Telephone and Data Systems, Inc. (NYSE:TDS) Q4 2022 Earnings Call Transcript

Telephone and Data Systems, Inc. (NYSE:TDS) Q4 2022 Earnings Call Transcript February 17, 2023

Operator: Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the TDS and U.S. Cellular Fourth Quarter 2022 Operating Results Conference Call. All lines have been placed on mute to prevent any background noise . I would now like to turn the conference over to Colleen Thompson, Vice President, Corporate Relations. Please go ahead.

Colleen Thompson: Good morning, and thank you for joining us. We want to make you all aware of the presentation we have prepared to accompany our comments this morning, which you can find on the Investor Relations sections of the TDS and U.S. Cellular Web sites. With me today and offering prepared comments are from TDS, Vicki Villacrez, Executive Vice President and Chief Financial Officer; from U.S. Cellular, LT Therivel, President and Chief Executive Officer; Doug Chambers, Executive Vice President, Chief Financial Officer and Treasurer; and from TDS Telecom, Michelle Brukwicki, Senior Vice President of Finance and Chief Financial Officer. This call is being simultaneously webcast on the TDS and U.S. Cellular Investor Relations Web sites.

Please see the Web sites for slides referred to on this call, including non-GAAP reconciliations. We provide guidance for both adjusted operating income before depreciation and amortization or OIBDA and adjusted earnings before interest, taxes, depreciation and amortization or EBITDA, to highlight the contributions of U.S. Cellular’s wireless partnerships. TDS and U.S. Cellular filed our SEC Forms 8-K, including the press releases and our 10-Ks yesterday. As shown on Slide 2, the information set forth in the presentation and discussed during this call contains statements about expected future events and financial results that are forward-looking and subject to risks and uncertainties. Please review the safe harbor paragraphs in our press releases and the extended version included in our SEC filings.

In terms of our upcoming IR schedule on Slide 3, in early March, we will be attending the Raymond James Institutional Investors Conference in Orlando and the Morgan Stanley TMT Conference in San Francisco, and then we will also be attending the New Street’s second annual Fiber to the Future Conference on March 28th. And as always, we have an open door or video call policy, so please reach out if you’re interested in speaking with us. I will now turn the call over to Vicki Villacrez. Vicki?

Vicki Villacrez: Okay. Thank you, Colleen, and good morning, everyone. This year end call is important as it gives us the opportunity to reflect upon our accomplishments over the past year, recognizing all the actions that both business units have taken to strengthen their competitive positions and plans to support our long term strategic objective of higher returns. I’ll remind you that our mission at TDS is to provide outstanding communication services to all our customers and to meet the needs of our shareholders, our people and our communities. We continued to make substantial investments in our businesses in 2022, pressuring free cash flow. However, we made substantial progress towards our net worth goals as both business units will talk to.

And while investing still remains a high priority, we will moderate our CapEx spend in 2023 across the enterprise. Turning to Slide 4. Our balance sheet remains healthy at year end with approximately $1.5 billion in available sources of liquidity, including cash, term loans, revolvers and asset securitization facility, and we have long dated maturities and preferred equity, extending any sizable maturities to very far in the future. We believe that we have the right mix of both long term maturities and shorter term financings to help fund our investments while appropriately managing through the current interest rate environment. Both business units are continuing their rigorous multiyear cost discipline programs taking place throughout their organization, focusing on both OpEx and CapEx, which should contribute favorably to cash flow going forward.

I also want to highlight that during the quarter, Slide 5, we once again repurchased a modest amount of stock in both companies and for the full year 2022, we repurchased $40 million of stock at TDS and $14 million at U.S. Cellular. Importantly, we remain committed to our dividend and we raised it once again for the 49th consecutive year. This stretch of 49 years puts us with an elite group of companies that have this many consecutive years of dividend increases for their shareholders. And now I’ll turn the call over to LT.

LT Therivel: Thanks, Vicki. Good morning, everybody. Hope everyone is doing well. Just a quick add. We repurchased $43 million worth of stock at U.S. Cellular. I think Vicki’s number got cut off, at least I heard 14, it’s 43, just for everybody to note. Okay. I’m on Slide 7, a fair amount to be proud of in 2022, I don’t think it’s a surprise. Last year was a challenging year, both from a subscriber standpoint and with an aggressive competitive environment and shifts in the macro economy. Based on that competitive pressure, we did a lot of testing and innovation on a number of different promotional approaches. And our goal and we’ve talked about this in the past has always been to balance subscriber goals with financial goals.

So midyear, we pivoted to providing much more aggressive offers for existing customers, and the goal there was to drive higher upgrade rates. And we launched flat rate pricing in a subset of markets in the second quarter and the third quarter, and we expanded that offering across the entire footprint in November. And those moves drove steady quarter-over-quarter subscriber improvements. And back to that concept to balance our postpaid ARPU growth was one of the best in the industry, and that was really a highlight for us in the year. We’re seeing good initial adoption of those flat rate plans. On average, nearly a quarter of our customers that are choosing flat rate are choosing higher tier unlimited plans. And customers on flat rate pay full price for their device nothing to exchange for that reduced pricing, and that helps lower our promotional expenses and mitigates the financial impact of this lower planned pricing.

Both flat rate pricing along with our new and existing offers has led to a meaningful improvement in our in-contract rate. So we ended the year at 64% of our postpaid handset customers in contract, and that’s in comparison to 59% in June when we initially launched our new promotions, and that’s significant because those in-contract customers churn at a much lower rate than out of contract customers. Additionally, we also generated operational savings and capital efficiency through our cost optimization programs, and that’s helped us mitigate the effects of increased promotional spend and inflation. More specifically, excluding the impact of increased loss on equipment and bad debt expense, our remaining cash costs were down 2% year-over-year on a full year basis, and we think there’s significant opportunities to reduce costs in 2023 and beyond.

We’re seeing positive results from our investment in our digital platform, and that’s in terms of both an improved customer experience as well as increased traffic. Our customer experience now exceeds four stars in the mobile apps, and we’re averaging more than 1 million app sessions per month, that’s up 54% compared to 2021. And this will be another driver of cost reduction moving forward as interactions move from our stores and from our care centers to digital. Other areas of the business we have good progress in pursuing our growth initiatives. We’re seeing strong momentum in fixed wireless. We ended the year with 77,000 fixed wireless customers, that’s up from 49,000 a year ago. Tower has produced another strong quarter of results, growing revenues by 14% in the quarter and ending up the full year up 13%.

On the network side, our modernization program and multiyear low band 5G deployment is making good progress. We currently have approximately 50% of our POPs covered with 5G and 80% of our overall traffic is carried by sites supporting 5G. And you’ll notice we achieved these results efficiently, because we ended the year at the lower end of our CapEx guidance. We have plans in 2023 to continue our low band 5G build out along with making significant progress on our mid band 5G build out. We plan to be able to make mid band available in portions of our network when that spectrum is cleared in late 2023. I also want to highlight, we recently partnered with some local communities to bring broadband access using fixed wireless to some very hard to reach areas in both Maine and North Carolina.

Although the amount of state funded grants that we received is pretty small, it highlights how we can put funding to work to help bridge the digital to buy. Turning to 2023, on Slide 8 are our strategic goals and we build on our investments and progress in 2022. First and foremost, and you won’t be surprised by this, our top priority is to improve our customer results. You can expect to see us continue to pulse and trial pricing and promotions regionally, balancing subscriber growth with financial discipline. And you can also expect continued emphasis on our growth initiatives. We had our best year by far in fixed wireless in 2022. We expect more growth in 2023. And that’s even prior to us getting access to that mid band spectrum. We expect our tower portfolio revenues to maintain growth and that team is highly focused on expanding our opportunities in that space.

We’re also expecting strong growth in B2B, particularly in the IoT space. As it relates to our mid band network rollout, U.S. Cellular has been engaging in pre-coordination with the FAA ahead of our planned 5G deployment, and our joint coordination efforts to date confirm that our C-band deployment can proceed without delay once that spectrum is cleared, and that’s crucial. If any delay in deployment of mid band with harm Americans to need connectivity the most impede our collective effort to bridge the digital divide. And before I hand it off to Doug, let me share a few thoughts on guidance. Our guidance assumes a continuation of aggressive ongoing promotional activities, a focus on cost reductions and efficient capital spend. Our long term goal remains to grow return on capital while generating positive free cash flow, and we’re going to be pulling every lever at our disposal to improve it over time.

I also want to thank the entire U.S. Cellular team for navigating through a dynamic and challenging year. I’m excited about the opportunities in front of us. I think we’re on the right path to drive the business forward and deliver long term value. So I’m going to turn the call over to Doug, who will now take you through the operating and financial results in some more detail. Doug?

Doug Chambers: Thanks, LT. Good morning. Let’s start with a review of the customer results on Slide 9. Postpaid handset gross additions decreased year-over-year by $20,000 and net additions correspondingly declined $18,000 largely due to the continued highly competitive environment, a decrease in the switcher pool and an increase in involuntary churn. Connected device gross additions increased by 9,000 and net additions increased by 13,000, driven by fixed wireless customer growth. As LT mentioned, we continue to see momentum in fixed wireless with our base of customers up 57% from the end of 2021 and 17% from the third quarter of 2022. Postpaid handset churn increased from the prior year, driven by higher involuntary churn and throughout 2022, the frequency of non-pay customers increased to pre-pandemic norms.

This was offset by a decrease in voluntary churn, partially driven by the growth in the percentage of in-contract customers. Now let’s turn to the financial results, starting on Slide 11. Total operating revenues for the fourth quarter decreased 2% from the prior year. Retail service revenues were relatively flat as higher average revenue per user was offset by a decrease in average postpaid connections. Inbound roaming revenue declined 54% due primarily to lower negotiated rates with other carriers, which also has the impact of decreasing our roaming expense. Overall, roaming expense declined at higher amounts than roaming revenue in the fourth quarter and the full year 2022. Equipment sales revenues decreased by 4% due primarily to a decline in the average revenue per unit as a result of our promotional offers.

Our postpaid ARPU and ARPA results are presented on Slide 12. LT mentioned the strong increase in ARPU and this increase, along with the increase in ARPA was driven primarily by favorable plan and product offering mix, an increase in cost recovery surcharges and an increase in device protection revenues. These increases were partially offset by an increase in promotional costs. We continue to see consistent growth in our highest tiers of unlimited plans, and 41% of our postpaid handset customers are in these higher tier plans at the end of the quarter. Our quarterly financial results are shown on Slide 14. For this discussion, I will refer to adjusted operating income before depreciation and amortization as adjusted operating income. Adjusted operating income declined 10%, driven by increases in loss on equipment and bad debt expense.

As LT commented earlier, we continued our new and existing promotion throughout the fourth quarter. This promotion rewards our existing customers, increased our in-contract rate and contributed to the strong increase in ARPU as our customers adopted to our higher value plans in conjunction with these offers. This promotion was also the primary driver of $9 million increase in loss on equipment. Bad debt expense increased $17 million as our involuntary churn rate has returned to pre-pandemic levels and the average write off has increased as a result of customers selecting higher priced devices, partially attributable to promotional incentives. As a reminder, bad debt expense trended lower throughout 2021 as a result of the continuing impacts of the pandemic, including relatively higher personal savings rates, which resulted in stronger customer payment behavior in the prior year.

LT mentioned our ongoing cost optimization program, and this continues to deliver results. Despite our current inflationary environment and our ongoing 5G rollout, excluding cost of equipment sold and bad debt expense, other fourth quarter cash expenses decreased 3% year-over-year. This was driven by lower roaming expenses resulting from favorable rates with other carriers, as mentioned earlier, and actions to keep all other cash expenses flat year-over-year. Now let’s turn to Slide 15 where we show our full year financial results. Adjusted operating income for the year declined 9%, driven by similar factors mentioned for the quarter. Adjusted EBITDA, which incorporates the earnings from our equity method investments, interest and dividend income also decreased 9%.

This decrease is primarily driven by the impact of the implementation of C-band spectrum leases in certain partnerships, and we expect this impact to continue in future periods. Turning to Slide 16. I will cover our guidance for the full year 2023. Our guidance contemplates the impact of our subscriber base decline in 2022, a continued highly competitive and promotional environment and a continued decline in roaming rates, which we expect will cause a corresponding decline in both roaming revenues and roaming expense. We expect ranges of approximately $3.05 billion to $3.15 billion in service revenues, $725 million to $875 million in adjusted operating income and $875 million to $1.025 billion in adjusted EBITDA. For capital expenditures, the estimate is in the range of $600 million to $700 million.

We’re very pleased with the progress we have made to date in our 5G rollout. Our investments in low band and network modernization and mid band 5G deployment remain on track, and this guidance reflects our continued commitment to invest in 5G and our outstanding network while prudently managing the level of this investment and the free cash flow of our business. I will now turn the call over to Michelle Brukwicki, Michelle?

Michelle Brukwicki: Thanks, Doug. Good morning, everyone. I’m pleased to report on TDS Telecom’s fourth quarter and full year results, and I’m also proud to highlight the progress we made in 2022 towards reaching our longer term 2026 goals that we shared with you last year. At TDS Telecom, we are grounded in our mission, and that mission is to create a better world by providing high quality communication services, connecting people and businesses, supporting education and strengthening communities. Our goal is to be the preferred broadband provider in the markets we serve. On Slide 18, you can see our strategic areas of focus that will help us achieve this goal. Investments in these strategic priorities will drive profitability and improved returns over time, ultimately strengthening TDS Telecom’s financial and market position.

So what exactly are we doing? We’re growing our scale and revenue primarily through our fiber market expansion, and we’re continuously streamlining and automating our operations to reduce legacy costs. We keep this customer at the center of everything we do, continuously investing in customer experience improvements. And finally, the foundation of our entire business is our highly engaged, resilient and dedicated workforce. We invest in our people to ensure we can attract and retain top talent. So moving to Slide 19. Let me update you on our progress towards achieving our longer term goals, and I’ll tell you the headline is we are on track. There are certain metrics we’re monitoring to ensure we’re moving at a pace to reach our 2026 targets.

I’ll highlight those three metrics for you now. The first metric is number of service addresses. We are targeting 1.2 million marketable fiber service addresses by 2026. We ended 2022 with 582,000, so we are halfway there. The second metric is the percent of service addresses that are served by fiber. We’re targeting 60% of our total service addresses to be served by fiber by 2026, and we ended 2022 with fiber to 39%. This reflects progress in growing fiber through our expansion markets as well as fibering up our incumbent markets. And specifically, we’re working to serve 50% of our ILEC service addresses with fiber and we’re making good progress. At the end of 2022, we were at 36% of our ILEC addresses being fibered up. The third metric is the percent of our footprint with speeds of 1 gig or higher.

By 2026, we’re expecting to offer those speeds to at least 80% of our footprint. And we finished 2022 with 66% at gig speeds. So we’re pleased with the pace of our fiber builds and with our fiber expansion results so far. We have continued to successfully navigate challenges in getting those builds completed. We’ve been scaling up our service address deployment since we launched this program, and we plan to continue that in 2023. Based on our experience, we are seeing positive contributions from our market launches starting around the three year mark, and we still expect to achieve broadband penetration rates of at least 40% in steady state. The success that we’ve seen in our early markets is validating our business cases and our expectation of low to mid double digit returns on these projects.

On Slide 20, I’ll highlight some key accomplishments from 2022. We grew our footprint by 9%, which came from delivering 133,000 marketable fiber service addresses. This is a 50% increase over what we delivered in 2021, and 60,000 of those service addresses were added in the fourth quarter, that was our highest quarter yet. At year end, we had about 100 communities that are in various stages of development. During the fourth quarter, we began offering service in several new communities, including Oshkosh, Oak Claire and Janesville, Wisconsin, along with Nampa, Idaho. Our momentum is strong and we’re going to continue scaling up to deliver 175,000 fiber service addresses in 2023. This will be an increase of over 30% from what we delivered in 2022.

As a reminder, we expect seasonality will impact the quarterly cadence of service address delivery. So this is going to steadily build throughout the year. We also continue to address the broadband needs in our most rural markets by upgrading our copper networks with support from state broadband grant programs and by meeting our obligations under the federal A-CAM program. We are still optimistic that the FCC will adopt an extension of the A-CAM program, and we hope to have a final decision soon. We also still believe that extending the current federal A-CAM program first and then pursuing the BEAD program funding would provide the fastest path for TDS Telecom to take fiber deeper into our communities. All of these broadband investments are driving positive results.

As shown on Slide 21, we experienced a 4% increase year-over-year in total broadband residential connections. Shown on the graph on the right, we see demand for greater broadband speeds with 72% of our customers taking 100 megabits per second or greater, and that’s up from 66% a year ago. As I mentioned before, TDS Telecom can now offer at least 1 gig service to 66% of its footprint. And in some markets, we are now even offering an 8-gig speed product. In areas where we offer gig service, we’re seeing 22% of our new customers taking this product. And finally, our focus on fast reliable service has generated an 8% increase in total residential broadband revenue. On Slides 22 and 23, I’ll share some financial highlights. Total revenues increased 1% for the quarter and for the full year as broadband growth offset our legacy declines.

Residential revenues across all of our markets increased 4% in the quarter. Price increases and overall product mix partially offset by promotions drove a 4% increase in average residential revenue per connection. As shown in the chart on the left, expansion market revenues increased year-over-year following the timing of service address delivery. Residential wireline incumbent and cable revenues increased year-over-year due to price increases and growth in broadband connections, partially offset by declines in video and voice connections. Commercial revenues decreased 5% in the quarter and for the full year, primarily driven by lower CLEC connections. And lastly, wholesale revenues decreased 2% for the quarter and for the year. Cash expenses increased 8% in the quarter and 5% for the year due to both supporting our current growth as well as future growth.

So we’re incurring costs, but the revenues have not come yet. These costs to support our fiber expansion include direct costs such as sales, marketing, real estate and technicians in addition to shared services. As expected, the increased cash expenses to support our growing fiber program resulted in a decline in adjusted EBITDA of 13% for the quarter and 6% for the full year. Capital expenditures of $556 million were up from the prior year due to increased investment in fiber deployment as well as advanced capital purchases to mitigate longer supply chain lead times. Keep in mind that these investments support our multiyear strategy and our goal of increasing free cash flow and return on capital over the long run. On Slide 24, we provided guidance for 2023.

Our guidance factors in the foundational investments we’re making to enhance our network and expand our footprint over the next several years. We’re forecasting total telecom revenues of $1.03 billion to $1.06 billion. This reflects our goal of top line growth driven by continued improvements in residential revenues across all of our markets, offsetting declines in the legacy parts of our business. Adjusted EBITDA is expected to be between $260 million and $290 million in 2023. Adjusted EBITDA reflects our continued fiber expansion, which requires upfront spending. By the end of 2023, however, almost all of our 100 communities will have been launched. As our market builds mature and we increase our penetration, we expect the pressure on adjusted EBITDA to lessen over time.

Capital expenditures are expected to be between $500 million and $550 million in 2023. This reflects increased spend on fiber service address delivery and reduced advanced equipment purchases as supply chain constraints are expected to lessen, and nearly 90% of our capital spending is allocated to broadband growth. Before turning over the call, I want to thank the team for all of their hard work in 2022. We accomplished a lot and we are executing on our priorities, and I expect that momentum to continue into 2023. And I’ll now turn the call back over to Colleen.

Colleen Thompson: Okay. Operator, we are ready for the first question.

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Q&A Session

Operator: Our first question will come from the line of Rick Prentiss with Raymond James.

Rick Prentiss: A couple of questions, if I could. First, for U.S. Cellular. LT, you laid out with kind of the ’23 guidance. If we think back to ’22 guidance, you did pivot midyear and you’ve addressed kind of the more competitive marketplace, the aggressive promotions. It sounds like the ’23 guidance assumes that competitive pressure continues as opposed to maybe a pivot that might be needed in the middle of the year? Just trying to compare how we started ’22 guidance with how we’re starting ’23 guidance.

LT Therivel: Rick, I’d say that the way you’ve characterized it is accurate. We take the trends and essentially the moves that we made in the market in the second half of €˜22, meaning a more aggressive approach to upgrade, pulsed in and out. You may notice we only did it here about a week or two ago, we actually pulled our existing famous new promotions and we’ve replaced them with no hidden requirements to offer that’s specifically designed to appeal to kind of multiline customers. At the same time, we also have our flat rate pricing in place, which we think is highly competitive in the marketplace. So with those moves — those kinds of moves in response to the competitive environment, you can expect to see in 2023. And we’ve seen the benefit of it, right?

If you look quarter-over-quarter, we’ve seen continued positive movement in our net add performance. And so in general, yes, I think you can probably expect think of 2023 in a similar fashion to second half, both in terms of our view on the competitive environment as well as the moves that we’re doing to compete well in it.

Rick Prentiss: There’s been a lot of debate about the industry level of adds coming back down to a more normalized level versus what maybe happened? What’s your view of the industry level on the wireless adds area?

LT Therivel: Let me hit it to, Doug. I think you’ve got a sense of this. Go ahead, Doug.

Doug Chambers: Yes, Rick, we’re projecting about 1.5% for an industry increase during 2023. So above the population growth below where it’s been, so kind of in between those two data points.

Rick Prentiss: And we’re sitting here in February, you’ve instituted the — getting more people under contract. How is that playing out? Sometimes, I think you’ve said in the past maybe six to nine months, that should hopefully benefit into churn. Are we seeing that, have you got enough data points to get comfortable? And does that mean as we think about Q3 ending, we’re not going to have negative postpaid phone adds or we won’t as negative? Just trying to think through the churn action with the contract and how you set up with the postpaid phone for the year?

LT Therivel: So Rick, I mean, we’ve stayed away from kind of projecting specific net add performance or when we’re positive or when we’re not. In general, what I’ll tell you is that the moves that we’ve made to get people more under contract, get more upgrades. We’re starting to see some positive signs on the consumer side when it comes to improved churn. We offset that a little bit in the fourth quarter with some higher B2B churn, and you don’t really see that in the numbers. In general, we expect to see that churn continue to improve throughout the year because of getting more customers under contract, couple that with what we believe will be improved gross add performance due in no small part to flat rate. And we do expect to see that general momentum year-over-year of improved net adds continue.