in wholeheartedly. We typically use 3- to 4-year cycles to roll out any technology. There's a huge learning curve involved in doing it. There's some nice behavior of a cost curve in terms of the manufacturers, on the supplier side. So I'd like to do it. I actually like to keep capital relatively flat, so you don't have to organizationally deal with a 15% or 20% increase and then the trough that follows it. However, where we're at this year is we are in our last year of our VoLTE rollout. So we -- 4 years, we've got 1 slice of VoLTE that we still have to complete.

That's Voice over LTE.

I'm sorry. Correct. And so the last phase of 4G, and we've got to complete that. At the same time, our biggest markets, where our deepest money is, we're going to have other carriers coming in splashing all over about 5G. And part of our business is a retail business. And the worst thing that happens to a retailer is a customer comes in and says, "Do you have...?" And you say no. You say no, customer walks out. Doesn't even know what he needs, but you just said no to him. And I need to be in a position to say yes and then have a conversation about whether or not what you've just asked for makes sense or not. And that makes -- that's the same thing whether you're talking about an individual device, a different type of a rate plan or the actual technology itself. You've got to be able to start with, yes, and then make sure you find the right service or product for that customer. So for us, we have to start down the 5G path. Quite frankly, [ you realize that ] otherwise really would, [ probably ] see it stabilized more. There's a huge amount of learning, as I said, that goes on every time we do this. But we are starting that. And as you saw in our guidance slide, there's a chunk -- meaningful chunk that starts this year. And late in the year, it's possible that we could deploy some of it at the millimeter wave spectrum. And we're a little bit later in kind of some negotiations and supply chain issues. So when we issued guidance, it's not really clear whether we're going to be able to spend that this year. We put it in so as to not surprise people and wind up there and not tell people. And as the year plays out, if it takes a little bit longer, like a triangle loop, we'll just -- we'll pull our guidance back in.

And so it sounds like the initial build for 5G will be on the low-band, the 600. It matches up a little bit with what T-Mobile plan is. Talk a little bit about what you see in the 600 band that's interesting, also what the device lineup will look like.

So what's interesting about the 600 or low-band spectrum is the fact that you get coverage, okay? You get coverage that is equivalent to maybe even just a little bit better than the current frequencies we use today. So that's very attractive to us. On the other side, it's not a lot of spectrum. And where the real speed benefit comes in 5G is its ability to use very large swaths of spectrum. And that's what was made available to the industry in the millimeter wave option. So if I think about where we are today with all the different bands of spectrum that we have on the low-band side between the original cellular frequencies and PCS frequencies and everything else that's been issued, we could be anywhere from 50 to 75, 80 megahertz of spectrum in our markets, okay? When we bought the millimeter wave, we were buying 400 or more megahertz of spectrum. So just order of magnitude the difference in pipe size, and that's what's going to really deliver the speed. But what we get when we started is the advantage of coverage, which is critical, and especially in the more rural areas that we serve.

Makes sense. When we think about spectrum, clearly, the C-band is something you've been talking about for a long time. For those not aware, C-band is a mid-band, but it's up on the upper end, up in the 3.7, 4.2 range. FCC voted on Friday, so it's very recent. I don't know if you've had a chance to look through, there's not even a lot of public information. But what are your thoughts on the C-band? What does it mean for you guys, interest and what it means to the business plans?

So we've actually been working with the C-Band Alliance, with other carriers trying to free up the spectrum as soon as possible. What's attractive to it is, it is much better coverage than the millimeter wave spectrum we have now. What also attractive is there's meaningful amount of spectrum that is being made available. Quite frankly, I'd like to see more of it. They actually have 500 megahertz of spectrum, 280 of it is going to be repurposed to the wireless carriers. I'm like, "Would have like to see all 500. I'm greedy." We'll see auctions later this year. It's attractive given all the other options. The fact of the matter is that the rest of the world is using that spectrum band to roll out 5G, actually, before they even use millimeter. And so there's equipment that's available. There's an infrastructure that's already built out. The challenge in the United States is it's going to -- even if we get an auction this year, it will be 3 years before we see it widespread across the -- widespread availability across the industry.

Yes. You also mentioned on your earnings call last week that you might be willing to swap strategic assets. Spectrum is a strategic asset. Towers are a strategic asset. Can you talk a little bit about how you view the towers vis-à-vis spectrum or other alternatives?

Yes. So Ric has been, I think, very clear in terms of the value of towers. And what are you sitting on them for, Ken? And the answer is our strategic asset, okay? We own 2/3 of all the towers that we're on, roughly 4,000 of them. And as we have competed based upon network quality, and that's been an underpinning to our strategic position from day 1, the fact of the matter is every time we change technology, we evolve it. One of the factors that allows us to move quickly is the ownership of our tower as we move up or down on the tower with different technologies. We started off on top of some very, very, very tall towers in the early days. And as we have changed technology, added capacity, we kept moving down. Well, now as we think about the millimeter wave deployment, one of the things we're looking at is going back up to the top of the tower. And so towers are like real estate, okay? There's some prime spots on that. And you could sell your towers, a big pot of money and lose control over the real estate. Or you can keep all control of that, and that's what supports the base business that we have. So it's been strategic, notwithstanding how values have increased. And one of the things that we have said is we understand that there's a lot of value there. We understand we could monetize it. And what I said is I would monetize it for another strategic asset. But I wouldn't give up a strategic asset just for cash as much as cash is, right? And so the question is, well, what else is strategic? And in this business, spectrum is the lifeblood of any wireless carrier. And so as we look at other spectrum opportunities and/or needs, it's possible that I could see a scenario that said, "That's a real important, that spectrum. How you're going to pay for it? I have another strategic asset that we could redeploy for it." But currently, those towers are just as important today as they were yesterday.

Sure. Jane, let's get a TDS Telecom question in there then. You talked about -- and you guys are very excited about the fiber expansion plans, both in footprint, out of footprint. What's the gating factor? How many homes passed are you trying to add in the next year versus how many you added last year? And why not 2x or 3x that?

It's a great question, Ric, because I think we view what's important is choosing the right market. And so to the degree we have a pipeline of markets that we feel have the right competitive environment. So whether it's a weak ILEC, what cable company we're up against, the demographics of those markets in terms of density, in terms of household income, household growth, even the regulatory environment as to whether or not we have the support of a local community that can help with permitting and such. And so we look at all of those things, we've developed a model that says, "Okay, now we can go and start our discussions with these communities." And so as we've done that, we now have a pipeline of 230,000 service addresses that have qualified and started construction negotiations or actual launches. So we've got a cluster in Southern Wisconsin, we've got a cluster in Mid-Wisconsin. We've got a cluster out in Coeur d' Alene, Idaho, and we just announced Meridian, Idaho as another cluster. And so we see the opportunity to launch these markets and do it well with a very, I think, successful sales approach where we can go neighborhood by neighborhood. And so we're not even starting to lay fiber in the ground until we've reached a certain penetration. And so given where we are, last year, we turned up about 50,000 homes. We think, given what we have in the pipeline and resources we have available, we will be able to double that this year. And then next year, I think we'll see. We've certainly got the markets identified, and it's going to be a function of organizationally, can we do this? Financially, can we do this? But I think right now, we're very, very excited about the opportunity.

And on the -- well, first, let's see if there's some questions in the audience. So as we think about that ramping of the CapEx live within kind of the flat zone is what it looks like to shift more into the fiber piece. What type of penetration rates do you try to get before you start building? And where could you -- because the homes is how many you passed, not how many you get.

Right.

So what do you hope to get that hurdle to build and what you hope to ultimately get?

So I think where we started out maybe a different place from where we are now, given the success we've seen, first, in Sun Prairie, which was our trial market, which reached about a 50% penetration in broadband customers within the first year. And all of the markets that we're launching now -- and again, it's not like we turn on a whole market at the same time, it is neighborhood by neighborhood, are seeing that or better pace. And so I think with that, we're always adjusting our financial models because each market that we launch goes through a very rigorous model to determine where we think the initial return will be.

That kind of speaks to the demand for broadband, the lack of alternatives for broadband then because you're going into ILECs, local exchange carriers, that have just copper.

Yes.

And cable company maybe is not the most favored provider.

I think you said it well.

Great. There's time for one more question. I think we're almost up on our time. Any questions in the audience? I'll throw one more to end it with the tougher one. Given the stock price, which has come down at TDS -- let's take TDS since TDS owns 84% or so of USM. How do you think about stock buybacks, the long-term return to shareholders? You mentioned the dividend increase, but...

Yes. As we look at capital allocation, what we've said recently is that these investment opportunities are significant and very long term in nature. And that is clearly how TDS, our controlling shareholder, thinks about the business in terms of long-term operation. Over the years, you've known us well, we've done a lot of buybacks. So it's something that we certainly look at from time to time, we look at the other uses of our cash. We look at the dividend and see what we're returning. So I think it's something that we do consider on an opportunistic basis or just as part of our capital allocation, but it's going to have to be weighed against the opportunities that we have for the business for the long term.

Great. I think we'll take it to the breakout session, and I appreciate your time. Thanks.

Thank you, Ric.