Frontier Communications Parent - Q2 2022

Transcript

Operator (participant)

Welcome to today's Frontier Communications Q2 2022 earnings call. My name is Jordan, and I'll be coordinating your call today. If you'd like to register a question, you may do so by pressing star followed by one on your telephone keypad. I'm now gonna hand over to Spencer Kurn, Senior Vice President of Investor Relations, to begin. Spencer, please go ahead.

Spencer Kurn (SVP of Investor Relations)

Good morning, and welcome to Frontier Communications' second quarter 2022 earnings call. This is Spencer Kurn, Frontier's Head of Investor Relations, and joining me on the call today is John Stratton, Executive Chairman of the Board, Nick Jeffery, President and Chief Executive Officer, and Scott Beasley, Chief Financial Officer. Today's presentation can be followed within the webcast and is available in the Events and Presentation section of our investor relations website. Let me now refer you to slide two, which contains our safe harbor disclaimer, and remind you that this conference call may include forward-looking statements that involve risks and uncertainties that may cause actual results to differ materially from those expressed today. In addition, during this call, we will refer to certain non-GAAP financial measures, which are defined and reconciled in our earnings presentation, press release, and trending schedule. With that, I'll turn the call over to John.

John Stratton (Executive Chairman of the Board)

Good morning, everyone, and thank you for joining today's discussion. Let me start with an updated snapshot of where our company is today on slide four. Frontier is well-positioned to win in key markets, and we continue to realize our unique opportunity to create significant shareholder value. Our footprint passes a total of 15 million locations across 25 states. 4.4 million of these locations are passed by our superior fiber optic network, and we plan to expand our fiber footprint to at least 10 million locations by 2025. Our reach continues to expand, and we now serve 2.8 million broadband customers across both consumer and commercial businesses. In the last 12 months, we've generated $6 billion of revenue and $2.2 billion of adjusted EBITDA, which represents a 37% adjusted EBITDA margin.

As we've said before, fiber is the future of Frontier. This is becoming our reality as fiber products alone generated $2.7 billion of our revenue and $1.1 billion of our EBITDA in the last 12 months. Fiber now represents the majority of customers and EBITDA, and we are relentlessly focused on investing to grow our fiber EBITDA rapidly. Slide five outlines our fundamental industry thesis that the significant growth in data consumption we've seen over the last two decades will only continue to ramp up, tripling over the next four years alone. We believe fiber is best positioned to meet this long-term demand for data consumption for several reasons. First, fiber is a vastly superior product to cable and wireless alternatives today. It provides faster download speeds, faster upload speeds, and significantly lower latency.

Second, the superior nature of fiber is magnified by the usage trends we see in real time. Our average fiber broadband customer consumes nearly 1 Tb of data per month, multiples of what cable and wireless customers consume. In an industry where data consumption is expected to triple over the next four years, we believe the market will naturally move towards fiber. Third, fiber networks have a clear low-cost path to delivering broadband speeds of up to 10 Gbps and beyond while requiring minimal additional capital investment. Fiber has the best economies of scale of any technology as data throughput and consumption continue to increase across networks. Lastly, fiber is America's future-proof infrastructure and the ideal recipient of government broadband stimulus.

We appreciate the NTIA's recent guidance on the deployment of federal infrastructure funds, which shifts the emphasis from instantly obsolete download and upload speed standards to a more technology-based approach with fiber-preferred network construction. We look forward to actively participating in federal and state subsidy programs to bring fiber to more Americans. Now turning to slide six for an update on Wave 3. As I mentioned at our Investor Day one year ago, we announced plans to rapidly build fiber to 10 million homes in our footprint, what we have designated as Waves 1 and 2, and we said we would assess the value of maximizing our remaining 5 million homes in our footprint, what we refer to as Wave 3. Over the past year, we've worked hard to execute and scale up our fiber build engine.

We've also increased our level of understanding and command of the fundamental levers of the business to a very detailed level, and this has led us to the conclusion that the return profile of Wave 3 is significantly higher than what we had initially modeled one year ago. More specifically, we've identified an additional 1 million-2 million+ locations that are attractive build candidates today without requiring broadband subsidies. This leaves 3 million-4 million remaining locations, which could also meet our return thresholds dependent upon the distribution of $42 billion in federal infrastructure funding over the next several years. Importantly, our recent capital raise affords us more time to curate our Wave 3 assets. We see an attractive runway for maintaining ownership of these locations and upgrading them to fiber, although we remain open to other strategic options.

It is a more attractive footprint and will remain laser-focused on maximizing its value. Turning to slide seven. ESG has always been a critical component of our mission to build Gigabit America, and publishing our inaugural report in June was an important step to share some of the initiatives that go hand in hand with our Fiber First transformation. On the environment, we recognize both our opportunity and responsibility to lead our sustainability in the industry and serve as stewards of the environment. Fiber uses less energy than competing technologies like cable. As we upgrade our copper network to fiber, we're simultaneously on a path to significantly reducing our greenhouse gas footprint. We've also launched Frontier Green initiatives to decrease energy consumption and reduce waste, including the order of our first ever electric vehicles. On social, valuing diversity, equity, and inclusion is core to our business.

This includes our commitment to creating a safe, healthy, and inclusive workplace in which our people can thrive, as well as investing in the communities where our employees live and work. On governance, we are committed to the highest standards. We lead with integrity through diverse board and executive team representation and have direct board oversight of our ESG initiatives. We've also implemented comprehensive compliance and ethics programs and built a pay-for-performance compensation philosophy into our executive compensation programs. I encourage you to read our report for more detail on how we're applying our ESG initiatives to align our business and practices with our values. We look forward to updating you on our progress. Now on slide eight. Our opportunity demands a relentless focus on our four levers of value creation, fiber deployment, fiber penetration, customer experience, and operational efficiency.

Nick and his team have been unwavering in their pursuit of these critical priorities, and we're pleased with the strong momentum we've been able to build in the business. I'll now turn the call over to Nick to review how we've performed in the second quarter. Nick.

Nick Jeffery (President and CEO)

Thanks, John. Our team executed extremely well against our strategic priorities in the second quarter, and here are just a few of the highlights. We built a record 281,000 new fiber connections and raised our 2022 build target to 1.1 million to 1.2 million locations. That's up 10%-20% from our original target of 1 million locations. Additionally, our fiber customer base continued to grow this quarter. We added 50,000 broadband customers in our consumer business and achieved another record quarter of customer additions in our SMB business. We're focused every day on improving our customer experience, and this quarter, our fiber NPS continues to increase. It remains up about 30 points year-over-year. Finally, we raised $1.2 billion of debt to fund our accelerated fiber build through mid-2024.

As you saw in our press release this morning, we're starting to see the success of our operational initiatives translate into financial growth. We achieved sequential EBITDA growth ahead of schedule this quarter and raised the midpoint of our 2022 EBITDA guidance. Scott will cover this in more detail later in the call. As we expected, our Fiber First strategy is transforming our company, and we've reached critical milestones on our path to returning Frontier to profitable growth. Let's review our progress. First, we began by scaling our fiber build in the second quarter of 2021, and we've consistently hit records in building fiber every quarter since. Then we scaled our sales organization, and in the third quarter of 2021, our team drove an inflection in fiber broadband net adds, and at that point, fiber EBITDA surpassed copper EBITDA.

Our acceleration of fiber net adds continued in the fourth quarter of last year, when for the first time in more than five years, fiber adds were greater than our copper declines. This resulted in total broadband customer growth. This quarter, the operational milestones we achieved and investments we made began to translate into our financial results, delivering healthy sequential EBITDA growth. To put this into perspective, Frontier has not produced sequential EBITDA growth of this magnitude since 2015. This progress gives me greater confidence in achieving our most critical milestone, sustaining year-over-year revenue and EBITDA growth in 2023. Now let's dive deeper into our strategic initiatives, beginning with fiber deployment. As I noted earlier, we've had another record quarter, passing 281,000 new locations with fiber.

I'm pleased with our team's strong execution in the face of a challenging supply chain and macroeconomic environment. It's complicated work, and our strong performance this quarter enables us to build faster than we originally planned. It also gave us the confidence to raise our 2022 fiber build target by 10%-20%. On slide 13, I want to highlight the foundational steps that Veronica Bloodworth, our Chief Network Officer, and her team have taken over the past year to give us this confidence. Firstly, we diversified the fiber build into six additional states and plan to be building in at least 12 states by the end of the year. This geographic diversity expands our opportunity to build fiber and provides redundancy for maintaining our build pace. Secondly, we're continually diversifying our supply chain with additional contracts for labor and equipment.

Thirdly, we're realizing cost efficiencies with route optimization, improved cluster density, and new construction techniques. This allows us to manage through inflation and labor challenges in order to meet our build and cost per passing targets. Finally, we've significantly improved our permitting process over the past year, which has helped accelerate our build. Our second strategic initiative is fiber penetration, where our strong momentum continued in the second quarter. As I mentioned earlier, we added 50,000 consumer fiber broadband customers, driving a 14% increase in our customer base to the same period last year. Although net adds declined modestly from 52,000 in the first quarter this year, it's important to recognize that our base fiber footprint fluctuates due to seasonal movement in Florida. We expect this seasonality to be a tailwind for the second half of the year.

Slide 15 takes a closer look at our fiber penetration in our base and expansion fiber markets. Our base fiber footprint is made up of 3.2 million homes that have had fiber for several years and are in mature markets. Penetration in this footprint increased 20 basis points sequentially to 42.6%, even with the seasonal headwinds in Florida. These results demonstrate that we're on the right path towards achieving our long-term target of 45% penetration. In our expansion footprint, our 2021 cohort reached 17% penetration at the 12-month mark. That's right in the middle of our 15%-20% range that we previously set out. We expect the 2021 cohort's penetration to rise in the second half of this year as the effects of our Q2 2021 initiatives start to show up in our results.

Lastly, our 2020 build cohort continues to exceed our expectations, reaching penetration of 44% at the 24-month mark, well above our target range of 25%-30%. Moving forward a slide, you can see we grew broadband ARPU 2% sequentially from a combination of structural price increases and improved mix with an increasing adoption of gigabit per second speeds. Customer demand for 1 Gbps+ speeds has been rising each year, and in the second quarter, between 45% and 50% of our new fiber customers chose 1 Gbps speeds or higher. Our 1 Gbps mix of new activations is significantly higher than the 1 Gbps mix of our entire customer base.

Since ARPU for customers on the 1 Gbps plan tends to be meaningfully higher than for sub-1 Gbps plans, we have the potential to grow ARPU as customers demand faster symmetrical speeds over time. Our third strategic initiative is improving the customer experience, which we measure through net promoter scores and churn, as you can see on slide 17. Our fiber NPS increased sequentially this quarter and remains up about 30 points year-over-year. Our brand NPS now ranks among the highest of all our major competitors. Broadband churn across both fiber and copper broadband customers also remains at the low end of historical ranges. This is primarily due to improving voluntary churn and in part due to lower move-related churn. Copper churn did rise slightly compared to the same period last year, largely because 2021's churn was artificially low due to COVID-related disconnect restrictions.

We're putting the customer at the center of everything we do, and I'm encouraged to see these improvements showing up in our NPS and churn data. On slide 18, you'll see the results of the improvements we're systematically making every week to digitize and improve our customer experience. We've deployed a suite of digital self-service tools and are excited about the work we're doing to roll out new capabilities like self-installation, a new mobile app, and all focused on making it easier and faster for customers to work with us. We're also using AI to improve dispatch logic, call center efficiency, and have exciting plans to use telematics, natural language processing, and a mobile tech portal to better support our customer-facing teammates. Lastly, I want to highlight the good momentum we're building in SMB. Over the last few quarters, we've made a series of improvements that have revitalized this business.

We're strengthening our product with a 2 Gbps offering and a new partnership with RingCentral. We've expanded our sales channel four-fold, adding a new CRM platform and established account management teams focused on cross and upselling opportunities. Together, these actions have resulted in another quarter of record net adds. We have a long runway with SMB, and I'm encouraged by our early process. Now before I turn over to Scott to walk you through our financial performance, I did just want to say thank you to our team. Turnarounds are really hard work, and I'm so grateful to the whole Frontier team for all the progress we've made together in building Gigabit America. With that, I'll now hand over to Scott. Scott, over to you.

Scott Beasley (CFO)

Thank you, Nick, and good morning, everyone. As I've done on the last several calls, I will reference pro forma figures that have been adjusted for fresh start accounting changes in order to more clearly describe the performance of our business versus previous periods. Turning to results on slide 21, second quarter revenue was $1.46 billion, an increase of $12 million sequentially. We earned $101 million of net income and $535 million of adjusted EBITDA. $292 million of our adjusted EBITDA came from fiber products. This was up 6% year-over-year due to strong consumer fiber broadband growth and cost savings initiatives. Additionally, we generated $229 million of net cash from operations, bringing the first half total to $757 million.

These healthy cash flow results demonstrate the underlying cash generation potential of our business, as well as our increased focus on liquidity and working capital management. The quarter's adjusted EBITDA was also helped by a one-time sales tax refund of $8 million. Moving to slide 22, our primary growth engine of consumer fiber broadband drove a sequential increase to consumer revenue in the quarter. Total revenue declined 9% versus last year's second quarter, primarily due to the expiration of CAF II revenue. Fiber revenue was up roughly 1% year-over-year and 2% sequentially as consumer revenue growth more than offset declines in business and wholesale. A few key points on our fiber revenue growth. Excluding video, fiber revenue grew 4% year-over-year, representing an acceleration from 3% growth last quarter.

Our consumer fiber broadband ARPU increased 2% sequentially, driven by underlying price increases and a higher 1 Gbps or above speed mix. Copper revenue declined 9% year-over-year, consistent with prior quarters as both consumer and business faced expected headwinds. Turning to slide 23, fiber EBITDA grew 6% year-over-year, an acceleration from 2% growth last quarter as strong consumer fiber broadband growth and margin improvements offset EBITDA headwinds from video products. It's clear that Frontier today is a Fiber First company. Fiber products represent 56% of our adjusted EBITDA and will increasingly drive the growth trajectory of the overall company. Slide 24 shows the $3.7 billion of liquidity to fund our fiber build. We ended the second quarter with roughly $3 billion of cash in short-term investments and $767 million of available revolver capacity.

In addition to this strong liquidity, we also have ample balance sheet flexibility. Our net leverage remained low at 2.8x at the end of the quarter, giving us healthy headroom under our net leverage target. Following our $1.2 billion debt raise in May, approximately 84% of our debt is now at fixed rates, and we do not have any significant maturities earlier than 2027. This capital structure and maturity timeline provide us a clear runway to continue accelerating our fiber build. Next, we'll move to capital allocation on slide 25. We made great strides on our business simplification initiatives this quarter. We continued to attack Fit for the Future cost savings, and through the end of Q2, we had realized roughly $200 million of gross annual cost savings.

This puts us about one year ahead of schedule and on track to exceed our initial goal of $250 million by the end of 2023. Additionally, the underlying cash flow generation of our business remained strong. We generated $757 million of cash from operations in the first half of the year, which we invested in our high return fiber build. Slide 27 describes our strong positioning in the current macroeconomic environment. The services we provide are critical to our customers, and we offer a wide range of products and services to meet specific needs, including the government's Affordable Connectivity Program. The customer payment metrics that we track closely, like days sales outstanding and bad debt, continue to be healthy. Both measures improved versus the second quarter of 2021.

While we see pockets of inflationary pressure in our fiber build, we are still confident in our $900-$1,000 cost per location. We have multi-year agreements in place with key labor and material suppliers and are continually finding ways to become more efficient in our supply chain and construction techniques. Finally, as I noted before, our capital structure is well insulated from rising interest rates with 84% of our debt at fixed rates and no significant maturities until 2027. Turning to slide 27, we are updating our guidance to reflect our improved position at the halfway point of the year. We now expect capital expenditures of $2.5 billion-$2.6 billion, reflecting our accelerated build of 1.1 million-1.2 million fiber locations.

Finally, due to the acceleration of our consumer revenue growth and cost savings initiatives, we are raising the midpoint of EBITDA guidance and tightening our range. Our new range is $2.05 billion-$2.15 billion. We remain on track to deliver a sustainable EBITDA inflection by the end of the year and year-over-year revenue and EBITDA growth in 2023. I'll close today's remarks by reiterating Frontier's investment thesis. First, there is strong and growing demand for fiber, driven by expanding household data consumption. Second, fiber is a superior product for a number of reasons, including symmetrical upload and download speeds that far exceed cable's capability, a lower cost of ownership driven by fiber's passive technology, and lower latency levels that enable critical uses like video conferencing and telemedicine. Third, we have a clear strategy and purpose at Frontier.

We are building Gigabit America to connect Americans to the digital economy. Fourth, we have ample liquidity and a strong balance sheet, providing us with access to capital to fund our strategy. Last, I'm proud to be part of a strong and experienced leadership team. We have executed well for four straight quarters and are excited to continue building on this operational and financial momentum. I'll now turn the call back over to Spencer to open up the line for questions.

Spencer Kurn (SVP of Investor Relations)

Thanks, Scott. Operator, we're now ready for Q&A.

Operator (participant)

Thank you. As a reminder, if you'd like to register a question, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two, and please ensure you're unmuted when speaking. Our first question comes from Brett Feldman of Goldman Sachs. Brett, please go ahead.

Brett Feldman (Managing Director)

Yeah, thanks for taking the question and great to see the EBITDA result in the quarter. You know, if we look at your updated EBITDA guidance, it implies at the midpoint that your EBITDA in the second half of the year would be reasonably comparable to what you did in the first half. So I was just hoping you could maybe walk us through some of the puts and takes, including maybe any seasonal factors that we should be taking into consideration. And then it sounds like you are increasingly constructive on the opportunity to develop some of the passings in your Wave 3 footprint. I think you identified 1 million-2 million during your prepared that you could do without subsidy.

I'm curious, is that now officially part of the business plan, or would you still need to do some additional work to kind of pull that in, into Wave 2? Just the last question here, if you can indulge me a little bit. You know, the cable companies have clearly been impacted by rising competition from you and from others, and I'm just curious what level of competitive response you're starting to see, if any, from those operators? Thanks.

Scott Beasley (CFO)

Yeah, sure, Brett. This is Scott. Let me take the first question, then pass to John for the second, then Nick for the third. First question on kind of first half versus second half. Coming into the year, we knew that the most important financial milestone would be an EBITDA inflection by Q4, and we're still very confident in that. If we look at the first half, we outperformed our own expectations, driven by a few factors. One, we had consumer outperformance. Two, the cost reduction program was ahead of plan. Three, we had the one-time sales tax benefit. And then four, we executed extremely well in Q2 in a really solid quarter of execution.

That first half outperformance led us to raise the midpoint of our guidance from $2.075 billion-$2.1 billion, and we're still confident in that sustained inflection for Q4. Q3 is the highest energy cost quarter of the year just due to seasonality trends, so that'll be a bit of a headwind, but we're highly confident that the Q4 will be that sustained inflection point heading into year-over-year revenue and EBITDA growth in 2023.

John Stratton (Executive Chairman of the Board)

Yeah. Hey, Brett. Good morning. It's John. I'll take the second question. We'll go round robin here. I'll take the second question on Wave 3. Yeah, as we declared, you know, sort of more specifically here, this extra 1 million-2 million households looks very solid. You know, we've gotten a bit sharper here in terms of our methods and process and efficiency with which we build. We have a pretty high level of clarity on how best to generate demand against the build, and to ensure we're attaining proper returns. As we look ahead, what we expect to see happen is this. First, you know, the pace of our build is something that we are accelerating still.

You saw us bring it up to 1.1 million, 1.2 million. You know, we've talked about a significant uplift from that next year in the drive to the 10 million by 2025. You may see some of those Wave 3 properties filtering into a sooner period, but the overall pace of the build will remain as we've described so far. This 1.6 million roughly for next year is where we'll sit, and then we'll see if there's an opportunity to go further. The financing piece of this is something that we continue to work, as we think about this, there's a combination of opportunities. Because of the raise we did a few months ago, it allows us now to have pushed out the goalposts in terms of demand for capital.

This actually is super important to Wave 3, because one of the things that we want to make sure we're doing really well is preparing the business and then moving and working with the regulators, federal, state, local, municipal officials to ensure our participation in the subsidy programs. This $42 billion in subsidy for building out broadband networks is something that we're successfully engaging. With this additional time here in the Wave 3, it will allow us a chance to even pull further into that total of 5 million households. You should expect a combination as we go out. You know, if we do this organically, it'd be a combination of government subsidy, pulling cash from operations, non-recurring and recurring cash savings, and then lastly, debt if we chose to go there.

Stay tuned. We have more work to do in terms of curating those assets. We'll be updating, you know, sort of as we go. Nick, do you want to take the piece on competition?

Nick Jeffery (President and CEO)

Thanks, John. Yeah, just to repeat the reaction that we're seeing or not from our cable competitors. I think it's clear to see from recent results that as we've always said, fiber is a superior product to cable. While the cable and fiber market remains competitive, it's also worth reminding ourselves that in our specific footprint, we have 84% of that where we have one or fewer competitors today. That said, in this quarter, we gained share against every competitor in every geography we operate in, and that's the second quarter where external data suggests that that's true.

I think if we sort of take a step back, it's very clear that customers do want fiber. It's a superior product. We continue to make it better with better service, faster speeds. Of course, in its nature, it's symmetrical and therefore that offers a lot of benefit to customers, particularly in this continued era of home working. Now, when I think about the reaction that cable might have. Of course, cable has a long history of pricing practices that customers really don't like. You know, promo prices that then get jacked up later on in the customer journey. We won't do that to be very clear. We will remain a rational pricing player and focus all our energies on providing the best value and the best product.

We see customers reacting to that, hence the results we have today. Now, of course, occasionally, we will use promotional pricing in targeted geographies because we need to remain relevant to our customers in all the markets in which we compete in, both geographically and demographically. That is always going to be within the framework of rational pricing discipline and transparency and predictability for our customers.

Brett Feldman (Managing Director)

Thank you.

Operator (participant)

Our next question comes from Phil.

Spencer Kurn (SVP of Investor Relations)

Operator, we'll take the next question, please.

Operator (participant)

Our next question comes from Philip Cusick of J.P. Morgan. Phil, the line is yours.

Philip Cusick (Managing Director)

I understand. I'm up. Thanks, guys. A follow-up on Wave 3. Does it look like no longer any outside equity capital to come in on Wave 3? It sounds like you had looked at that in a bunch of different ways over the last year. Is that now dead? Second of all, I understand the seasonal fiber headwinds and from Florida completely, but the copper departures really accelerated this quarter. Were those from seasonal areas, or is that more widespread, and could that be blamed on fixed wireless competition? We've seen copper acceleration departures at almost every company this quarter. Thanks very much.

Scott Beasley (CFO)

Hey, Phil, this is Scott. Let me take the first one, and I'll pass to Nick for the second one. Yeah, on Wave 3, the big point today is to show that, A, we think it is worth more than we thought it was at emergence, and then B, give you guys a specific dimensionalization. We think there's 1 million-2 million incremental homes to pass there that are, they're gonna be positive to fiberize. In terms of funding, we're you know, we have a range of options. We John talked about it. We think the business will be able to take on additional leverage as we continue to transform it into a much more fiber-centric company. We could pursue partnership or JV options.

Government subsidies will likely be in the mix for a portion of that. We have a solid range of options there that we'll work through. Importantly, the capital raise that we did buys us time there to continue transforming the business and figure out the best way to go build Wave 3.

Nick Jeffery (President and CEO)

Yeah. Phil, it's Nick here.

Philip Cusick (Managing Director)

Yeah. Sorry.

Nick Jeffery (President and CEO)

Phil, sorry.

Philip Cusick (Managing Director)

I was just gonna say that on that, I didn't hear raising outside equity as one of the options, and I know that's one of the things that has been looked at in the past. It sounds like that's not gonna happen.

John Stratton (Executive Chairman of the Board)

Yeah. Listen, I think we hold our powder dry on this. You know, Phil, as we said, we've kinda come through the period. What I can say declaratively is that, you know, when we first started looking at this last 5 million, it was kind of marginal across the whole expanse, and you'd see pockets where you'd say, "All right. I could build this out in this small pocket or that," but it didn't scale. The notion of kind of holding it aside as we announced Wave 2 and very affirmatively declared the first 10 million total households, that made sense for us to work it a bit more. Now, with what we've been able to build and determine, it is really clear that that 1 million-2 million homes, you know, must be built.

I mean, it is very, very clear and very compelling financially. You know, our bias is to do that organically. If there was a really interesting proposal for us to do with some level of outside equity, might we consider a JV structure or something like that? We'll look at it. This is no longer kind of hanging back. We now are pretty encouraged that this is gonna make very nice economic sense, great returns. Then the means by which we'll be funded, as Scott described, we have, you know, several different options. You know, the timeframes here, as we talk about government subsidies, it's quite a process. I mean, there are like thousands with an S at the end, thousands of applications that need to be pulled together across the very many jurisdictions.

The methodologies are different in every state, and there is a significant flush of funding that will come through principally sort of middle to second half of 2023 in a material way that will be right sort of in the heart of these territories that we're describing. More work to do in terms of the specifics of how it gets done, but I think the takeaway from this is 1 million-2 million, you know, sort of very reliably can, will, and should be built. Then the balance of that, the other three, will largely depend on sort of those external factors, principally subsidization.

Nick Jeffery (President and CEO)

Yeah. Phil, Nick here.

Philip Cusick (Managing Director)

Nick, sorry. Yeah.

Nick Jeffery (President and CEO)

I'll pick up the question on FWA and its impact on copper churn. Just on FWA, first of all, we've said on previous calls, of course, it's gonna exist. We expect at some point it will begin to nibble at the edges of our copper base, perhaps more in rural areas and so on. But also we have very serious questions about how far fixed wireless access can scale, whether it's actually for the fixed wireless operators an efficient use of capital and spectrum, and indeed, over time, as usage grows, whether those customers will remain profitable or not. I think those are less questions for us, more questions for the industry.

Of course, fixed wireless access is a very fundamentally different proposition to our core fiber proposition, so we don't see it really overlapping in that area. If we take a step back and just dig a little deeper into copper churn, the year-over-year increase in churn we saw was mostly, in fact, driven by a 12 basis point increase in non-pay churn. Of course, this year we've been able to disconnect non-paying or lower quality customers, whereas during COVID, we couldn't. Now, if you look at voluntary churn, it actually declined 6 basis points year-over-year, which is really an encouraging sign that many of the changes we're making every single week to improve our customer experience, customer communications, customer engagement and so on, is leading to better retention.

While we do of course see high levels of broadband net adds from the fixed wireless players, we're actually not seeing a significant impact in our copper base.

Philip Cusick (Managing Director)

Thanks, guys.

Spencer Kurn (SVP of Investor Relations)

Thanks, Phil. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Gregory Williams of Cowen. Greg, the line is yours.

Gregory Williams (Senior Analyst)

Great, thanks. Another question on Wave 3 here, and that 1 million-2 million builds. John, you noted you may trickle them in over, on top of the wave, Wave 2 builds. Does it behoove you not to build as fast as possible on those 1 million-2 million homes? 'Cause if they are attractive and you're seeing an influx of PE and infrastructure capital in the space, you know, there could be some encroachment on fiber to the home in your areas. Maybe that's my second question is, are you seeing any encroachment as a third provider in your footprint? Thanks.

John Stratton (Executive Chairman of the Board)

Yeah. Great. Thank you. I think that, you know, to your second question first, it's a really difficult time to be an overbuilder. I mean, if I think about, like, lifelong ambitions, one of them would not be to be in that position right now. I think it's gotten really hard for those guys. You know, access, availability and cost of capital is really, really problematic, I think, for many of them. I think we've seen that in terms of a lessening of a presence. You know, it has not been a factor that we've seen in any meaningful way across our footprint. Candidly, I'm a little surprised that that's the case.

I'm less surprised now because it's gotten harder, but even before, the markets tightened up a bit, you know, we weren't really seeing a significant level of presence. We watched this pretty closely in terms of permitting applications and the like. That still remains at a pretty low level. Regarding acceleration, I should probably. You know, there's two sides to this. One is what is financially viable? Where do we see great return opportunities? The other side is how fast can we build? You know, like, what is the capacity of the organization to build? We are jamming on that side. Veronica Bloodworth and her team are cranking the build significantly.

When Scott and Nick describe a 10%-20% increase in our build for this year, and then carrying forward with another really significant increase in next year's build, you know, this is kind of hair on fire, run as fast as you can, get it done, kind of orientation that the build team brings to the game here. Look, we're gonna, in every case, look to accelerate the build where we can, doing it well, you know, with the right kind of approach in all jurisdictions. I would tell you that we have more work to do here to see how much further and faster we can go with regards to specifically that 1 million or 2 million in Wave 3. You know, we'll inform that as we go forward.

You'll hear us sort of adjusting our targets as we go to encompass more and more of that opportunity set.

Gregory Williams (Senior Analyst)

Got it. Thanks for the color.

John Stratton (Executive Chairman of the Board)

Okay.

Spencer Kurn (SVP of Investor Relations)

Thanks, Greg. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Vikash Harlalka of New Street Research. Vikash, please go ahead.

Vikash Harlalka (Equity Research Analyst)

Hi, this is Vikash Harlalka for Jonathan Chaplin. Thanks for taking the question. Two, if I could. First, you have more insight into returns that give you confidence in deploying 1 million-2 million homes within Wave 3. What does this mean for returns in Wave 2? Is the expected return still mid-teens or higher? And if it's higher, is it because expectations for penetration are up, or cost to deploy are down, or is it something else? Second, there are stories that Suddenlink may sell to private equity at a value of close to $5,000 per line. If private equity players are willing to pay that for broadband infrastructure, would it make sense to consider a sale of some of your Wave 1 assets? Thank you.

Scott Beasley (CFO)

Yeah, sure. Thanks, Vikash. This is Scott. Let me take both of those. On your first question on Wave 3 modeling, I'd say that the detailed modeling we did on wave three fortifies our conviction around our mid- to high-teens IRR on wave two gives us increased confidence in our $900-$1,000 cost per passing, increased confidence in our penetration and ARPU assumptions that we've met or exceeded in the past four quarters. Again, the first priority will be completing wave two and our wave three analysis gives us even more conviction around Wave 2.

On your second question about different potential transactions in the market, I'd say at our Investor Day last year, we showed a view of valuation that fiber passing should be valued at between $3,000 and $4,000 per passing, at least. If there are data points in the market that would suggest other assets out there worth $5,000 per passing, I think that only strengthens our conviction that $3,000-$4,000 is reasonable, maybe even conservative, and then gives us increasing confidence to accelerate the build, convert copper to fiber as rapidly as we can.

Vikash Harlalka (Equity Research Analyst)

Thank you.

Spencer Kurn (SVP of Investor Relations)

Thanks, Vikash. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Frank Louthan of Raymond James. Frank, please go ahead.

Frank Louthan (Managing Director)

Great. Thank you. Looking at the resi subs, can you give us an idea of what percentage of those subscribers you're getting from some of your newer builds versus the legacy California, Texas, Florida markets where you're winning back customers and cutting down churn? Thanks.

Scott Beasley (CFO)

Yeah, sure. This is Scott, Frank. If you note in the presentation, we show base fiber penetration and expansion fiber penetration, and we've really had great success in both. Base fiber penetration has crept up into the mid-42% and has been a nice tailwind for our overall customer growth. Expansion has become an even bigger part of that as we layer more builds into the expansion markets. You know, we've always kind of described base will be the baseline from which we grow, then we'll layer on more and more expansion adds per quarter, and that's really what's showed up in Q2, which is typically a seasonally slow quarter given our Florida footprint, and still we were able to manage very healthy growth.

Frank Louthan (Managing Director)

All right, great. I apologize if you mentioned this earlier, but did you take up any of your bad debt reserves? Can you compare where you're running bad debt today versus in 2019?

Scott Beasley (CFO)

Yeah. You know, it's really a question around the financial health of the customer, and it's something we keep a close eye on, particularly in this challenging macroeconomic environment, and we have not seen an impact on payments. I said in the prepared remarks that our day sales outstanding and bad debt expense were actually better at the end of Q2 this year than they were at the end of Q2 last year. Part of that is due to operational improvements we've made. We've incentivized people to get on auto pay, which helps reduce bad debt expense and reduce day sales outstanding. Part of it is our customer base has remained healthy.

Frank Louthan (Managing Director)

All right, great. Thank you.

Spencer Kurn (SVP of Investor Relations)

Thanks, Frank. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Nick Del Deo of MoffettNathanson. Nick, please go ahead.

Nick Del Deo (Managing Director)

Hey, good morning. You know, first, just to expand on some of the preceding questions, you know, on the 1 million-2 million Wave 3 homes you now say look appealing. Yeah, how would you characterize the return profile in those locations? You know, are they comparable to Wave 2, or are they a notch lower? You know, it might be hard to generalize, but are these typically locations that are, you know, part of Wave 1 and Wave 2 geographic clusters, or are they new cities that you would be hitting on if you go down this route?

Scott Beasley (CFO)

Yeah, Nick, thanks for the question. Let me answer the second part first. The 1 million-2 million are really a combination of two things. One, it's incremental locations in the states where we're already building rapidly. California, Texas, Florida, Connecticut are examples where as we've refined our construction estimates and also our penetration estimates, now those become economic to build. We're excited to do that because of all the advantages of adjacency with marketing and operations. The 1 million-2 million also includes some states where we don't have as much scale in our base, but we still have very attractive copper assets that can be converted to fiber, because of the cost and the customer dynamics there. It's a bit of both.

In terms of the overall return profile, it's lower than Wave 2 just by virtue of some of the higher cost per passing, but it's still attractive. I'd call it mid-teens versus mid to high teens. We'll continue to get better at construction. I think we'll get better at penetration, and we're excited to eventually reach those with fiber.

Nick Del Deo (Managing Director)

Okay. Understood. A question on copper ARPU, you know, which jumped pretty noticeably, you know, versus Q1. I think it was up about 2.5% sequentially. You know, to what degree is that a function of, you know, non-paying customers churning out, you know, versus a like for like increase? Maybe more generally, you know, just talk a bit about, you know, how you think about the trade-off between pushing price on legacy broadband versus, you know, keeping price down a bit to try to hang on to subscribers for longer.

Scott Beasley (CFO)

Yeah. Nick, this is Scott too. Most of the copper ARPU growth was driven by price increases. We have just normal price increases built into the relationship with customers, and so that was most of the ARPU growth. You know, a lot of that was passing on inflationary pressures as our input costs went up of fuel, electricity, and other things. Your second question of what's the right trade-off between pricing. As Nick mentioned, most of the increase in churn in copper was driven by non-pay disconnects that weren't allowed last year.

We haven't seen price increases drive a big increase in churn because I think in general customers understand that input prices have gone up across the economy and the cost to serve them is higher.

Nick Jeffery (President and CEO)

Yeah. Scott, if I can just build on that and again, take a step back on pricing. I mean, look, we do fundamentally believe we have the winning product in the market here. We have a superior product. It's a better product than cable. And we believe that the price that that product should command over time should also be superior because we're not comparing apples with apples here. We're comparing, you know, a horse with a car. They're fundamentally different things that should command different prices in the market. Now, of course, we also recognize that in Frontier's case, we're rebuilding the company as it comes out of chapter 11. We're improving our customer offer, we're making ourselves easier to deal with, building a stronger brand and so on.

Over time, those things should lead to a greater bifurcation of our price compared to kind of the legacy cable offers in the market.

Nick Del Deo (Managing Director)

Okay, great. Thank you.

Spencer Kurn (SVP of Investor Relations)

Thanks, Nick. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Simon Flannery of Morgan Stanley. Simon, please go ahead.

Simon Flannery (Managing Director)

Great. Thank you. Good morning. Staying on the ARPU topic, you had nice fiber ARPU improvement. I think you've said in the past, you expected the growth to accelerate in the second half as you lapped some of the promotions from last year. Could you just update us on what we should be expecting to see there and have you changed your expectations on gig mix going forward? We've talked about SMB a little bit. Haven't really touched on enterprise. Any updates on what you're seeing there? Some of your peers talked about slower decision-making. Any macro impacts on that side of your business? Thanks.

Scott Beasley (CFO)

Sure, Simon. This is Scott. Let me take the first one, and I'll pass to Nick for the second one. ARPU, our expectation is still the same, that we'll have 3%-4% year-over-year ARPU growth from the end of 2021 till 2022. We did have the mid-year headwinds related to the auto pay discount and promotional gift card pricing, but we seem to have lapped most of that in Q2. It'll get a little easier in Q3 and Q4, because those were in place in the second half of last year. That's one dynamic. The other dynamic is we are seeing a healthy increase in the percentage of our customers who take our gig or above service.

As we continue to build our expansion customer base, and they're increasingly taking it, and we showed today in the slides between 45% and 50% of those customers are taking a gig or above, that will drive an increase in our underlying ARPU.

Nick Jeffery (President and CEO)

Yeah. Thanks, Scott. Just on the enterprise question. If we kind of take a step back and reflect on progress over the last year and a half or whatever. One of the things that I am very determined to drive in this company is focus. We've really been disciplined, I think, on this, starting with the build and firing up the whole build machine, which is now working on all cylinders and accelerating as per our increased guidance. Service, which you've seen begin to flow through into improved NPS scores and a lot of work still to do there, but that's now going. This quarter, you see, that flowing through in consumer, where we see sequential consumer revenue growth.

I'm very pleased with the early progress we're seeing now on SMB, which we called out early on as a natural area of focus for us, and where we went through the same process of reevaluating our pricing, you know, improving our go-to-market, improving our customer offers and so on, and that's now flowing through into growth as well. I think when we think about the next kind of engines of growth, you think about enterprise and wholesale. Your question was on enterprise, so let's just call that out. I mean, firstly, I remain very confident in our ability to hit our targets for this year for kind of fiber business and wholesale. We actually saw some early signs of stability this quarter with revenue trends roughly flat sequentially.

We can't get away from the fact that we are exposed to the kind of secular shift in enterprise customers from legacy services to more modern ones. I want to call out that our business differs very materially from, you know, the results that, you know, AT&T and Verizon and Lumen have recently shared. We're actually in the enterprise market, a very small part of the overall industry. In a way, we are insulated from macro industry trends because we're not the industry, we're a small part of it. We're also much less exposed to large enterprise accounts than some of our competitors. We all know that those large enterprise accounts have complicated needs on footprint, off footprint economics.

They're very demanding in the way that they buy, and they're very expert in the services that they want to buy from operators like us, and so they have strong bargaining power. We have far fewer of those customers than our competitors. Now, if we look at our own revenue mix, the enterprise segment's about 15% of our revenue. It's also true it's been undermanaged for many, many years, and I think there's a lot of potential to improve our performance in that segment. I'm super excited. We've got new leadership starting later this month, in fact, that I think is gonna revitalize our efforts in this market and I hope turn it into an engine of growth over time, just as we've done in consumer, as we're starting to do in SMB.

Simon Flannery (Managing Director)

All right. Thanks, Nick.

Spencer Kurn (SVP of Investor Relations)

Thanks, Simon. Operator, we'll take our next question, please.

Operator (participant)

Our next question comes from Anthony Nemoto of Citi. Anthony, the line is yours.

Anthony Nemoto (Equity Research Analyst)

Great. Thanks for taking the questions. You're continuing to run ahead of targets for the cost savings program. Any update on how we should think about how much is reinvested versus falling to the bottom line? Could you unpack how much of your fiber gross adds came from your own DSL conversions? Thank you.

Scott Beasley (CFO)

Anthony, this is Scott. On cost savings, I think the key message is we're about a year ahead of plan. We expected to be able to take out $250 million of cost savings by the end of 2023. We've already taken out $200 million, so we expect to be at that $250 million number by the end of this year, and then hopefully find additional savings as we continue to be very focused on being more efficient, doing fewer things, digitizing and automating, and then making structural improvements to the business. The part of how much of that is reinvested versus falls to the bottom line, most of it is falling to the bottom line now. We are being selective in reinvesting it in some of these digitization opportunities.

We're investing in a number of things to improve the customer experience, but most of it will fall to the bottom line and that's one of the things that drove our EBITDA growth in Q2 significantly ahead of the plan that we had set out. On your second question-

Nick Jeffery (President and CEO)

Scott, so Nick, can I just build on that, the first part of that question? I wanna be really clear for everyone on the call that while we're making fantastic progress on becoming more efficient and taking cost out, we are not taking cost out across the whole of the business. Very important point. What we are doing is doubling down on investing and improving the key areas of our strategy. Improved customer service, improved automation, improved customer offers, improved marketing, stronger brand. We are doubling down in those areas. What we're being ruthless about is stopping everything else. Strong execution, strong investment behind our strategy, ultra efficient everywhere else.

I think that's hopefully something that creates value for our customers and our shareholders and stops us falling into the cost out traps that we've seen elsewhere in the industry. Scott, thank you.

Scott Beasley (CFO)

Yeah. Anthony, on your second question on gross adds, the vast majority of our gross adds are still coming from new customers, so our copper to fiber migrators are a healthy portion, but the vast majority are new to Frontier.

Anthony Nemoto (Equity Research Analyst)

Got it. Thanks.

Spencer Kurn (SVP of Investor Relations)

Thanks, Anthony. Operator, we have time for one more question, so, we'll take our final question now.

Operator (participant)

Our final question comes from Matthew Harrigan of Benchmark. Matthew, please go ahead.

Matthew Harrigan (Equity Research Analyst)

Thank you. Continuing on the cost theme, it feels like almost whatever happens with inflation, you're gonna get some labor cost escalation given everything happening with demographics. Does that tweak your long-term margin, you know, potential? Something like NLP, I know you don't want to talk too much about that, but I mean, that was fairly dysfunctional for a long, long time, and now it actually works decently well. I mean, do you think you'll be able to use things like that to offset what's likely to be a continued upward trend in labor? Thank you.

Scott Beasley (CFO)

Yeah. Matthew, this is Scott. Let me start on that. The answer is yes, we do see some labor cost inflation and that is really highlighting the need to automate and make sure we're being as efficient as possible. You know, the whole U.S. workforce faces a wave of retirements in the next several years that will likely make it harder to find people and wage inflation will go up. We are investing now to automate as many processes as we can so that our people can be focused on the most high value-added activities.

Some of the customer service opportunities where we wanna make it easier for customers to self-serve, so they don't have to call and talk to somebody, make it easier for our technicians to do their job with AI routing and telematics versus having to call somebody individually to figure out the next place to be dispatched to. Really across our operation, we are looking at ways to automate and become more efficient.

John Stratton (Executive Chairman of the Board)

Yeah. Just I'll add to the end. I mean, listen, I think Nick said it. This is a journey and you know where we are right now. I think as Nick and I talk about the business, there is a notion a year ago when we came in and said, "Okay, this business has been in bankruptcy. They've probably you know stripped this thing down to the bare walls." Not the case. There's tremendous opportunity for us to improve the efficiency and effectiveness of our work because much of it requires investment in the manner that Nick described. In those areas that are really important to us, we're plowing those dollars back into the business to ensure we can automate, digitize, and improve the efficiency and effectiveness of our delivery.

You know, we as we look down the road here, it gets hard for a business when you run out of ideas, when you run out of ways to sort of turn it up and to the right, and we are not at all in that place. This remains sort of a target-rich environment of things that we can do to improve the way we deliver service, and the efficiency with which it's done. We are less concerned about those kinds of factors creating the long-term pressure on the business as we are just simple execution, just focusing on the fundamentals here. I think that's a

Matthew Harrigan (Equity Research Analyst)

Thank you.

John Stratton (Executive Chairman of the Board)

That wraps this up. Yeah.

Spencer Kurn (SVP of Investor Relations)

Yep. Thanks, Matt. That concludes our second quarter 2022 earnings call. Thanks everyone for joining us.

Operator (participant)

This concludes today's call. Thank you for joining. You may now disconnect your line.