Earnings Call Transcript - TDS Q4 2022

Operator, 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, Vice President, Corporate Relations

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 websites. With me today, 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 websites. Please see the websites for slides referred to on this call, including non-GAAP reconciliations. We provide guidance for both adjusted operating income before depreciation and amortization (OIBDA) and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), to highlight the contributions of U.S. Cellular's wireless partnerships. TDS and U.S. Cellular filed our SEC Forms 8-K, including 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, Executive Vice President and CFO

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 an asset securitization facility, and we have long-dated maturities and preferred equity, extending any sizable maturities very far into the future. We believe that we have the right mix of both long-term maturities and shorter-term financing 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 in 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, President and CEO

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 believe Vicki's number got cut off; at least I heard 14, but 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. 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. 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. Those moves drove steady quarter-over-quarter subscriber improvements. The balance of 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. 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. We ended the year at 64% of our postpaid handset customers in contract, 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, up 54% compared to 2021. This will be another driver of cost reduction moving forward as interactions move from our stores and our care centers to digital. In 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, 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 are 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. 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 divide. Turning to 2023, on Slide 8 are our strategic goals as 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, 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. Any delay in deployment of mid-band would harm Americans who need connectivity the most and impede our collective effort to bridge the digital divide. 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, Executive Vice President, CFO and Treasurer

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 (ARPU) 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 had 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 promotions 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 our higher value plans in conjunction with these offers. This promotion was also the primary driver of a $9 million increase in loss on equipment. Bad debt expense increased by $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, along with 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, Senior Vice President of Finance and CFO of TDS Telecom

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 improve 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 the customer at the center of everything we do, continuously investing in customer experience improvements. 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. 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. We finished 2022 with 66% at gig speeds. 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, which was our highest quarter yet. At year-end, we had about 100 communities 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. 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. 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. 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 and future growth. 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, Vice President, Corporate Relations

Okay. Operator, we are ready for the first question.

Operator, Operator

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

Rick Prentiss, Analyst

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 the '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, President and CEO

Rick, I believe your assessment is correct. We have taken the trends from the second half of 2022 into account, adopting a more aggressive upgrade strategy, implemented in waves. You may have noticed that about a week or two ago, we discontinued our previous promotions and replaced them with offers tailored for multiline customers that have no hidden requirements. Additionally, our flat rate pricing remains in effect, which we consider very competitive in the market. Given these changes in response to the competitive landscape, we anticipate similar strategies for 2023. We are already seeing positive results; our net add performance has improved quarter-over-quarter. Overall, you can expect 2023 to mirror the latter half of 2022, both in our outlook on the competitive landscape and in our tactics to stay competitive.

Rick Prentiss, Analyst

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, President and CEO

Let me hand it to Doug. I think you've got a sense of this. Go ahead, Doug.

Doug Chambers, Executive Vice President, CFO and Treasurer

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

Rick Prentiss, Analyst

As we sit here in February, you've started getting more people under contract. How is that unfolding? You've mentioned in the past that this could potentially benefit churn within six to nine months. Are we observing that? Do you have enough data to feel confident about it? When considering the end of Q3, should we expect to avoid negative postpaid phone additions, or will we remain negative? I'm trying to understand the relationship between churn, contracts, and your postpaid phone strategy for the year.

LT Therivel, President and CEO

So Rick, 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 we've made to get people more under contract and 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, coupled that with what we believe will be improved gross add performance due in no small part to flat rate. We do expect to see that general momentum year-over-year of improved net adds continue. It's important to highlight we showed a pretty dramatic improvement every quarter when it comes to net adds quarter-over-quarter. Q1 is always a tricky quarter relative to Q4, so I don't necessarily expect you can just draw a straight line. But in general, I think the moves that we have in the marketplace are resonating, and I expect them to continue to drive positive performance.

Rick Prentiss, Analyst

Last one from me. Vicki, I appreciate the comments about CapEx moderating to the market, like sharing that from the standpoint of free cash flow monitoring and in this interest rate environment. But circling back to CapEx, what it means to wireless. LT, do customers understand what 5G means, what 5G gives them? And if not, what will it take to help customers understand what 5G means?

LT Therivel, President and CEO

An interesting question. I mean, I think that there's a couple of different ways you could think about answering that. You've got, on one hand, when you look at how the industry has talked about 5G, I sometimes wonder if customers are a little numb to all the various competing messages in the marketplace. They hear 'best this' and 'fast is that' and 'broad at this.' I do wonder how it's resonating with customers. We're pleased, I will tell you with the rate of our 5G build-out and what we’ve been able to deliver in terms of capabilities to customers. We talked earlier about the specific metrics and over 50% of our sites modernized, carrying over 80% of our traffic. We do see our customers give us feedback that where we modernize the network, not only are the network performance metrics better, but the perception is meaningfully better. That would be the flip side to the coin of our customers getting numb to it. I think that customers are numb to claims. I don't think they're numb to the performance that we're bringing. We see it in the performance and we see it in the perception scores, that's an important distinction. Because, I mean, I'm chuckling, Mike Irizarry is sitting here next to me; engineers will always say, well, the numbers are a lot better. And then you’ll say, okay, but do customers care? The perception where we modernize our network says that, yes, customers care. The speed performance that we're able to deliver is meaningfully better. We're in the early stages of our 5G SA launch. As we roll out SA, customers will start to see meaningfully improved experience. We also talk about mid-band. As we roll out mid-band, that will result in a meaningfully better experience. I'll loop back to how you led off the question, which was around capital. What we’re doing is we’re balancing the feedback that we’re getting back from customers in terms of what is meaningful for them with a prudent and targeted approach to where we spend capital. We feel very good about how we're managing the balance of spending the money where we need to and getting the customer feedback and the customer metrics in a place that we're pleased. Hopefully, that gives you a sense of how we’re tackling it.

Operator, Operator

Your next question comes from the line of Simon Flannery with Morgan Stanley.

Simon Flannery, Analyst

If I can start, LT, with fixed wireless, good to hear the momentum is going well. You've obviously got the C-band coming on later this year. So what's your latest thought on where you want to deploy this product? Is it still going to be kind of an ex-urban rural kind of a product, or do you think we might see a broader footprint? We've seen quite a lot of suburban success with T-Mobile and Verizon, a lot of B2B interest as well. And then both for you and on the wireline side, just latest thoughts on the BEAD program. Do you think that's something that you have a lot of interest in participating in either on the wireless or wireline side?

LT Therivel, President and CEO

Let's start with fixed wireless. Our approach is somewhat different in deployment compared to T-Mobile, but we view the market similarly. We've had great success with this product in rural areas and in the transition zones between rural and suburban. We're primarily deploying a low-band product, with some mid-band trials, but most of our sales have been from low-band. We're proud of the service we're offering, although it's not particularly high-speed. This highlights the opportunity ahead of us because once we launch mid-band, we expect to offer speeds around 300 Mbps. That will open up new market opportunities. In 2023, there's significant growth potential with low-band, particularly in areas with cable monopolies, where our product competes effectively. With mid-band rolling out in 2023, we plan to expand from suburban into more urban areas with a competitive product. However, I maintain that our product won't compete well in areas with good fiber to the home options. We'll still serve customers who want our product, but fiber is ultimately the better choice for those customers. We see strong potential for this product beyond 2023 as we introduce mid-band. Regarding the BEAD program, we're quite optimistic about the potential funding for fixed wireless. We've conducted extensive analysis and engaged with states, and we believe that despite the $46 billion allocated nationally, it won't cover every home and business with fiber. Many claims of universal fiber connectivity overlook the realities of rural America, where it's often neither cost-effective nor timely to deliver fiber connections. It’s difficult to ask rural residents to wait years for fiber. With our mid-band rollout, we can provide a product that delivers 300 Mbps, easily meeting the BEAD thresholds of 100 down and 20 up. We're eager to collaborate with states on this opportunity, although we don't anticipate significant state funding until early 2024. We see potential growth in acquiring new fixed wireless customers, and our existing wireless and wireline bundle will support this growth. Bringing on new fixed wireless customers can also reduce our capital expenditures, allowing us to expand our tower business in cost-effective ways. When we have more towers, we can boost our tower revenue. Currently, our co-location rate is above 1.5%, compared to the industry average of 2.3%. We see three potential revenue streams from BEAD funding: fixed wireless, mobile revenue, and tower co-location revenue. Based on our initial discussions with states, we are hopeful that a significant portion of the funding will be directed towards fixed wireless. Now, Michelle, would you like to share your perspective on fiber opportunities and the BEAD program?

Michelle Brukwicki, Senior Vice President of Finance and CFO of TDS Telecom

So Simon, generally from the TDS Telecom perspective, we agree with everything that LT said, but we do have a unique perspective from the wireline side. For us, there are actually two federal programs that are in front of us. The first one is the A-CAM program. We already participate in that and are almost halfway through that program. The SEC is considering a proposal to take the addresses that are under that program, and require higher speeds be provided in exchange for more years of revenue support on the back end of that program. This would be a great development that would help us get those faster speeds. They're talking about the same speed as the BEAD program, 100 down, 20 up. That would be a great opportunity to get those speeds faster to customers under the A-CAM program. That program is established and already running, allowing us to pivot quickly. The BEAD program also provides another opportunity for us. We believe there are other areas where we can take fiber under BEAD, and we’d be excited to participate in that program. We agree with what LT said that it's probably going to take until 2024 until money starts flowing under that program. We've got to get through the mapping challenge first this year. Our companies are working hard with the FCC on that. The combination of A-CAM and BEAD really represents two important opportunities for continuing to provide higher quality broadband, likely through fiber, into the most rural areas of our serving territories. There are places where it doesn't make sense to take fiber all the way out; if there are opportunities for us to work with U.S. Cellular and partner to best serve those customers, we're certainly already talking about that.

Simon Flannery, Analyst

You talked about accelerating the fiber build this year. I think Lumen mentioned a higher cost to pass, going up to about $1,200. Have you got any color on what's kind of developing there? There are concerns about inflation and labor supply or that stuff, any color would be great?

Michelle Brukwicki, Senior Vice President of Finance and CFO of TDS Telecom

Yes. We are planning to keep scaling up and delivering more addresses in 2023. We're shooting for 175,000 service addresses under the program this year compared to the 133,000 that we delivered in 2022. Each year, we keep developing a nice increase in address delivery. So yes, we will keep accelerating the program. In terms of the actual cost of the build, that's already factored into our business cases. Over the last year, 18 months, we did start to see some of our contract RFP proposals come in with slightly higher costs. But we were diligent in working with those vendors to find opportunities where we can reduce some build costs in those markets. When you factor everything into the business case, that's why you’ll hear me talk about does the business case still hang together? Can we still achieve the low- to mid-double-digit returns that we’re targeting? Even with all of those cost factors adjusted in, we’re still getting those attractive returns out of those business cases. All of that is already factored into our guidance and our CapEx expectations.

Operator, Operator

Your next question comes from the line of Phil Cusick with JPMorgan.

Unidentified Analyst, Analyst

It's Jerome on for Phil. Congrats on the quarter. I was hoping to drill down into the solid low single-digit to mid single-digit ARPU growth we've seen on the postpaid business. Kind of what's driving your ability to grow ARPU despite the heavy promotional environment and pausing price hikes, etc.? And then as we look at 2023, how should investors think about ARPU growth moving forward?

Doug Chambers, Executive Vice President, CFO and Treasurer

With respect to ARPU growth, one thing that drove it during the year was moving customers up the stack. We started the year with 32% of our handsets on our top two tier plans and ended the year with 41% on the top two tier plans. A lot of that was driven by strong efforts by our sales team, but also promotional requirements that we had tied to our new and existing offers. That was really a tailwind for ARPU. We're doing much better in device protection revenue, the profitability of that product. We've been migrating customers to a new provider where we earn a better margin, as well as slightly increasing the penetration of that project. We also had some cost recoveries surcharges that went in at the beginning of 2022 that helped as well. All that led to the 4% increase. Looking to 2023, building ARPU is still a goal; that growth rate is not likely to sustain at that level. One reason is flat rate pricing. Obviously, we have a lower rate flat rate pricing. In exchange for that, we don’t support that with the same level of promotion. There's an offset there from a profitability standpoint. Flat rate pricing alone is a bit dilutive, but we're still focused on moving customers up the stack. Like I said, 41%. We have a long runway to sell our higher value plans, and we're optimistic about that. That’s an overview of how we think about 2023.

Unidentified Analyst, Analyst

Your next question comes from the line of Michael Rollins with Citi.

Michael Rollins, Analyst

I have two questions. First, regarding Slide 16, I'd like to understand more about the service revenue guidance indicating a slight decline. Can you elaborate on how roaming impacts this along with the core business, up-tiering opportunities, and the competitive landscape? Secondly, do you believe that U.S. Cellular can achieve positive growth in wireless service revenues over the next one to three years? I'll have one more question after this.

Doug Chambers, Executive Vice President, CFO and Treasurer

The service revenue guidance, yes, you hit on it. Roaming revenue has been declining, and it will continue to decline; that's impacting service revenue. But it's important to remember the reason for that is that we're driving rates down. There’s an offsetting impact on roaming expense, whereby roaming expenses are going down, and so from a profitability standpoint, it's slightly accretive this year, and we project as well into 2023 when you go down to the operating cash flow line. That's actually a positive. But on the revenue line alone, there is a decrease. The other thing with service revenue, we lost connections during 2022. There’s obviously a carryover impact of that into 2023 that's factored into the guidance. We're certainly offsetting that with some increased B&G revenue, particularly in IoT wholesale, as well as some tower revenue and some other areas. That’s all factored in as we ended up on service revenues, and over time, absolutely, our goal is to grow service revenue. That’s a key priority and starts with growing our base of connections. That’s a key motivator for implementing flat rate pricing and having a compelling one, two, and three, four line price point for our customers.

Michael Rollins, Analyst

And then looking at the investment opportunities that you've been describing in fiber and wireless. What are your latest thoughts on the opportunity to monetize the tower business or your wireless investments, and whatever term that would be in the debt interest with the operating strategy and for shareholders?

LT Therivel, President and CEO

It's something we can't consistently evaluate, right? We want to make sure that the assets that we have and the capabilities that we have can generate more value to us moving forward and put together than they can in isolation and sold. We continue to believe that this is the case. I'll use the towers as a good example, our tower portfolio drove double-digit revenue percentage growth year-over-year. We expect to see continued revenue growth in that portfolio. I mentioned earlier the co-location rates, just over 1.5 versus industry average 2.3. We’ve got a lot of growth on the tower side. Interestingly enough, and this is de minimis right now from a revenue perspective, but it gives you a sense about the opportunity here. The last quarter was the first time we actually sold not just access to the tower but also access to the shelter. We're discussing generator access; we're discussing backhaul access. Those are things that we can market to a potential tenant that our tower competitors cannot. The reason they can't is that they don’t operate a wireless network in conjunction with a tower portfolio. Having the assets together benefits the tower business and drives more growth in the tower business. Similarly, if I fast forward and take a look at the build on 5G and even getting to 6G, we talked about being in a good place with our network build and able to be a little more conservative with capital in the next year. In the long run, as you move 5G to 6G, what is 6G going to be? The standards are still being worked out, but you're talking at a high level about denser networks and more intelligence at the edge. If you have denser networks and more intelligence at the edge, it means you're going to need to be touching your towers a lot more. The fact that I don't have to beg permission and pay the notes to a tower landlord makes Mike's network costs lower. We continue to evaluate it. The question we ask ourselves every quarter to ensure we’re comfortable with the answer. We remain comfortable in the answer that those assets are better together and drive more growth together, which is revenue growth with cash flow growth as well.

Operator, Operator

Your next question will come from the line of Sergey Dluzhevskiy with GAMCO Investors.

Sergey Dluzhevskiy, Analyst

My first question is for LT on the fixed wireless side. As C-band spectrum becomes available and you start deployment, how do you plan to prioritize the fixed wireless build in terms of geographies or types of markets? And also, how are you thinking about the capacity needs for fixed wireless business versus core mobile business to make sure that you have sufficient capacity and the core mobile business doesn't suffer?

LT Therivel, President and CEO

The beautiful thing about that fixed wireless business is that with the exception of a few very targeted builds here and there, it's that, that business builds on the investments that we make to support our core mobility business. We have a few targeted builds where we have to look to increase capacity to support the needs of our fixed wireless customers, but that's very much on the margin. The bulk of that business is driven by the underlying investments made to support our mobility business, and what that means is that the revenues from that fixed wireless business generate really attractive margins and those attractive margins turn into attractive cash flows. Thus far, we have not seen meaningful capacity challenges driven by fixed wireless. We've been able to architect the network. Mike and team have done some creative things to ensure that we're in a good place from a capacity perspective. You mentioned the C-band deployment and the 3.45 deployment which will happen throughout 2023. That will add more capacity and enable us to serve and support those customers more effectively. We don’t see meaningful capacity challenges arising from this business. The build of the business will continue to be driven, and the prioritization of the business will continue to be driven by the core mobility business. That’s why we continue to be bullish about the economics. I referenced this when I talked about BEAD. If you were going to build a tower in rural America, and you were only going to subsidize that if you were only going to pay for that tower with fixed wireless customers, you’d need in the range of 200 to 250 customers within a 7-kilometer range of that tower. That’s pretty dense for rural America. It’s difficult to make the economics standalone on fixed wireless. The beautiful part is we don’t have to. We have a core mobility business that subsidizes it. The capacity and the capacity demand for that business worked out pretty nicely, and we expect that to continue since we also have the mid-band spectrum coming online.

Sergey Dluzhevskiy, Analyst

My second question is for Doug. You mentioned continued cost optimization efforts. U.S. Cellular’s margins continue to be under pressure for various reasons, part of it is competitive intensity in the market, and part of it is your counter-moves. All of that is putting pressure on margins. But what are some of the cost efficiency initiatives you have in place for 2023 and beyond that you think could provide a meaningful offset to some of those pressures? What are some of the larger buckets of cost savings you see over the next few years?

Doug Chambers, Executive Vice President, CFO and Treasurer

It's really across the business, Sergey. Every single area we're seeing, and we have a significant amount of savings built into our budget. Examples are: we've been driving backhaul costs down, sell-side rents; we have a program to drive those down. We saved quite a bit of money with our marketing media agencies over the past years, and we'll continue that in the future. With respect to network maintenance and software, we've renegotiated contracts with our vendors. If you look at the big buckets of spend, that’s where we're placing the main focus. But it’s really across the business that we’re driving savings, and we’ve been doing it through a formalized program since 2017, and we haven't stopped.

Sergey Dluzhevskiy, Analyst

My last question is for both LT and Michelle. Earlier this year at the investor conference, management mentioned that in 2023, U.S. Cellular and TDS Telecom will step up their collaboration efforts, including an MVNO relationship, you're selling each other's products, potentially applying for big funding, or just broadly government funding together. Could you provide more color on these initiatives as far as what you have already been doing in 2023? And what forms of collaboration or partnership do you see as the greatest value-creating opportunity for both companies over the medium term?

LT Therivel, President and CEO

Michelle, do you want to tackle that one?

Michelle Brukwicki, Senior Vice President of Finance and CFO of TDS Telecom

Yes, I can start, and LT, you can certainly feel free to jump in. We did mention a couple weeks ago, I guess, some collaboration efforts that we're doing together. On the MVNO front, TDS Telecom is working our way through all the details of how we can get an MVNO product launched, so that we can get wireless into our bundle of services to offer to customers. We hope to get that product launched sometime during 2023, hopefully by midyear. We certainly want to partner with U.S. Cellular where our territories overlap. However, our territories don't overlap perfectly. About 40% of our addresses can be covered by the U.S. Cellular wireless network. So we will have to supplement and partner with other wireless carriers as well. We are working through that process. We also mentioned earlier at one of the conferences, and we're still working on the ability to do some cross-selling; selling TDS Telecom broadband through U.S. Cellular retail stores in certain geographies. We're working through the details of that and seeing if that could be an uplift opportunity for both companies. We’ll probably start that in a small way, test that out, do some learnings, and then see if that could be expanded into anything bigger. As I mentioned earlier about the BEAD program, we don’t have all the state program details yet. Those are still coming. Once we get those, we’ll be more firm in our discussions with each other. But we've already started high-level discussions about how to partner in the most rural areas to reach customers in the most economical way possible through a combination of fiber and fixed wireless. I think those are the primary things that we’re doing and talking about together this year.

LT Therivel, President and CEO

No, I think you nailed it, Michelle. MVNO, co-selling, and BEAD are the three big opportunities. Thanks, everybody. It was good chatting with you. Colleen?

Colleen Thompson, Vice President, Corporate Relations

Okay, that was our last question. Thanks again to everyone for your time today. Again, please reach out to IR if you have any additional questions. Have a good weekend.

Operator, Operator

Ladies and gentlemen, that will conclude today's call. Thank you all for joining.