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

Okay. Good afternoon everybody. Thanks for joining us. Before we get started, please note important disclosures, see the Morgan Stanley Research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. Well, we're delighted to have Doug and Michelle here today. Thank you for joining us. Maybe if I can ask both of you to start with the strategic priorities for 2023, both on the U.S. Cellular and then on the TDS Telecom side.

Sure thing. Well, thanks for having us Simon. On the U.S. Cellular side, the #1 priority is turning around our trajectory of postpaid handset subscribers. We've lost postpaid handset subscribers in 2022. And changing that is #1 priority. We have sequentially throughout 2022, improved our net add results, and we're very focused on that through a number of tactics, including our flat rate pricing that we rolled out footprint-wide last November, very compelling $30 price points, starting with the single line for customers. We've launched a master rebranding in the beginning of this year as well. And in addition, getting even more aggressive with some of our promotions, no hidden requirements, very transparent for customers, getting a great promotion without requirements necessary for an upgrade, a trade-in plays very well with our customer base. So that's the #1 priority. I would say in addition, we've talked about our growth factors, which include our tower business, which has a very nice double-digit growth rate last year. We expect it to grow nicely again in 2023. Our HSI business, that we grew subscribers 57% in 2022. We're looking for another strong year of growth in that area. And we've talked about business and government, we're having particular success on the wholesale side with respect to IoT revenues, signed 3 private network deals in 2022. We look for that revenue to grow fairly substantially on a percentage basis in 2023 with understanding that revenue base right now is fairly small. I'd also call out our cost optimization program, which has yielded fantastic results for us. You look at our cash expenses, aside from loss in equipment and bad debt expense, they were flat year-over-year in 2022. We look to continue that optimization program and have success with that. Lastly, our 5G build. We now have 5G covering 80% of our traffic on our network. So we feel really good about where we're at. We're going to continue that investment with a particular focus in 2023 on our mid-band rollout, which we can't turn that spectrum on the C-band until the end of 2023, but we'll be prepared with substantial portions of our network built out by then over a mid-band spectrum, which of course, is very good for our mobility business as well as our HSI business and the speed and capacity that, that brings. So that's how I'd summarize our priority, Simon.

Great. And we'll love to dig into there Michelle.

Yes. Thank you for having us Simon. At TDS Telecom, our goal is to be the preferred broadband provider in the markets that we serve. And we've got certain strategic areas of focus that we've had for the last few years is going to be the same in 2023, and you're going to see them continue into the future as well. First and foremost, we are trying to grow our scale and our revenue, and that is primarily happening through our fiber program going into new expansion markets. We have been ramping up this program for the last few years. In 2022, we delivered 133,000 incremental fiber addresses. And in 2023, we're aiming for $175,000. So each year, we keep increasing the number of addresses that we're going to be deploying with fiber. So that is one of our critical strategic areas of focus. We also like Doug said, we focus on our cost optimization as well, trying to make sure that we are operating as efficiently as possible, taking costs out of the business where possible so that we can keep reinvesting into our growth areas. We also keep the customer experience at the heart of everything we do, looking to enhance our products and services that will add value to our customers. We keep increasing the speeds that we're able to offer on our broadband products. We're now able to offer 8 gig service in all of our new markets. And we're looking at an MVNO product so that we can add wireless into our bundle with broadband and video and voice. I hope to get that program, that product launched in 2023. And finally, we just like U.S. Cellular across our whole enterprise, we invest in our people in order to make sure that we're attracting and retaining our top talent. So those are our big areas of focus for this year, and we'll continue into the next few.

Great. I wonder if both if you could just comment on your latest read on the macro environment, both the health and the consumer payment patterns as well as enterprise trends. Doug?

Yes, I would say we're predicting a mild recession later in 2023. And from our perspective, given wireless is an essential service, we don't spend a lot of time concerning ourselves with that. We offer, as I mentioned, our flat rate pricing plans start at $30 per line. So we have a great solution for customers looking to move down the stack as well as up the stack. So we can meet the needs of consumers that are experiencing some level of financial distress. And wireless is not the service customers are going to do without, it is a watch point on bad debt and bad debts since the pandemic obviously has been spiking. We've been responding to that. We've tightened credit a few times in late 2022. We're likely going to tighten credit a little bit here in early 2023, just to adjust the environment and make sure that we're optimized there. We're also putting in some enhanced fraud mitigation sort of procedures in our stores. We've done some of that. There's more to do there to manage bad debt. That's sort of the key watch point for us as we enter -- we're continuing, obviously, in a tough inflationary environment. But to the extent things become more challenged, that's the key watch point for us.

Yes. For us, we're in a similar situation, offering a wired broadband service. It's also a pretty essential element in people's lives. And so we also don't worry too much about a recession and people cutting that service out of their lives. We actually are very proud to be able to help enable some of the things that got us through the pandemic and can help customers as they have to cut back on other expenses. For us, bad debt is not quite as big of a deal as at U.S. Cellular. We also saw some benefit during the pandemic, and it bounced back to pre-pandemic levels, but nothing significant that we are worrying about it on that side. What we do see is as it relates to our fiber program over the last year or so as we've gone through a lot of RFP processes to get contractors lined up, we do see those bids coming back with some higher pricing on labor and materials. And so what that does is challenges us to figure out how to build those networks even more efficiently, where you can take cost out on other areas of the build, how to design them, make sure that you're getting to the most economically attractive areas of our market. And so far, we've been able to do that so that we can stay on track, keep the same number of communities in our program, stay within the economic balance that we set and our business cases are still producing our targeted mid- to low double digits for IRRs.

So if we go back to some of the key priorities, Doug, you started off with postpaid phone growth, you've provided revenue guidance that's a slight decline at the midpoint. You've obviously got some roaming pressure weighing in there. Is breakeven a good assumption for '23 and maybe you unpack what's, what you think about how much of that is going to come from better gross adds from better churn? How should we think about the course of the year and knowing if you're on track or not?

Yes. Let me step back with respect to our guidance. Our revenue guidance at least at the midpoint, a slight decline from 2022. 2 factors at work there. One is we have a secular decline in our inbound roaming revenues. By the way, we're offsetting that with even with higher declines in our outbound roaming expense. So it's slightly accretive to our operating cash flow. Our roaming usage on the outbound side is 5x of the inbound side, we've been driving down this rate. So that's one thing impacting revenues year-over-year. The other thing is we've lost 130,000 postpaid connections. In 2022, I talked about, that's not where we need to be. We're highly focused on changing that. But the reality is that loss of connection flows into our 2023 revenue guidance. So that's where we're at with revenue. And offsetting that, yes, what we're aiming to do is continually improve our net add results so that we're increasing gross adds, decreasing churn. It's going to be a journey that we're looking for continual improvement each quarter. And that's so we still have work to do there, and we are working on that. And as I mentioned, in addition to that, all the other revenue things, revenue opportunities in our growth factors are also a focus and are helping to offset some of the decline that we're seeing in the first 2 things that I mentioned.

Great. And how would you describe the wireless competitive environment right now? We've obviously seen the cable companies come in with some aggressive bundled offers, has that made a difference to you?

It continues to be intense. I mean, look, we have in cable competes in 56% of our -- or 56% of our POPs right now. So where we compete for wireless. So we have 4 or 5 competitors including us in each market. And so it's highly competitive for the foreseeable future. I anticipate it will continue to be highly competitive. It is I think healthy that the promo environment as you would expect has subsided a bit from Q4 to Q1. So the offers are not quite as rich, which is normal. And we're in the same place. We had new and existing offers turned on through the back half of 2022. We turned those off at least footprint-wide in early February. So we're back to maybe a more normalized promotional posture right now, which is a better -- from a financial standpoint, a good place to be. But the competitive environment and the quest to add subscribers is going to remain intense through 2023 and beyond. I don't see it subsiding substantially during the next year.

Michelle, if we can talk about fiber. I think your increase from this year, $133 million to $175 million that you outlined is one of the biggest across the industry. We've seen a number of companies pull back, you didn't hit your original goal for '22, but you had a strong acceleration into the end of '22. So perhaps unpack that a little bit. What was going on last year, what gives you confidence this year around targeting that big jump?

Yes. So our fiber program is a multiyear program. We've been doing this for a few years and steadily ramping. So go back a couple of years. In 2021, we delivered 86,000 addresses. 2022, it was 133,000 addresses. Now we're shooting for $175. You're right. The last couple of years, we did fall short of our original goals and I would say it's not because of any of the fundamentals of the fiber program. All these addresses are still going to come. But I think we've learned a lot in those first couple of years, and these builds actually take a little longer to get off the ground, they're a little harder to get the momentum behind them than we maybe had originally had in terms of aspiration. And we last year, we did have to pivot on a couple of things. We had contractor performance challenges in one area, there was just a little bit more competitive threat than we had expected to see, and so we pulled back on a market. So we make the right decisions when the right information comes up. But the fact that we've been able to steadily ramp for the last few years, and now 2022 is a big year for us in terms of getting our market -- the market selection finalized of what's going to be in our portfolio. Then we undertook the RFP and contracting process to get all the vendors, the construction companies lined up to work with us. We launched several markets in 2022. 2023, we're on the cusp now that we've got our vendors lined up, markets selected. Now we're going to really start launching markets in 2023. So by about the end of 2023, we have about 100 communities at some various stages of development. Almost 100 of those will be able to be launched where we're providing service to customers. So the fact that we've kind of gotten ourselves ramped up, scaled up is giving us confidence that the $175 million is an achievable number. Each year, it won't keep increasing by that same magnitude. At some point now with all 100 communities in process and the builds will sort of level off and kind of stay at a steady state for the next few years until we complete those markets. And you're right, the fourth quarter, we had our best fourth quarter, our best quarter yet. We had 60,000 addresses that came online in fourth quarter, and that momentum has continued into this year. So January, February are off to a great start in terms of addresses getting built and becoming marketable to our customers. I think we're on the right track for 2023.

I guess some mild winter helps with the construction.

Right.

And of the $133 million and before that, what are your learnings in terms of cohort penetration and ARPU and how that's tracking versus your plans?

Yes. So we have talked about our penetration assumptions, we expect to get to at least a 40% broadband penetration at steady state. And steady state means probably about year 4 or 5 after you get into the market. And the reason it takes that long is because these market builds take, it depends on the size of the city, but they can take 2 to 3 to 4 years to get the market builds done. Once you start building, we turn up neighborhood by neighborhood. As soon as a neighborhood becomes available, we'll start selling to those customers. But it takes you maybe 2, 3, 4 years to get to all of the areas that you're building. So by the time you really start selling into all those customers, takes a little time after the builder. That's why we say it takes until 4 or 5 years to get to steady state. But we're expecting to get to at least 40% residential broadband penetration. And so far, we've had a few markets or clusters that have been launched for enough time period that we say they're fully launched. Some of them are exceeding that expectation by a pretty good degree. Some of them are a little bit behind. Some of them are right on the average. So with the portfolio of markets, some are going to be up, some are going to be a little bit lower than that. But on average, that's where we expect it to come in. And so far, we're seeing that that's achievable.

You're doing quite a bit, both in-region and out-of-region, you've seen much difference in the performance between the 2?

Right. So what I'm talking about is the out of region for our expansion markets where we're a new entrant. And when we go into those markets, we've selected those markets carefully. We're going to places that have household growth potential. They have customers who are going to want and demand and value the products that we're bringing high speed, very high-speed broadband. And the competitive environment is such that the incumbent lack has not meaningfully upgraded its network. So we go in and there's a cable provider offering gig speeds, but the lack is usually offering lower speed DSL. And so when we come in with a fiber product, it essentially is putting 2 gig plus providers competing with each other, we kind of end up splitting the market. And so that's what's giving us confidence on those penetration rates. And so that's the expansion market. You are correct. In addition, we are investing into our legacy, our incumbent markets as well. We've been investing in those markets for a decade now. So this is not new to us. Where we're at in our ILEC markets, we have 36% fiber today of those service addresses, and we plan to get that to at least 50% by 2026. So we're going to keep investing in those areas as well. Those, I would say, the 40% penetration is a little bit different because in some of those markets, we're actually starting with higher than 40% penetration. We're a major broadband provider. So it's a little bit different for those incumbent markets. When I say the 40%, we're focusing on it.

Great. And you're also talking Doug, about high-speed Internet yourself. And I think a lot of what you're offering right now is LTE, if I'm right. But there's this opportunity to pivot to fix wireless using 5G using mid-band. So talk us through, you said you'll get the C-band spectrum at the end of the year. To what extent are you prepping so that you will have decent coverage as soon as it's delivered? And then how do you tie the fixed wireless expansion that LTE was talking about on earnings over the next few quarters?

Yes. Well, first of all, correct, our entire base so far is effectively on LTE, and we've been very successful with that. We anticipate that momentum will continue throughout 2023, even before we have the mid-band turned on. And as I mentioned, we're going to be upgrading cell sites to mid-band throughout 2023. So once we hit December or the date we can turn it on, we can flip the switch, turn on a lot of mid-band right away. And it's our goal to curate our customers. The customers that are on low band, upgrade than the mid-band over time. And obviously, we can then market new mid-band product that's hundreds of megabits per second and even more competitive with cable and fiber. So just -- and it also solves some capacity issues that are brought about by HSI over a low band as well. So it's just a really elegant and competitive solution that will just advance our HSI product, and we're looking forward to being able to turn it on later this year.

And how much footprint will you have with mid-band once at the end of this year, have you said that?

We haven't said that. And it's going to be -- the mid -- our mid-band rollout is a multiyear process. So it's going to be a minority of our footprint. However, it's we're obviously doing it very strategically, going to a higher penetration, denser markets first with mid-band. And so we're going to have in our highest priority areas first, but it's going to be a multiyear rollout over mid-band that we execute.

And presumably, a lot of your markets are reasonably low density, so your spectrum should give you a ton of fallow capacity to use for HSI.

Well, that's right. That's what's occurring right now over low band as well. So that's why we're able to offer right now our low-band HSI product footprint wide. I mean we're watching the capacity carefully because the economics of the product are predicated on it riding on excess capacity. So over time, we may have to adjust that and stop the sale of it in certain areas, but we'll supplement that with our mid-band and still have a very substantial market we can go after.

Right. And you talked about the MVNO, Michelle you obviously have a large sister company with a big wireless business. To what extent can you leverage. The overlap is not perfect, but...

Right. We're not perfectly overlapped. But for the TDS Telecom territory, U.S. Cellular is able to serve about 40% of our customers. So when we think about an MVNO product, we are definitely trying to work together so that U.S. Cellular could be a service provider to us where we do overlap, but we will also have to work with other wireless providers to fill in where U.S. Cellular does not operate.

It sounds like they're we'll open to having wholesale customers as well. And we were talking about fixed wires. It's been a big topic here for the cable companies. You have cable operations. What are you seeing in terms of the competitive environment from fiber providers from fixed wireless?

Yes. So fixed wireless, we definitely see them out there. I would say fixed wireless has not been a competitive threat in areas where we offer gig products. So fiber, even some of our cable markets, we're not seeing a lot of fixed wireless in terms of a competitive threat. But where we do see it is in areas where we do not have fiber and cable, so in our legacy DSL markets, where we're able -- even if we've upgraded our copper, we're offering lower speeds than what fixed wireless can even deliver. So that is a viable alternative for customers in those types of geographies. And that's great. So actually, U.S. Cellular and Telecom are pretty aligned on where this product will be adding the most value to our customers. In terms of other competitive situations, like in our cable markets, we are starting to see some overbuilders start to come into some of our cable markets and how we have chosen to defend against those. There's a number of things that we can do in a couple of smaller areas. We've chosen to overbuild ourselves with fiber to see if that is an effective way to deter the overbuilders from coming in. And we do that in selective areas where the economics really make sense, where we've got certain network plants in place where we can deploy fiber in a very economical cost. Otherwise, what we see is over builders going in, the cable company is generally competing on price and with promotions. We would have that same lever to pull in our cable properties over builders start to come in.

One thing that we've seen with the fiber companies is, obviously, the CapEx is up significantly and $1,000 plus, but there has been an OpEx component to it as well. Where are we in that process of kind of getting that cost base to where we don't see the negative operating leverage, the revenues accelerate the cost sort of subside, is this the investment year?

It is. I would say '22 and '23 are -- we're at the wall point right now. So like I mentioned, we have about 100 communities that are in this fiber program. And yes, there's a lot of capital that goes into these communities as you start to build. That's all upfront in those first few years. There's also the operating expenses. You have to have your real estate established, so your warehouses, your retail space, you hire your door-to-door people, you hire your technicians, you have to get your marketing going before you even turn up a customer. So all of that expense happens upfront. And like I said, in 2022, we started launching several markets. In 2023, we'll be launching almost all the rest of them. So that OpEx hit is happening in '22 and '23 before we've actually really started turning up a lot of the revenues on those markets. But what I have said in the past and what we're experiencing with our very first markets that we've launched is that these markets generally turn contribution margin positive in about 3 years. So that means that by the end of 2023, almost all these markets will be launched, we'll have had the big OpEx hit. But as those markets mature and we start to build our penetration with the customers, that's when you'll start to see the -- our adjusted EBITDA start to pick back up.

Right. Doug, you talked about the growth in the tower business, and you've certainly seen some strong performance there. I think investors still feel like you're not getting full credit for the value of that portfolio. And obviously, you've shown that over more visibility into the financial disclosure around that. So what's the latest thoughts on ways to surface value to potentially monetize that or the wireless affiliates?

Yes. I think with respect to surfacing value, we provide pretty good data in the sense that we provide the revenue at this point. And we've said before that this revenue in our business has greater than 90% contribution margin because we use the towers in our operating business. So that revenue effectively drops to the bottom line. So we provide the data as far as the contribution of those assets to our business. With respect to showing towers as a separate segment and enhanced reporting. In our view, that wouldn't provide any really incremental information, it would highlight it more. And so it's not completely off the table, not something that we plan for the near term, but it's something that we're mindful of. And again, we talk about the towers a lot and we highlight the revenue and the value they provide to our business. So hopefully, that is recognized. And there we own 2/3 of our towers. They're very important assets in our business. We tend to continue to hold them. We've also said that if we ever do need them as a financing vehicle, it's not our first option, but if we go on the stack, if we need to do that, it's something we could avail ourselves of. Again, not something we plan to do in the near term, but it's there. And so again, we were really pleased with the fact that over time, we've decided to hang on to that asset has proven very valuable, not only as a revenue stream, but in addition for our operating costs, when we do upgrades and we touch our towers, we're not paying additional rent expense and not incurring significant escalators in our tower rent, and it's really benefited our operating expenses over time.

Thank you. Maybe a couple of minutes left. Can we talk about BEAD? You've obviously made big commitments to broadband on both sides of the business. So what is your latest thought on the TDS side first? And when does this all start to flow to CapEx?

Yes. So anytime anybody ask me about BEAD, I also take the opportunity to talk about another federal program. There's actually 2 that are very important to TDS Telecom. The first one is the A-CAM program. That's a current program that we are a part of. We're about halfway through the program, but that provided 10 years of revenue stream. We get about $80 million a year of revenue stream. In exchange for getting broadband at certain speeds out to a certain number of addresses, about 160,000 addresses for us. We've been clipping away and meeting our obligations under the A-CAM program. There's a proposal with the FCC right now to extend that A-CAM program in exchange for raising the speeds that you'd have to deliver to those 160,000 addresses for us. And that speed enhancement would be 100 megabits down, 20 megabits up. So the same speed requirements under the beat program. And what that means is fiber would be the best alternative to provide those speeds. So we are really supportive of getting that ACAM extension approved and finalized. That's a program that is already up and running. The mechanism exists the companies are already a part of it. That would be an easy transition for us to make in order to execute on that program, and we think that would be the fastest path to get those customers served with higher speeds as fast as possible. So that's number one. Number 2 then is the BEAD program, and we do see this as a great opportunity as well. Again, it's getting a certain high quality broadband product out to more and more customers in rural America. And we would certainly want to be a participant in that because that program will touch some of our most remote areas in our legacy incumbent markets that we would love to be able to serve with higher quality broadband, but it's just very uneconomical to do it ourselves. Any government assistance to help us do that, we would certainly be interested in and want to participate in. And this is another area where U.S. Cellular and TDS Telecom could certainly think of partnering together because we would approach BEAD just like we approach state broadband grants those types of things with fiber, but it's not going to be economical to take fiber to 100% of the addresses in the country. So there's going to be a place for the fixed wireless product to come in and partner with fiber and make sure to get wonderful coverage out to those customers using the best technology in the most economical way possible. Great. And the last word on BEAD from your perspective.

Great opportunity for us. We've been very focused on advocacy at the state and federal level, and we have a team rallied around it, and we're going to be all over it.

Great. Well, good luck with that, and thank you so much for joining us today.

Thank you.

Thank you.