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Edited Transcript of ALSK earnings conference call or presentation 7-Mar-19 7:00pm GMT

Q4 2018 Alaska Communications Systems Group Inc Earnings Call

Anchorage Mar 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Alaska Communications Systems Group Inc earnings conference call or presentation Thursday, March 7, 2019 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. - President, CEO & Director

* Laurie M. Butcher

Alaska Communications Systems Group, Inc. - SVP of Finance

* Tiffany Smith

Alaska Communications Systems Group, Inc. - Manager of Board & IR

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Presentation

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Operator [1]

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Good day, and welcome to the Alaska Communications Systems Fourth Quarter Year-End 2018 Earnings Call. Today's conference is being recorded.

At this time, I would like to attend the conference over to Ms. Tiffany Smith, Manager Investor Relations. Go ahead.

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Tiffany Smith, Alaska Communications Systems Group, Inc. - Manager of Board & IR [2]

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Thank you, and welcome to the Alaska Communications Fourth Quarter and Full Year 2018 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 displayed on your screen. For others, you will find it on our investor website, www.alsk.com.

Now, 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. You are cautioned not to put undue reliance on forward-looking statements as actual results could differ materially 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. These reconciliations are in the appendix to our presentation. 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. - President, CEO & Director [3]

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Thank you, Tiffany. Good day, and thank you for joining us.

Starting with Slide 5. We have 2 levers for shareholder value creation, and we are fully exercising both options. First, our operating business is well positioned to create value, reflecting the strengths of our business performance.

Our results for 2018 are robust. Our business outlook for 2019 and beyond is solid, and we have a terrific balance sheet that provides the capacity and run rate to perform to our business plan.

Second, unquestionably, our Board's top priority has been, is, and will continue to be its consideration of all alternatives to maximize shareholder value, whether it'd be strategic transactions, business combinations, accretive growth investments or creating returns for shareholders via dividends and/or share buybacks. The company's strong performance only strengthens the Board's hand in this regard.

Moving to Slide 6. I'm pleased to report solid operating results for 2018 at or above guidance on all categories. Total revenues of $232.5 million increased 2.5% for the year. Our performance in wholesale broadband and managed IT services led the way for a 3.9% increase in Business and Wholesale that underpins our revenue performance.

Continued attention to cost management is reflected in our adjusted EBITDA of $60.2 million for the year, an increase of 4.9%.

Lastly, adjusted free cash flow of $7.2 million was at the high end of our guidance range, reflecting strong EBITDA performance, while our capital expenditures of $38 million for the year position us well for future growth.

As I'll note in upcoming slides, we believe Alaska Communications is well ahead of its peers in its journey to drive performance and adjusted EBITDA expansion from our investments in fiber networks.

In Slide 7, I'll discuss the key drivers of 2018 performance, all of which will serve us well going forward.

As I've noted previously, we do not compete as a low-cost provider in the market. Rather, we compete on technology and service differentiation. Our work in 2018 lends further credence to this assertion. Enabling our C-Band transponder capacity allowed us to win one of our largest opportunities in 2018, with the Kuspuk School District.

Through the year, we turned up 15 satellite locations for the school district and other customers, also improving our profitability for satellite services as we get close to owners economics. Standing up software-defined networking, or SDN, capabilities using Juniper technology enabled 2 key wins in 2018 in oilfield services and the social services sectors on our SD-WAN solutions. We see this as an important differentiator for our Enterprise customers going forward.

Enabled by our partners' fiber deployment, we now have access to 6 new markets in Northwest Alaska, including the communities of Utqiagvik, Wainwright, Point Hope, Deadhorse, Nome and Kotzebue. We've deployed local fiber in Nome and Utqiagvik, allowing us to serve our Enterprise customers, while in other markets, we've enabled mass-market capabilities, working with the local carriers in these markets.

Driven by the demands of 5G wireless backhaul, we upgraded our optical transport network in 2018, and we expect to upgrade capacity on our NorthStar submarine system fiber in 2019.

Finally, we continue our journey of stabilizing the mass market Consumer business via our investments in fixed wireless assets and fiber-fed multi-dwelling unit.

At the end of 2018, we passed about 6,000 locations using FWA and about 3,000 locations in MDUs, while fully meeting our CAF II obligations for the year. As I have previously noted, an equal emphasis in mass market is changing our operating model, increasingly moving to online customer service. Closing out 2018, we had approximately 80% of bills, 74% of orders and 50% of support incidents processed online. We are super focused on increasing that engagement model for our customers.

As we move to Slide 8, at our last earnings call, and in my investor presentations since, I've started a conversation to enable our shareholders to better understand the secular trends in our sector and how that plays out in both our revenue and EBITDA trends, and how we should consider return on capital invested.

Broadly, you will see that we have 2 buckets of revenues. First, legacy revenues tied to the legacy copper networks that declined, including Consumer business, wholesale voice and regulatory revenues. The decline in legacy copper-based revenues is a trend shared by all companies in our sector.

Second, growth revenues that are tied to our investments in our fiber network, including consumer, business, wholesale broadband, equipment sales and managed IT services.

As this slide notes, our growth revenues have consistently outpaced our legacy revenues, despite pressures from the Rural Healthcare, or RHC program in 2017 and 2018 that somewhat muted our growth up revenue performance in those years.

As you can see on this chart, the impact of RHC was approximately $5 million and $4 million respectively, in 2017 and 2018.

While we anticipate further reductions in our RHC in 2019, the rest of our Enterprise and Carrier business has really picked up steam. And we expect to be back on track in 2019 with growth revenue more in line with what we saw in prior years.

You will note that in 2019, we expect growth revenues to be at approximately 62% of our total revenues. In fact, considering that our CAF II revenues are stable through 2025, I would note that growth revenues and the stable CAF II revenues, collectively, are 71% of our total revenues expected in 2019.

Further, I'll note that the reduction in legacy revenues of between $7 million and $9 million in 2019 is largely driven by the effects of USF program restructuring, which is something we see rarely and not likely to recur in the next few years. Some of these reductions are tied to passthrough revenues that have no effect on our EBITDA and cash flow.

It is this trajectory of growth revenue and its increasing separation from the legacy revenue trend line that will create the basis for EBITDA expansion.

Moving to Slide 10. You'll see a visual representation of the impact of revenue trends on contribution margin and the returns on success capital. The key takeaway is that as we move forward into 2019 and beyond, we anticipate the strength in our growth revenues and contribution margins, thereof, to outpace the margin declines from legacy revenues.

Additionally, you will also note our attention to cost management and that focus continues going forward as well. This is how we see a clear path to EBITDA expansion.

Our growth revenues are fueled by success-capital investments we make in our fiber network. The contribution margin from these growth revenues is the return on our success capital. Returns were modest in 2017 and 2018, reflecting the impacts of RHC on growth revenues that I previously discussed.

As we swing back into our expected trajectory of fiber-based growth revenues in 2019 and beyond, the returns from success capital are very attractive.

Turning to Slide 12. I'll now share my thoughts on 2019 and beyond. First, our opportunity remains strong. We continue to assess our overall market opportunity at about $1.6 billion, split roughly half and half between telecom and IT services.

In the fourth quarter of 2018, we commissioned a third-party market study that provided additional insights. The study estimates our near net opportunity, that is the opportunity we have within one mile of our existing fiber network, at approximately $250 million, and estimates our market share within this opportunity at about 40%. Not only do we have further room to grow, this also supports our thesis that where we strategically deploy our capital, we improve our competitive position and gain market share.

This significant opportunity over the next several years is the provision of 5G wireless backhaul for a national carrier. As Laurie will note in her prepared remarks, this opportunity is the reason for creating additional capacity under the delayed draw term-loan facility, providing us balance-sheet capacity to invest behind our growth.

Additionally, we have a set of opportunities with the federal government that we are working through a national carrier partner. These opportunities significantly strengthen our long-haul fiber network. We started this work several years ago and our latest phase is currently underway in Oregon. We remain in discussions about additional phases, all of which are completely prefunded investments.

We see strength in our oil and gas opportunities, leveraging our relationship with ConocoPhillips as well as investments in technologies like SD-WAN.

State and local governments and education, targeting selected school districts, will all provide growth for us in 2019 and into the years beyond.

Finally, the work we've done on our balance sheet provides us the investment capacity and the runway we need to fund our business-plan growth and performance.

With that, let me now turn the call over to Laurie, who will review our financial performance. 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 14, let me start with our revenue performance for the fourth quarter and full year. We had a very strong fourth quarter and ended the year on a high note.

Total revenue increased 6.8% in the quarter and 2.5% for the year. Business and Wholesale, representing approximately 63% of total annual revenue, grew 11.8% in the quarter and 3.9% for the year.

Business and Wholesale broadband increased 13.2% for the quarter and 1.7% for the year. Consumer revenue, representing approximately 16% of our total annual revenues, was flat for the quarter and increased 0.5% for the full year. Consumer broadband grew 2.8% both for the quarter and the full year, while voice declined 5.9% in the quarter and 4.4% for the year.

Regulatory revenue, representing approximately 21% of our total annual revenue, declined 1.1% for the quarter and was flat for the year.

It is a testament to our strong Enterprise and Carrier performance that we continue to show growth in our Business and Wholesale market. Our Business and Wholesale revenue growth of 3.9% was tempered by a $3.8 million decline in Rural Healthcare revenue in 2018.

As Anand mentioned in his prepared remarks, the company has experienced pressure from the Rural Healthcare program over the last 2 years, this uncertainty around both the approval of rates and the timing of funding.

I'd like to note that in the fourth quarter of 2018, the SEC notified Alaska Communications that it had approved the funding year 2018 cost-based Rural rates. And as of December 31, 2018, the USAC has issued funding commitment letters for the majority of our Rural Healthcare customers. With both 2017 and now the 2018 rates approved, we have more certainty around this revenue stream and the receipt of cash in a timely manner as we enter 2019.

Turning to Slide 15, as a result of our strong financial performance, I'm pleased to report that we met or exceeded all of our 2018 guidance.

Total revenue of $232.5 million and adjusted EBITDA of $60.2 million, both exceeded guidance.

Net capital spending was within guidance at $38 million, and adjusted free cash flow was at the higher end of guidance at $7.2 million.

If you'll recall, on our last earnings call, we increased our capital guidance to approximately $3 million to accommodate customer demand. This increase was due to the kickoff of a significant project spanning the next several years, providing 5G wireless backhaul for a national carrier.

In 2018, we deployed about $2.5 million of capital towards this opportunity and expect to deploy, at a minimum, between $7 million and $8 million in 2019.

This project will result in a significant fiber addition to our network, with excess capacity that we will be able to leverage over many years. This is really a case of the first car over the bridge, substantially underwriting the investment and allowing us future growth opportunities. We're very excited about it.

Also positively impacting free cash flow in 2018 is, the latest phase of the long-haul fiber project with the federal government that we're working through in national carrier partner. We started this work several years ago, and our latest phase is currently underway in Oregon. The financial construct of this project is perfect for us, as unlike more typical customer bills, the capital is entirely prefunded by the customer.

In 2019, due to the new tax reform rules, we will also see a $5 million refund of AMT tax credits accumulated in prior years. At December 31, 2018, the company had approximately $10 million of these AMT credits, which are scheduled to be refunded over the next few years, positively impacting our cash flows.

Looking at our balance sheet, we ended 2018 with total cash of $15 million, compared to a balance at December 31, 2017, of $16.2 million. We ended 2018 total debt of $170.3 million and net debt of $161.2 million compared to $186 million and $177.2 million, respectively, at December 31, 2017.

Turning to Slide 16. I'm very pleased to say that in January of 2019, in the midst of a volatile market, we were able to refinance our balance sheet with more favorable terms, creating even greater stability and certainty. Both the timing and the terms of this transaction underscore the confidence our lenders have in the strength of our management and our ability to perform to our business plan.

In the agreement, we established a single-term loan of $180 million with a reduced interest rate of LIBOR plus 450, which replaced both the A1 and A2 tranches of our prior instruments, previously at LIBOR plus 500 and LIBOR plus 700 and extended the term as alone by 2 years to 2024.

We were able to increase our revolving credit facility by $5 million to $20 million, while reducing the interest rate to LIBOR plus 450.

One of the key additions to our new credit agreement was the addition of a delayed draw term loan of $25 million, also at LIBOR plus 450 when drawn. This instrument is available for us for 24 months, and is to be used specifically for success-based capital projects, giving us flexible capacity for growth that's currently in our pipeline and will grow revenue in years to come.

Additionally, we were able to reset amortization levels and delay payments by 2 quarters. The new credit agreement also reset key covenants and lightened the thresholds. We also created an initial specified distribution basket of $5 million, which, at the discretion of our Board, can be used for dividends or share buybacks.

At closing, on January 15, 2019, net debt available to the company was $225 million, of which we had $180 million drawn.

Turning to Slide 17, as we look forward to 2019, our guidance expectations include: total revenue between $230 million and $235 million; adjusted EBITDA between $60 million and $62 million; net capital spending of between $40 million and $42 million, inclusive of the 5G network build; and adjusted free cash flow between $10 million and $12 million, inclusive of the AMT credit. We look forward to reporting our progress to each of these guidance measures in future quarters.

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

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

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Thank you, Laurie. Turning to Slide 18. As we bring this call to a close, I'm hopeful that you will share in the conviction of the management team, the Board and, in fact, our lenders and the quality of our business plan and our ability to perform to such a plan. Let me take the opportunity to welcome Pete Aquino to our board.

Pete is a seasoned and highly respected leader in our sector, and currently serves as a CEO of INAP. His very recent board work with Lumos and FairPoint is very relevant to our business and Board priorities. I'm delighted Pete is joining our board, and he will strengthen our capabilities.

Wrapping up, let me repeat what I said at the beginning of this call. We've 2 levers for shareholder value creation and we are fully exercising both options. First, our operating business is well positioned to create value as we are poised to strengthen our business performance. Our operating results for 2018 are robust. Our business outlook for 2019 and beyond is solid, and we have a terrific balance sheet that provides the capacity and runway to perform to our business plan.

Second, unquestionably, our Board's top priority has been, is, and will continue to be its consideration of all alternatives to maximize shareholder value, whether it be strategic transaction, business combinations, accretive growth investments or creating returns for shareholders via dividends and/or share buybacks.

Our Board is well advised and regularly considers value-creation alternatives with the assistance of nationally recognized financial and legal advisors. The company's strong performance only strengthens the Board's hand in this regard. I look forward to providing updates on our progress on all fronts in the months and quarters ahead.

Thank you for joining us today. With that, let me open up the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) That concludes our question-and-answer session. I'd like to turn the conference back over to the company for additional or closing remarks.

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Tiffany Smith, Alaska Communications Systems Group, Inc. - Manager of Board & IR [2]

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Thank you all for joining us on the call today, and we welcome the opportunity to talk to our shareholders. If you are interested in meeting with us, whether by phone or in person on future roadshows, please reach out to myself, Tiffany Smith, in Investor Relations. Thank you, and good day.