Alaska Communications Systems Group, Inc.
Q4 2017 Earnings Call Transcript

Published: 19 Mar 2018

[Operator:]

Good day and welcome to Alaska Communications Systems’ Fourth Quarter and Year-End 2017 Conference. At this time, this call is being recorded. I would now like to turn the call over to Ms. Tiffany Smith, Manager Investor Relations. Please go ahead.

[Tiffany Smith:]

Welcome to the Alaska Communications fourth quarter and year-end 2017 earnings 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 will 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 can go to our investor website www.alsk.com, click on the Events section and go to the fourth quarter 2017 earnings call event and click on the PDF version of the presentation. We will indicate which slide we are discussing so you can follow 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 to 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. As was noted in our earnings call release, we will not be conducting a live Q&A at the end of the call. Instead, we will response to question, which had previously been submitted. With that, I would like to turn the call over to Anand. Anand.

[Anand Vadapalli:]

Thank you, Tiffany. Good day and thank you for joining us. Starting with Slide 5, let me begin by covering some financial performance highlights for the year. Total annual revenues were $226.9 million slightly lower than our guidance and flat year-over-year. Business and wholesale revenues grew 1.7% for the year with strength in our carrier and federal vertical driven by wireless carrier backhaul and federal end-user opportunities. We expect this vertical to be a strong performer in the upcoming years as well. The one soft spot in our performance in 2017 was a healthcare vertical impacted by the funding uncertainties related to the SEC’s rural healthcare program. As we have previously noted, the program funding level has remain constant for 20 years and it remain subject to regulations that are equally dated. Demand has grown in the last few years as held the technology modernize that’s used to deliver these critical services. At a tactical level, we have taken several steps to adapt to the program constraints. Our Q4 revenue declines are primarily the cumulative effective price compression we have seen for the most recent funding year impacting the back half of this year. In addition to impact on revenue or adjusted EBITDA performance for the year includes a $2.6 million bad debt expense related to customers covered by the same program and as of December 31, 2017, we had about $8.6 million in accounts receivable type of this program. All that said to maintain context, the rural healthcare business is about 9% of our total revenues. While these impacts were not anticipated for 2017, we believe, we are much better prepared going into 2018. Further, healthcare is one vertical out of several in the larger enterprise and carrier business with many other verticals firing on all cylinders. Adjusted EBITDA for the year was $56.7 million and within the guidance range we have provided. More importantly as Laurie will begin in our financial review, we have made some significant progress and reducing our SG&A expenses during the year and further expense reduction actions have been taken going into 2018. Our commitment to margin improvement and free cash flow generation remain strong. Capital spending was a $32.9 million of which 59% was success based. This is also within the guidance we have provided for the year. Lastly, I’m pleased to note that with our commitment to type management of operating and CapEx expenditures, we generated $8.1 million in free cash flow, which was above our guidance for the year. Over the next few slides, I will cover key elements of our business that will drive performance not just in 2018, which will gives ahead. Turning to Slide 6. Our network capabilities have been and will continue to be a market differentiator and the foundation of our performance. We have previously discussed our long-haul fiber optic network at link. This includes two or four submarine fiber optics systems connecting Alaska to the low-48 and a redundant in state long-haul network connecting the major population centers. Over the last few years, our success this capital program has continued to strengthen our metro or access network. Today, we have over 800 lit buildings and fiber to cell sites of major carriers. Continued fiber densification remains underway through our capital program and this will benefit the investments we make in our fixed wireless and fiber fed WiFi programs directed towards our mass market customers. In April 2015, we partnered with Quintillion to expand our fiber optic network by acquiring certain network assets from Conoco Phillips in the North Slope oil producing areas. Since then Quintillion has invested in a submarine network with landing stations in several northwest Alaska Communities and a terrestrial extension that connects to North Slope to Fairbanks. The submarine network became operational in late 2017 with five Arctic market recently turned up. We now have opportunity in markets previously unavailable to us. Our focus in these communities is in the areas of education, healthcare, public safety, commercial office of native corporations and federal opportunities. As I have noted on previous calls. We successfully completed the trials of fixed wireless technology in our network and expect to use it extensively and meeting our CAF II obligations. We also see applications in more urban markets giving us a competitive network for consumer and small business customers. Additionally, we are selectively adopting a fiber fed WiFi model to serve mutli-dwelling units. We have very successfully piloted this approach in a few buildings on military basis. Combined with an innovative online customer interaction model, we have seen very positive market reception and we are able to serve this opportunity in an extremely cost sufficient manner. Lastly, in 2017 we acquired C-Band transponder space on Eutelsat 115 WB satellite which we deploy into production used in Q4 2017. In 2018, we intend to expand the utilization of this satellite network serving new customers and also migrating existing customers to this more cost efficient solution compared to our current approach of buying third-party capacity on a circuit-by-circuit basis. Turning to Slide 7. As I have noted consistently, the demand drivers for our core product broadband are strong. Applications like streaming video, gaming, augmented and virtual reality, cloud migration and the migration of data centers closers to the edge of the network. These are all trends that are driving the demand for our core business. With this backdrop, given the market dynamics in Alaska and our relative share. Our opportunities for growth and enhancing shareholder value comes from three sources. Growing the market, taking share and seeking an increasing share of wallet from our customers. The enterprise and carrier business will remain and important driver of our growth. We approach our customers in a strategic manner. We try not to be everything to everyone. We are price competitive, but do not seek to be the lowest cost provider in the market. Our differentiation comes from technology leadership and a customer service orientation to developing comprehensive and innovation solutions for our largest customers. Our mass market business serve small business and consumer customers where there are several similarities in product needs and how we serve these segments. There is much greater price sensitivity, but value matters in the form of reliability and convenience. This is reflected in the need for an always on, always available service model. This where our investments in IT systems coming to play. Creating an experience our customers want and creating a scalable and higher margin operating model for us. On to Slide 8. I strongly reaffirm the market opportunity ahead of us. Our focused approach to this opportunity and our confidence in our ability to be one of the few growth oriented companies in our sector. Our carriers and federal team is one of the best in the business. We have built superb relationships with national carriers and several federal agencies both civilian and military. We have an equally superb record of past performance and technology differentiation, both of which are extremely important in this sector. Driven by wireless backhaul and federal end-user opportunities, we expect to see this vertical as an important driver of our growth. We see strengths in other verticals as well. The energy sector continues its investments these investments in Alaska and since are North Slope fiber acquisition three years ago, we have continued to build a roster of business in this sector and expect to grow this vertical further. With the access to five new Arctic communities, we already have several contracted opportunities that are reflecting new customer relationships and expect to generate performance from these markets over the next several years. We are factoring in to the best of our ability, the continued uncertainty in the healthcare vertical. That said, we note the technology enabled healthcare delivery for the more communities in Alaska, it’s not a choice, but in a necessity. We remain strong advocates for modernizing and increasing funding for the Rural Health Care Program. On the mass market side, our CAF II program will start picking up steam by the end of this year. This program will enable broadband to about 30,000 locations over the next seven to eight years. We expect to have enabled about 9,000 locations by the end of 2018 and completing the engineering design for the full program by October of 2018. By extending the same technology of fixed wireless into non-CAF II areas and adding on fiber fed WiFi for multi-dwelling units. We are now able to offer very competitive 100 megabits per second plus capability on a broader basis. Combined with an increasingly online model of customer operations, we see this offering accretive growth opportunities over the next several years. With this, let me hand the call to Laurie. Laurie.

[Laurie Butcher:]

Thank you, Anand. Turning to Slide 10, let me start with our performance reviews for the quarter and year ended December 31, 2017 compared to the same periods in 2016. For the fourth quarter, total revenues were $54.9 million, down 4.9% compared to $57.8 million in the prior year quarter. Full year 2017, total revenues were flat year-over-year at $226.9 million, which was slightly below guidance. Providing greater detail, business and wholesale revenue for the quarter was $33.1 million, decreasing $2.3 million or 6.5% compared to the fourth quarter of 2016. Contributing to that decline was a decrease in business broadband revenue, which was impacted by price compression in the Rural Health Care Program. Annually, business in wholesale revenue represented 61.3% of our total revenues at $139.1 million, it increased 1.7% year-over-year. This reflects business and wholesale broadband growth of 7.5% or $6.8 million. This increase was driven by wireless carrier backhaul and strong federal end-user demand moderated by lower than expected growth from our healthcare vertical and lower one-time equipment sales. Consumer revenue was $9.2 million for the quarter, down 1.5% compared to the fourth quarter of 2016. Consumer broadband was $6.2 million, down 1.9% compared to the same quarter of 2016. For 2017, consumer revenue represented 16.4% of our total revenues and at $37.1 million it declined 1.7% compared to the prior year. However, consumer broadband revenue for the year grew 1.8%, reflecting ARPU increases that were partially offset by year-over-year connection decline. Regularly revenue was 3.1% for the quarter and the year compared to the same periods in 2016. It was $12.6 million for the quarter and $50.7 million for the year. Regulatory revenues, which represented 22.3% of our total revenues for the year, consisted of $19.7 million in high cost support, 19.5% million in surcharges, which includes $6.6 million in pass-through funding and $11.5 million in COLR and Access charges. Turning to Slide 11, adjusted EBITDA was $14.9 million for the fourth quarter and $56.7 million for the year compared to $16.4 million and $58.2 million in the respective prior year periods. With pressure on our revenues we have actively managed cost during the year, resulting in G&A being down 4.2% driven by reductions in labor cost. We have taken further cost reduction action late in Q4 and have negotiate a six year collective bargaining agreement giving us labor cost certainty for the next few years. For the fourth quarter and full year 2017 respectively, capital spending was $8.9 million and $32.9 million, 59% of total capital spend was success based with an average IRR of about 26%. In 2018, our planned growth capital includes network expansion, wireless backhaul investments and network initiatives in fiber fed WiFi and fixed wireless to offer competitive broadband feeds for the mass market customers and fulfilling our obligations under the CAF program. Adjusted free cash flow was positive $2.2 million for the quarter and 8.1 million for the year, ahead of guidance. Turning to Page 12 at December 31, 2017, gross debt was $191.5 million and net debt was $177.2 million, compared to $184.1 million and $162.8 million respectively at December 31, 2016. Cash with $16.2 million at December 31, 2017 compared to $23.1 million at December 31, 2016. Going into 2018, we continue to focus our intention on optimizing capital allocation and cost management. While pursuing opportunities to grow specific verticals in our enterprising and carrier business. We are targeting stable performance across all of our key financial metric and expect to provide 2018 guidance by the time we report our first quarter results. With that, let me hand the call back to Anand. Anand.

[Anand Vadapalli:]

Thank you, Laurie. This call thus far has focused on operational performance and outlook for our business. That is appropriate. At the end of the day a quality business that does well in the market gains customers and retains talent is the foundation for value creation. However, we fully acknowledge the need to move forward on a parallel path to consider all opportunities for value creation. In this context, I want to acknowledge the dialogue and feedback we have ongoing with several of our shareholders including the public discourse you may have seen and read in this regard. I want to state that we welcome and value the perspective of all our shareholders. Our interest are fully aligned. We’re committed to evaluating all alternatives to maximizing shareholder value. Our Board and management team are singularly focus on driving value for all our shareholders. As a core piece of our ongoing shareholder engagement, we have proactively engaged in dialogue with many of our shareholders as we develop our compensation program design for 2018 and beyond. We value shareholder feedback in this regard and we are confident our investors will note in our upcoming proxy statement, the significant and constructive changes to our compensation program. We also had feedback regarding the Section 382 Tax Benefits Preservation Plan we adopted in January of 2018. As you will note from our 10-K, we had approximately $78 million of net operating loss carry forwards that could potentially be used in certain circumstances to offset our future taxable income and reduce our federal income tax liability. This is valuable asset and an important value block. The recent attention from an activist perspective, dramatically increase the risks of materially limiting the availability of these net operating losses under Section 382 provisions of the Internal Revenue Code. The Board, with the input of its independent legal, tax and financial advisors carefully evaluated the risks and potential value disruption for this valuable asset of the Company. And as a result, adopted this Tax Benefits Preservation Plan to preserve this asset for the benefit of all shareholders. I want also note as this is very important, our Board has always welcomed new thinking and new perspectives that we believe could add to shareholder value creation and remains committed to doing so. As evidence of that, we added a new Board member last year upon the recommendation of one of our largest shareholders. While, we regret recently losing that director, who design for personal reasons and relate to an issues of the Company. We remain open to adding new appropriately qualified directors to our Board, who have complementary and relevant industry expertise that would compliment strength of our current Board and our focused on creating value for our shareholders. In summary, our Board is committed to pursuing all actions to create most value for our shareholders and the Board has focused the management team on successful running, a growing business. We want our Board to continuously assess, what is in the best interest of shareholders and what is the best path to ultimately create value for our shareholders. In that regard, our Board composed of all independent members other than myself is committed to reviewing a broad range of opportunities to enhance shareholder value through strategic, financial and/or operational measures. I look forward to reporting progress on all fronts over the upcoming months and quarters. With this, let me turn the call back over to Tiffany for pre-submitted questions.

[Tiffany Smith:]

Thank you. Our first question is for Anand. You recently sold a significant number of shares, should this be of concern for the shareholders?

[Anand Vadapalli:]

Thanks for the question. No. This should not be of any concern for our shareholders. I would like to say that the recent stock sale, which represented less than 10% of my holding was the first sale of stock I have had since joining the Company in 2006 nearly 12 years ago. And was a result of a program 10b5-1 trading plan, which was put into place in August 2017 as normal financial plan. That trading program is now complete.

[Tiffany Smith:]

Thank you. Our next question. When will you be executing your share repurchase program and if there are any plan to reinstitute a quarterly dividend possibly in the 2% to 4% yearly range to encourage greater institutional investments?

[Laurie Butcher:]

Thank you for the question. At December 31, 2017, we were in compliance with all of our debt covenants. However, we were not in a position to issue dividend or repurchase stock until we have excess cash flow defined in our debt agreement. More specifically, our ability to execute on the share repurchase program is based on the publication of positive excess free cash flow in our 10-K. For the year ended 2017, that calculation was negative. We remain committed to executing to the Board authorized share buyback programs and more broadly maximizing value for our shareholder and we look forward to reporting further in this regard.

[Tiffany Smith:]

These were the only questions submitted in advance. We thank for your attention and look forward to reporting our progress our future calls.

[Anand Vadapalli:]

Thank you.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today’s conference. We appreciate your appreciate your participation and you may now disconnect.