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Edited Transcript of ALSK earnings conference call or presentation 4-May-17 7:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Alaska Communications Systems Group Inc Earnings Call

Anchorage May 11, 2017 (Thomson StreetEvents) -- Edited Transcript of Alaska Communications Systems Group Inc earnings conference call or presentation Thursday, May 4, 2017 at 7:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anand Vadapalli

Alaska Communications Systems Group, Inc. - CEO, President and Director

* Laurie M. Butcher

Alaska Communications Systems Group, Inc. - SVP of Finance

* Leonard A. Steinberg

Alaska Communications Systems Group, Inc. - SVP of Legal, Regulatory & Government Affairs and Corporate Secretary

* Tiffany Smith

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Conference Call Participants

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* Barry Michael Sine

Drexel Hamilton, LLC, Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good day, everyone, and welcome to Alaska Communications Systems First Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Tiffany Smith, Manager, Investor Relations. Please go ahead, ma'am.

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Tiffany Smith, [2]

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Thank you. Welcome to the Alaska Communications First Quarter 2017 Conference Call. I'm Tiffany Smith, Manager of Investor and Board Relations. With me today are Anand Vadapalli, President and Chief Executive Officer; Laurie Butcher, Senior Vice President of Finance; and Leonard Steinberg, General Counsel.

During this call, we'll be using a slide deck that we'd encourage everyone to have available. For those listening to this call via the webcast, the presentation will be presented on your screen. For others, you can go to our investor website, www.alsk.com, click on the Events section, go to the First Quarter 2017 Earnings Call event and click on the PDF version of the presentation. We will indicate which slide we are on, so you can track the presentation material throughout the call. Now as we get started, please review Slide 3 for our safe harbor statement.

During this call, company participants will make forward-looking statements as defined under U.S. securities laws. Forward-looking statements are statements that are not historical facts and may include financial projections, estimates of shareholder returns or other descriptions of the company's business plans, objectives, expectations or intentions. You are cautioned not to put undue reliance on forward-looking statements as actual results could differ materially from expectations as a result of a variety of factors, many of which are outside the company's control. Additionally, any non-GAAP measurements referred to during this call have been reconciled to their nearest GAAP measure. You can find these reconciliations in the appendix to our presentation and on our website. Following our remarks, we will open the line for questions.

With that, I would like to turn the call over to Anand. Anand?

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [3]

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Thank you, Tiffany. Good day, and thank you for joining us. Starting with Slide 5. We are making steady progress to our business plan. Our key operating metrics grew on all fronts, driven primarily by our performance in total broadband, which grew 11% on a year-over-year basis. We made solid progress enhancing our capabilities to drive future differentiation and growth. Our net partner, Quintillion, turned up their [dead horse] to Fairbanks Fiber link in April, providing a much needed extension of our ConocoPhillips fiber assets all the way to our network in Fairbanks. I'm very pleased with the progress we are making on our managed IT services partnerships, in particular with Microsoft, where we are enhancing our cloud solution capabilities, establishing Alaska Communications as the cloud enablement partner for Alaska businesses. While Laurie will cover further details, we achieved a major milestone in wrapping up our refinancing process when we repurchased 89% of our convertible notes that mature next year. All of this work has mitigated the debt maturity overhang on our equity while allowing management to focus on driving market performance.

Moving on to Slide 6. I'll conclude this section of my remarks by providing additional colors on our market opportunity and performance. I characterize our longer-term growth opportunity in 3 broad areas: one, growing with the market as organizations consume more broadband in pursuit of cloud strategy; two, continuing to take share; and three, increasing our share of wallet with a focus on managed IT services. This slide provides customer examples from the recent months that illustrate each of these 3 growth drivers.

Our relationship with the leading national carrier is strong and is reflected in our continued expansion of services with the carriers. The relationship growth is based on the quality of our sales and service teams and our ability to meet future needs of the customers.

We continue to take share with some key customer opportunities, as illustrated by our recent win with an Alaska native corporation in one of our new Arctic fiber markets that have been enabled by our Quintillion partnership. Our wins are based on solution design and sales relationship, and we expect to drive further results in these geographic markets over the next several years.

Lastly, I'm gratified to see our continued progress with taking an increased share of wallet via managed IT services. We are improving our internal competencies every day while we are broadening our external partnerships, bringing new capabilities to the Alaska market. Leveraging the strength of partners like Microsoft, we can bring world-class solutions to Alaskan businesses, and we see these partnerships as very beneficial to us.

With that, let me hand the call to Laurie. Laurie?

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Laurie M. Butcher, Alaska Communications Systems Group, Inc. - SVP of Finance [4]

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Thank you, Anand. Turning to Slide 8, let me start with our performance report for the quarter. Total revenue increased 0.7% on a year-over-year basis, reflecting total broadband growth of 11.1%, offset by lower equipment sales. Business and wholesale representing approximately 61% of our total revenue grew 2.9%, with business and wholesale broadband growing 12.9%. Our business and wholesale growth for the quarter was impacted by the timing of nonrecurring revenue items, which always have a certain variability.

Consumer revenue, representing approximately 16% of our total revenues, declined 2.1%. However, consumer broadband grew 4.5%. And on a sequential basis, consumer revenues were essentially flat, now representing 2 consecutive quarters of our targeted relatively flat performance.

Regulatory revenues, representing approximately 23% of our total revenue, declined 2.9%. Adjusted EBITDA of $14.1 million increased 1.5% from the first quarter of 2016. Net capital spending was $5.1 million for the quarter, and adjusted free cash flow was $7.5 million.

Turning to Slide 9, and focusing on the balance sheet. We substantially completed our debt restructuring. In March, we entered a new $195 million senior credit facility with 2 tranches totaling $180 million and a revolver of $15 million, which extended our maturities out 5 to 6 years. Using proceeds and cash on hand, we repaid $86.8 million in existing debt, paid $6.5 million in debt-related expenses and placed $94 million in restricted cash designated for the repurchase or settlement at maturity of our 6.25% convertible notes due in 2018.

As a result, at March 31, we reported total debt of $268.6 million, which included $94 million of notes, and net debt of $171.3 million compared to $162.8 million at December 31, 2016. This increase in net debt is not due to us increasing the size of our overall borrowings, it reflects our lower cash balances. Rather than borrowing more and increasing our debt balances, we chose to use cash on the balance sheet to pay a portion of the existing principal and all of the related financing fees. Although this brings our near-term cash balances down, it was a purposeful choice that will result in lower interest payments over time.

In April, we took yet another step in simplifying our debt structure and successfully repurchased $84 million or 89.3% of the convertible notes in an open tender process. Today, $10 million still remains in our restricted cash for the settlement of the balance of these notes.

As we've previously mentioned, our board has also authorized a stock repurchase program for up to $10 million of the company's outstanding shares. Currently, we are in the process of establishing the implementation mechanics for the program, including setting up a trading plan for future purchases.

Turning to Slide 10. We are reaffirming guidance of total revenue between $229 million and $235 million, adjusted EBITDA between $59 million and $61 million and net capital spending between $35 million and $38 million. Although we continue to expect the timing of revenue and cash flow to fluctuate quarter-to-quarter, we are also providing 2017 full year guidance for adjusted free cash flow between $4 million and $7 million.

There are a couple of factors that contribute to our guidance relative to 2016 performance. First, we have a lower-than-expected capital spending in 2016, which we anticipate to come back to normal levels in 2017, and we expect to have additional interest expense in 2017 relative to the remaining outstanding balance of our convertible notes, which are scheduled to mature in May of 2018. Offsetting these increased expenses is the expected growth in adjusted EBITDA this year. We believe 2017 free cash flow performance will provide the baseline from which we expect to see annual increases.

In summary, we're confident about our annual performance for 2017 and look forward to reporting our future progress.

With that, let me hand the call back to Anand. Anand?

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [5]

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Thank you, Laurie. Let me wrap up by reiterating our 3 drivers of value creation. Performing to our business plan and driving top and bottom line growth remains central to our thesis. We have a strong commitment to allocating capital in a manner that maximizes long-term shareholder value. And lastly, we'll continue to look at strategic actions that enables scale and geographic diversification. I look forward to (inaudible) progress on all fronts in the future.

With that, let me open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll hear first from Barry Sine with Drexel Hamilton.

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Barry Michael Sine, Drexel Hamilton, LLC, Research Division - MD of Equity Research [2]

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Laurie, start with you, I think if I heard you correctly, I was trying to jot everything down, you talked about some nonrecurring items in business and wholesale. Could you go through what those were and what impact they had on the growth rate?

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Laurie M. Butcher, Alaska Communications Systems Group, Inc. - SVP of Finance [3]

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Sure. Thanks for the question, Barry. Actually, if you look in our earnings release, it's kind of a good visual of what I was talking about. Our business and wholesale categories by line item have categories of equipment and installation and our MIT services, which are often onetime projects. Those 2 line items for us this quarter were relatively low. So on a quarter-over-quarter basis, of course, you know we don't provide guidance by line item or by quarter, but those types of nonrecurring services can be very cyclical or variable in nature. So it just happened to be a low equipment quarter.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [4]

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Yes. Barry, this is Anand. If I can just provide a little more color. I mean, I think if you look at the underlying performance of business and wholesale, we had 12.9% in broadband growth, which is the core recurring revenue that we track, and that was just absolutely rock solid growth. And effectively, it was these onetime equipment sales, professional services and installation kind of work that varies on a quarterly basis. So again, while we are not looking at any quarterly or line item guidance, we remain very comfortable with our longer-term directional view of business and wholesale continuing to grow at or above 8% CAGR. And certainly, we are also very comfortable with the overall revenue guidance for the year. So it's -- I hope that gives you a little bit of color.

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Barry Michael Sine, Drexel Hamilton, LLC, Research Division - MD of Equity Research [5]

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That's very helpful. So, Laurie, while you were speaking, I was running my numbers on my calculator. If I did the math right, if I take those 2 line items out, the rational line items collectively grew about 6.4%. That's still a little below the 8% you guys aspire to. Anything else -- and I guess where I'm going to is, obviously, you guys are facing a bit of a headwind from an economic standpoint in the state.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [6]

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Yes. Barry, again, I really don't want to set any expectations on a quarter-over-quarter kind of basis. I think I'll reiterate that we remain very comfortable with our longer-term directional view of 8% or higher for business and wholesale. I think that remains a very achievable goal for us as we drive performance. And particular, relative to your comment in -- with respect to the economy, I think I stand by what we've said. I mean, this is now our third year of relatively low oil prices, and we've continued to demonstrate growth. And now particularly with the opening up of some of the Northwest Alaska markets to the Quintillion partnership and assets, we have -- we will slowly start seeing growth from those markets that were not previously available to us as well. So again, in terms of both opportunity and outlook, I think we remain comfortable with some of the previous targets we've set for ourselves.

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Barry Michael Sine, Drexel Hamilton, LLC, Research Division - MD of Equity Research [7]

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Okay. And then on consumer. You had a modest decline but still a revenue decline in consumer. And I know in the past, you guys have talked more aspirationally about getting that segment stabilized, and you have appointed a business unit manager to take responsibility for that. Could you talk about what you did in the quarter and if that's still a realistic aspiration to get that consumer revenue stabilized?

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [8]

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Yes. Barry, very good question. In fact, as I think Laurie noted in her prepared remarks, you're right, while there was a very modest decline year-over-year for the quarter, but if you actually look sequentially, Q4 performance and Q1 performance really had been relatively flat on a sequential basis. And we certainly, as we've said before, go to market in a very targeted way really in the 95,000 locations where we have 10 megabits or higher speed. And our penetration in those -- in these network locations is still in the 25% range. So when you look at our number of connections that are at 10 megabits and higher, our penetration in our capable network is still only about 25%. So we continue to see our performance there on a very targeted basis. And I believe last quarter, I made some remarks about some of the work that we've done on military bases in terms of a -- essentially, an industrial-grade WiFi solution providing consumer enable -- consumer solutions, and we see that as an attractive operating model to further our performance in consumers. So consumer, yes, I think the goal of keeping revenue flat and stabilizing is something that we continue to target. It's a lot of hard work that goes in that, but that's our target. But I also want to emphasize that on consumer, something that's equally important to us is our operating model and how we continue to take costs out of that business. I've always said that when I look at the volume of work, which drives costs, it's disproportionate to the revenue that consumer contributes to our top line. And we have to address that disproportionate spread of costs, and that's the goal that we have. And whether it is online capabilities, whether it is these WiFi-enabled buildings or other changes, there's a lot of focus, almost an equal amount of focus on managing costs as there is on stabilizing top line. Both of those are important to us.

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Barry Michael Sine, Drexel Hamilton, LLC, Research Division - MD of Equity Research [9]

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Okay. And then my last question, kind of continuing on the same theme. Via the Connect America Fund, you've agreed to take funds that will increase that addressable broadband market. Could you give us an update on that? Have you decided on a network architecture? Have you started build? Have we seen any homes come into service? And what's the updated outlook for that Connect America Fund? I think that's in the Kenai Peninsula, if I'm not mistaken.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [10]

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Yes. I'll start, and then I'll also let Leonard provide a little bit more color. You are correct, Barry, our commitment over the next decade is about 30,000 locations, of which about 26,000 are unserved locations that will be added with the 10 megabits or higher capability. And clearly, by definition, these are unserved locations, so it's really now a question of what is the penetration that we can achieve, which would be a function of the demographic and the affordability in some of these areas. And the vast majority of these locations are in the -- a combination of the outskirts of Fairbanks and Kenai. And I'll let Leonard give you a quick update on where we are in our plans.

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Leonard A. Steinberg, Alaska Communications Systems Group, Inc. - SVP of Legal, Regulatory & Government Affairs and Corporate Secretary [11]

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Sure. Thank you, Anand. We have a team of planners and engineers working on this project now. We have an obligation to provide the Federal Communications Commission with a list of all the locations that we intend to serve by October of 2018. So as you can see, that's a little ways out. And we actually believe we'll take a substantial portion of that time to complete that process. There's a tremendous amount of work to be done to just make sure we've got this planned and engineered properly. We are looking at a variety of technologies, and I would expect that we will probably implement with multiple technologies to meet our obligations. And we'll have more to report on that as we go forward.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [12]

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Yes. And the only, I think, comment I would make in this regard is we certainly are taking a very hard look at fixed wireless as a solution for last mile. We are testing it. We have a couple of pilots underway. And we can -- we believe we can -- we may be actually able to deliver some greater speeds and -- while we manage our deployment process using these. And, Barry, really, if you look at these 26,000-odd locations, I think the assumption we are making over the next decade as these locations get turned up is approximately a potential 50% take rate. So if you think about that assumption that we have put forward and you look at the ARPU, that kind of gives you a sense of how revenue will ramp. Now it takes time, obviously, but that gives you a sense of how revenue may ramp through the CAF locations over the next several years relative to consumer.

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Operator [13]

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(Operator Instructions) And next, we'll move on to a question from [Blaine Marder] with [Lighthouse Capital Markets].

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Unidentified Analyst, [14]

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So recently, you saw the announcement that your largest competitor in Alaska is being acquired, and I'm wondering if you could give us a sense of what, if anything, that can mean for the competitive environment. And then I'll just follow up with a couple more.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [15]

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Sure. Great question, [Blaine]. Thank you. Obviously, as you would expect, we are following that transaction closely. But I'll just say that our focus on business and wholesale and our growth opportunity there, our entire focus is really on how best we add value to our customers. I think over the last several years, we've demonstrated that our value proposition resonates in the market. We have a differentiated network. We provide superior customer service. And our IT partnerships are a clear advantage in the marketplace. And frankly, I see these 3 things continuing to set us apart even as our competitor works their way through their transaction. So we'll continue to play to our strength, and I believe that we'll continue to win in the market.

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Unidentified Analyst, [16]

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Okay. And the multiple that those guys received was sort of shockingly high, and also the 8x or 9x EBITDA multiple, while our company sits here below 5x. And so I'm wondering if your Board of Directors has commented on this. Is the Board of Directors willing to sort of step up and actually explore your strategic alternatives so we can maybe get -- I mean, we don't even need an 8x or a 9x but a 6x or a 7x multiple for our company.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [17]

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[Blaine], again, good question. Look, I have said in the past, and I'll continue to say, that where our equity trades, I believe, undervalues the operating performance of the company. And I've said that fairly openly. And now clearly, our addressing some of the debt maturity issues, I think, has removed at least some part of the overhang that may have existed on the company before. In terms of strategic actions and opportunities, again, I think I've been fairly open in my prepared remarks that we are looking for the right kind of opportunities that will allow us to develop scale and diversification. So I think we, as a board and management team, particularly with the wireless transactions, I think we've demonstrated that, a, we can do large and creative transactions, and we are open to that. And when the right kind of opportunities present themselves, we'll take a hard look at it.

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Unidentified Analyst, [18]

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Okay, I'll look forward to that. And finally, just Laurie, on the balance sheet, it looks like the working capital was a $6 million use this quarter. Is that going to sort of bleed down over the next couple of quarters to your benefit?

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Laurie M. Butcher, Alaska Communications Systems Group, Inc. - SVP of Finance [19]

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I believe it will. Again, the use -- the uses of cash through working capital can be very cyclical by nature. So we -- of course, that's one of the reasons that we don't give guidance on operating cash flow, but we should see some benefits of that coming in the future quarters.

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Operator [20]

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And at this time, we have no further callers in the queue. I would like to turn the call back over to Anand Vadapalli for any additional or closing remarks.

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Anand Vadapalli, Alaska Communications Systems Group, Inc. - CEO, President and Director [21]

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Thank you. I'd just like to note that I'll be traveling to meet investors mostly to the East Coast the week of May 15. So if there are any shareholders who would like to schedule a meeting, please do reach out to Tiffany Smith and Investor Relations and we'll do our best to get it calendared. Thanks for joining us today, and I look forward to our next quarter call.

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Operator [22]

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Thank you. That does conclude today's call. We do thank you all for your participation. You may now disconnect.