Array Digital Infrastructure Inc (AD) Q1 2013 Earnings Report, Transcript and Summary

Nice broad question to start with. And my IR person isn’t in the room. But if she was, she would be making me tell you about our Safe Harbor slide that’s on our website or something. So, I want to make sure that I said that otherwise you won’t be going tonight. Actually ‘12 was a big year. Telephone and Data Systems or TDS has two primary businesses, a wireless business U.S. Cellular and a fixed wire-line business. And at Cellular we brought in a new CEO about two years ago, Mary Dillon, Ex-Chief Marketing Officer at McDonald’s and has been sharpening our marketing focus in that business over the last couple of years. And have reversed what I would call a loss of gross add market share, the last year gross adds were up nicely year over year, it’s the first time that’s happened in a couple of years. Same time we made great progress on our roll-out of LTE, and completed the review of part of our portfolio and wound up with a transaction where we were divesting certain assets including Spectrum customers in St. Louis in Chicago to Sprint. On the wire-line side - all of that subsets up what we’re doing in ‘13. In the wire-line side, one of the things that we’ve been doing in the last couple of years is investing in our network for IPTV, we kicked that off in 10 markets at the end of the year and have been investing in the hosted and managed services space and had four different acquisitions come together over the last two years and tee up a little business there. So, as we look at ‘13, priorities at Cellular quite frankly are to leverage that increase in gross adds to start driving some more customer growth. In order to do that, we’ve got to overcome the churn pick-up that we saw in the fourth quarter. They have to close the transaction that we call the divestiture transaction or the Sprint transaction which will bring in about $480 million into that business. We’ve got to complete our LTE roll-out where we finished the year at what 61% of our customers covered, we expect to be just under 90% by the end of ‘13. And we are in the midst of rolling out a new billing system at Cellular. We spent the last two years building (inaudible) capital a little bit, what the – and in this year it’s got about $60 million OpEx hit. But it brings with it a lot of capabilities in ‘14 and so that’s a big initiative there. On the wire-line side, this is the year that HMS investments we’ve made to date need to kind of come to the fore. We need to drive some penetration in those IPTV markets to prove that investment thesis. And the third one, is, there is quite frankly completion and integration of a acquisition we announced last week where we bought a cable company. And there shouldn’t be surprise when you think about that because all that company does is exactly the same thing we do today, deliver voice broadband and video to rural and suburban customers but using a different technology, and so it’s something that we see it as a natural extension of what we do and we’re pretty excited about that. Jon Epstein – Deutsche Bank: Thanks for that overview, lots to talk about there. On the LTE build-out you have your coverage target for you said almost 90% going into the end of 2013. But how do you think about the quality of the network in terms of competitive speeds, and is that mean that over time you’ll need to invest in upgrading the network in terms of additional spectrum or densification or upgrading the backlog?

Yes probably and no in that order. Let’s take them, so yes, we will continue to invest in your network. Last year we spent $850 million in capital in the company. And this year we’re targeting $600 million, a big drop, and the big drop is really driven primarily by capping 3G technology spend that because we are preceding our markets, putting – selling LTE devices even before we turn the LTE on, we’re stopping – we’re going to stop CDMA and LTE and EVDO spend. But at $600 million that’s still about 15% of revenue and I just see, we’re constantly going to be spending into your network. Perhaps at that level, so I look backwards that’s not an unusual level over many years that’s where you spend it for right. We have 700 over most of our footprint we have Cellular underneath it, we’ve got marketed at AWS, we’ve got marketed at PCS. So, we aren’t spectrum starved anywhere but you will be spending instead for things like carrier aggregation so you can use the spectrum, the different spectrum pool you have to continue to increase speed, I think in reduction levels right now our speeds are fine, but you’re going to make investments on speeds. So that’s specifically around aggregation and already to keep growing where it goes in the future. Jon Epstein – Deutsche Bank: Great. On the sale of about 10% of your customers to Sprint, exiting markets such as Chicago and St. Louis. Does this indicate any sort of change in strategy now that your overall footprint will be less stance and maybe you’ll have higher reliance on roaming revenue in markets such as Wisconsin or Iowa?

I don’t think of it as a change in strategy at least vis-à-vis something like roaming. It’s a case of examining our portfolio which we do on a regular basis and then these two markets spectrum constrained needed more spectrum especially to get to LTE. And that the investment level for that would then raise the penetration levels necessary in those markets to get to where reasonable returns we just didn’t see it happening. And if you can’t see us generating value that way, we looked at other ways to generate value. The rural and mid-size markets, quite frankly is where the company started, roaming is a nice revenue stream in them. It always has been. And nothing really changes that dynamic and we keep – pricing keeps changing but the company’s been a net beneficiary forever and keeps developing whatever relationships it needs to do as we’re going forward. We still have the advantage of having very, very good spectrum that allows us to economically cover areas that can’t be covered with high frequency spectrum. And so the more different carriers grow that’s used for high frequency spectrum the more we get the benefit of that in roaming services. Jon Epstein – Deutsche Bank: In that divestiture footprint you have assets in the form of 565 towers and you have spectrum covering the footprint that’s not included in the transaction how do you intend to monetize those assets over time?

So, the company has a philosophical bend towards that, network quality is key to what we do. And controlling some of the real-estate in our footprint is how we deliver that. So, our towers and we own about 4,700 of them have been the strategic asset. And we’ve always maintained the ownership of those, that’s about half of our total towers I guess. In the markets we did not sell those as part of the transaction with Sprint and so since we are no longer operating those markets, they aren’t a strategic asset. So we’re looking at how do we capture more value from those, we’re looking at whether there is a model where we can lease them up further and operate them ourselves as well as checking out what the value of those are in the marketplace today and we’ll see which, what are the opportunities to capture value there. Similarly, we sold what we sold in this transaction with customers and some PCS spectrum. We – in building our spectrum portfolio for these markets we had different licenses that weren’t part of that transaction, those two are no longer strategic. An example of that is we have a license that covers the – what’s called the South, the Mississippi Valley, our AG, is a 10 megahertz AWS spec license that was purchased to give us capacity in St. Louis. We don’t need it, so it’s something that and a few others would be looking at what our options exist around them. Jon Epstein – Deutsche Bank: Okay. Just staying with spectrum, on 700 megahertz inter-operability, how critical is that for U.S. Cellular and what’s their timeframe that we can really get there?

It’s very important. The inter-operability gets to how your phones will interact on different networks across the county as customers travel back and forth, it’s critical for us that our customers are able to receive equivalent services wherever they are at. And in the old voice world that was done with voice roaming agreements and all the phones work the same way, same band, same spectrum. That changes in an LTE world short-term, I’d say it changes short-term, it changes to in terms of the delivery of data, it doesn’t change in terms of the delivery of voice because all the phones still have CDMA in them as well as LTE. And I think medium term as chipsets are being developed that handle multiple bands and multiple frequencies, it gets resolved, it’s more of a short-term transitionary issue that engineers and manufacturers and lobbyists and everybody else is working on. And I think the next 12 months will give us more visibility to how that plays out. Jon Epstein – Deutsche Bank: Okay. Moving to the handset portfolio, U.S. Cellular currently does not offer the iPhone. And I understand that due to some cost, and compatibility issues in the past, this has become more urgent now that T-Mobile is coming into the market. So, if we don’t get an iPhone announcement from U.S. Cellular, do you think the existing smartphone portfolio could drive subscriber growth to meet your net add objectives?

Could, I’m trying to think how I answer this, so we start off with – we’ve got the best handset portfolio we’ve ever had. Samsung has been a phenomenally supportive partner of ours. We had the Note before some of the majors, we had the Galaxy III, the same time they did – both performed extraordinarily well. Having said that, we picture ourselves, when it comes to handsets it’s been a retailer. And it’s important to have your shelves filled with whatever your customers want. There are various reasons that any point in time we carry one set of products or not. We constantly are in discussions with all of the handset vendors and suppliers around different options and opportunities, the fact that we may or may not carry one phone today, doesn’t mean that we are going to not carry them tomorrow, it’s a dynamic world. Clearly I think in the fourth quarter, our increase in churn was impacted by the impact of free iPhone, the bottom tier 1 now becoming free, clearly was attracted to consumers. But the same time that isn’t necessarily a good phone on our network right now as we’re trying to cap the spend in that, so, no announcement today. There is no change in the handset. We like it. We like the support that we’re getting. But we’re also always looking at what other options are. Jon Epstein – Deutsche Bank: Great. Following the success of prepaid in the Big Box channel you have been selling prepaid in Walmart for I don’t know how many quarters now. But you’re going to be introducing postpaid in that channel. And I’d like to understand how you think about the average lifetime subscriber value of a customer that signs up for a contract at Walmart versus in a direct channel? And how do you manage the challenges of contracts and credit checks and the new source of pressure on margins from smartphone subsidies coming from the Big Box channel?

So, it’s a very interesting question. And it really reflects a change that we needed to make. Early on, I’ll go back a few years ago, our – we built a culture around customer service that was second to none. The customer experience in our stores is the highest rated for any wireless company out there. But, and so when we did that we kind of took, we walked away, we ignored, we were not involved in Big Box as much because we really wanted to be able to control that customer experience in a way that we thought we could only do through our own exclusive agents, with our own stores. And what’s happened over the last couple of years, as customers have decided they want to buy some place else and they like buying in the Big Box store, and they’re doing a lot of other things. So, it’s necessary for us to find ways to still deliver that type of experience but to deliver it through a different channel. So, last year, we rolled out, first a pre-paid product with Walmart, exceeded all of our expectations. It was very, very fast launch, it’s a very high take rate. And where we launched – it got launched was in all the markets where you’ve been there for years. I mean, it was a case where our name was extraordinarily well known in Wisconsin and Iowa. And it was just a different channel. And I think, and things that we’ve looked at, we would say that mid-80% of all of those adds were new customers. It wasn’t channel, or they weren’t just changing the channel they were buying and they were new customers for us. In order to roll that out, we had to invest in enablement for Big Box that we didn’t have on the shelf, okay. Systems, changes and things like that to support it. We then rolled out a postpaid product in Wal-Mart stores late in the fourth quarter. Don’t expect it to be anywhere near as big as the prepaid but again it was growing our ability to work in the Big Box environment. We would expect to continue to expand that channel this year and next. We think there are opportunities and quite frankly, that’s where customers want to buy, that’s what we need to do. That was one part of your question. Then you asked this other question about lifetime value and everything else. Lifetime value postpaid and prepaid is different okay. And the way the carrier has to respond to that is that you have to be able to change your cost to acquire, your marketing cost for those different customer behaviors. And what happens to you is a very different churn profile on the two of them and that’s what drives your customer behavior. So as long as you can align your marketing cost, they remain edited to the bottom line and we’ll continue to settle, it doesn’t change our strategy, we are still primarily a postpaid focus company. But again, as a retailer and you’ve got – you got the fixed cost network, the more you can load it up with things that contribute more profitable you’ll be. Jon Epstein – Deutsche Bank: Okay. And on the new billing system that you mentioned that’s coming online. What kind of improvement or flexibility in terms of pricing plans, does that give you and can you quantify any sort of run-rate savings just due to the billing system?

So, it’s due to the current system we have, technology is in mid-1990 base. It was an AmDoc system that we put it in ‘96 through ‘98. This is another AmDoc’s product that we’re moving to. And we have spent, we’ve disclosed we’re going to spend $150 million with AmDocs in building this thing, most of that has been spent or it gets completed by – let’s say middle of this year. Run rate this year, just training, rollout, testing, implementation of costs will hit operating cash flow by about $60 million to $65 million this year, that’s a one-time item. The whole billing system is built to generate certain benefits all of which start in ‘14. So, next year you get the double benefit of not only not spending anymore but starting to see some of these changes. And what some of those changes look like and as an example, the current technology has this with six instances of this billing system. And next year you get to move to one instance. So, when you try to rollout a product, it’s much faster. It’s got a faster store experience for the consumer which affects your productivity in the stores. It’s got product capability like the ability to build out a shear data-point that doesn’t exist in the current platform. So there is a lot of – a lot of capabilities as well as immediate cost positives off of this. Jon Epstein – Deutsche Bank: Great. And moving on to wire-line where you have a diversifying set of assets and you mentioned hosting in managed services you’ve made some acquisitions last year including the few tier 3 datacenters. Can you describe the new capabilities and also how you see the revenue and margin trajectories given the typically longer sales cycle for this type of business?

So, we have – our view of this opportunity is we are looking at trying to buy couple of different companies such that when we’re done, we can offer end-to-end services from the IS area for mid-size companies. And when I say mid-size, we’re talking, our target is that 200 desktop to maybe 2,000. We aren’t talking about the big banks or the big Johnson & Johnson type companies, we’re talking about manufacturers that are in Wisconsin and Iowa. And when we look at that, yes we bought a couple of co-location companies that they can store their data ad. We bought a managed service company that can provide more services. And you’re right, we’ve talked about a long lead-time – a long cycle – a long lead time cycle and also to relationship selling. You’re talking about moving the data out of some manufacturers back room it’s been there forever, and they were little nervous about that. And so, what we’ve recently did is we added a value-added reseller who has been selling equipment to these guys for years has that long relationship. And all you’ve done is you’ve added another set of products to his bag when he’s out calling on these customers. And with that, last year we put the four companies in effect together, common product, we built some cloud offerings and started to use some nice traction around the cloud sales. It think most of the sales uptick that we’re expecting for this year is second half, just given that lead time you talked about. But given the investments we’ve made in the last few years, we expect to see meaningful cash flow growth out of those this year. And it’s a case where single digit revenue growth ought to have double digit cash flow growth off of these businesses. Jon Epstein – Deutsche Bank: Okay. And another set of assets that you’re moving into, you’ve rolled out IPTV in 10 markets through last year. So, what are your objectives related to units past, penetration and overall contribution of these assets?

So, on the wired side, we have a secular change going on, we’ve got younger generations that aren’t using voice the same way that some of us may have. And so we’ve been looking at augmenting that product set and one of them has been with IPTV. We actually had run two test markets for a few years and one was a fiber based, one was copper based. And we saw some really, really strong response, we’ve got under 30% penetration in those markets. With that, we now have launched it in 10 other markets passing about 65,000 cellphones. Our targets aren’t to get 30% but this year is all about selling that product. What it does in terms of an overall revenue mix for the company is it helps stabilize the wire-line revenue but not enough to change, it gets it to flat, it doesn’t get to really change the trajectory in terms of adding growth at this point in time. But if we can validate the economics in those models then we can continue to look at where else we can roll it out in the future. Jon Epstein – Deutsche Bank: Great. In broadband you’ve mentioned the target of 40% of households that you’d like to reach with 25 megabits per second up from 25% through last year. How and when do you plan on getting there and are you thinking of installing any new technologies over time that enable even faster speeds to remain competitive?

This is an area that we’ve spent from a capital standpoint, heavier than maybe some others. We think it’s necessary to continue to invest in the business to deliver the quality of services that customers are demanding. We’re up to 25 covered but what has happened so far is we’ve got more covered than people are buying, okay. So you got it available but people – we haven’t seen as many buyers at the high technology. And so we want to be careful that we don’t get out in front of the investment curve on that making sure that you can deliver a lot of different suites that no one is buying it, doesn’t do much for us, right. So, I think we’re going to be, we’re going to be measured over the next 12 to 18 months as we watch take rates right now. Jon Epstein – Deutsche Bank: Great. The Baha broadband asset is expected to come online in the third quarter. And you’ve communicated the anticipated benefits of buying a docs history platform that’s under-penetrated and that’s obviously on the broadband side. But on the video side, how do you think about the opportunity, for example you mentioned that the homeowners associations that occupy that particular footprint currently prefer satellite. But could you see them maybe coming around to the cable side at some point especially with the availability of bundles and so forth?

I think one of the things that our telephone team has done extraordinarily good job of in – it’s historic footprint has been, their success with bundling, we have used a combination of voice, video and broadband and we wind up driving churn down to one third of the level of visitors standalone product, it’s under about 0.5% a month. And so I would expect, we’re going to deploy many of those same strategies to drive bundling. Yet there are opportunities around the video side of just given where they are in their head and consolidation. I would expect that we will continue along to consolidate more of those head ends which will give us better control and the video choices. But that is kind of an additional piece above the pie as we really look at it, it’s the broadband growth that got us most excited about those assets. Jon Epstein – Deutsche Bank: Okay. And switching back to the business side, now that we have at least some of the uncertainty you related to the physical cliff. Behind this, are you sensing any sort of pent up demand for a new IP connectivity or services playing out this quarter. And if not, what other macro hurdles do we need to clear for things to start picking up?

Are there any bankers in the room? I’m not near qualified to answer that question. I think that there is still my sense a reluctance to get excited about the economy. We all, we see a lot of things that kind of tick up a little bit, but we’re still waiting for the second few to drop. I don’t see consumers knocking down the doors of our business, I think there is just a lot of uncertainty right now. And so, the one thing that I would like to see is more certainty, tell us the rules and I think a lot of people can figure it out. But until we get to some certainty there is just the reluctance to commit. Jon Epstein – Deutsche Bank: Thanks. My last question on wire-line operations is on margins. When you put all the moving parts together ranging from rising pressure on wholesale to hopefully accretion in hosting and managing services and possibly opportunities to improve the cost structure? What direction and magnitude of expansion or contraction are you looking at for this year and possibly into next year?

So, this year you get all the looping pieces at on the wire-line side going on about flat is where you come out with this year, which is actually quite an achievement given that they lost $16 million in cash flow as a result of regulatory changes last year and probably have about $12 million at risk this year. So, between the two right there you got $28 million, we’ll get some contribution off of some of the new products and services that are going to offset that this year. But this year it’s about flat in that business. Jon Epstein – Deutsche Bank: Okay. At this time, I’ll take any questions from the audience before we get into the balance sheet.

Coming soon, right behind you.

Hi, thanks. You said when you rolled out the IPTV that you saw a meaningful change and you reached 30% penetration in some of those areas where you rolled it out. How much of a lift was that, so in other words what was the penetration kind of before you rolled out the IPTV?

No, because that was our first video product into those markets.

I see.

Okay. So, we got to 30% penetration on our video product alone. It wasn’t – we already were there, we were there with voice, we were there with broadband where we had 30% penetration just on the video product.

Okay, got you, thanks.

Right behind you.

You mentioned the $480 million proceeds from the divestiture, is that a pre or post tax number?

That’s a pre-tax number and as a result of the structure of the transaction, it eventually gets to be the post tax number but not in the first year. And what happens is we are – we are selling customers and spectrum to Sprint for $480 million and we’ll have a tax hit this year that probably is in the $130 million area. However, we did not sell the network, we continue to operate the network for Sprint’s benefit for some period not to exceed two years. My guess is probably going to be about a year. But that could be as much as two. When we shut down that network we get to write off those assets and we’ll recoup that tax payment so it’s probably a one, I’m thinking of it as a one-year timing difference on the taxes. Jon Epstein – Deutsche Bank: Okay. Getting to the balance sheets of Telecom and Wireless, what do you think about current levels of financial flexibility and balancing the priorities of investment for growth versus net leverage and credit ratings?

So, as I think – I think the balance sheet is pristine. The company likes to operate in an investment grade model, I would say it likes to operate there in that – the ratings of the company are based upon both the rating agency’s view of the industry as well as our performance, and we’ve got that rating today, we like it. I get a sense from the agencies of increased concern about our size in the industry. So we could have better risk just in terms of how they are thinking. But in terms of how we finance, in terms of how we make our decisions, we want to keep that, okay. And that’s about we think that we’ve got a 2.5:1 debt to EBITDA ratio, that’s about where we’re at. Having said that that doesn’t include – that is exclusive because that’s on gross debt of about $900 million on cash on the balance sheet, about $500 million of that sits at U.S. Cellular and that’s before the $480 million that comes in on the Sprint transaction. We also have $700 million in uncapped revolvers. So, huge liquidity, huge flexibility and that’s what it’s allowing us to continue some of the transitions that we talked about in terms of HMS or the Baha acquisition. Jon Epstein – Deutsche Bank: All right. And on specific uses of cash, you’ve been executing on a lot of the options that you mentioned including the dividend raise last week, you finished up a buyback, some new spectrum licenses recently and the list goes on. So, how do you think about the best ways to deploy cash at each company going forward?

Boy I hate that question, best way. I don’t know what the best one is in any point in time. We are constantly, like every other company out there, we’re trying to balance our investments in terms of where we think we can drive value. And our case, we have spent $900 million over the last five years buying shares. We continue to pay a dividend, and we continue to invest in the business. And I think we have to do all of those. And we will continue to try to balance them, I can look at U.S. Cellular’s price, these would be the parent price and say there is a huge discount in the parent, that’s one of the reason that we’ve been buying back so many shares as we have in the past. At the same time we have to be careful that we just don’t buy back shares to the point that we don’t have a business that we’re investing in at all. And so you’ll continue to try to balance those. Jon Epstein – Deutsche Bank: That’s great. It looks like we’re running out of time here. So, I want to thank Ken again. Good luck. And hopefully we’ll be back here soon.

Thank you very much. Thank you for your time.